[Federal Register Volume 64, Number 98 (Friday, May 21, 1999)]
[Rules and Regulations]
[Pages 27705-27709]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 99-12930]
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FEDERAL EMERGENCY MANAGEMENT AGENCY
44 CFR Part 62
RIN 3067-AC92
National Flood Insurance Program (NFIP); Determining the Write-
Your-Own Expense Allowance
AGENCY: Federal Emergency Management Agency (FEMA).
ACTION: Final rule.
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SUMMARY: We (FEMA) are changing our method for establishing the Write-
Your-Own (WYO) expense allowance percentage for years beginning on or
after October 1, 1999. We will use a new formula to derive the expense
ratios in determining the operating portion of the expense allowance.
This formula will use direct, as opposed to net, premium and expense
information for the property/casualty industry and will have the effect
of lowering the expense allowance. However, during arrangement year
1999-2000 only we will set the expense allowance at the mid-point
between the expense allowance calculated using direct as opposed to net
premium and expense information.
EFFECTIVE DATE: This rule is effective on October 1, 1999.
FOR FURTHER INFORMATION CONTACT: Edward T. Pasterick, Federal Emergency
Management Agency, Federal Insurance Administration, 500 C Street SW.,
room 429, Washington, DC 20472, 202-646-3443, (facsimile) 202-646-3445,
or (email) edward.pasterick@fema.gov. We will post at www.fema.gov/nfip
the text of the 1999-2000 Arrangement by June 1, 1999.
SUPPLEMENTARY INFORMATION: On November 13, 1998, we proposed a rule at
63 FR 63432 that would change the method for establishing the Write
Your Own (WYO) expense allowance percentage for arrangement years
beginning on or after October 1, 1999. We proposed using a new formula
to derive the expense ratios used in determining the operating portion
of the expense allowance. This new formula would use direct, as opposed
to net, premium and expense information for the property and casualty
industry. It would have the effect of lowering the expense allowance to
participating companies.
On Tuesday, February 9, 1999, we held a public meeting to discuss
the proposed rule and other changes to the WYO expense allowance that
were published in an advance notice of proposed rulemaking at 63 FR
63431, November 13, 1998. Nineteen people representing fourteen WYO
companies and vendors attended this meeting. Most of the comments made
at the public meeting duplicated the written comments submitted in
response to the notice of proposed rulemaking. This Supplementary
Information also discusses new comments made at that meeting.
General Comments
Concerns about reduced WYO company compensation. During the comment
period, we received comments from ten WYO companies that opposed
reducing the WYO expense allowance. The companies agreed that it is
reasonable to use direct rather than net
[[Page 27706]]
data in order to establish the expense allowance percentage, but the
overarching concern of the companies was that such a change would
reduce company compensation. In every case where a commenter cited the
differences or complexities of writing flood insurance, the underlying
concern was not that we are creating a further complexity with this
rule but that reducing the expense allowance will reduce profits. None
of the companies, however, provided any data to support the assertion
that their operating costs have increased during the fifteen years of
operation of the WYO program. Nor has the WYO program ever guaranteed
any set profit margin for participating companies.
We want to continue the same basic approach that we have used for
more than 15 years. That is, we will continue to use published
property/casualty industry expense information to derive flood
insurance expense allowances. But we base our new formula on
statistical data that were not available fifteen years ago when we
established the compensation formula, that is, direct versus net
premium.
Direct versus net premium. Our use of direct rather than net
premium more accurately than before reflects the unique nature of the
flood insurance partnership between the Government and industry where
we assume liability for flood losses, and companies do not have to
incur costs for reinsurance. A number of companies that commented on
the proposed change agreed that this is a logical approach. At issue
are the specifics of the formula we use to set compensation for
participating companies.
We believe that continuing to use net rather than direct premium
for the property/casualty industry as basis for compensation would
neglect more refined data now available to us and would also include
components that do not apply to the NFIP. Fifteen years ago, the
Insurance Expense Exhibit for the property and casualty insurers did
not provide direct premium and expense information comparable to what
is available today in Aggregates and Averages. The result was that we
calculated an expense allowance that all found in the early days of the
program to be reasonable and acceptable.
