FEMA’s first NFIP flood cat bond launches, a $275m FloodSmart Re 2018

by Artemis on July 16, 2018

The U.S. Federal Emergency Management Agency (FEMA) has launched its awaited first catastrophe bond to transfer risk from the National Flood Insurance Program (NFIP) to the capital markets and is seeking $275 million of reinsurance protection from a FloodSmart Re Ltd. (Series 2018-1) issuance.

National Flood Insurance Program logoFloodSmart Re Ltd., a Bermuda domiciled special purpose insurance vehicle, will seek to issue two tranches of notes that will be sold to ILS funds and ILS investors to collateralize underlying reinsurance agreements to benefit FEMA and cover a portion of the National Flood Insurance Program (NFIP) U.S. flood exposure.

FloodSmart Re will be the first catastrophe bond to solely provide reinsurance coverage for flood risks, another first for the cat bond market in this busy year.

But the resulting reinsurance will only cover FEMA and the NFIP’s exposure to flood events caused by U.S. named storms, so it is not a broad flood coverage, but this will likely help to make it more palatable to cat bond investors given their comfort with modelling the probability of named storms, tropical storms and hurricanes.

FEMA and the NFIP’s entry into the catastrophe bond market had been expected this month, after the Agency said that it would look to tap the capital markets and ILS fund investors in July 2018, adding to and diversifying its already growing reinsurance program arrangements.

FloodSmart Re Ltd. is the result, the first U.S. flood cat bond and FEMA’s first foray into the ILS market for reinsurance protection for the NFIP flood insurance book.

With FloodSmart Re Ltd. we’re told that FEMA is seeking minimally $275 million of reinsurance protection from the capital markets and ILS investors, through the issuance of two tranches of notes by Bermuda domiciled special purpose vehicle FloodSmart Re Ltd., both of which will be exposed to flood events in the United States that result from named storms.

Being a U.S. government agency FEMA likely found it hard to face off directly with the SPI, hence Hannover Re is acting as the ceding reinsurance firm for the transaction, fronting the coverage for the NFIP.

So FEMA and the NFIP will be reinsured by Hannover Re, which will in turn enter into retrocession agreements with FloodSmart Re Ltd., with those agreements being fully collateralized by the proceeds of the issuance and sale of the two tranches of catastrophe bond notes.

We understand that the two cat bond tranches will sit partially alongside the $1.46 billion of private reinsurance that FEMA purchased at January 1st 2018, but will also extend further up into the tower as well, taking a share of losses within a layer that attaches at $5 billion of NFIP losses and extends up to $10 billion.

It will be interesting to see whether FEMA would take the chance to fill more of that layer if the appetite from ILS investors was sufficiently strong for this first flood cat bond deal to upsize beyond the marketed $275 million.

FloodSmart Re Ltd. will provide FEMA and the NFIP with a three-year source of reinsurance protection, making the cat bond the first multi-year flood reinsurance protection that the Agency will have purchased.

The reinsurance protection afforded through the FloodSmart Re cat bonds will be on a per-occurrence basis and the transaction utilises an indemnity trigger, we’re told.

The transaction will cover FEMA against NFIP losses from flood events that are directly or indirectly caused by a named storm event impacting the United States and also Puerto Rico, U.S.  Virgin Islands and District of Columbia.

FloodSmart Re Ltd. will issue two tranches of Series 2018-1 notes that will be sold to qualifying investors.

The first is being marketed as a $200 million Class A tranche that would attach at $7.5 billion of losses, covering a percentage up to $10 billion. This Class A tranche has an initial attachment probability of 6.04%, expected loss of 4.94% and is being offered to investors with price guidance in a range from 11.25% to 12%, we understand.

The second is marketed as a $75 million Class B tranche, which would attach at losses above $5 billion and cover a percentage up to $10 billion, giving the notes an initial attachment probability of 9.68%, expected loss of 6.32% and this tranche is offered to investors with price guidance for a coupon in a range from 13.5% to 14.25%.

Both tranches of notes will certainly be attractive to ILS funds and cat bond investors seeking higher returning opportunities, as anything with a double-digit coupon and above is less frequently seen in the cat bond market.

Another first for this FloodSmart Re cat bond is the risk modelling agent, as this service is to be provided by flood risk modelling specialists KatRisk LLC. This is the first time KatRisk has been involved in a catastrophe bond transaction, as far as we are aware.

So this FloodSmart Re cat bond has been designed to provide reinsurance protection to the NFIP and FEMA after major named storm related flooding events, such as those seen with hurricane Katrina, last year’s hurricane Harvey and superstorm Sandy.

As we understand, a repeat of Katrina would result in a total loss for the FloodSmart Re cat bond investors, where as a repeat of Harvey or Sandy would erode the principal of both tranches but not cause a total payout.

As flooding from named storms can take time to develop, sometimes after a hurricane or tropical storm has technically dissipated, the terms of the cat bond mean that flood insurance losses will be covered for up to 504 hours after the event date, we’re told.

Another point to note is that the named storm related flooding can be from either storm surge or rainfall.

FloodSmart Re Ltd. will provide FEMA with broad reinsurance protection for the NFIP against named storm risks then, as it is surge and rainfall that cause its policies to pay out, given it does not cover property damage from anything other than water.

It’s a good test case for the ILS markets appetite for flood risks and another example of the capital markets being ready to offer robust coverage to government agencies that hold significant financial risks.

We understand that issuance of the FloodSmart Re Ltd. (Series 2018-1) catastrophe bond is set to be completed before the end of this month.

We’ll keep you updated as and when further information becomes available on the first FEMA and NFIP cat bond and you can read about this and every other catastrophe bond transaction in the Artemis Deal Directory.

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