subsidy, did not set up the fund to be actuarially sound. At the same time, the Congress required rates on post-FIRM structures to be set at risk-related rates. As of 1993, rates for about 41 percent of the 2.5 million flood insurance policies are subsidized and average only about one-third of what the actuarial rate for those policies would be. The latest available information shows that 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 effected by higher rates.

In the 1980s, FIA developed a goal for NFIP to collect sufficient revenues each year to at least meet the expected losses of an average historical loss year based on experience under the program since 1978. Because the NFIP has not suffered any catastrophic loss years since 1978, the average historical loss year used by FIA involves less claims loss than the average expected per annum claims loss over the long run. Thus, premium income does not reflect collections necessary to build reserves for potential catastrophic years in the future.

Since fiscal year 1987, FIA's goal of basing premium income on the historical average loss year, which is estimated to be between $375 million to $400 million as of 1993, has allowed the fund to cover insurance claims as well as program and administrative expenses without borrowing from the U.S. Treasury. However, the fund may not be able to cover all claims and expenses in fiscal year 1993 which amounted to about $765 million by the beginning of September 1993, primarily due to the December 1992 nor'easter, the March 1993 flooding in western Florida, and the July 1993 Midwest flooding. Thus far, FIA officials expect about 5,000 to 10,000 claims amounting to between $50 million and $100 million from the July 1993 Midwest flooding. FIA does not yet know what impact Hurricane Emily will have on the flood insurance fund, but as of early September 1993, FIA projects that Emily will generate about 2,000 claims. According to FIA officials, as of August 1993, NFIP's obligations were about $35 million more than its assets. Whether, in fact, FIA will have to exercise its borrowing authority will depend on (1) the relative timing of payments on its current obligations and monthly premium receipts of about $55 million and (2) the amount of future insurance claims.

Modifying the fund to be actuarially sound by requiring owners of pre-FIRM structures to pay actuarial rates may not minimize the Federal Government's expenditures on flood-related disaster relief. If the subsidy on pre-FIRM structures were phased out, insurance rates would need to rise approximately threefold, implying an annual average premium of about $1,100 for these structures. Such a significant rate increase would likely lead some pre-FIRM property owners, although we do not know how many, to cancel their flood insurance. If owners of pre-FIRM structures, which suffer the greatest flood loss, cancelled their insurance policies, the Federal Government would likely face increased costs in the form of FEMA disaster assistance grants and SBA low-interest loans in future floods. Although the information is dated, Mr. Chairman, it is interesting to note that in the early 1980s, our analysis indicated that if NFIP doubled the then existing average premiums (both subsidized and actuarial) about 40 percent of the homeowners would cancel their policies.2

The effect on total Federal disaster assistance costs of phasing out subsidized rates cannot be estimated because the number of current NFIP policyholders that would cancel their policies is unknown. Thus, it is not possible to estimate if the increased costs of other Federal disaster relief programs would be less than, or more than, the current NFIP subsidy cost.

We noticed, Mr. Chairman, that S. 1405 contains provisions to study the NFIP's premium structure. It would set up an interagency task force, including representatives from FEMA; Departments of Housing and Urban Development, Veterans Affairs, and Agriculture; and SBA to, among other things, study the possibility of revising the rate structure to account for catastrophic events and to propose strategies to establish an actuarial-based premium structure to account for all insurable risks. Because of the complexities of the NFIP and the potential impact changes to this program have on other disaster assistance programs, we believe that the establishment of such a task force is a necessary step in proposing revisions and strategies to establish an actuarial-based premium structure.

2National Flood Insurance Program: Major Changes Needed if it is to Operate Without a Federal Subsidy, (GAO/RCED-83-53, Jan. 3, 1983).

ACTUARIAL AND SUBSIDIZED RATE SETTING

As I mentioned previously, Mr. Chairman, NFIP flood insurance premiums are either based on actuarial principles or are subsidized depending on when the structure was built. FIA's method for establishing actuarial rates for post-FIRM construction lying within the identified 100-year floodplain follows a hydrologic method based on studies performed by the U.S. Army Corps of Engineers and private engineering companies.3 These rates are based on available hydrologic data, flood insurance claims, simulations, as well as engineering and actuarial judgment. The basic elements needed to predict expected flood loss include probability estimates of the frequency with which floods of different severity will occur, and estimates of associated structural property damage incurred due to different types of floods. Actuarial rates are based on actual risk exposures and generally vary according to several risk-related features, such as the flood-risk zone, the height of the structure, and the amount of insurance purchased.

