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GAO Looks at Flood Ins. 2.0, Suggests Improvements

The federal oversight group said Risk Rating 2.0 is an improvement, but it suggested a number of changes, including greater transparency on how rates are calculated.

WASHINGTON – The U.S. Government Accountability Office (GAO), sometimes called the “congressional watchdog,” completed a study of the National Flood Insurance Program’s (NFIP) recent update, Risk Rating 2.0. In the report, the GAO said the Federal Emergency Management Agency (FEMA), which oversees NFIP, has two conflicting goals that are often at odds with each other – providing flood insurance to Americans at a reasonable cost while making sure owners’ premiums cover the cost of the program.

GAO’s synopsis of findings, in its one-sentence introduction, is: “FEMA’s new rate-setting methodology improves actuarial soundness but highlights need for broader program reform.”

GAO said the “historical focus on affordability” pushed the flood program to borrow $36.5 billion from the Treasury – money that current premiums should also be paying back. Its primary recommended change to address the affordability vs, solvency dilemma is a “means-based assistance program that’s reflected in the federal budget.”

What GAO found

In October 2021, FEMA began implementing Risk Rating 2.0, a new methodology for setting premiums for flood insurance, which “substantially improves ratemaking by aligning premiums with the flood risk of individual properties.” However, policyholders also pay two other charges that are not risk-based. “Unless Congress authorizes FEMA to align these charges with a property’s risk, the total amounts paid by policyholders may not be actuarially justified, and some policyholders could be over- or underpaying,” GAO says.

In addition, GAO says Congress doesn’t have certain information it needs about the actuarial soundness of NFIP.

“By producing an annual actuarial report that includes these items, FEMA could improve understanding of Risk Rating 2.0 and facilitate congressional oversight of NFIP,” GAO’s report recommends.

GAO also found that the average flood insurance charges today fall short of what’s needed to make the program self-sustaining. In December 2022, the median annual premium was $689, but “this will need to increase to $1,288 to reach full risk.”

Annual caps vs. means-based premiums

GAO found problems with Risk Rating 2.0’s cap of 18% increases per year:

  1. The caps perpetuate an unfunded premium shortfall. GAO estimates it would take until 2037 for 95% of current policies to reach full-risk premiums, resulting in a $27 billion premium shortfall.
  2. The caps address affordability poorly. The discounts will gradually disappear as premiums transition to full risk.
  3. The caps keep NFIP premiums artificially low. GAO says this makes it harder for the private market to offer competing policies.

Instead, GAO recommends a system where lower-income households pay less for flood insurance “based on their ability to pay.”

GAO says this system would “make NFIP’s costs transparent and avoid undercutting the private market.” If this option isn’t considered, it’s likely that more lower-income households would eventually drop flood coverage altogether because they could no longer afford it.

It recommends that “Congress consider creating a means-based assistance program that’s reflected in the federal budget.”

Overall report recommendations

GAO recommended six matters for congressional consideration, including:

  • Authorize and require FEMA to replace two policyholder charges with risk-based premium charges
  • Replace discounted premiums with a means-based assistance program reflected in the federal budget
  • Address NFIP’s current debt by canceling it or modifying repayment terms and potential for future debt
  • Authorize and require FEMA to revise NFIP rules hindering the private market related to (1) continuous coverage and (2) partial refunds for midterm cancellations

GAO also made five recommendations to FEMA, including that it publish an annual report on NFIP’s actuarial soundness and fiscal outlook. It says the Department of Homeland Security agreed with the recommendations.

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