Sandy highlights need for private flood risk transfer via catastrophe bonds again


Once again a northeast U.S. hurricane has been a major flood catastrophe event. This happened last year with hurricane Irene which saw the U.S. National Flood Insurance Program, pick up a significant portion of the economic losses from the storm. It’s expected that this will also happen with Sandy and this has once again highlighted the need for the NFIP to cede risk to the private reinsurance and risk transfer markets, with catastrophe bonds one potential tool at their disposal.

The NFIP provides flood insurance coverage to somewhere between five and six million Americans across the country, which equates to around $1.25 trillion of cover in force, $527 billion of which is in the most exposed coastal flood plains. New Jersey, one of the worst hit areas for flooding from hurricane Sandy, is said to have over $50 billion of NFIP cover in place.

Hurricane Irene resulted in claims payments totalling $1.287 billion for the NFIP, according to their numbers. The NFIP has also had $435m of claims from tropical storm Lee last year. Those events again reduced their capital buffer and now claims from Sandy are expected to eclipse those figures and could cause the NFIP to seek more government money to help them meet claims costs.

With loss estimates for hurricane Sandy now estimated at anywhere up to $50 billion in economic losses with $10 billion to $20 billion insured, some are suggesting that the NFIP could pick up a significant portion of that economic loss bill, with much of the rest going to the private insurance and reinsurance market. Generally private homeowner insurance doesn’t include flood, that is down to the NFIP, flood is included in many commercial and auto insurance policies though. It’s thought that if the NFIP’s claims are so high then it will need to go back to Congress to borrow more money in order to meet its obligations. This has happened before and is the reason many have been calling for the NFIP to leverage the private risk transfer and reinsurance markets in order to reduce the burden on taxpayers.

A number of reforms are expected in the NFIP after they were tasked with modernising their processes and structure when the Biggert-Waters Flood Insurance Reform and Modernisation Act of 2012 was signed into law in July. However with a U.S. presidential election looming and the potential for a change of government, none of those reforms are guaranteed. The act could push business to private reinsurers if it is followed through on as the NFIP were tasked with looking to the private risk transfer markets, including reinsurance, to lessen the taxpayer burden.

A storm like hurricane Sandy drives home the need for the private risk transfer and reinsurance markets to assist the NFIP with transferring risks away from government and taxpayers and into the private reinsurance or capital markets. The reinsurance market and capital market are adequately equipped to understand the risks and assume them from the NFIP, thus releasing the NFIP from the reliance on additional government funding when disaster does strike.

R Street Institute, a strong voice on these issues, provided some comments to InsuranceNewsNet here. Senior R Street fellow R.J. Lehmann said; “It appears likely that Sandy will exhaust the NFIP’s remaining $3 billion of statutory borrowing authority, meaning it will need to request more money from Congress to pay its claims. In the short term, we would insist the NFIP use its existing authority to raise rates, buy reinsurance and issue catastrophe bonds, so that the private market, rather than taxpayers, assume the risk of these sorts of catastrophes in the future. Over the longer term, further NFIP reform must include phasing in actuarial rates for all policies, and possibly selling some of the NFIP’s 5.6 million policies to private insurers.”

If the NFIP is indeed hit with a large loss from hurricane Sandy, as is expected, it could help to increase these calls for private market assistance. Flood catastrophe bonds seem like a viable way to achieve this, an indemnity cat bond could be structured and issued to protect the NFIP against levels of claims which would force it to call on the government for funding. Or perhaps the NFIP could seek to tap reinsurers and collateralized players for cover and those reinsurance sources may in turn seek to transfer their flood risk to capital market investors via cat bonds. The cat bond investor base would likely welcome the opportunity to invest in a new class of risk as long as it is structured in a way that supports their need for diversification.

The amount of losses that are apportioned to the NFIP will have a bearing on the overall industry loss figure for Sandy and the question of flood vs wind damage is going to take some time to fully understand. Another issue with Sandy is regarding deductibles as there could be different ways of treating Sandy and deductibles depending on insurer and state and how they treat what was once a hurricane but officially became a post-tropical storm just before landfall. Once again, definitions and policy terms are going to also have a bearing on the final loss estimates.

Artemis Live - ILS and reinsurance video interviews and podcastView all of our Artemis Live video interviews and subscribe to our podcast.

All of our Artemis Live insurance-linked securities (ILS), catastrophe bonds and reinsurance video content and video interviews can be accessed online.

Our Artemis Live podcast can be subscribed to using the typical podcast services providers, including Apple, Google, Spotify and more.

Print Friendly, PDF & Email

Artemis Newsletters and Email Alerts

Receive a regular weekly email newsletter update containing all the top news stories, deals and event information

  • This field is for validation purposes and should be left unchanged.

Receive alert notifications by email for every article from Artemis as it gets published.