Earlier this week, National Public Radio and PBS Frontline aired powerful and distressing reports on the state of the National Flood Insurance Program. The programs focused on two key aspects of the National Flood Insurance Program (NFIP) in the wake of Superstorm Sandy: claims handling and insurance company profits.
Watch the PBS Frontline program.
Listen to the NPR story.
I should note at the outset that this issue is not just important to me as a consumer advocate but also because I was the Federal Insurance Administrator and ran the nation’s flood insurance program soon after it was created. We tackled some of these same problems 40 years ago, but over the last few decades they have been allowed to seep back into the system, leading to this deluge of consumer complaints and the opportunistic profiteering by insurers.
One key reminder that should preface any discussion of insurance company practices and profits is that the private insurance companies that sell the bulk of the nation’s NFIP policies bear no risk associated with the coverage. All of the insurance risk is owned by the NFIP (and the American taxpayers); insurance companies are paid to sell and administer the policies and manage the claim process for the government. Insurance companies cannot lose money when flood disasters strike, because they have no skin in the game.
Superstorm Sandy claims
Three years after Sandy many claims still remain unresolved and there have been 1,700 lawsuits filed by storm survivors who believe the insurance companies handling their claims have unfairly and fraudulently lowballed, delayed, or denied them. Because of the outcry, FEMA offered reconsideration to 144,000 homeowners with claims problems. 19,000 have appealed. Almost 80% of the appeals resulted in more money for the homeowners. The review process has already cost FEMA over $100 million.
FEMA is now settling many of the lawsuits. However, about one-third of the settlement money is used to pay the Sandy survivors’ attorneys, who FEMA refuses to pay separately from the claim settlement value. Shockingly, FEMA covers the millions of dollars in that the insurance company lawyers have billed in these cases. As one of the victims put it, “FEMA pays for the lawyers for the insurer that tried to cheat me.” Roy Wright, FEMA’s Director of the flood insurance program, says he “inherited” these “contract stipulations” but that he is “making some specific changes.”
One of the key problems revealed in the NPR/Frontline reporting and the Sandy lawsuits is how fraudulent engineering reports were constructed to justify underpayments or no payment at all. FEMA Director Wright notes that even when the reports describe damage in detail, the insurance company-hired engineers still recommend denying the claim. Alleged pre-existing conditions such as “earth movement” consistently led to denials, even where basements had no cracks before Sandy and major cracks after the storm.
In the NPR/Frontline program, insurance adjusters claim that after Hurricane Katrina insurance company managers got a lot tougher on flood claims, ordering adjusters not to pay certain things that were regularly covered before. Some in the news program suggest that the reason for this about face was that insurers were trying to hold down NFIP payments so the program would not go so deep into the red that Congress terminated it. I think it is more likely that certain insurers have corporate cultures so set to lowball customers that they can’t do the right thing on flood claims from force of habit, even though the insurers have no skin in the game when a claim is paid. If an insurer is systematically underpaying homeowners and other property claims, a sudden flood claim gets the same treatment. The same adjusters are used, the same computer programs are used, and any bias for the insurer creeps into the flood claim process. Insurers also fear setting precedents in paying claims on policy language similar to that in their own homeowners and other property policies.
The second area of focus, and the area that NPR/Frontline discussed extensively with me, is the extent to which the flood program has become a source of outsized profits for the insurance companies that sell and service the policies for FEMA.
In 1999, the Government Accountability Office ordered FEMA to look into the cost of the Write Your Own (WYO) Program under which the private insurers contract with FEMA to service flood insurance policies, with the total risk borne by the taxpayers, not the WYO companies. GAO asked this because it found one-third to two-thirds of premiums that came in went back to the WYO companies and, therefore, that money was not available to pay claims. GAO criticized FEMA for not knowing what the WYO costs and profits were.
WYO companies still take about one-third of the premium today, about $1 billion a year.
Frontline asked Roy Wright how much the profits are for the WYO companies. He answered, “I’ve never looked at the book of business to understand their profits…so you’d need to go specifically to the companies to understand these numbers.”
The insurer representative, Bob Hartwig of III, was also unable to answer (“off the top of my head”) what the profits are. In the program I surmised that “obfuscation” by FEMA and the insurers was helpful to them given the ugliness of the facts.
But through its reporting, NPR/Frontline obtained some data that I analyzed with them. We could calculate what NFIP paid to the WYO companies from public documents related to FEMA accounts and what the insurers paid out as flood-policy expenses from publicly available reports compiled by the National Association of Insurance Commissioners. We calculated the pre-tax profits for the WYO companies for 2011 to 2014, averaged about 29% of the fees they received, a whopping $317 million a year!
Even worse, when Sandy claims were paid, since the WYOs receive income from handling claims, the profit for 2013 soared to $406 million! Just when the taxpayers were being asked to fund billions of program shortfalls and Sandy survivors were facing denials and lowball settlement offers, the WYO companies, as I put it on the program, “made a killing” through this “a sweetheart deal.”
FEMA’s Roy Wright, when confronted with these profits, said, “As I go back and look, while we were providing oversight, it was not enough.” This has to be in the running for understatement of the year.
GAO is now examining the profits. FEMA is also investigating.
FEMA also announced reforms to both the claims process and the WYO program costs. As reported in the Asbury Park Press:
- FEMA has proposed to re-do its contract with the private insurance companies that offer flood policies…This will allow FEMA to re-examine and potentially re-negotiate the contract, while increasing oversight of private insurers, Wright said.
- FEMA has redesigned the appeals process for policyholders who are not satisfied with the amount they receive in their initial flood claim. The new process, scheduled to take effect later this year, will allow those who appeal their flood claims to have access to their files and to get information that outlines the basis for the final decision on their claim. “I found the former process to lack credibility,” Wright said. Sandy victims have repeatedly complained that they have been kept in the dark about the methodology used to resolve flood claims. FEMA will also create an oversight team to oversee all costs involved when private insurers are sued for flood-related claims. Sandy victims have complained that since FEMA pays all litigation costs associated with disputed claims on policies issued by the private insurers, the companies have no incentive to quickly settle the suits.
All these sudden changes now underway at FEMA show the power and accuracy of Frontline’s work. But, the insurers are clever and can wait out the news and still win (as they did after the GAO called for FEMA review of profit several years ago). We must stay vigilant!
 During the program III’s Hartwig tweeted that the pre-tax profits should be reduced by 35% to reflect the federal tax rate. In fact, since this is a retrospective review, if we were to reflect other items the proper tax rate to use is not the nominal rate but the observed rate. For the years in question, the tax rate observed for these insurers was 15%, not 35%. We would also have to reflect investment income. If we did that, the $406 million pre-tax return would fall to about $350 million in after tax profit in 2013. The 29% pre-tax return on fees for the 4 years would fall to about 25% after tax. This is for providing a service with zero downside risk. According to Best’s Aggregates and Averages, the entire property-casualty insurance industry’s pre-tax return for those 4 years was 9.5%, with taking risk. Under the FEMA deal, the profit is three times the normal industry profit.
 I did some further research using the FEMA data NPR/Frontline obtained. This data set identified the fees paid to each carrier, including the Direct Servicing Agent, a contractor selected after competitive bids. From 2004 to 2014, the payments as a percentage of premium written for WYO companies was 39.9%. The Direct Servicing Agent percentage was 17.9%. In other words, the contractor doing the same work as the WYO insurers could function at an acceptable profit for less than half of what the WYOs were getting out of each premium dollar they collected. This is more evidence that excessive profits are going to the WYOs.