Subsidized rates are available only on the first $35,000 of insurance coverage for pre-FIRM properties with actuarially-based rates for any additional insurance coverage. They have never been set through an analysis of underlying flood risk on these properties. Instead they are set through a rule making and legislative process. In order to set rates on subsidized policies, FIA first determines the revenue needed to meet an average historical loss year based on its current policies in-force and its expected loss and nonloss-related costs. Next, FIA determines the revenue it will receive from policies with actuarially based rates. FIA then subtracts the expected revenue from actuarially based policies from the average historical loss year to determine the minimum premium income needed from policies with subsidized rates. FIA then computes the subsidized rate based on the minimum revenue needed and the number of subsidized policies. The proposed subsidized rate is published in the Federal Register for public comment and subsequently submitted for congressional approval as part of FIA's budget and authorization proceeding.

According to FIA documents, the average premium on an actuarial policy will be $247 in 1994. The average premium on a subsidized policy for 1994 will be $401 if the Congress approves a 5 cent increase in the subsidized rate. Premiums for subsidized policies are higher than those for actuarial structures but are only about one-third of what they would need to be for these rates to fully reflect flooding risks on pre-FIRM construction. FIA officials told us that pre-FIRM structures are not as elevated as post-FIRM structures and, thus, on average, are 41⁄2 times more likely to suffer a loss. When pre-FIRM structures suffer a loss, the damage sustained is about one-third more than for post-FIRM structures. According to FIA, when these two factors are combined, pre-FIRM structures on average suffer about 6 times the damage of post-FIRM structures. The higher elevation standard is one of the primary building standards that FIA requires communities to adopt as a prerequisite for joining NFIP.

The previously mentioned interagency task force that would be created if S. 1405 became law, Mr. Chairman, will also study the extent to which the flood insurance premium rate structure could be revised to minimize existing premium rate subsidies and to incorporate premium rate adjustments for erosion hazards.

NFIP'S FINANCIAL MANAGEMENT SYSTEM

Because of recent losses sustained by the fund, it may not have sufficient financial resources to meet future estimated losses, and FIA may have to exercise its borrowing authority to pay claims. However, two audits of FIA's financial statements for fiscal years 1991 and 1992 made in accordance with the Chief Financial Officer's Act identified serious problems in NFIP's financial management affecting the fund's balance on deposit in the U.S. Treasury. Furthermore, FEMA's Inspector General found problems in other NFIP financial management systems.

FEMA's Inspector General reported that FIA does not have systems or records to effectively track or monitor NFIP's fund balance with the U.S. Treasury. Furthermore, the audits found serious problems with NFIP's financial management system and internal control structure that prevent the accumulation and reporting of reliable financial information. Since 1979, FEMA has acknowledged that its financial management procedures and practices have been both limited and inconsistently implemented. Also, the Office of Management and Budget has listed both FEMA's internal control structure and its financial management systems as high-risk areas. NFIP's cash balance with the Treasury along with investments represent the resources available to pay flood claims and the program's administrative costs. FEMA's Inspector General reported that NFIP's balance with the Treasury is com

3 We have not reviewed these studies.

mingled with all other FEMA funds into one balance and FIA has not reconciled its records with reported U.S. Treasury funds for many years. Therefore, FIA cannot verify that the NFIP balance it maintains is accurate according to the Inspector General.

FEMA's Inspector General recommended that FEMA establish a separate account for the NFIP fund in the U.S. Treasury. FIA officials have not implemented the Inspector General's recommendation to establish a separate account, but acknowledged inaccuracies with the fund balance and said that they are working at resolving the problems.

FEMA's Inspector General also reported that it was unable to express an opinion on NFIP's financial statements for fiscal years 1991 and 1992. Specifically, the OIG reviews found that (1) property and equipment accountability was inadequate, (2) inventories were not accounted for, and (3) administrative expenses were not accurately reported. The Inspector General recommended various short-term actions to correct these problems, such as conducting physical inventories of NFIP's assets and reporting administrative expenses on an accrual basis. FIA has not implemented either of these actions, but instead is relying on the implementation of FEMA's FiveYear Financial Plan for fiscal years 1992-96 to provide long-term solutions to NFIP's financial management problems.