Information on direct premiums, however, provides a superior
indicator for computing the expense ratio. Direct premiums written
represent the aggregate amount of recorded, originated premiums--other
than reinsurance--written during a year after deducting all return
premiums. Net premiums written include direct premiums written plus
reinsurance assumed, less reinsurance ceded.
Reinsurance is not, however, a part of the WYO company's flood
business because the Federal Government assumes liability for all
losses. Therefore, the expense allowance should not include reinsurance
in the calculation of the expense ratio. Using net premium has the
effect of including non-applicable reinsurance costs and has had the
effect of providing a WYO company with a level of compensation that is
too high, one that we can no longer justify. This rule appropriately
changes the basis for compensating companies and is adequate to
compensate companies for doing business under the NFIP.
Final Decision on Compensation for Arrangement Year 1999-2000
At the February 9, 1999 public meeting, several companies asked us
not to implement a change in the compensation formula from October 1,
1999 to October 1, 2000 before we study the change in more detail. We
do not believe such a study is necessary. The WYO companies agreed that
using direct as opposed to net data published by A.M. Best is
reasonable. We recognize that any decrease in compensation will require
adjustments by the WYO companies. Therefore, we have decided to provide
a transition phase before the change we proposed on November 13, 1998
becomes effective.
As an accommodation, we will set the WYO expense allowance for FY
2000, which begins on October 1, 1999, at the mid-point between the
expense allowance calculated using direct premium and expense
information and the expense allowance calculated using net premium and
expense information. This will give the companies a one-year adjustment
period before they implement the new method for calculating the expense
allowance.
For the 1999-2000 arrangement year, the midpoint is 31.7 percent,
which compares with the base allowance for the current arrangement year
of 31.6 percent. For FY 2001, beginning October 1, 2000, we will
calculate the WYO expense allowance using direct premium and expense
information.
We are working with the WYO companies to develop new incentives for
rewarding companies' marketing efforts. These incentives will be in
addition to the basic WYO expense allowance described above. We intend
to put these new incentives in place on October 1, 1999.
Specific Comments
During the comment period, a number of Write-Your-Own companies
submitted comments for consideration. We believe that we have addressed
many of the underlying concerns of the commenters in the light of the
accommodation we are making with this final rule. Since these comments
comprise the public record on this rulemaking action, we state our
position on these comments.
No ``Built-In'' Profits
Five companies expressed concerns that the proposed change in the
expense allowance has no ``built-in'' profit margin for flood business
and that companies may not accrue and retain interest on investment
income--a potential source of profit. During the fifteen years of the
WYO program, the expense allowance has never included a specific profit
component in the expense allowance for participating companies. There
is, however, an implicit profit margin because the program draws
insurers whose costs are below the expense allowance. Hence, they earn
a profit.
Also, private WYO participants, appropriately, may not retain
interest on their flood premium income. WYO companies participate in
the program without risk, that is, the Arrangement guarantees
reimbursement for all loss payments. The ability to earn a return on
invested premiums to pay for losses in other lines of insurance is not
a consideration in flood insurance. The proposed change in the expense
allowance does not affect that long-standing and appropriate
restriction.
Commissions
One company believed that company profits decrease as companies
compete for business by offering higher commissions as an incentive to
attract agents. We have always maintained that what a company chooses
to compensate agents is a matter between the company and the agent. We
believe that fifteen percent is a reasonable compensation figure for
agent commissions, which we account for in the expense allowance;
however, if a company chooses to increase its commission as a business
incentive, then that is the company's prerogative.
Reduced Expense Allowance May Reduce the Number of Participants
Five companies expressed concern that a reduction in the expense
allowance will hurt the WYO program-- marginal companies will withdraw
and new companies will balk at joining the program. The result, these
companies
[[Page 27707]]
believe, will be more business on the direct side and less growth in
policies. One of our goals is to encourage insurers to participate and
at the same time to hold the line on program costs which policyholders
and taxpayers bear. But as with any industry, when competition
increases, marginal participants may withdraw and new entrants can
expect less profit. We do not believe that this is necessarily a
negative consequence. We are also confident in our cost data, and we do
not believe that the reduction in the expense allowance will cause
withdrawals from the program by successful companies.
