FEMA seeks second NFIP flood cat bond with $300m FloodSmart Re 2019

FEMA has returned to the capital markets and ILS investors with a $300 million FloodSmart Re Ltd. (Series 2019-1), seeking support for its second flood catastrophe bond to transfer risk from the National Flood Insurance Program (NFIP).

The U.S. Federal Emergency Management Agency’s (FEMA) first flood catastrophe bond was successfully issued last July, when the agency secure $500 million of collateralized and capital markets backed reinsurance for its flood insurance Program.

Having been well-received by insurance-linked securities (ILS) funds and investors and continued to engage with them over the following months, FEMA’s administrators of the NFIP are back and seeking to add to the flood reinsurance coverage that ILS markets provide with a second securitized issuance, sources told Artemis this morning.

For its second flood cat bond, FEMA is once again using its Bermuda domiciled special purpose insurance vehicle FloodSmart Re Ltd.

Again, FEMA has enlisted the support of German reinsurance giant Hannover Re, which will be acting as the ceding reinsurer for the transaction through its Irish domiciled entity.

FloodSmart Re Ltd. will seek to issue two tranches of catastrophe bond notes, both of which will be sold to ILS investors with the proceeds used to collateralize the underlying retrocession agreements between it and Hannover Re. Hannover Re ultimately provides the reinsurance coverage to FEMA and its National Flood Insurance Program (NFIP).

This 2019 flood cat bond issuance features a $250 million Class A tranche of Series 2019-1 notes and a $50 million Class B tranche, which are the more risky layer of the issuance.

Both tranches of Flood Smart Re 2019-1 notes will be exposed over a three-year term to qualifying losses from flood events that are caused by named storms, the same covered peril as the 2018 flood cat bond deal.

Coverage is on an indemnity and per-occurrence basis and this cat bond will protect FEMA against certain NFIP losses across the United States, Puerto Rico, U.S. Virgin Islands and D.C., we understand.

Covering named storm related flood events only means this is protecting the NFIP against the true peak catastrophe events that it faces, as the largest flood insurance losses in its history have been tropical storm and hurricane linked.

This new FloodSmart 2019 cat bond will sit in a vertical slice of the higher layers of the NFIP’s reinsurance tower, alongside the 2018 cat bond and the two higher layers of FEMA’s 2019 flood reinsurance arrangements.

The proposed $250 million Class A tranche of FloodSmart Re Series 2019-1 notes will sit alongside the highest layer of FEMA’s NFIP reinsurance , we understand. These notes would attach at $8 billion of losses to the NFIP and exhaust at $10 billion, which we’re told give the notes an initial expected loss of 4.15% and attachment probability of 4.93%. This tranche is being offered to investors with coupon guidance in a range from 10.25% to 11.25%, sources said.

The smaller $50 million of Class B notes that FloodSmart Re is proposing to issue will sit alongside the second layer of the NFIP reinsurance program, so attaching at $6 billion of losses and covering up to $8 billion. That gives the notes an initial expected loss of 6.01% and attachment probability of 7.31%, while the coupon guidance is set in a range from 13.5% to 14.5%, we’re told.

In terms of pricing, these ranges are roughly similar to the 2018 cat bond, although have room for pricing to settle very slightly higher it appears.

Given the returns possible from this cat bond these notes are likely to be popular, particularly among the sophisticated cat bond investors and funds who can model flood risk for themselves.

There is plenty of room for the tranches of notes to expand as well, as FEMA could elect to fill out more of its tower with this cat bond if pricing is attractive and investor demand strong.

As with the 2018 deal, flood risk modelling specialists KatRisk LLC are the third-party risk modelling agency, making this the second time KatRisk has been involved in a catastrophe bond transaction.

We’re told a repeat of hurricane Harvey would cause a total loss to the Class B notes of this transaction and around half the Class A tranche would be exposed to losses from a similar sized named storm linked flood event as well.

In addition, we understand the flooding from superstorm Sandy could have triggered the notes, while hurricane Katrina would have resulted in a total loss.

These notes are targeted at the very extreme hurricane and named storm linked flood events where FEMA’s NFIP would face significant losses and typically call on the government and taxpayers for financial support.

By transferring that risk to the ILS market FEMA is better securing the flood insurance program and ensuring its ability to pay flood insurance claims.

FEMA is in the process of reshaping the NFIP, with a new risk based pricing rubric that promises to result in better risk rating and likely enable greater transfer of risk to reinsurance and capital markets in future.

That could enable FEMA to leverage the cat bond market for lower down layers and broader flood related risks, not just from named storms, in years to come.

But by shifting as much of the named storm related flood insurance risks to the reinsurance and capital markets, FEMA is already taking significant steps to protect taxpayers and ensure claims can be paid when disasters strike.

We understand that this FloodSmart Re Ltd. (Series 2019-1) catastrophe bond issuance is targeted for April.

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

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