NATIONAL FLOOD INSURANCE REFORM ACT

OF 1993-S. 1405

WEDNESDAY, SEPTEMBER 15, 1993

U.S. SENATE,

COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS,
SUBCOMMITTEE ON HOUSING AND URBAN AFFAIRS,

Washington, DC.

The committee met at 9:03 a.m., in room 538 of the Dirksen Senate Office Building, Senator John F. Kerry presiding.

OPENING STATEMENT OF SENATOR JOHN F. KERRY

Senator KERRY. The hearing will come to order.

At 9 o'clock, we test who the true believers are. I appreciate everybody putting up with the transition here, and apologize for the inconvenience. But I think you saw, yesterday, we would have had everybody just sitting around for a couple of hours, and I think this is a better way to proceed.

Why don't we just pick up right where we left off. We have Judy England-Joseph here representing GAO and Don Collins sitting in for James Lee Witt, so there'll be a few questions left, and then we'll proceed.

Do you have a statement that you want to make?

STATEMENT OF JUDY ENGLAND-JOSEPH, DIRECTOR OF HOUSING AND COMMUNITY DEVELOPMENT ISSUES, GAO Ms. ENGLAND-JOSEPH. Yes, sir, I do. I have a full statement I'd like to submit for the record, and just have some summary remarks. And I do only represent GAO. My title includes looking at the housing and community development issues.

Senator KERRY. Understood.

Ms. ENGLAND-JOSEPH. And the gentleman to my left is from FEMA, but his last name is Collins.

I'm pleased to be here today, Mr. Chairman, to discuss the preliminary results of our ongoing work of the National Flood Insurance Program, as you requested, as you consider S. 1405, the National Flood Insurance Reform Act of 1993.

This work was requested by the former Chairman of the subcommittee as well as the Chairman of the Senate Committee on Banking, Housing, and Urban Affairs, and by yourself.

As you know, NFIP is administered by FEMA, the Federal Emergency Insurance Administration.

The December 1992 nor'easter, the March 1993 storm in Florida, and the Midwest flooding this summer have almost flooded, certainly have almost drained the NFIP fund. This has raised con

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cerns by some Members of the Congress and the public about whether the NFIP, whose purposes include reducing Federal expenditures on disaster assistance, has sufficient financial resources to meet its current obligations and potential future payments resulting from flood damage claims made by property owners insured under the program.

Among other things, we were asked to review the actuarial soundness of the fund and the implication of eliminating its subsidized flood insurance rates, look at procedures used to set the program's flood insurance rates, and finally, the financial management problems addressed in FEMA's Office of Inspector General audits of the fund.

In summary, the NFIP fund is not nor is it required to be actuarially sound. This means that the NFIP fund may not have sufficient financial resources to meet future estimated losses. The fund is not actuarially sound primarily because Congress authorized insurance rates charged many policyholders to be subsidized without providing annual appropriations to fund the subsidy.

Modifying the fund to be actuarially sound by requiring subsidized property owners to pay actuarial rates may not minimize the Federal Government's overall expenditures on flood related disaster relief. The significant rate increase that would result from subsidized property owners if this change were made would likely lead some of them to cancel their flood insurance.

If policyholders with subsidized rates cancel their insurance policies, the Federal Government would likely face increased costs in the form of other Federal disaster relief assistance such as the FEMA's disaster assistance grants.

Whether the increased costs that would be incurred by other Federal disaster relief programs would be less than or more than the current subsidy cannot be estimated because the number of policyholders that would cancel their insurance is unknown.

Currently, 59 percent of the 2.5 million NFIP policyholders are charged actuarial rates based on actual risk exposures and risk-related features, such as the flood risk zone. However, for 41 percent of the policyholders in areas of high flood risk, FIA sets the subsidy rates based on the revenues needed to at least match the difference between NFIP's average historical loss year and the revenue expected from its policies with actuarial rates.

Subsidized policyholders currently pay greater premiums than policyholders paying actuarial rates, but average premiums would have to approximately triple to about $1,100 if FIA computed these rates on an actuarial basis.