Reduced Expense Allowance May Result in Poor Customer and Agent
Service
Two companies believed that the proposed reduction in the expense
allowance could lead to a deterioration of services to policyholders
and agents. We strongly disagree with this position. The expense
allowance accounts for the costs needed to provide and maintain
adequate services to NFIP policyholders and a profit for efficient
companies.
Inherent Differences Between Flood Insurance and Other Lines
Eight companies said that the ``flood product'' is essentially
different from other property/casualty insurance products because of
the complexity in writing flood insurance. The companies claim that
these complexities, for example, identifying risks ineligible for flood
insurance under the Coastal Barrier Resources Act, increase costs.
There are clearly differences between flood insurance and other lines
of property and casualty insurance. Therefore, we believe that the five
lines of property/casualty insurance that we have been using are still
the best proxy for compensating WYO companies. But we also believe that
using direct rather than net premium data will provide WYO companies
with adequate compensation for their costs.
Flood Insurance Rating
Five companies also highlighted the difference in rating
methodology for flood and for other lines of property and casualty
insurance. The companies cited as an example flood maps, which they
called ``antiquated.'' The companies also expressed concern over the
use of ``non-standard'' forms such as the elevation certificate in the
underwriting process. Because of these complexities, several of these
companies have obtained the services of third parties to determine the
flood zone on FEMA's maps for rating flood insurance policies. The
companies expressed concern that these costs are not reimbursable under
the program. While we do not reimburse companies specifically for
outsourcing flood work, the method of determining the expense allowance
by this rule is adequate to cover these costs.
Agent Training and Education
Several companies also expressed concern that agents find the flood
insurance program complicated, which complexity creates a demand for
training. Training of company agents is the primary responsibility of
the company, and the expense allowance accounts for the expenses of a
WYO company to train its agents. Still, we have made a commitment to
help WYO companies with their agent training in the past, and we will
continue to do so in the future. By the end of the current arrangement
year, we will have conducted 150 workshops for insurance agents
interested in selling flood insurance. The workshops are open not only
to independent agents but also the agents of our WYO partners. We plan
to hold the same number of workshops for agents next year as well. We
have also helped participating companies develop training delivery
systems of their own by conducting, upon request, train-the-trainer
sessions on the NFIP for company trainers. To give agents immediate
access to underwriting and rating information about the NFIP, we
provide on our web site (www.fema.gov/nfip):
The flood insurance manual,
Underwriting information,
A list of WYO companies,
Dates and locations of agents workshops, and
Other program information.
Statistical Reporting
Four companies expressed concern that the WYO program requires
monthly statistical reporting whereas other lines of property and
casualty insurance only require statistical reporting on a quarterly
basis. This point is accurate. Most other lines require statistical
reporting on a quarterly basis. Even so, the WYO program has been
requiring statistical reporting on a monthly basis for fifteen years,
and the method of setting the expense allowance under this rule is
adequate to cover reporting costs as well.
Unique Adjuster Skills
Four companies also pointed out that handling flood claims requires
unique adjuster skills with the adjusters certified by the Federal
Government. This is also accurate. Adjusters handling flood claims
under the Write Your Own program have, for fifteen years, needed
special training and certification to adjust flood claims. Reducing the
expense allowance does not affect this aspect of a company's
participation in the WYO program. Training adjusters is a cost
necessary to do business under the flood insurance program, a cost that
we have taken into consideration in setting the expense allowance.
Higher Company Costs
Two companies commented that we used to provide forms, the flood
insurance policy, manuals, and seminars free of charge to WYO
companies. Companies must now cover the nominal costs to produce these
materials and conduct training at their own expense. We recognize that
companies are now paying for some products that were free; however, the
general expense category of the WYO expense allowance compensates
companies for these and other costs of selling and servicing flood
insurance. Providing companies with free materials was for companies a
further enrichment that we can no longer justify.
