NFIP flood cat bonds called for in reauthorisation proposal

A newly proposed draft piece of legislation which calls for the National Flood Insurance Program (NFIP) to be reauthorised for a 10 year period also clarifies the authority of the administrator FEMA to issue flood catastrophe bonds.

With the legislation authorising the NFIP coming up for expiry on September 30th 2017 U.S. lawmakers are concentrating on a variety of efforts to both extend the flood insurance program and continue its reforms.

The NFIP currently carries almost $25 billion of debt and due to the short nature of its authorisation, requires reauthorising and extending regularly which heightens uncertainty and creates a legislative burden.

Senators Bill Cassidy, MD (R-LA) and Kristen Gillibrand (D-NY) have published draft legislation to reauthorise the National Flood Insurance Program (NFIP) for a 10 year term, saying that this is “Needed to avoid short-term extensions and program lapses that create uncertainty in both the insurance and housing markets.”

“The National Flood Insurance Program gives essential coverage for many,” Cassidy explained. “This legislation extends this critical program, ensuring that Louisiana families have what they need to recover if ever flooded.”

“New Yorkers deserve the peace of mind that if a storm damages their property, they won’t go bankrupt trying to fix it and that the National Flood Insurance Program will be there to help,” added Gillibrand.

Part of the risk there is the lack of protection that the NFIP has from private markets and the fact that currently its burgeoning debt and risk of major losses sits on the shoulders of the government and ultimately taxpayers.

So the draft legislation calls for a raft of amendments and reforms to make the NFIP more sustainable and to lessen the burden on taxpayers, which include calls for greater private market involvement by lowering barriers to flood risk insurance privatisation, enhanced flood mapping tools to enable better pricing of risk, greater use of reinsurance protection and issuing of insurance-linked securities (ILS) or flood catastrophe bonds to transfer the NFIP’s risk.

Senator’s Cassidy and Gillibrand call for enhancing the NFIP’s solvency and sustainability, through legislation that “Clarifies FEMA’s authority to cede NFIP risk in the capital markets through Insurance-Linked Securities (ILS).”

The legislation would mandate that; “The FEMA Administrator shall annually cede a portion of the flood insurance program’s risk to the private reinsurance and/or capital markets at rates and on terms determined by the Administrator to be reasonable and appropriate, in an amount sufficient to maintain the ability of the program to pay claims and limit the program’s exposure to potential catastrophic losses from extreme events.”

The proposed legislation explicitly tells the FEMA Administrator that they must consider all forms of risk transfer, including ILS and capital market means.

In carrying out its duties to cede a portion of the NFIP’s flood risk to private risk transfer markets annually, the legislation says FEMA must; “Consider all forms of risk transfer, including traditional reinsurance, catastrophe bonds, collateralized reinsurance, resilience bonds, and other insurance-linked securities.”

FEMA’s aim must be to maximise price competition while also diversifying the sources of risk capital available to it, ultimately securing the best value risk transfer for the National Flood Insurance Program.

It’s perhaps the most explicit call to date for the ILS market to play a significant role in helping to de-risk the NFIP.

The Senator’s have clearly spoken to the market to identify that there are a range of options available and that be seeking to transfer risk to the traditional reinsurance and capital market at the same time the best terms may be achieved.

The ILS market, ILS funds and catastrophe bond investors would be extremely keen to participate in the NFIP’s risk transfer program, as long as robust risk modelling is available to provide the clarity of the risks being ceded.

Given the appetite for risk in the capital market and among ILS funds and their investors, if legislation like this could be passed to extend the NFIP, the use of catastrophe bonds to transfer its flood risk could come as quick as next January, when its next reinsurance renewal may occur.

Of course any approach to the ILS market is likely to be smaller to begin with, growing in size over time. But with so much risk in the NFIP, if even a slice of it could be structured into catastrophe bond form it could bring a relatively meaningful new diversifying peril to the ILS market.

Importantly, alongside the calls for greater use of risk transfer and reinsurance capital the legislation also calls for greater efforts in flood mitigation and resiliency, which alongside the use of private markets can help to reduce the risk while also making the private market insurance and reinsurance solutions more affordable.

A 10 year extension under such terms would bring greater stability to the NFIP and give FEMA a chance to significantly downsize it over the term.

With more private market insurance solutions and a growing use of reinsurance and catastrophe bonds to offload flood risk, FEMA could make a significant dent in the NFIP’s risk pool and put more of the risk in the hands of private market experts.

For ILS funds and the global reinsurance industry that would be an opportunity to grow their portfolios of flood insurance risk, while also helping the U.S. government to solve a problem that weighs on its taxpayers.

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