FloodSmart Re Ltd. (Series 2018-1)

This new FloodSmart Re 2018-1 catastrophe bond is the awaited first catastrophe bond that will provide reinsurance protection to the National Flood Insurance Program (NFIP) which is administered by the U.S. Federal Emergency Management Agency (FEMA) .

FEMA and the NFIP’s entry into the catastrophe bond market had been expected in July 2017, after FEMA 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 cat bond 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.

Hence this is not a pure flood risk cat bond in the broadest sense, rather it is narrowed to only cover losses to the NFIP from flood events caused by named storms (so tropical storms and hurricanes).

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%.

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.

Update 1:

FEMA’s FloodSmart Re 2018-1 cat bond is understood to have expanded by 82% to $500 million, while pricing has dropped to the bottom of guidance during marketing.

We’re now told that the Class A tranche, with its expected loss of 4.94% has grown by 63% to $325 million in size, while its pricing is set to settle at the bottom end of the marketed 11.25% to 12% range, so is expected to pay investors a coupon of 11.25%.

The Class B tranche, which is the riskier with its expected loss of 6.32%, has grown by 133% to $175 million in size and its pricing has now been fixed again at the lowest end of the marketed range of 13.5% to 14.25%, so with investors set to receive a coupon of 13.5%.

Update 2:

The FloodSmart Re 2018-1 catastrophe bond issuance was successfully completed at the upsized $500 million and with pricing at the lowest end of guidance.

“Reinsurance is a lynchpin to help strengthen the financial framework of the NFIP,” explained David Maurstad, chief executive of the National Flood Insurance Program. “Engaging capital markets was the logical next step in maturing the NFIP Reinsurance Program in a way that benefits policyholders and taxpayers, and expands the role of the private markets in managing flood risk in the United States.”

The cat bond, which is structured into two tranches, provides FEMA with reinsurance coverage for 3.5% of its losses between an attachment point of $5 billion and exhaustion of $10 billion through the riskier $175 million tranche of Class B notes, and 13% of its losses between $7.5 billion and $10 billion through a $325 million tranche of Class A notes.

FEMA said that it will pay $62 million in premium for the first year of coverage, with the cat bond term running for three years from August 1st 2018 to July 31st 2021.

Added to FEMA’s January 2018 procurement of $1.46 billion of traditional reinsurance coverage from 28 reinsurance companies, the Agency has now transferred $1.96 billion of the NFIP’s flood risk to private markets.

More than 35 capital market investor groups, ILS or cat bond funds, mutual funds and direct investors, invested in the FloodSmart Re cat bond transaction.