Acceptable Error and Reject Rates
Two companies expressed concern that maintaining acceptable error
and reject levels is costly. Company systems, they claimed, for
standard property and casualty processing, do not lend themselves to
handling flood business. Therefore, many companies either outsource
this part of their flood business or develop stand-alone systems. This
is accurate. But again outsourcing or operating stand-alone systems is
no different today than it has been for fifteen years since the start
of the WYO program. Outsourcing or developing stand-alone systems is a
cost of doing business under the program, a cost that participating
companies willingly assume when they choose to join the program.
Audits
Two companies expressed concern that the WYO program requires an
independent audit at the expense of the company. First, we always have
required such an independent audit at the company's expense under this
program. It is nothing new. In addition, independent audits of
companies' financial statements are not a unique requirement of the
flood insurance program. Any publicly traded company requires
accountability to its shareholders in the form of financial statements
that are subject to independent audits. Annual statements by insurance
companies to the National Association of Insurance Commissioners are
also subject to an independent audit.
[[Page 27708]]
Program Changes
Four companies expressed concern that frequent program changes
require additional computer programming, new printing and publications,
more training and mailings, as well as more rewriting of policies.
These companies offered no specific data to indicate the relationship
between the program changes and cost increases to implement those
changes. We believe our data, which justify a lower expense allowance,
take into consideration systems and other program changes that
participating companies must make each year.
Reducing Expenses
One company suggested that we should conduct an analysis of ways to
reduce expenses while improving service to policyholders before
proposing to adjust the expense allowance formula. They contended that
our proposal to reduce the expense allowance failed to consider how to
reduce or eliminate operating costs. The responsibility to hold program
costs to a minimum and to provide the highest service exists apart from
the issue of the expense allowance. We agree that we must provide
improved service at reduced costs, but our purpose in proposing the new
expense allowance formula was to take advantage of data that were not
available when we established the current formula. These new industry
expense data support the proposed reduction in the expense allowance
that, we believe, is adequate to cover companies' operating costs.
Alternative Formula
One company proposed an alternative formula for calculating the
expense allowance. They suggested that we only use cost data for
participating WYO companies rather than data for five property
insurance lines and that we replace the fixed 15 percent commission
allowance in the current formula with the ``Commission & Brokerage''
expense published in A.M. Best. Under their proposal, the ``Commission
& Brokerage'', ``Other Acq.'', ``General Exp.'' and ``Taxes'' would be
combined and the expense allowance would be set at the mean of this
amount plus one standard deviation which, would cover the operating
costs of approximately two-thirds of the companies. The commenter
recognized that companies would have to report their expenses
associated with the NFIP and suggested that this be done on a mandatory
separate statement line on the NAIC Insurance Expense Exhibit. This
company also proposed reporting this information annually and updating
the WYO expense allowance every three years.
We have always favored using published average industry expense
ratios for other acquisition, general expenses and taxes because
neither we nor the WYO companies can affect those ratios. A
disadvantage to the alternative approach to the proposed compensation
formula is that it would impose an additional reporting requirement on
the companies and require the NAIC to change the Insurance Expense
Exhibit. We believe that for 15 years the formula for compensating the
companies has been fair and that we should continue to use it in its
current form based on the best available data.
Adverse Impact on Industry Ratios
One company said that the adverse impact on industry ratios and
ratings, as a result of an insurer's decision to join the WYO program,
should be a factor in determining the expense allowance level. We
recognize that companies must report flood insurance activities on
their financial statements that are used to derive industry ratios and
ratings. However, we believe that a company should evaluate the impacts
that reporting flood business will have on their industry ratios and
ratings before deciding to participate in the WYO program. The effect
of reporting this information will vary significantly among the WYO
companies and is not easily measured. We do not believe the impact on
industry ratios and ratings should be a factor in our compensation to
companies, nor should it be a deterrent to companies participating in
the program.
The Expense Allowance and Marketing Incentives
One company said that the expense allowance should recognize the
marketing goals of the program, that is, to increase the policy base of
the program. Part of that recognition, the company claimed, should
include geographic distribution and retention of policyholders. In
general, the marketing guidelines, which we have and will continue to
develop in close coordination with the companies, address the overall
issue of rewarding a company's growth. We have not included incentives
designed to reward companies for selling and retaining policies in
specific areas of the country because we do not have the data or
indicators needed to target areas of the country for flood insurance
marketing. When we have this capability, we will discuss whether and
how to include geographic based marketing incentives in the
compensation scheme with the WYO companies.
