The first flood catastrophe bond, sponsored by the U.S. Federal Emergency Management Agency (FEMA) to transfer risk from the National Flood Insurance Program’s (NFIP) risk to the capital markets, was a “very significant” transaction for the ILS market, according to Fermat Capital Management’s John Seo.
Speaking to Artemis around the Monte Carlo Reinsurance Rendez-vous 2018 in September, Seo discussed the recent groundbreaking flood cat bond deal, highlighting the reasons he sees this as a particularly significant stage in the ILS market’s ongoing evolution.
FEMA secured $500 million of coverage to add to its NFIP flood reinsurance program with the FloodSmart Re Ltd. (Series 2018-1) catastrophe bond transaction and the deal was backed by more than 35 ILS investors and ILS funds.
“You might say flood was the original catastrophe risk. The first private market for insurance to fail due to catastrophe risk was really the flood market, well before the earthquake and hurricane market. And the failure was significant enough that it wasn’t even absorbed at a state level. It was absorbed at a Federal Government level,” Seo explained.
“So for the Federal Government itself to actually be partnering with the ILS market, and embracing it is very significant.”
Seo highlighted the groundbreaking first of the U.S. government turning to the capital markets for risk transfer in this way for the first time.
He continued, “What people don’t understand is we’re not just seeing a development of a market here. We’re seeing a change in deeply seeded attitudes about catastrophe risk and the insurability of flood that are actually very important.”
ILS market experts, including Seo, have long been educating government departments about the benefits of risk transfer and the opportunity that cat bonds and the ILS market presents to federal entities looking to transfer risks away from the taxpayer.
By shifting the risk into the capital markets FEMA reduces the need to apply levies or for the federal government to require taxpayers to help in paying for reconstruction and recovery after flood events. This could easily be applied to other natural perils, where the government holds the risk and the taxpayers acts as the backstop, as well.
“I always felt in the past when flood itself was labelled as so-called uninsurable really what they’re referring to more is the capacity issue. But as we know the proposition of ILS is that potentially even if you took a trillion dollars single event loss, it is diversifiable, because the global capital markets capital base is in excess of $100 trillion,” Seo told Artemis
Adding, “So this catastrophe bond that’s been brought to market and sponsored by FEMA is really significant because it’s going to remind people that ‘of course you can underwrite and you can rate the risk’. You just need to be able to handle large single event risk, like we’re already doing in the hurricane market and like we’re doing in the earthquake market.”