NFIP extension could see more U.S. flood risk move to private reinsurance markets

At the end of last week the two U.S. houses of Congress passed a bill which will see the National Flood Insurance Program (NFIP) officially extended for another five years with some reforms enacted to it as well. The reforms do not go as far as many had wanted but along with the extension this will see more emphasis on passing flood risk away from tax payer funded loans from the Treasury to the private risk transfer markets such as reinsurance.

The successful extension of the NFIP for five years, contained in a transportation funding bill which was approved on Friday, will please a lot of people who feared that the scheme could disappear as different levels of reform were argued without any signs of consensus being reached. This extension see’s a number of reforms come into place which will put the emphasis on the NFIP getting its house in order and dealing with the close to $18 billion debt to the Treasury it was left with after the 2005 hurricane season and a number of other large flood events.

The bill allows for some rate rises over the next five years for certain flood exposed properties, with annual rate rises now allowed to be as much as 20% until they hit actuarially indicated levels, so in other words until premiums are at levels in line with the risk properties face. This will help the NFIP to better fund itself although also seeing a greater level of dollar risk being assumed.

To deal with the risk being assumed the bill will require the NFIP to update its flood insurance rate maps, build a flood catastrophe reserve for large flood events and reiterates requests that FEMA investigate increasing its use of private reinsurance and risk transfer instruments such as catastrophe bonds to ensure it has the claims paying ability to deal with large events. This it is hoped will reduce the NFIP’s reliance on the taxpayer and eventually see more risk moving into the private reinsurance and capital markets where it can better be dealt with. The bill specifically asks the NFIP to obtain details of quotes and rates for private reinsurance options which are available to it within the next year.

A study must be undertaken by FEMA to look at moving the NFIP towards a privatised structure and the use of reinsurance and catastrophe bonds will likely play a big part in the affordability of this. For the NFIP to become a private entity it will have to be able to acquire sufficient reinsurance coverage and that may not be available from the traditional reinsurance market alone meaning that cat bonds and other collateralized reinsurance structures will have a role to play in providing capacity.

The bill also states that lenders must accept non-NFIP flood insurance, so provided by the private insurance market, as long as its coverage meets all the same requirements as an NFIP policy. This could allow insurers back into the U.S. flood market and given that the NFIP will be raising rates private insurers may find it a sector that it becomes viable to operate in again.

So while this bill has not gone as far in reforming the NFIP as many wanted it does provide the foundations for the flood insurance market to become more competitive and for it to reduce its reliance on the government and taxpayers. Instruments such as catastrophe bonds will likely come under scrutiny to see whether they can provide additional reinsurance capacity so capital markets investors may yet see a U.S. flood cat bond and get the opportunity to invest in a new diversifying risk. Of course for cat bond investors the structure of any flood cat bond will be vital as they will want to understand how flood risk will be correlated with other perils issued in cat bonds such as hurricane, wind storm and thunderstorm risks. For flood cat bonds to succeed in the U.S. they may have to be parametrically linked to rainfall or river levels we’d imagine. At the very least, the market can now get involved in any studies which take place and give their opinion to the NFIP and FEMA on the best way that the cat bond market could assist with flood risk transfer.