FEMA to Issue First Catastrophe Bond for Flood Insurance Program

By | April 5, 2018

In another step shifting risk to private markets, the Federal Emergency Management Agency (FEMA) said it intends to secure additional reinsurance for the National Flood Insurance Program (NFIP) through issuance of a catastrophe bond.

FEMA began purchasing private reinsurance in 2017 and recovered $1.042 billion from the private markets due to losses from Hurricane Harvey. In early January 2018, FEMA continued the practice by securing $1.46 billion in reinsurance from 28 private reinsurers to cover any qualifying NFIP flood losses in excess of $4 billion per event occurring in calendar year 2018.

FEMA said it now plans to transfer additional risk by engaging the capital markets for the first time through an insurance-linked securities (ILS) transaction on or about July 1, 2018.

Adding this new resource will enable FEMA to transfer risk through two avenues – the traditional reinsurance markets and the capital markets. Wright said that using both markets will create more competition and reduce the NFIP’s risk transfer costs. It will also enable FEMA to access greater market capacity and spread its risk across a more diverse pool of companies and investors, according to the announcement.

“The NFIP requires a stronger financial framework built on expanding our portfolio of actuarially-priced policies. Transferring more of the risk burden to the private capital markets continues to be part of that strategy,” said Roy Wright, director of the NFIP.

Source: FEMA

He noted that in 2017, the second largest loss year in the program’s history, the reinsurance marketplace “came through and supported” the NFIP.

“We expanded the traditional reinsurance cover earlier this year. Now we will continue that risk transfer by tapping the capital markets,” Wright said.

Under the Biggert-Waters Flood Insurance Reform Act of 2012 and Homeowner Flood Insurance Affordability Act of 2014, Congress authorized FEMA to secure reinsurance from the private reinsurance and capital markets to strengthen the financial framework of the NFIP.

FEMA has published a public notice of its intent to pursue the mid-year ILS transaction. Potential reinsurer partners are instructed to contact FEMA by April 6, 2018, to indicate interest in participating and receive additional information.

FEMA said it cannot guarantee that it will complete such an ILS transaction in 2018 and that it will do so “only if it is beneficial to the NFIP.”

Last week FEMA announced that a typical premium charged by the NFIP will rise about eight percent in the coming year, with the estimated average premium going from $866 to $935.

However, according to a Congressional Budget Office (CBO) report issued last fall (National Flood Insurance Program Financial Soundness and Affordability), these latest premium increases are unlikely to be enough to keep the NFIP from eventually falling into the red. That’s because the NFIP’s current approach to setting premiums has underestimated how much its claims will cost by about $1.1 billion and legislated surcharges are about $300 million shy of covering the premium discounts given to certain properties, according to the CBO.

Last October, Congress passed and President Trump signed into law a hurricane and wildfire disaster relief bill that provided $16 billion in debt relief to the NFIP, which was about to run out of money to pay claims from hurricanes because it had reached the $30 billion limit on its ability to borrow form the U.S. Treasury.

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