National Flood Insurance Program (NFIP); Revisions to Methodology for Payments To Write Your Own (WYO) Companies
| Published date | 08 July 2019 |
| Citation | 84 FR 32371 |
| Record Number | 2019-14343 |
| Section | Proposed rules |
| Court | Federal Emergency Management Agency |
Federal Register, Volume 84 Issue 130 (Monday, July 8, 2019)
[Federal Register Volume 84, Number 130 (Monday, July 8, 2019)]
[Proposed Rules]
[Pages 32371-32379]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2019-14343]
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DEPARTMENT OF HOMELAND SECURITY
Federal Emergency Management Agency
44 CFR Part 62
[Docket ID FEMA-2017-0025]
RIN 1660-AA90
National Flood Insurance Program (NFIP); Revisions to Methodology
for Payments To Write Your Own (WYO) Companies
AGENCY: Federal Emergency Management Agency, DHS.
ACTION: Advance Notice of Proposed Rulemaking.
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SUMMARY: As directed by the Biggert-Waters Flood Insurance Reform Act
of 2012, the Federal Emergency Management Agency (FEMA) intends to
modify the way it pays private insurance companies participating in the
Write Your Own (WYO) Program. FEMA seeks comment regarding possible
approaches to incorporating actual flood insurance expense data into
the payment methodology that FEMA uses to determine the amount of
payments to WYO companies.
DATES: Comments must be submitted by September 6, 2019.
ADDRESSES: You may submit comments, identified by Docket ID FEMA-2017-
0025, by one of the following methods:
Federal eRulemaking Portal: http://www.regulations.gov. Follow the
instructions for submitting comments.
Mail/Hand Delivery/Courier: Regulatory Affairs Division, Office of
Chief Counsel, Federal Emergency Management Agency, 8NE, 500 C Street
SW, Washington, DC 20472.
FOR FURTHER INFORMATION CONTACT: Sarah Ice, Federal Insurance and
Mitigation Administration, FEMA, 400 C St. SW, Washington, DC 20472
(mail); (202) 320-5577 (phone); or [email protected]
(email).
SUPPLEMENTARY INFORMATION:
I. Public Participation
We encourage you to participate in this rulemaking by submitting
comments and related materials. We will consider all comments and
material received during the comment period.
If you submit a comment, identify the agency name and the docket ID
for this rulemaking, indicate the specific section of this document to
which each comment applies, and give the reason for each comment. You
may submit your comments and material by electronic means, mail, or
delivery to the address under the ADDRESSES section. Please submit your
comments and material by only one means.
Regardless of the method used for submitting comments or material,
all submissions will be posted, without change, to the Federal e-
Rulemaking Portal at http://www.regulations.gov, and will include any
personal information you provide. Therefore, submitting this
information makes it public. You may wish to read the Privacy and
Security Notice that is available via a link on the homepage of
www.regulations.gov.
Viewing comments and documents: For access to the docket to read
background documents or comments received, go to the Federal e-
Rulemaking Portal at http://www.regulations.gov. The public may also
inspect background documents and submitted comments at FEMA, Office of
Chief Counsel, 500 C Street SW, Washington, DC 20472-3100.
II. Glossary of Terms, Abbreviations, and Frequently Used Acronyms
To aid the reader, the following glossary (Table 1) defines
technical terms most commonly used throughout this notice.
[[Page 32372]]
Table 1--Glossary of Frequently Used Technical Terms
------------------------------------------------------------------------
Term Definition
------------------------------------------------------------------------
Allocated Loss Adjustment Expense A loss adjustment expense that
(ALAE). is assignable or allocable to
a specific claim, usually
adjuster fees.
Credibility............................ (1) An actuarial term
describing the degree of
accuracy in forecasting future
events based on statistical
reporting of past events. (2)
The weight assigned or
assignable to observed data in
contrast to that assigned to
an external or broader-based
set of data. Credibility is
used to provide a measure of
the relative predictive value
of the data being reviewed.
Weights can be determined
through detailed formulas or
by judgment. The weight
assigned should generally
increase with the number of
exposure bases in the observed
data and should decrease with
higher levels of variability
in the observed data.
General Expenses....................... An insurer's marketing,
operating, and administrative
expenses. Does not include
loss adjustment expenses.
Incurred Loss.......................... Sustained losses, paid or not,
during a specified time
period. Incurred losses are
typically found by combining
losses paid during the period
plus unpaid losses sustained
during the time period minus
outstanding losses at the
beginning of the period
incurred in the previous
period.
Loss Adjustment Expense (LAE).......... The cost of investigating and
adjusting a loss.
Net Written Premium.................... Written premium less deductions
for reinsurance premiums and
any commissions resulting from
the purchase of reinsurance.
Paid Losses............................ Losses and allocated loss
adjustment expenses (ALAE)
paid to policyholders during a
financial reporting period.
Ratio.................................. Percent. For example, the
percentage of ratio 2:4 is
50%. (2:4 can be written as \2/
4\; 2 divided by 4 equals .5,
or 50%).
Special Allocated Loss Adjustment A loss adjustment expense
Expense (SALAE). assignable or allocable to a
specific claim that is not
covered as ALAE because the
expense is not applicable in a
standard claim. For example,
an insurance company may need
to hire an engineer to
determine if flooding caused a
covered loss or an expert to
determine the extent of damage
to a large piece of machinery.
SALAE also includes litigation
costs associated with a
specific claim.
Unallocated Loss Adjustment Expense All external, internal, and
(ULAE). administrative claims handling
expenses, including
determination of coverage,
that are not included in
allocated or special allocated
loss adjustment expenses.
Written Premium........................ The premium registered on the
books of an insurer or a
reinsurer at the time a policy
is issued and paid for. This
also includes any changes to
that premium due to
cancellations or mid-term
endorsements.
