Bill calls on California to use re/insurance, ILS & ART for natural disasters

A bill has been introduced that if enacted would authorise the California Governor, Insurance Commissioner, and Treasurer to purchase insurance, reinsurance insurance-linked securities (ILS) or other alternative risk transfer (ART) products to help pay costs resulting from natural disasters.

California is of course particularly exposed to major earthquake events, but it is since the two years of devastating wildfires that the conversation on disaster risk financing has moved forwards sufficiently to result in a bill calling on the State to better protect its finances and its citizens by transferring some of its disaster risks.

SB 290 has been introduced to the California legislature and if passed could result in the State becoming a purchaser of ILS or catastrophe bonds to hedge some of its exposure to losses from disaster events including earthquake, wildfires and flooding.

The bill states that on approval it would, “Authorize the Governor to purchase insurance, reinsurance, insurance linked securities, or other related alternative risk-transfer products for the State of California to help mitigate against costs incurred by the state in response to a natural disaster, including, but not limited to, an earthquake, wildfire, or flood.”

The California Office of Emergency Services, or another agency designated by the Governor, would be required to work with the Treasurer and the Insurance Commissioner in determining the best risk transfer tools to use, to transfer its disaster risk to private market participants.

There have been a number of moves to mandate disaster risk transfer and financing for perils such as flooding in the United States, as well as broader legislation that would mandate the country to acquire disaster insurance for broader means.

But, aside from the use of reinsurance and catastrophe bonds by FEMA to underpin and transfer risks from the National Flood Insurance Program (NFIP), many of these efforts have failed to get through the twin-houses of the legislative.

But a state looking to better protect its citizens likely has much more chance of getting a bill through, particularly when this state has been so badly impacted by two years of wildfire destruction and also flooding and landslides in recent years as well.

Commenting on the bill, Senator Bill Dodd, D-Napa, said, “Rising wildfire suppression costs can strain California’s financial resources and threaten cuts to critical programs. As climate change continues to contribute to devastating infernos, we need a strategy to reduce the pressure on state and community coffers. This bill would do just that, allowing the state to invest in an insurance policy to ensure budget predictability and reduce taxpayers’ exposure to increasing costs associated with disasters, especially wildfires.”

“In seven of the last ten years, our firefighting costs have exceeded our budget projections—by more than $450 million in 2017 alone,” added Insurance Commissioner Ricardo Lara. “California Disaster Insurance is a better solution that gives taxpayers the benefit of predictable costs, so we can invest in a safer future. As we confront destructive climate-drive events, we need to be open to new models that reduce risk to our communities and budgets. California Disaster Insurance is our first response.”

“This policy makes annual wildfire suppression costs more predictable, protecting the taxpayers from the volatility that has been seen over the past several years and creating budget stability and preserving other investments,” stated State Treasurer Fiona Ma. “It is time for California to be proactive and not reactive.”

Unsurprisingly the wildfires are the focus it seems, but California would also be wise to secure some disaster insurance provisions for earthquakes as well, given the potential for damage in the state.

California spent $947 million in 2017-18 through its emergency fund for firefighting, over $450 million more than had been budgeted.

The state could have secured a significant proportion of that through insurance, reinsurance and ILS markets it would seem, taking the liability for the costs away from its taxpayers.

For an earthquake the costs would be significantly higher, as infrastructure damage would largely come down to the state to pay for.

Hence transferring as much of this risk to the capital markets and re/insurers would make perfect sense and now is an ideal time to plan to do so.

The ILS market and catastrophe bond investors are very familiar with California and wider U.S. earthquake risks, which currently makes up a significant percentage of the outstanding cat bond market.

As a result, if this bill passes and becomes part of the California Government Code, there is a good chance we could see the state looking to the capital markets to fill some of its disaster risk transfer and financing needs.

The bottom-line is that with disaster costs rising, potentially increasing severe weather trends, and at the same time financial exposures ballooning due to economic growth, local, regional and national governments should all be considering insurance and risk transfer for their natural disaster and severe weather risks.

Taking some of the financial risks associated with disaster away from taxpayers and the public purse can deliver benefits to any state entity, enhancing their resiliance and ability to respond when the worst happens.

With the appetites of re/insurance and ILS markets strong for assuming new risks, the timing could also be right for a state like California to enter the market and any transactions would likely be well-received.