Because the current obligations of the fund exceed its present balance, we believe that FIA should implement the OIG's recommendation to establish a separate NFIP balance in the U.S. Treasury. Also, we believe that FIA should reexamine its decision not to make short-term improvements in NFIP's financial management system. LENDER COMPLIANCE WITH THE MANDATORY INSURANCE PURCHASE REQUIREMENT

Mr. Chairman, in 1990 we issued a report on lender compliance with the mandatory insurance purchase requirement involving two floods in the States of Texas and Maine. In 1992, we testified before this subcommittee on the results of our review. Specifically, we found that a large majority of the flood victims in the two States that received disaster assistance-78 percent-were not subject to the mandatory purchase requirement, either because households had unmortgaged property or mortgages were held by unregulated lenders. We also found that most disaster-assisted households in Maine subject to the mandatory purchase requirement had flood insurance; however, most in Texas did not. We could not identify the reason for the disparity between the two States.

Reasons cited by lending institutions in both Texas and Maine varied as to why the properties that should have been insured were not. The most frequently cited reasons were the lender (1) erroneously classified the property as not being in an area for which insurance was mandatory or the property was not classified at all, (2) neglected to require the flood insurance at loan closing even though the lender identified the property as in an area for which insurance was mandatory, and (3) required the flood insurance at the time the loan was made but later allowed the policyholder to drop the insurance without taking any action.

Our current work on lender compliance with the mandatory insurance purchase requirement focuses on flooding caused by the December 1992 nor'easter in New York and New Jersey. FEMA had estimated that it would receive NFIP claims amounting to about $243 million shortly after this storm which was greater than the NFIP's combined losses for Hurricanes Andrew and Iniki.

Nearly two-thirds of the Federally associated assistance applied for by flood victims in the two States was for individuals covered under the NFIP as shown in table 1 below. In recent years, premium income received from policyholders paying actuarial rates has exceeded the policyholders' claims. Therefore, the NFIP had funds available to pay the claims from the 1992 nor'easter without borrowing from the U.S. Treasury. About one-third of the Federal assistance was for flood victims, most of whom were not insured under the NFIP, who applied for either Treasurysubsidized low-interest disaster loans from SBA or grants from FEMA.

Table 1: Analysis of Federally Associated Assistance in New York and New Jersey for Which Application Was Made by Flood Victims of the December Nor'easter

We are currently examining the databases for SBA loans and for FEMA individual and family grants made in New York and New Jersey to determine whether recipients of these loans and grants lived in a special flood hazard area, had flood insurance, and, if not, why not. While we have not yet begun work on SBA loans, our preliminary work on recipients of FEMA grants indicates that many of them were not required to comply with the mandatory insurance purchase requirement because they had no mortgage or had a mortgage with an unregulated lender. However, we are also finding some recipients that should have had insurance but did not.

FEMA attempted to obtain the names of lenders, if any, for those recipients of its grants that lived in special flood hazard areas in New York and New Jersey. Of the 1,403 homeowners who received grants and live in special flood hazard areas, FEMA identified 125 homeowners who also had flood insurance-we have not yet determined why homeowners with insurance also received a grant. As a result, there were 1,278 homeowners who received grants in special flood hazard areas that did not have flood insurance. However, FEMA was not able to obtain mortgage information on 526 of these homeowners. The results of our analysis of the remaining 752 homeowners that did not have flood insurance for which mortgage information is available is presented below.

⚫ 232 homeowners, or 31 percent, should have had insurance, and

• 520 homeowners, or 69 percent, were not required to have insurance because (1) 491 homeowners, or 94 percent, did not have a mortgage and (2) 29 homeowners, or 6 percent, had mortgages with unregulated lenders.

In addition, Mr. Chairman, we have begun to obtain reasons why the 232 homeowners did not have the required insurance. At this point, we have information for just a few of these homeowners which indicates that the lenders (1) made erroneous flood determination prior to loan closing and (2) did not enforce flood insurance policy renewals. Also, Federal bank regulatory agencies, such as the Federal Deposit Insurance Corporation, told us that, when conducting compliance examinations, examiners review loan files for compliance with many regulations of which flood insurance is one. With the problems facing the banking industry over the past few years, the agencies told us that their examiners have had to spend additional time looking at the safety and soundness of the bank and less time looking at flood insurance and other compliance items.

In the next few months, we intend to complete our efforts on lender compliance. We will continue to examine SBA's and FEMA's data bases and contact lenders and homeowners to determine reasons why the required insurance was not purchased or renewed.