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To further aid the reader, the following table (Table 2) provides
abbreviations and acronyms frequently used in this notice.
Table 2--Abbreviations and Acronyms
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Term Abbreviation/Acronym
------------------------------------------------------------------------
Allocated Loss Adjustment Expense....... ALAE
Biggert-Waters Flood Insurance Reform BW-12
Act of 2012.
Federal Emergency Management Agency..... FEMA
Federal Insurance and Mitigation FIMA
Administration.
Homeowner Flood Insurance Affordability HFIAA
Act of 2014.
Loss Adjustment Expense................. LAE
National Association of Insurance NAIC
Commissioners.
National Flood Insurance Act of 1968.... NFIA
National Flood Insurance Program........ NFIP
Special Allocated Loss Adjustment SALAE
Expense.
Unallocated Loss Adjustment Expense..... ULAE
Write Your Own.......................... WYO
------------------------------------------------------------------------
III. Background
A. The National Flood Insurance Program (NFIP) and the Write Your Own
(WYO) Program
The National Flood Insurance Act of 1968 (NFIA), as amended (42
U.S.C. 4001 et seq.), authorizes the Administrator of the Federal
Emergency Management Agency (FEMA) to establish and carry out the NFIP
to enable interested persons to purchase insurance against loss
resulting from physical damage to, or loss of, real or personal
property arising from flood in the United States. See 42 U.S.C.
4011(a). Congress intended the NFIP to be ``a program of flood
insurance with large-scale participation of the Federal Government and
carried out to the maximum extent practicable by the private insurance
industry.'' See 42 U.S.C. 4001(b). Under the NFIA, FEMA may carry out
the NFIP through the facilities of the Federal government, using, for
the purposes of providing flood insurance coverage, insurance companies
and other insurers, insurance agents and brokers, and insurance
adjustment organizations, as fiscal agents of the United States. See 42
U.S.C. 4071.
Pursuant to this authority, FEMA works closely with the insurance
industry to facilitate the sale and servicing of flood insurance
policies. A person can purchase an NFIP flood insurance policy, also
known as the Standard Flood Insurance Policy (SFIP), either: (1)
Directly from the Federal government through a direct servicing agent,
or (2) from a private insurance company (referred to as a WYO company)
through the WYO Program. The SFIP sets out the terms and conditions of
insurance. FEMA establishes terms of insurance and rates, which are the
same whether purchased directly from the NFIP or through the WYO
Program.
FEMA enters into a standard Financial Assistance/Subsidy
Arrangement (Arrangement) with the WYO companies, which addresses the
[[Page 32373]]
terms and conditions for administering the NFIP policies, including
compensation. FEMA publishes the annual Arrangement in the Federal
Register. See 44 CFR 62.23(a). FEMA published the Fiscal Year 2019
Arrangement in March 2018, which became effective October 1, 2018. 83
FR 11772 (Mar. 16, 2018).
B. Legislative Mandate To Revise the WYO Compensation Methodology
Congress enacted the Biggert-Waters Flood Insurance Reform Act of
2012 (BW-12) (Title II, Subtitle A of Public Law 112-141, 126 Stat.
405) to extend the NFIP's authorities through September 30, 2017, and
to adopt significant program reform. Section 100224 of BW-12 (42 U.S.C.
4081 note) directs FEMA, the Government Accountability Office (GAO),
and WYO companies to take a series of actions designed to improve the
oversight of compensation provided to WYO companies under the WYO
program.
Subsection (b) directs FEMA to develop a methodology for
determining the amount of reimbursements paid to WYO companies for
selling, writing, and servicing NFIP policies and adjusting claims.
FEMA must develop such methodology using ``actual expense data for the
flood insurance line.'' FEMA can derive the methodology from either:
(1) Flood insurance expense data provided by WYO companies; (2) flood
insurance expense data collected by the National Association of
Insurance Commissioners; or (3) a combination of previous two methods.
This methodology is due 180 days following the enactment of BW-12.
Subsection (d) instructs FEMA to ``issue a rule'' adopting a
revised WYO payment methodology. Such methodology must specify
compensation in both catastrophic and non-catastrophic loss years and
be structured to ensure reimbursements track the actual expenses of WYO
companies as closely ``as practicably possible.'' Based on the
structure of section 100224, FEMA believes that Congress intended that
the rule also align with the methodology FEMA is required to develop
pursuant to subsection (b). FEMA intends to adopt a replacement WYO
payment methodology via the notice-and-comment rulemaking process in
order to comply with this direction.
C. Current WYO Payment Methodology
As set forth in the FY 2019 Arrangement, FEMA currently pays WYO
companies for their expenses by authorizing companies to retain a
portion of the premiums they collect on behalf of the NFIP. Article III
of the Arrangement describes the methodology for calculating the amount
WYO companies may keep as compensation. This includes the methodology
for paying WYO companies for their marketing, operating, and
administrative expenses (collectively referred to as general expenses)
(Article III.B of the Arrangement) and the methodology for compensating
WYO companies for their loss adjustment expenses (LAE) (Article III.C
of the Arrangement). Figure 1 illustrates this payment methodology.
[GRAPHIC] [TIFF OMITTED] TP08JY19.004
1. Marketing, Operating, and Administrative Expenses (General Expenses)
(B in Figure 1)
Article III.B of the Arrangement authorizes WYO companies to retain
a certain percentage of the written premiums they collect for the NFIP
as compensation for their general expenses, including the costs of
marketing, selling, and servicing policies.
