FEMA confirms intention to sponsor NFIP flood cat bond at July 1st

by Artemis on April 4, 2018

The U.S. Federal Emergency Management Agency (FEMA) has confirmed its intention to enter the insurance-linked securities (ILS) market for the first time for a mid-year 2018 transfer of risk from the National Flood Insurance Program (NFIP), to secure capital markets backed source of flood reinsurance using a catastrophe bond.

National Flood Insurance Program logoFEMA has announced that it intends to secure additional reinsurance for the National Flood Insurance Program (NFIP) through a mid-year placement involving ILS investors from the capital markets, as it looks to further expand the role of private markets in managing U.S. flood risk.

This would be the first pure flood catastrophe bond issue, if FEMA is successful in its approach to the cat bond market as its preferred mechanism for transferring risk to the capital markets.

“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,” explained Roy Wright, director of FEMA’s National Flood Insurance Program.

“During 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,” he continued.

Wright had said earlier this year that FEMA would look to place a second reinsurance arrangement at the mid-year point, as we reported at the time, and it was hoped in the market that this could be the first time that FEMA invited the capital markets to participate.

Now that looks a certainty and for the first time there will be participation in NFIP reinsurance program layers by ILS funds and investors.

FEMA placed its first major reinsurance program in January 2017 with a NFIP flood reinsurance arrangement that provided it with $1.024 billion of coverage, supplied by a panel of 25 reinsurers. That layer was fully exhausted and paid out after the devastating impacts of hurricane Harvey in Texas.

FEMA then returned to the reinsurance market at the start of this year, placing an enlarged and restructured $1.46 billion placement, secured from a panel of 28 private market reinsurers.

FEMA said that it will seek to transfer additional risk using the capital markets for the first time through an insurance-linked securities (ILS) transaction, with an expected issuance date of on or around July 1st 2018.

FEMA intends to procure reinsurance, “via a reinsurer that will act as a transformer and transfer flood risk using a 144A catastrophe bond.”

Guy Carpenter’s capital markets unit GC Securities is expected to act as the broker, likely structuring and acting as the bookrunner as well. It’s not known whether any other capital market brokers will assist in that respect.

The use of ILS and the capital markets for transferring flood risk and securing flood reinsurance will add a new “building block” to FEMA’s risk transfer toolkit, the Agency said, meaning it has both the traditional reinsurance markets and the capital markets, with ILS structures, both at its disposal.

Having both traditional and alternative reinsurance capital at its disposal will benefit FEMA significantly as it seeks to further de-risk the National Flood Insurance Program.

A wider, deeper and more liquid pool of capital will be available, while transacting with both markets will also help to create more competition in its reinsurance placements, helping to lower the NFIP’s risk transfer costs.

FEMA would also be able to lock-in capital markets backed reinsurance for at least a three-year term using a catastrophe bond, helping it to secure its reinsurance pricing over a longer horizon.

Additionally, FEMA will have access to the largest amount of risk transfer capacity possible, spread its risk across the most diverse pool of companies and investors, and also open up possibilities to syndicate risk to investors through catastrophe bonds, enabling secondary trading, which can ultimately make the risk transferred more liquid as the flood risk transfer program grows.

The benefits to FEMA of having a capital markets placement, alongside traditional, as it grows its reinsurance program could be significant, as it will provide it with a vehicle to test pricing, find the best recipient markets to transfer different layers of risk to, and add efficiency to the overall program.

FEMA has put out a call for responses from potential reinsurance partners, to act as the transformer reinsurer provider, but also notes that it cannot guarantee a mid-year flood ILS placement will occur, as it will only proceed as long as terms and pricing are attractive to issue the flood ILS deal.

Interestingly, FEMA said it would not say how large a placement could be, but noted that, it is “committed to making a significant placement if market capacity, pricing and other relevant terms are suitable.”

Given the way the catastrophe bond market has begun 2018 and the evidence available from recent pricing and settlement terms, FEMA may find the cat bond market particularly receptive and so this has the potential to become a large flood cat bond deal.

A flood cat bond for the NFIP would be a groundbreaking step in securing the risk transfer support that FEMA needs to significantly de-risk the program and remove a large amount of risk from taxpayers.

The market will no doubt be receptive to such an issuance and it will be interesting to see how the NFIP cat bond deal process is taken forwards.

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