If all 2.5 million policies had paid actuarial rates in fiscal year 1991, the fund would have received about $780 million more in premium income that year, or more than double the premium income actually collected.

While FEMA only estimated the dollar value of the subsidy for this one year, the fund would currently have a significant reserve if rates had never been subsidized and participation in the program had not been affected by higher rates.

Because of recent losses sustained by the fund, it may not have sufficient financial resources to meet future estimated losses, and

the FIA may have to exercise its borrowing authority to pay those claims.

However, FEMA's IG identified serious problems in the NFIP's financial management system including the fact that the NFIP fund balance on deposit in the U.S. Treasury is commingled with all other FEMA funds into one balance, and therefore FIA has not reconciled its records with reported U.S. Treasury funds for many

years.

FIA has not implemented the IG recommendation to establish a separate account, but it has acknowledged inaccuracies with the fund balance and is working to resolve those problems. Therefore, FIA's determination of when, and if, the fund needs to borrow may not be based on adequate data on the amount of funds on deposit with the U.S. Treasury. Because the financial condition of the fund has deteriorated, we believe that FIA should implement those recommendations to establish a separate fund.

We were also, Mr. Chairman, asked to look at lender compliance with the mandatory insurance purchase requirement, and also to address some issues dealing with mitigation. We are just beginning some of that work. We can speak to the work that we did in 1990 on compliance questions, and have some limited data as it relates to the nor'easter flood in New York and New Jersey.

But in conclusion, Mr. Chairman, our work does not contradict any of the things that I think you are proposing as a part of your bill. And in fact, I'd like to highlight a couple of things that we think are the most notable.

The one concern that we do have is that S. 1405, with increased compliance, could in fact increase the number of subsidized policyholders that would come into the program. If that were the case, they are riskier policyholders and therefore would create a greater risk to the fund, because if they are not paying actuarial rates. However, through compliance, if actuarial rate policyholders are brought into the fund, then in fact there would be no positive nor no negative effect on that fund.

The big problem, obviously, is those people who are not required to have flood insurance, those individuals who do no longer have mortgages and, in some cases, who have unregulated lenders. And I think the emphasis and priority that you're placing in S. 1405 on mitigation is one way of addressing that concern, and hopefully will help to prevent future losses.

Maps, issues dealing with erosion hazardous zones, all of those we think are a positive direction toward trying to improve the insurance program.

Senator KERRY. I really appreciate that testimony, and thank you for pointing out those last two issues.

On the final issue you mentioned, about the non-mortgage status, no Federal guarantee, you know, we've scratched our heads and that's the toughest one of all, I suppose. We obviously can't mandate that somebody have insurance if there's no mortgage and no Federal linkage, no nexus legally but perhaps we could do something about Federal assistance.

There was one amendment that was poised to come to the floor from Senator Brown of Colorado to the effect that we are not going to grant Federal assistance to people who haven't taken out flood

insurance or storm damage, and so you take your risk. And that's one way because there is a Federal giveaway there.

We don't have that in here right now. It's something that may come on as an amendment. I'm going to talk to Senator Brown and we'll follow up on it. But that's a possibility.

On your other issue of the increase in the number of participants, I mean, obviously that happens, but on the other hand, today, there's nothing between them and the disaster, and we're providing Federal assistance. So we're losing money without at least putting it into a risk pool where you're spreading that risk. I think when you look at the, while not strictly private sector actuarial basis, actuarials with respect to damage and potential payout, you're far better off having them participate in the fund, having a larger fund and having sufficient money to cover out. Ms. ENGLAND-JOSEPH. Yes, sir.

Senator KERRY. It stands to reason that if we're only marginally below the level today at the current rate of storm damage, if you have many more participants, historically you're not going to have that much more storm damage.

So I think we'd have, you know, barring that disaster, a much more fiscally sound structure. But I think your study is helpful, and we certainly appreciate it.