FEMA calculates the Base WYO Expense Allowance Percentage (D in
Figure 1) and then adds additional amounts, as described below. To
determine the Base WYO Expense Allowance Percentage, FEMA begins with
data from five non-flood insurance lines, namely Homeowners Multiple
Peril, Fire, Allied Lines,\1\ Farmowners Multiple Peril, and Commercial
Multiple Peril (non-liability portion).\2\ It
[[Page 32374]]
uses these five insurance lines because (1) data on flood insurance
expenses has only recently become widely available; (2) current
reporting of flood insurance expenses has limited reliability; and (3)
these non-flood lines are the most similar to flood insurance.\3\ FEMA
obtains data for these five insurance lines from A.M. Best Company's
Aggregates and Averages publication.\4\ Each of these five insurance
lines has various expense categories. FEMA uses three expense
categories that fit most closely with flood insurance expenses. These
include ``General Expenses,'' ``Other Acquisition Expenses,'' and
``Taxes, Licenses, and Fees.'' For each expense category, FEMA divides
actual expenses by the written premium to come up with an expense
ratio. For example, if the General Expenses are $50 and the written
premiums are $5,000, FEMA divides $50 by $5,000 to come up with an
expense ratio of 1%, meaning General Expenses equaled 1% of the written
premium.
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\1\ ``Allied Lines'' are coverages which are generally included
with property insurance, such as glass, tornado, windstorm and hail;
sprinkler and water damage; explosion, riot, and civil commotion;
growing crops; flood; rain; and damage from aircraft and vehicle.
See http://www.naic.org/consumer_glossary.htm.
\2\ The non-liability portion is the portion that deals with
property insurance; the liability portion covers non-property based
risks, such as civil liability for libel, slander, negligence, and
unlawful employment practices. The property side is the side most
akin to flood insurance and so FEMA uses that side for its
calculation.
\3\ As explained later in this notice, in December 2016, the
Government Accountability Office (GAO) found that insurers were not
consistently reporting flood insurance expense data to the National
Association of Insurance Commissioners, resulting in underreporting
of certain underwriting and loss expenses for their flood insurance
lines. See GAO, Flood Insurance: FEMA Needs to Address Data Quality
and Consider Company Characteristics When Revising Its Compensation
Methodology (Jan. 9, 2017), at http://www.gao.gov/products/GAO-17-36.
\4\ A.M. Best is an independent rating agency that focuses on
the insurance industry. See http://www.ambest.com. A.M. Best obtains
their data from financial statements submitted to the National
Association of Insurance Commissioners (NAIC) by insurers in order
to comply with State insurance regulator reporting requirements.
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After FEMA calculates the expense ratio for each of the three
expense categories, it adds them together to come up with the total
expense ratio for each of the five insurance lines identified above.
For example, if the expense ratio for General Expenses is 1%, for Other
Acquisition Expenses is 5%, and for Taxes, Licenses, and Fees is 2%,
FEMA then adds all three together (1 + 5 + 2) to come up with the total
expense ratio for that insurance line (1 + 5 + 2=8%), which in this
scenario is 8%. FEMA does this calculation for each of the five
insurance lines. Once it has the total expense ratio for each of the
five insurance lines, it weight averages them (using written premiums
as weights) to determine the average expense ratio for all five lines
of insurance combined. For example, if the expense ratios for each of
the five insurance lines is: 2.6%, 9%, 11%, 13%, and 5%, and each line
expressed as a portion of the total premiums of all five lines is: 25%,
25%, 25%, 15%, and 10%, respectively, FEMA multiplies each expense
ratio by its portion of total premiums. FEMA then adds the products to
get an annual weighted average expense ratio for the non-flood
insurance lines of insurance of 8.1%
((2.6x0.25)+(9x0.25)+(11x0.25)+(13x0.15)+(5x0.1)=8.1%).
To account for variability from year to year, FEMA then takes the
annual weighted average expense ratio that it calculated for each of
the previous 4 years, plus the weighted average expense ratio for the
current year and averages them. For example, if the current year
expense ratio is 8.1%, the previous year 1 ratio is 6%, the previous
year 2 ratio is 4%, the previous year 3 ratio is 8%, and the previous
year 4 ratio is 3%, then FEMA would add these ratios together (8.1 + 6
+ 4 + 8 +3 = 29.1%), and then divide 29.1% by 5 to get an average
expense ratio of 5.82%. The Base WYO Expense Allowance Percentage would
then be 5.82%.
FEMA then adds an additional 15 percentage points to pay WYO
companies for commissions or salaries of insurance agents, brokers, or
other entities producing qualified flood insurance applications and
other related expenses (E in Figure 1). See Arrangement III.B.2. Prior
to the Fiscal Year 2019 Arrangement, FEMA also added an additional 1
percentage point to the Base WYO Expense Allowance Percentage to
account for the additional complexity associated with selling and
servicing NFIP policies. See FY 2018 Arrangement, Art. III.B.1, 82 FR
17017, 17020 (Apr. 4, 2017); Arrangement, 44 CFR 62, App. A, Art. III.B
] 2 (Arrangement applicable prior to FY 2018).\5\
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\5\ See 81 FR 84483 (Nov. 23, 2016) (removing the Arrangement
from regulation).
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From 2009 to 2017, the percentages of written premium for each year
(which include the Base WYO Expense Allowance Percentage, the extra 1
percentage point for years prior to FY 2019, and the 15 percentage
points for agent commissions), were as follows:
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\6\ Percentage reflects the FY 2019 Arrangement's one percent
reduction in compensation for general expenses. The rate would have
been 31 percent without FY19 Arrangement's 1 percent reduction.