Use of Data Published by A. M. Best
Three companies commented that since 1994 we have not based the
expense allowance solely on data published in A. M. Best's Aggregates
and Averages. As an incentive for companies to increase the number of
flood insurance policies, we set the expense allowance below the amount
indicated by Best's data, and companies had the chance to earn
additional expense allowance. The companies noted that they believed
this was not a true bonus but a penalty if a company did not meet the
marketing goal.
Granted, since 1994, we have not based the expense allowance
strictly on Best's data. We did this because Best's was simply too high
as a basis for company compensation. Beginning in arrangement year
1994-1995, we determined that the exact amount that a company may
retain would be the extent to which the company met its marketing goal
for the arrangement year and this amount could exceed the calculated
amount. For arrangement year 1996-1997, a company could withhold 32.6
percent of written premium. If a company failed to meet its marketing
goal, the percent of retained expense allowance decreased in proportion
to the unmet goal but would not fall below 30.6 percent. If a company
met its marketing goal, it would retain the entire 32.6 percent. If a
company exceeded the goal, the exact amount of compensation depended on
the extent to which the company exceeded its marketing goal, and the
size of the company's flood business in relation to the total number of
WYO policies. We are discussing alternative marketing incentives with
the companies and plan to address this and other concerns in the next
arrangement year.
Company Investments in Flood Business
Four companies commented that they had made investments to simplify
writing flood insurance, which they believed they could recover based
on the current expense allowance. The companies claimed that a reduced
expense allowance would jeopardize this recovery. We have always
encouraged company investments in their flood insurance business, and
we believe that the expense allowance, which this rule implements, is
adequate to cover start-up costs and other operational improvements.
Such investments, when made wisely, result in improvements in
productivity that
[[Page 27709]]
reduce the cost of doing business for a company and ultimately increase
its profits.
Summary
We believe that basing the amount of compensation for companies
participating in the WYO program on a formula using direct rather net
premium simply takes advantage of statistical data unavailable fifteen
years ago when we first established the compensation formula. This also
better reflects the nature of the liability for companies because
companies do not have to pay for reinsurance for their flood business
since the Federal Government assumes the liability for flood losses. We
believe however in the light of both the written comments and the
comments we heard at the February 9, 1999 public hearing that a one-
year transition will serve the interests of the program better. This
transition will give the NFIP's industry partners time to adjust to the
change in how we calculate the level of compensation for participating
in the WYO program. This rule reflects that decision and adjusts the
effective date of the arrangement to coincide with the start of
Arrangement Year 1999-2000.
National Environmental Policy Act
This rule is categorically excluded from the requirements of 44 CFR
Part 10, Environmental Consideration. We have not prepared an
environmental assessment.
Executive Order 12866, Regulatory Planning and Review
This rule is not a significant regulatory action within the meaning
of sec. 2(f) of E.O. 12866 of September 30, 1993, 58 FR 51735, and the
Office of Management and Budget has not reviewed it. Nevertheless, this
rule adheres to the regulatory principles set forth in E.O. 12866.
Paperwork Reduction Act
This rule does not contain a collection of information and is
therefore not subject to the provisions of the Paperwork Reduction Act.
Executive Order 12612, Federalism
This rule involves no policies that have federalism implications
under Executive Order 12612, Federalism, dated October 26, 1987.
Executive Order 12778, Civil Justice Reform
This rule meets the applicable standards of section 2(b)(2) of
Executive Order 12778.