S. 1405 contains provisions to increase the rate of compliance with the mandatory insurance purchase requirement. It notes that the low percentage of homeowners having flood insurance in a special flood hazard area is not caused solely, or even primarily, by a lack of compliance by those that must purchase insurance but is also caused to a large extent by a lack of coverage among those that are not required to purchase such insurance. The bill proposes steps to (1) strengthen the purchase requirement for Federal agencies that support home loans and the Federal National Mortgage Association and the Federal Home Loan Mortgage Corporation; (2) require premiums to be escrowed if possible; (3) force place, or buy the flood insurance for the property owner, if the owner does not; and (4) fine lenders for not complying. Mr. Chairman, I would like to make two points regarding S. 1405's provisions aimed at increasing the rate of compliance with the mandatory insurance purchase requirement. Increased participation by subsidized and unsubsidized property owners in NFIP is likely to reduce the cost of other Federal disaster assistance programs-FEMA grants and SBA loans. However, increased participation by subsidized property owners will increase the potential liability of the NFIP because the

premiums received from subsidized policyholders will not be sufficient to meet future estimated losses on these policies.

NFIP'S ATTEMPTS TO MITIGATE FUTURE FLOOD DAMAGE

Our work to date has not yet focused on NFIP's efforts to mitigate flood damage; however, we would like to point out three areas that we will be reviewing. Specifically, (1) the impact of FIA-established building standards used in special flood hazard areas, (2) FIA's efforts to deal with repetitive losses, and (3) FIA's efforts to assist State and local governments, such as the section 1362 program which authorizes funds to purchase both flood-prone structures and their lots on a willing-seller basis.

Building standards. One of the primary building standards a community must adopt to be eligible to join NFIP is to elevate structures within the identified 100year floodplain to at least a level at which there is no greater than a 1-percent risk that it will be flooded in a given year. Pre-FIRM structures not built to these standards, on average, suffer 6 times the flood damage of post-FIRM structures. However, pre-FIRM structures that incur damage of over 50 percent of the structure must be rebuilt according to NFIP building standards. But, elevating such structures could cost $30,000 or more, a cost that is borne by the homeowner. The high cost of such a procedure is causing some homeowners to consider not rebuilding structures destroyed by Hurricane Andrew. This may also be a problem for some homeowners affected by the recent Midwest flooding.

Repetitive loss structures. Under the current NFIP operational definition, a repetitive loss structure is defined as a structure that has received two or more flood insurance claim payments of at least $1,000 since 1978. According to FIA, about 50,500 structures fit this definition-about 2 percent of the NFIP's policies—but these structures account for 52 percent of the claims paid and 47 percent of the dollars paid out of the fund. An owner of a structure that has suffered repetitive losses of less than 50 percent in the past does not have to (1) take measures to improve the floodworthiness of the structure or (2) pay higher insurance rates.

Section 1362 program. Officials of various State and national organizations representing State floodplain and emergency management interests, told us that more resources are needed for flood mitigation programs. The section 1362 program is designed to reduce flood damage through the purchase and removal of buildings that have been severely damaged, or damaged more than 25 percent three times in a five year period.

We notice, Mr. Chairman, that S. 1405 highlights the need for NFIP to improve its mitigation efforts and authorizes the expenditure of additional funds for flood and erosion mitigation assistance activities. The bill would also allow FIA to charge the applicable risk premium rate based on accepted actuarial principles to a property determined to be a repetitive loss structure.

In conclusion, Mr. Chairman, requiring subsidized policyholders to pay actuarial rates would be a primary way to make the NFIP fund actuarially sound, but in doing so could (1) cause a significant number of these policyholders to cancel their insurance and (2) increase the costs of other Federal disaster relief assistance grant and loan programs. Whether the increased costs that would be incurred by other Federal disaster assistance programs would be less than, or more than, the current subsidy cost cannot be estimated because the number of policyholders that would cancel their insurance is unknown. Therefore, there is a need for the task force that would be established by S. 1405 in studying revisions to premium rate structures and strategies, to establish an actuarially based premium structure to not only examine such revisions in the context of their impact on NFIP, but to also consider their potential impact on other Federal disaster assistance programs.

Also, FIA's determination of when, and if, the NFIP fund needs to borrow from the U.S. Treasury may not be based on adequate data that FEMA's maintains on the amount of NFIP funds it has on deposit in the U.S. Treasury. FEMA's Inspector General has raised serious questions about FIA's system to track the fund's balance at the U.S. Treasury and the adequacy of its financial management and internal control structure. Because FIA may have to exercise its borrowing authority to pay claims, we believe that FIA should implement the OIG's recommendation to establish a separate NFIP balance in the U.S. Treasury. Also, we believe that FIA should reexamine its decision not to make short-term improvements in NFIP's financial management system.

Our limited work to date does not allow us to make firm conclusions about lender compliance; however, our work on the 1992 nor'easter does indicate most property owners in special flood hazard areas in New York and New Jersey that do not have flood insurance are not required to have insurance.