TABLE 3--WYO EXPENSE ALLOWANCE PERCENTAGE
------------------------------------------------------------------------
Percent of
written premium
Arrangement year paid to WYO for
general expenses
------------------------------------------------------------------------
2009................................................. 29.8
2010................................................. 30.0
2011................................................. 30.2
2012................................................. 30.4
2013................................................. 30.7
2014................................................. 30.7
2015................................................. 30.8
2016................................................. 30.9
2017................................................. 30.9
2018................................................. 30.9
2019................................................. \6\ 30
------------------------------------------------------------------------
In addition to these amounts, FEMA also provides for the
possibility of a growth bonus. (F in Figure 1). See Arrangement
III.B.3. The actual bonus varies by the extent a WYO company meets
certain marketing goals. The total growth bonus paid to all WYO
companies may not exceed 2 percent of aggregate written premium for all
companies. Prior to the 2019 Arrangement, an individual company could
not receive a growth bonus of more than 2 percent of such individual
company's written premium. See, e.g. FY 2018 Arrangement, Art. III.B.3.
2. Loss Adjustment Expenses (LAE) (C in Figure 1)
LAE are expenses incurred in the course of adjusting insurance
claims.\7\ There are three categories of LAE in the Arrangement: (1)
unallocated loss adjustment expenses (ULAE), (2) allocated loss
adjustment expenses (ALAE), and (3) special allocated loss adjustment
expenses (SALAE).
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\7\ Adjusting an insurance claim is a determination of the
amount payable by the insurer to the insured on a claim under an
insurance policy.
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ULAE (H in Figure 1) are expenses a WYO company incurs while
adjusting flood insurance claims but cannot attribute to a specific
claim. Examples of ULAE include general overhead, adjuster supervision
expenses, and catastrophic response resources, such as mobile claim
response units. FEMA reimburses ULAE based on a ``ULAE Schedule.''
Arrangement III.C.1. The Fiscal Year 2017 schedule provides for 0.9
percent of net written premium and 1.5 percent of incurred loss.\8\
FEMA
[[Page 32375]]
calculates incurred loss based on claims that have been reported to the
WYO company. FEMA excludes any estimate by the WYO company for
additional dollars the WYO company will pay on claims from flooding
events that have already happened but have not yet been reported to the
company. Further, in calculating incurred loss for those claims already
reported to the company, FEMA includes both amounts already paid on
those claims and the estimate by the company of amounts remaining to be
paid on those claims.
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\8\ Prior to Hurricane Katrina, FEMA reimbursed ULAE based on
3.3 percent of incurred losses, as that was the number FEMA
determined was required to maintain sufficient WYO company
participation in the NFIP program. Katrina, however, revealed that
in a high-severity localized event, a payment of 3.3 percent of
incurred losses resulted in significant overpayments to WYO
companies. For this reason, FEMA removed the percentage from the
Arrangement and instead communicated it on an annual basis. See 73
FR 18182, 18184-5 (April 3, 2008). Following this change FEMA
altered its ULAE reimbursement method to decrease variations between
low and high-payout years. Accordingly, it decreased its payment of
incurred losses to 1.5 percent, and began reimbursing 1 percent of
net written premiums, eventually reaching today's level at .9
percent of net written premiums. (The net written premium percentage
was designed to cover expenses that are more fixed; as such, it is
more static and thus avoids overcompensation during disaster years.)
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ALAE (I in Figure 1) are adjustment expenses attributable to
specific claims, such as fees to adjusters. FEMA pays for ALAE for
adjuster expenses according to a fee schedule, but only after the claim
has been closed. Arrangement III.C.2. The NFIP published the current
ALAE fee schedule in 2017. See NFIP Claims Manual, Appendix A.\9\ The
schedule provides for a range of flat rate fees varying according to
the disposition of a claim and the amount of the gross paid loss.\10\
The ALAE schedule is reproduced in part below:
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\9\ https://www.fema.gov/media-library-data/1535556801689-ef2b1232f884cc6e4396a8cc7e7526b3/Appendix_A_Adjuster_Fee_Schedule.pdf.
\10\ ``Gross Loss'' is the agreed cost to repair before
application of depreciation or the applicable deductible(s), but
subject to policy limitations (such as those dollar amounts
specified in Coverage B -- Personal Property Special Limits and
Coverage C -- Other Coverages, Loss Avoidance Measures and Property
Removed to Safety) and exclusions.
Table 4--ALAE Fee Schedule
------------------------------------------------------------------------
Claim Range Fee
------------------------------------------------------------------------
Erroneous Assignment...................... $95.00.
Claim Withdrawn........................... $95.00.
Closed Without Payment (CWOP)............. $395.00.
.01-$1,000.00............................. $525.00.
$1,000.01-$5,000.00....................... $800.00.
$5,000.01-$10,000.00...................... $1,035.00.
$10,000.01-$15,000.00..................... $1,175.00.
$15,000.01-$25,000.00..................... $1,275.00.
$25,000.01-$35,000.00..................... $1,475.00.
$35,000.01-$50,000.00..................... $1,750.00.
$50,000.01-$100,000.00.................... 3.4% but not less than
$1,750.
$100,000.01-$250,000.00................... 2.6% but not less than
$4,250.
$250,000.01-$1,000,000.00................. 2.4% but not less than
$7,800.
$1,000,000.01 and up...................... 2.2% but not less than
$24,000.
------------------------------------------------------------------------
The current ULAE and ALAE schedules have resulted in payments equal
to 6.7 percent of the total losses paid (the amount actually paid for
claims) during the last 5 years for which data is available. However,
annual paid losses and the annual amount of LAE payments that are
incurred to service them vary widely in that period, as seen in the
Table 5:
Table 5--Amount FEMA Paid for ALAE and ULAE \11\
[$ Thousands]
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D. Payment
for LAE/Paid
Arrangement year A. Paid Loss B. ALAE Paid C. ULAE Paid Loss Ratio
(B+C)/A = D
(percent)
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2013............................................ $7,463,580 $295,439 $137,529 5.80
2014............................................ 741,729 33,205 37,803 9.57
2015............................................ 687,407 28,116 36,358 9.38
2016............................................ 1,864,887 61,930 73,571 7.27
2017............................................ 3,376,735 107,296 141,216 7.36
5-Yr Total/Avg.............................. 14,134,338 525,986 426,476 6.74
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SALAE include specialized claims handling expenses attributable to
a specific claim, such as for legal, surveying, or engineering support.