Congressional Review of Agency Rulemaking
We have sent this final rule to the Congress and to the General
Accounting Office under the Congressional Review of Agency Rulemaking
Act, Pub. L. 104-121. The rule is not a ``major rule'' within the
meaning of that Act. It is an administrative action in support of
normal day-to-day activities. It does not result in nor is it likely to
result in an annual effect on the economy of $100,000,000 or more; it
will not result in a major increase in costs or prices for consumers,
individual industries, Federal, State, or local government agencies, or
geographic regions; and it will not have ``significant adverse
effects'' on competition, employment, investment, productivity,
innovation, or on the ability of United States-based enterprises to
compete with foreign-based enterprises. This final rule is exempt (1)
from the requirements of the Regulatory Flexibility Act, and (2) from
the Paperwork Reduction Act. The rule is not an unfunded Federal
mandate within the meaning of the Unfunded Mandates Reform Act of 1995,
Pub. L. 104-4. It does not meet the $100,000,000 threshold of that Act,
and any enforceable duties are imposed as a condition of Federal
assistance or a duty arising from participation in a voluntary Federal
program.
List of Subjects in 44 CFR Part 62
Claims, Flood insurance.
Accordingly, we amend 44 CFR part 62, Appendix A, as follows:
PART 62--SALE OF INSURANCE AND ADJUSTMENT OF CLAIMS
1. The authority citation for part 62 continues to read as follows:
Authority: 42 U.S.C. 4001 et seq.; Reorganization Plan No. 3 of
1978; 43 FR 41943, 3 CFR, 1978 Comp., p. 329; E.O. 12127 of Mar. 31,
1979, 44 FR 19367, 3 CFR, 1979 Comp., p. 376.
2. We revise the Effective Date of Appendix A to part 62 to read as
follows:
Appendix A to Part 62--Federal Emergency Management Agency, Federal
Insurance Administration, Financial Assistance/Subsidy Arrangement
* * * * *
Effective Date: October 1, 1999.
* * * * *
3. We revise the Article III.B of Appendix A to part 62, to read as
follows:
* * * * *
Article III--Loss Costs, Expenses, Expense Reimbursement, and Premium
Refunds
* * * * *
B. The Company may withhold as operating and administrative
expenses, other than agents' or brokers' commissions, an amount from
the Company's written premium on the policies covered by this
Arrangement in reimbursement of all of the Company's marketing,
operating and administrative expenses, except for allocated and
unallocated loss adjustment expenses described in C. of this
article. This amount will equal the sum of the average of industry
expense ratios for ``Other Acq.'', ``Gen. Exp.'' and ``Taxes''
calculated by aggregating premiums and expense amounts for each of
five property coverages using direct, as opposed to net, premium and
expense information to derive weighted average expense ratios. For
this purpose, we (the Federal Insurance Administration) will use
data for the property/casualty industry published, as of March 15 of
the prior Arrangement year, in Part III of the Insurance Expense
Exhibit in A.M. Best Company's Aggregates and Averages for the
following five property coverages: Fire, Allied Lines, Farmowners
Multiple Peril, Homeowners Multiple Peril, and Commercial Multiple
Peril (non-liability portion). During the first year of this
change--arrangement year 1999-2000--which begins October 1, 1999,
the expense allowance is set at the mid-point between the expense
allowance calculated using direct premium and the expense allowance
calculated using net premium.
The Company may retain 15 percent of the Company's written
premium on the policies covered by this Arrangement as the
commission allowance to meet commissions or salaries of their
insurance agents, brokers, or other entities producing qualified
flood insurance applications and other related expenses.
The amount of expense allowance retained by the company may
increase a maximum of 2 percent, depending on the extent to which
the company meets the marketing goals for the Arrangement year
contained in marketing guidelines established pursuant to Article
II.G. We will pay the company the amount of any increase after the
end of the Arrangement year.
The Company, with the consent of the Administrator as to terms
and costs, may use the services of a national rating organization,
licensed under state law, to help us undertake and carry out such
studies and investigations on a community or individual risk basis,
and to determine equitable and accurate estimates of flood insurance
risk premium rates as authorized under the National Flood Insurance
Act of 1968, as amended. We will reimburse the Company for the
charges or fees for such services under the provisions of the WYO
Accounting Procedures Manual.
* * * * *
Dated: May 20, 1999.
Jo Ann Howard,
Federal Insurance Administrator.
[FR Doc. 99-12930 Filed 5-20-99; 8:45 am]
BILLING CODE 6718-03-P