I might say, for the record, there's one aspect of your study— there is a factual question about the basis of the study with respect to your non-mortgage findings and the whole question of Fannie Mae and Freddie Mac and what is required or not required. How much of the pool is non-mortgage and outside of the Federal flood insurance structure?

We up here disagreed with the basis of your conclusion as to that. In point of fact, most of those homes are mortgage subjected to federally supported institutions and most of those that are just mortgage-broker supported are still subject to Fannie Mae, Freddie Mac standards, and so you actually have a very small pool, according to our information, that are outside of any regulatory capacity, because they don't really have a mortgage.

Ms. ENGLAND-JOSEPH. Are you referring to the information we provided on the nor'easter, the New York and New Jersey, where we identified 6 percent of the pool?

Senator KERRY. Correct. I think you identified 200 homes out of a sample of 200 or something?

Ms. ENGLAND-JOSEPH. That are required to have insurance?
Senator KERRY. Right.

Ms. ENGLAND-JOSEPH. Right. And a substantial portion who do not have mortgages?

Senator KERRY. Correct.

Ms. ENGLAND-JOSEPH. And what we identified, sir, were 29 or about 6 percent of the total were with unregulated lenders. We are looking, based on conversations with your staff, more deeply at that, but many of those are privately held mortgages in the sense that they are family members or friends.

Senator KERRY. I totally understand, and that's true of a number of northeast homes, but the majority of your homes exposed without flood insurance are actually in the Midwest in the floodplain of the rivers. So actually, you know, by taking that sample, you

don't wind up with a fair measure overall of the 11 million, only 2.4, 2.6 million of which are covered in that judgment.

Ms. ENGLAND-JOSEPH. Oh, yes, sir. And in no way did we intend, nor do I think we say in our statement that this is projectionable to the entire Nation at all.

Senator KERRY. OK. Fair enough. Good.

Let me, if I can just ask you, Mr. Collins, quickly, before turning to colleagues, I take it you would concur that there's a significant gap in compliance between what the current law requires and what Tending institutions have actually undertaken or provided, is that correct?

Mr. COLLINS. Yes, sir, I will.

I mean the fact that there now exist some 70 or 80 private corporations who are helping lenders review their mortgage portfolios to determine whether, when they closed, they should have bought the insurance, but didn't, and then force placing flood insurance which should have been provided at the closing attests to the lack of compliance.

We're gratified by the numbers of lenders who are using these facilities. We wish more would. And perhaps the mortgage review portfolio program that was in your previous bill, would be worth considering sir.

Senator KERRY. That's something I know you mentioned, or Mr. Witt yesterday mentioned that he wishes there were a stronger lender compliance component here.

Mr. COLLINS. Yes, we do.

Senator KERRY. Obviously, in the effort to get support and to really get broad-based consensus on this, there's a balance, and we've tried to balance by not being too heavy-handed in the regulatory approach.

And I think that the escrow requirement, coupled with the 5-year certificate, is a decent balance between sort of the effort to get a longer-term solution but not have an overly burdened administrative, heavy-handed requirement on banks, that already have an awful lot of regulatory requirement, to adhere to.

Mr. COLLINS. We firmly support the escrow requirement. In addition, the provision on loan originations by non-federally regulated lenders, where they're purchased by Freddie Mac or Fannie Mae, we think that too is a very strong measure of compliance.

Senator KERRY. Good. Well, I'm glad to hear that.

Mr. COLLINS. And the community review, sir, of the new maps and the information the community will give to residents about the flood risk, that's excellent.

Senator KERRY. New mapping plus the community rating component ought to be helpful, I think.

Mr. COLLINS. Yes, sir.

Senator KERRY. Senator Mack.

OPENING COMMENTS OF SENATOR CONNIE MACK

Senator MACK. Thank you, Mr. Chairman.

I was sitting here making notes, as you all were discussing this. I guess the reason that this issue has always been of such interest to me is because I entered the banking business in the mid-1960's when flood insurance was making its way through the Congress.