Unlike ULAE and ALAE, FEMA does not use a schedule to reimburse SALAE,
but rather pays for SALAE on a dollar-for-dollar reimbursement
basis.\12\
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\11\ Data were based on annual end of year financial statements
for the National Flood Insurance Program and expenses paid
exclusively for the Write Your Own program. All amounts shown in
this table track payments to the Arrangement Year (Oct 1 through Sep
30) in which they were made. This is in contrast to other methods of
tracking payments (see, e.g., Table 7) to the year the flood
occurred.
\12\ The basic SALAE guideline is WYO Bulletin W-10039 (April 1,
2010), available at https://bsa.nfipstat.fema.gov/wyobull/2010/w-10039.pdf.
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SALAE represents a very small portion of the National Flood
Insurance Program's expenses and overall claims process. In 2015,
FEMA's internal data indicates that 8.10 percent of claims involved
SALAE payments, which cost 0.47 percent of losses incurred for that
year. In 2016, 2.57 percent of claims involved SALAE payments, which
cost 0.18 percent of losses incurred for that year. However,
administering this small portion on a dollar-for-dollar reimbursement
basis requires significant administrative oversight on the part of
FEMA. FEMA program staff review each reimbursement request to ensure
fair pricing and reasonable use of professional services. Specific for
reimbursement of litigation of claims, FEMA employs several dedicated
program and legal staff members to oversee reimbursement of WYO
companies for their legal expenses.
D. Findings of Inadequacies in Current Methodology
Relevant to this discussion, the GAO has issued two reports
outlining its concerns with FEMA's methodology for calculating the
amount FEMA pays WYO companies. In August 2009, GAO issued a report
entitled, ``Flood Insurance: Opportunities Exist to Improve Oversight
of the WYO Program'' (2009 GAO Report).\13\ In the report, GAO
criticized the NFIP for not considering actual flood insurance expense
information when it determines the amount it pays the WYO company for
selling and servicing flood insurance policies and adjusting claims.
2009 GAO Report, 5-6. As part of the review, GAO examined the expense
payments FEMA made to six WYO companies for their actual expenses for
calendar years 2005 through 2007. Id. at 6. GAO found
[[Page 32376]]
that the payments exceeded the WYO companies' actual expenses by $327.1
million, or 16.5 percent of total payments made. Id.
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\13\ GAO-09-455 (Sept. 21, 2009), available at http://www.gao.gov/products/GAO-09-455.
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However, the 2009 GAO report also found inconsistencies in the
actual flood expenses data obtained by the National Association of
Insurance Commissioners (NAIC). Id. at 5-6. GAO found that some
companies reported their flood insurance expenses to NAIC after
offsetting them with the payments they received from FEMA. Id. In other
instances, it found that companies included payments made under service
agreements with affiliated companies that may have included profit
distributions that should not have been included. Id. Accordingly, GAO
found that the consistency of WYO companies' reporting to NAIC needs to
be improved in order for data on the companies' expenses to be fully
utilized. See id. at 5-6.
In December 2016, GAO issued another report entitled, ``Flood
Insurance: FEMA Needs to Address Data Quality and Consider Company
Characteristics When Revising Its Compensation Methodology'' (2016 GAO
Report).\14\ In this report, GAO affirmed its 2009 recommendations and
found that FEMA has yet to revise its WYO compensation methodology to
reflect actual expenses, due in large part to a lack of quality data on
actual expenses.
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\14\ GAO-17-36 (Dec. 8, 2016), available at http://www.gao.gov/products/GAO-17-36.
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E. WYO Expenses Reported to NAIC Compared to WYO Compensation
FEMA has examined the difference between payments made under the
current methodology and the actual expenses reported by WYO companies
to the NAIC between 2009 and 2013, the latest year data is available
for either methodology.\15\ The results appear in Table 6. FEMA found
that the reimbursement rate for general expenses under the current
methodology exceeded the actual flood expense ratio calculated using
NAIC data.
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\15\ In order to control for non-credible data in some NAIC
reports, FEMA only used data from participating WYO companies
reporting expense ratios of 10 percent and above.
Table 6--General Expenses: Reported Flood Insurance Expenses Ratio (i.e., Reported General Expenses as
Percentage of Reported Written Premium) vs. Current Methodology \16\
----------------------------------------------------------------------------------------------------------------
C. NAIC
Reported Table 3.
General Percent of
A. NAIC B. NAIC Expenses as Written
Arrangement year Reported Reported Percentage of Premium Paid
General Written Reported to WYO for
Expenses Premium Written General
Premium A/B = Expenses
C
----------------------------------------------------------------------------------------------------------------
2013........................................... 697,027,000 2,937,809,000 23.7 30.7
2014........................................... 719,039,000 2,911,660,000 24.7 30.7
2015........................................... 684,714,000 2,756,173,000 24.8 30.8
2016........................................... 723,487,000 2,759,584,000 26.2 30.9
2017........................................... 746,587,000 2,744,213,000 27.2 30.9
5-Yr Total/Avg................................. 3,570,854,000 14,109,439,000 25.3 30.8
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FEMA also analyzed LAE and found similar results, i.e., the
reimbursement rate under the current methodology exceeded the actual
flood expense ratio using NAIC data. Both the actual expense data from
the NAIC and the amounts FEMA pays under the current methodology show
variation from year to year; some years have lower LAE/loss ratios
while other years have higher ratios. However, as seen in Table 7, the
NAIC actual expense data indicates consistently lower ratios (i.e.,
lower LAE relative to paid loss) (column C of Table 7) than what FEMA
pays under the current LAE methodology (last column of Table 7, which
lists data from Table 5).
