The federal government is overpaying private insurance companies that manage flood insurance policies by as much as 16.5 percent. To just six of the 87 participating carriers, the Federal Emergency Management Agency (FEMA) paid $327.1 million more than their actual expenses, according to a new government report.
The Government Accountability Office (GAO) report says that FEMA does not have the information it needs to determine whether its payments to Write Your Own (WYO) insurance carriers involved in the National Flood Insurance Program (NFIP) are reasonable. On average, WYO insurers retain 30 to 40 percent of the flood insurance premiums they collect as reimbursement and payment for services rendered to FEMA to cover the cost of managing the flood policies they write. The GAO says this is excessive when compared against actual expenses.
The GAO undertook its 19-month study at the request of the Committee on Banking, Housing and Urban Affairs and its ranking member, Sen. Richard C. Shelby (R – Ala.).
Determining Payment to WYO’s
Ninety-seven percent of in-force NFIP flood policies are managed by 87 WYO carriers. These include large carriers such as Farmers, State Farm, Travelers, Liberty Mutual and The Hartford, along with smaller and medium-sized carriers such as Florida Family, Harleysville, Middlesex Mutual, Westfield and Utica First.
From a premium standpoint, these 87 WYOs control approximately 89 percent of the total flood insurance premium collected (based on 2007 data, the last year for which information is provided on FEMA’s Web site). FEMA paid WYOs $868.5 million in 2007 for managing these policies, representing 30.3 percent of total NFIP flood premiums written ($2.85 billion) and 34.3 percent of the $2.535 billion in premiums managed by WYOs.
The WYO Program began in 1983 and is a cooperative undertaking of the insurance industry and FEMA. The WYO Program allows participating property /casualty insurance companies to write and service the standard flood policy in their own names. The companies receive an expense allowance for policies written and claims processed while the federal government retains responsibility for underwriting losses.
In its report, the GAO states that “FEMA does not systematically consider actual flood insurance expense information when it determines the amount it pays WYOs for selling and servicing flood insurance policies and adjusting claims.” In fact, payment to WYO carriers is calculated based on proxy information (the cost to manage other lines of insurance) rather than the actual cost of managing the flood program.
At the time the WYO program was introduced (1983) there was no credible method for estimating a carrier’s cost of managing the program. To set the reimbursement rate, FEMA chose to base the flood program costs on the cost to manage five long-established property lines of coverage: fire, allied lines, farmowners’ multi-peril, homeowners’ multi-peril and the non-liability part of commercial multi-peril. Not until 2008 did FEMA apply actual cost when considering reimbursement rate, but such consideration was limited to claims processing expense; nothing has been done to alter the selling and servicing fee calculation method.
FEMA did not begin to require WYO carriers to report the actual costs for managing NFIP flood policies to the National Association of Insurance Commissioners (NAIC) until 1997. However, FEMA has chosen not to use this data when setting reimbursement rates because, as the GAO points out in its findings, the financial data submitted by the WYOs is suspect as there are currently no clear guidelines or rules regarding how and what cost information is to be provided.
Commission expense, operating expense, incentive bonuses, claims adjustment expenses, claims processing expenses and additional adjusting expenses are used to calculate the amount a WYO carrier gets paid. Commission expenses are a flat 15 percent of written premium. But operating expenses are determined annually based on the operating costs of the five “proxy lines” as reported by A.M. Best. Incentive bonuses are based on policy growth so that WYOs’ growing 2 percent receive a 0.5 percent bonus and those increasing their book by 5 percent or more can earn an additional 2 percent of the annual written premium.
Also, claim adjustment expenses depend on the size of the claim. Individual losses below $50,000 earn the carrier a flat rate ranging between $60 and $1,250; fees for claims over $50,000 are based on a percentage of the loss amount beginning at 3 percent and going down to 2.1 percent when losses reach $250,000 or more. The greater the amount of claims paid, the more the WYO earns.
Only the commission expense and the additional adjusting expense have any relationship to the actual cost of managing the flood program, according to the report. None of the remaining four, which constitute the greatest total cost to FEMA, have any correlation to the program’s cost to the WYOs.
To highlight its point, the GAO studied and reported on six of the largest WYO carriers. During the three policy years beginning 2005 and ending 2007, FEMA paid these carriers $327.1 million more than their actual expenses. This translates to a 16.5 percent overpayment.
The GAO came up with six recommendations for FEMA:
- Determine in advance the amounts built into the payment rates for estimated expenses and profit;
- Annually analyze the amounts of actual expenses and profit in relation to the estimated amounts used in setting payment rates;
- Consider the results of the analysis of payments, actual expenses and profit in evaluating the methods for paying WYO’s;
- Immediately reassess the decision to pay WYO’s an additional 1 percent of written premiums for operating expenses;
- Take actions to obtain reasonable assurance that NAIC flood insurance expense data can be considered in setting payment rates that are appropriate; and
- Develop comprehensive data analysis strategies to annually test the quality of flood insurance data that WYO companies report to NAIC.
A copy of the full report can be found on the GAO website.
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