The U.S. Federal Emergency Management Agency (FEMA) is being urged to explore the use of parametric triggers as well as insurance-linked securities (ILS) to help drive increased insurance penetration for flood and other natural hazards and enable better financed disaster recovery.
With a goal of increasing financial preparedness among both householders and local governments in the United States, FEMA’s National Advisory Council has advised in a report that parametric risk transfer should play a key role.
While FEMA is often best known in insurance and reinsurance circles for the National Flood Insurance Program’s (NFIP), as well as its reinsurance (which is up for renewal as we were the first to report last week) and catastrophe bond program, the Agency is also mandated to promote and facilitate the uptake of all-hazard insurance protection against a much wider range of weather, climate and disaster related perils.
FEMA plays a role in helping individuals, businesses and other entities understand how much insurance they need, of what type and what it means to be adequately covered when disaster strikes.
Affordability is of course an issue when it comes to being fully covered for the wide-range of disaster risks that those in the United States can be exposed to.
So FEMA is being urged to find ways to make risk transfer both more affordable, more suited to the needs of insureds and responsive as well.
The goal is to enable those facing disaster to better support their own recovery from it, part of which is to continue to expand the number of properties covered by flood insurance and continue to build up and then de-risk the NFIP flood insurance pool.
Enter parametric triggers.
FEMA’s National Advisory Council advises that the Agency “look towards a new model of insurance” as a way to further increase risk transfer penetration among households, to increase the number with flood or all-hazards insurance coverage.
FEMA is advised to look to creating all-hazards insurance coverage as one avenue, to broaden offerings in the market, but at the same time to look to parametric insurance triggers as a way to enable a more responsive form of protection for when the worst disasters strike.
In addition, the reduced cost of administering parametric insurance policies could benefit by helping assistance reach those in need more quickly, while payouts can be much more rapidly made.
It’s also expected that the distribution of post-disaster aid and payouts using parametric insurance would be a more cost-effective way to get money into the hands of those in need than FEMA’s own disaster relief efforts.
This is perhaps where the investigations into parametric risk transfer need to be at more than just the policyholder level.
A tiered approach, with parametric triggers utilised across insurance for individuals, businesses, governments and FEMA itself (for its disaster response, relief and recovery needs) could be a much more robust and responsive system of protection.
Under-insurance is a real issue when disasters strike, even in developed economies such as the United States. Hence FEMA is being urged to play a greater role in education and provision of insurance products that can help communities to recover.
Community level risk transfer is also in scope of these recommendations, with FEMA told that it can help to shift the post-disaster assistance burden away from communities and local governments by, “having the ability for communities to purchase an overarching parametric policy to cover their citizens.”
FEMA is advised to work with industry groups to leverage the opportunity in parametric risk transfer right now and expand the reach and remit of parametric insurance.
“When added to the ubiquitous nature of smartphones and other levels of connectivity, the opportunity for expanding parametric insurance protection to individual households may merely be a matter of connecting the dots, for which FEMA is uniquely placed to lead this effort,” the NAC report explains.
There is also a role for the capital markets and insurance-linked securities (ILS), outside of the NFIP flood catastrophe bonds that are already a feature of the market.
FEMA is urged to stress test state level insurance guaranty funds to establish just how ready and able to respond to large-scale disaster they actually are.
This work, as well as helping to determine the size of the protection gap and how prepared the nation is for disasters, can also help to catalyse private market interest in the risks, the report states.
This may help to stimulate private market appetite to make use of solutions such as parametric programs, catastrophe bonds and other insurance-linked securities as a way to increase the financial resilience of state and local government and community organisations.
As stated above, a tiered approach to this could be particularly effective, as ILS or catastrophe bond instruments could provide the necessary risk capital to enable the roll-out of parametric insurance programs for U.S. homeowners and businesses.
Utilising the same trigger inputs this layered approach could help to ensure that the capital and capacity is there to enable these protection gaps to be closed, while helping FEMA to increase uptake of flood and all-hazards insurance, and providing financial protection to state and local government actors as well.
The result would be a much higher level of disaster resilience, as well as a much more responsive form of financial protection.
It will be interesting to see where these recommendations go. It’s clear that parametric risk transfer is gaining adoption right now and if it was integrated into the disaster risk financing plans of countries like the U.S. the demand for capacity could increase significantly, providing opportunities for the capital markets and ILS funds to deliver the necessary support.