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\16\ These reported figures for flood insurance expense data are
the latest available as of November 2018. FEMA notes that the future
differences between NAIC reported expenses and the corresponding WYO
Expense Allowances will be slightly different than the historical
difference shown here because of the FY19 Arrangement's 1 percent
reduction in compensation for general expenses.
Table 7--Loss Adjustment Expenses (LAE) as a Percent of Paid Losses: Reported by NAIC vs. Paid Under Current
Methodology
[In $ Thousands]
----------------------------------------------------------------------------------------------------------------
C. NAIC
Reported LAE D. From Table
A. NAIC B. NAIC as Percentage 5 Payment for
Calendar year/Arrangement year \1\ Reported Paid Reported LAE of NAIC LAE/Paid
Loss Paid \2\ Reported Paid Loss Ratio \3\
Loss (B / A = (percent)
C)
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2013............................................ $6,393,676 $334,276 5.23 5.80
2014............................................ 588,622 61,435 10.44 9.57
2015............................................ 829,042 65,192 7.86 9.38
2016............................................ 3,091,250 141,377 4.57 7.27
2017............................................ 7,189,144 347,127 4.83 7.36
[[Page 32377]]
5-Yr Average................................ 3,618,347 189,882 5.25 6.74
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\1\ Both ``Calendar Year'' and ``Arrangement Year'' are presented in one column for user ease. Although there is
a calendar year and an arrangement year for each year of data, FEMA's definitions of the two differ.
Specifically, here the calendar year represents January 1 through December 31. The arrangement year represents
the time frame (generally the 365 days) covered in the standard Financial Assistance/Subsidy Arrangement with
private sector property insurers, also known as Write Your Own (WYO) companies, to sell NFIP flood insurance
policies under their own names and adjust and pay claims arising under the Standard Flood Insurance Policy
(SFIP). See 42 U.S.C. 4081(a).
\2\ In column B, the LAE values listed are the sum of both ULAE and ALAE for each year. SALAE is not included in
the values.
\3\ In column D, the values include only payments made for ULAE and ALAE for each arrangement year. SALAE is not
included in the values, as reported in Table 5.
IV. Possible Methodologies
FEMA is considering three possible methodologies for calculating
payments to WYO companies. The three methodologies only address
payments for general and loss adjustment expenses incurred by WYO
companies. FEMA is considering additional regulatory actions to address
the possibility of additional non-expense related payments, such as for
profit or performance-based incentives.
FEMA presents these possible methodologies in order to solicit
comments from the public. FEMA intends to use these comments to inform
the publication of a notice of proposed rulemaking that will propose a
new WYO payment methodology in the future.
A. Credibility Weighting Methodology: Incorporating Actual Expense Data
Into Current Methodology
FEMA is considering a payment approach that uses credibility
weighting procedures \17\ to incorporate actual flood expense data into
FEMA's current methodology (described in section III.C of this ANPRM).
Credibility weighting combines two or more values. In this case, the
values would be the expense compensation ratios under the current
methodology and those yielded by flood insurance expense data. However,
a weight is applied to each value to introduce a greater influence of
one over the other in the final result. The weights are based on
actuarial opinion of the quality, robustness, and representative nature
of the available data, and can differ from year to year. How these
factors are considered will vary based on the specific procedure or
procedures used to incorporate credibility. Such procedures include
Bayesian credibility procedures, empirical credibility procedures, and
classical credibility procedures.\18\
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\17\ The Actuarial Standard Board defines ``credibility
procedure'' as: ``A process that involves the following: (a) The
evaluation of subject experience for potential use in setting
assumptions without reference to other data; or (b) the
identification of relevant experience and the selection and
implementation of a method for blending the relevant experience with
the subject experience.'' Actuarial Standards Board, Actuarial
Standard of Practice No. 25: Credibility Procedures, 2 (Dec. 2013),
available at http://www.actuarialstandardsboard.org/wp-content/uploads/2014/02/asop025_174.pdf. ``Subject experience'' means ``[a]
specific set of data drawn from the experience under consideration
for the purpose of predicting the parameter under study.'' Id.
``Relevant experience'' means ``[s]ets of data, that include data
other than the subject experience, that, in the actuary's judgment,
are predictive of the parameter under study (including but not
limited to loss ratios, claims, mortality, payment patterns,
persistency, or expenses). Relevant experience may include subject
experience as a subset.'' Id.
\18\ See Actuarial Standards Board, Actuarial Standard of
Practice No. 25: Credibility Procedures, 5-6 (Dec. 2013), available
at http://www.actuarialstandardsboard.org/wp-content/uploads/2014/02/asop025_174.pdf.
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Credibility weighting procedures allow FEMA to incorporate flood
expense data in WYO compensation, while adjusting the impact of such
data to account for its shortcomings. As data from the NAIC becomes a
more credible indicator of actual flood expenses, this methodology will
allow FEMA to give it greater weight. Under this approach, FEMA would
steadily increase usage of actual flood expense data over time, as that
data increases in credibility, while continuing to draw from the non-
flood insurance expense data currently in use in the near term.
1. General Expenses
For general expenses, FEMA would credibility weight two sources of
expense data: The actual flood insurance expense ratio and the non-
flood insurance expense ratio. FEMA would obtain this data from A.M.
Best Company's Aggregates and Averages publication, as FEMA does under
its current methodology. The actual flood insurance expense ratio would
cover the ``General Expenses,'' ``Other Acquisition Expenses,''
``Taxes, Licenses, and Fees,'' and ``Agent Commission'' expense
categories incurred by insurance companies, averaged over the previous
five years for which reliable and complete data are available. FEMA
projects that, based on data reported by WYO companies to the NAIC for
FY 2013 through FY 2017, this would yield an expense ratio of 25.3
percent of written premium (i.e., actual expenses are 25.3 percent of
the written premiums) before credibility weighting.\19\
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\19\ 25.3 percent is estimated based on a 5-year average of
NAIC-reported data of WYO companies who reported expenses within the
10 percent and above range. FEMA limited analysis of NAIC data to
this specific range because it deemed WYO-reported expenses below 10
percent to be less than credible, based on number of firms reporting
and general experience with the WYO program and the NFIP.
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The non-flood insurance industry expense ratio would be the expense
ratios for the five non-flood property/casualty insurance lines used in
the current methodology. The ratios would cover the ``General
Expenses,'' ``Other Acquisition Expenses,'' and ``Taxes, Licenses, and
Fees'' expense categories, averaged over the previous five years, then
adding the static 15 percent agent commission percentage of the current
general expense scheme (discussed in section III.C.1. of this ANPRM).
FEMA expects this would yield an expense ratio of 30 percent of written
premium before credibility weighting.\20\
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\20\ 30 percent is based on data from FY 2014 through FY 2016
(which were factored into the WYO compensation rates between FY 2017
and FY 2019).
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[[Page 32378]]
Based on the current NAIC actual flood expense data, FEMA estimates
that the credibility-weighted general expense ratio for FY 2019 would
be approximately 28.8 percent of written premium (based on preliminary
estimates that assume an initial credibility weighting of only 25
percent for the self-reported NAIC data). This would represent
approximately a $36.63 million decrease in general expense payments to
WYO companies in FY 2019, as compared to the current compensation
baseline in 2019. As the flood expense data collected by the NAIC
becomes more credible, this approach would assign greater weight to the
flood insurance expense ratio.
2. LAE
As noted above, FEMA currently reimburses ULAE and ALAE using
different methods. It reimburses ULAE based on 0.9 percent of written
premium and 1.5 percent of incurred loss, and ALAE according to a
schedule based on a range of flat-rate fees. Under the credibility
weighting approach, FEMA would no longer reimburse ULAE and ALAE
separately using these different methods. Instead, FEMA would use one
new fee schedule (modeled after the current ALAE schedule) to determine
reimbursements for both. Because FEMA would use the same reimbursement
schedule for both, it would no longer need to differentiate between
ULAE and ALAE; as such, this new fee schedule would depict the overall
LAE payment rate. FEMA's reimbursement for SALAE would remain unchanged
because FEMA currently pays for SALAE on a dollar-for-dollar
reimbursement basis, and would continue to do so.
FEMA would revise this LAE fee schedule annually to minimize the
difference from year to year between actual LAE that WYO companies
incur as reported by NAIC and what FEMA pays to cover those incurred
expenses. FEMA would minimize this difference by adjusting the previous
annual LAE fee schedule by applying a certain calculated percentage.
FEMA would calculate this percentage by credibility weighting (1) the
payment amounts that FEMA would have made if the most recent LAE fee
schedule had been in place during recent years and (2) the payment
amounts that FEMA would have paid under the current LAE fee schedule,
revised to yield the actual reported LAE expenses for the same period.
In essence, FEMA would incorporate actual reported expenses incurred by
WYO companies by regularly examining the validity of the current LAE
fee schedule and revising that LAE fee schedule using historical LAE
payment experience.
Using this approach, FEMA's preliminary calculations indicate that
LAE under the unified fee schedule in FY 2019 would result in a payment
rate of 7.63 percent of paid losses (the dollar amount of claims paid
by the NFIP), which is a reduction of 0.66 percentage points from the
FY 2019 compensation rate of 8.29 percent under the current LAE
compensation methodology.\21\ This would represent an approximately
$20.28 million decrease in LAE payments to WYO companies in the first
year. Over time, the LAE payment rate would better align with the year-
to-year LAE expenses because FEMA would likely assign an increasing
credibility to the NAIC flood expense data and each year's experience
would inform and improve the next year's rates. FEMA expects an
increase in credibility because of FEMA's ongoing collaboration with
the NAIC to improve data quality and the NAIC's issuance of guidance on
the proper accounting of reimbursements to Write Your Own companies.
FEMA has also improved its monitoring of WYO expenses related to
litigation, see WYO Bulletin W-16045 (July 19, 2016), engineering
inspections, see WYO Bulletins W-15010 (Mar. 9, 2015), and overall
expense reporting, see WYO Bulletin W-16048 (Aug. 4, 2016). See, e.g.,
N.C. Gen. Stat. Sec. 58-2-180 (willful misstatement of information in
certain financial or other statements); Va. Code Ann. Sec. 38.2-2027
(withholding of certain information and giving false or misleading
information to the Commissioner of Insurance, statistical rating
agencies, or any other insurer).
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\21\ As a reference point, the average historical compensation
rate for ALAE and ULAE from 2013-2017 was 6.74 percent of total paid
losses.
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B. Methodology Based Completely on Flood Expense Data
FEMA is also considering a methodology that uses solely actual
flood insurance expense data, meaning it would no longer use industry
expense ratios as part of the calculation. Under this approach, FEMA
would use reported flood expense data to determine reasonable flood
expense payment ratios by dividing previous years' general expenses by
the associated written premium. Setting payment rates entirely on
publicly available expense data collected from the NAIC would likely be
the simplest approach for FEMA to administer, but would depend entirely
on the credibility of flood expense data obtained from the NAIC. While
the credibility of this data continues to improve, it is not likely
fully credible at this time. See GAO-17-36 (Dec. 8, 2016). Any approach
that depends entirely on the use of flood expense data would, at least
in the short term, suffer from the same deficiencies as the current
methodology, in that it would not be an accurate representation of the
actual expenses incurred by WYO companies in carrying out their
obligations under the WYO Program.
Over the long term, this approach could result in payments that
closely align with the actual reported flood expenses. However, relying
solely on flood expense data would very likely result in wide gaps in
what FEMA would pay year-to-year. This is because unlike expenses for
non-flood lines, which tend to be evenly distributed and thus
relatively stable, flooding tends to occur all at one time. Because
flooding is not an evenly distributed hazard, it is difficult to
insure. FEMA could continue its practice of averaging expense data over
5 years in order to smooth sudden changes in expenses. Tailoring
payments to WYO companies to their actual expenses in the long term,
therefore, would place the methodology solely on a self-reported basis,
which is not immune from manipulation and other potential
irregularities. FEMA would be required to rely entirely on data
provided by the NAIC, regardless of its credibility, which, as noted
above, GAO identified as a source of concern.
Based on the current NAIC actual flood expense data, FEMA projects
that the general expense ratio for FY 2019 would be approximately 25.3
percent of written premium (based on preliminary estimates that average
the most recent three years of expense ratios based on self-reported
NAIC data). This would represent approximately a $146.51 million
decrease in general expense payments to WYO companies in FY 2019.
In addition, using this approach, FEMA's preliminary calculations
indicate that LAE under the unified fee schedule in FY 2019 would
result in a payment rate of 5.67 percent of paid losses (the dollar
amount of claims paid by the NFIP), which is a reduction of 2.62
percentage points from the FY 2019 compensation rate of 8.29 percent
under the current LAE compensation methodology in FY 2019.\22\ This
would have represented an approximately
[[Page 32379]]
$81.11 million decrease in LAE payments to WYO companies in FY 2018.
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\22\ As a reference point, the average historical compensation
rate for ALAE and ULAE from 2013-2017 was 6.74 percent of total paid
losses.
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C. Methodology Based on Invoices
In a third possible methodology, FEMA would pay WYO companies on a
direct, invoice-supported, dollar-for-dollar reimbursement basis,
similar to how FEMA currently pays for SALAE. This approach would be
based on the actual expenditures of WYO companies and would allow FEMA
to collect detailed expenditure data. This would give FEMA more
monitoring and control over WYO expenditures while ensuring that
payments directly reflect an individual WYO company's incurred
expenses. It would also avoid the consequences associated with the
year-to-year variability of expenses discussed above. However, this
approach would likely create significant administrative burdens for the
NFIP and WYO companies. FEMA employs several legal and program staff
members in order to oversee current SALAE reimbursements, and an
expansion of direct reimbursements to cover all loss adjustment
expenses would entail expanded cost burdens, given the volume of losses
and the number of claims against which compensation would be tied. The
timely processing of each claim's related expenses from each WYO
company would not be possible given current staff and administrative
capacity of FEMA and as a result, expansion of the reimbursement
concept would likely require hiring numerous new staff members. Without
such an increase in FEMA processing staff, a direct reimbursement
methodology for all LAE expenses would result in reimbursement delays
and disruption to both the policyholders and WYO companies. WYO
companies would likely incur significant additional administrative
expenses.
V. Public Comment
FEMA seeks public comment on all aspects of a revised WYO payment
methodology, with particular interest in better understanding the
implication of the three methodologies described above. FEMA will use
the received comments to inform future rulemaking on the subject.
Comments accompanied by supporting data and analysis of the issues
addressed in those comments would provide the greatest assistance to
FEMA. Additionally, FEMA would derive particular benefit from
commenters addressing one or more of the following questions:
1. What are the limitations with the current WYO expense
compensation methodology that you believe FEMA needs to address in the
revised methodology?
2. What recommendations do you have for improving the current WYO
expense compensation methodology?
3. What credibility weighting procedures should FEMA consider
using, if any?
4. Do the five non-flood property/casualty lines of insurance act
as a good approximation of flood insurance general expenses in the
credibility weighting-based approach? If FEMA continues to use non-
flood property/casualty lines of insurance, what lines should FEMA
consider adding or subtracting from this list?
5. Should FEMA merge payments for ULAE into the existing ALAE fee
schedule so that ULAE payments are better tailored to the severity of a
flood event?
6. Does NAIC flood expense data accurately reflect the actual
expenses incurred by WYO companies? What are the challenges of ensuring
accurate data are provided to the NAIC and how can they best be
overcome?
7. What, if any, alternative data sources can provide WYO company
expense data that are more accurate than what the NAIC captures?
8. What, if any, additional costs would WYO companies incur if
required to submit all NFIP-related expenses for reimbursement as they
are incurred (i.e., the third alternative referenced above)?
9. Does the structure of the current ALAE fee schedule adequately
take into account the differences in incurred expenses between
catastrophic and non-catastrophic loss years?
10. What changes to the current methodology would allow FEMA to
better distinguish between catastrophic and non-catastrophic years in
paying out LAE?
11. What individual characteristics of WYO companies could be used
to better tailor a payment methodology to the actual expenses of
individual companies?
12. What additional data may help FEMA better understand actual
expenses of WYO companies?
Authority: 42 U.S.C. 4081 note.
Pete Gaynor,
Acting Administrator, Federal Emergency Management Agency.
[FR Doc. 2019-14343 Filed 7-5-19; 8:45 am]
BILLING CODE 9111-52-P
