De-Risking Governments Around the World- A Perfect Match for Abundant Insurance Capital?

Other states face catastrophic events that can come without warning, like earthquakes and fires on the west coast, blizzards in the northeast, and tornadoes and flooding in the heartland. One of the most important ways governments can measure their success in disaster recovery is how quickly and efficiently they can rebuild their communities while limiting their future liability by designing in resilience. Many state and local governments have made prudent investments in reinsurance to bring a globalized response to their localised threat. A great example of this is the state of Florida.

Long-time residents of Florida and state officials remember the devastation caused by Hurricane Andrew 25 years ago. Post Andrew, Florida took a hard look at where it was most vulnerable and made adjustments. Today, Florida’s homes and businesses are protected by tough building codes, state and local governments are better trained in emergency management, and the state is taking advantage of a reliable, globalised insurance market.

During the past two years of storms, both the private insurance market and state-owned Citizen’s Property Insurance did a phenomenal job in promptly and efficiently settling claims, while global reinsurers paid out claims to their clients within days of the visible evidence of catastrophic damage. This steady flow of capital from the global community allowed the state of Florida to stay focused on disaster recovery. That flow of capital was aided by a healthy investment in reinsurance. By spreading Florida’s concentrated and localised risk across the global community, much of the financial burden was taken off a relatively small population of affected Floridians and transferred to a much larger and diversified global population.

The Florida Legislature, which years ago created the Florida Hurricane Catastrophe Fund (FHCF), created an environment where prudent investments in reinsurance, matched with the proper amount of cash-on-hand, allow both the private and public sectors to thrive and capital to flow quickly to customers when they need it most. While the storm damage created by Hurricane Irma was much smaller than originally anticipated when it was on track to hit South Florida, the FHCF performed well. Eventually, a catastrophic event will hit and having a pool of capital to pull from will act as an economic infusion for a state facing crisis with too many calls on its available taxpayer resources. Currently, the FHCF is capped at US$17 billion, and while this should be enough to cover home owners’ losses from a truly catastrophic storm, planning for subsequent events is critical. 

Home insurers take the threat of a catastrophe into consideration when they write policies and take steps to safeguard their companies should a major event affect many of their policyholders. Diversifying risk allows these companies to pay claims quickly without severely depleting their cash-on-hand.

The National Flood Insurance Program Reform

Nearly every region of the country faces the potential for a catastrophic scenario caused by Mother Nature. The one constant, regardless of the type of threat, is the potential for severe water damage due to floods. Most homebuyers don’t consider flood insurance unless they live near a body of water that has the potential to rise. Unfortunately, many homeowners are unaware of the risk a potential flood can have on their home, particularly newcomers to coastal areas. It doesn’t help that standard home insurance policies have long excluded flood risk. In flood plains, developers, seeking to meet the demands of the housing market, begin to develop land that is at a much higher risk for flooding. Many homeowners in these areas are underinsured or don’t believe they need flood insurance due to antiquated floodplain mapping technology.

The National Flood Insurance Program (NFIP) was originally designed to mitigate flood risk and aid homeowners in procuring flood insurance when the private sector was unable to do so. The program has since grown into the single largest provider of flood insurance and, after a series of massive flood events around the country, has become financially overextended. The NFIP now sits at nearly US$21 billion in debt. That does not include the US$16 billion in debt forgiven by the federal government after the 2017 Atlantic hurricane season that brought major flooding events in Texas, with Hurricane Harvey, and in Florida, with Hurricane Irma. That debt cancelation was meant to be paired with serious reforms to make the NFIP a long-term sustainable program. Since September 2017, the NFIP’s statutory authority has been re-authorised through seven short-term extensions, with no reform proposals receiving serious consideration. The current extension, authorised at the eleventh hour on 31 July, is set to expire after the mid-term elections, adding to the mix the political uncertainty of the House and Senate leadership of the 116th Congress. Regardless of who makes up the majority in November, one fact remains – the NFIP is in desperate need of reform.

Congress has approved a series of extensions of the program without offering any real long-term solutions. Should Congress fail to reform the NFIP, there could be serious ramifications for homeowners around the country. Should the NFIP be allowed to expire without a long-term solution, homeowners who currently have flood insurance would not be able to renew. Real estate transactions in certain areas would come to a standstill as flood insurance required by mortgage companies would be unavailable. Existing flood insurance premiums could skyrocket. The effect on the nation’s economy could be crippling.

While reforms have not been implemented, that does not mean changes have not been proposed. Earlier this spring, representative Ed Royce (R-CA), representative Blaine Luetkemeyer (R-MO) and representative Dennis Ross (R-FL) proposed HR 5381, the Government Risk and Taxpayer Exposure Reduction (GRATER) Act, which encourages department and agency heads to make risk management a priority and protect taxpayers from future federal bailouts. The GRATER Act would, among other things, transfer taxpayer-held risk out of the federal government and into proven private sector capital and reinsurance markets. Unfortunately, HR 5381 has not moved in the House and is unlikely to advance before the mid-terms.

While fundamental changes are needed, there are prudent decisions being made now that could help alleviate some of the long-term effects. Following the 2017 hurricanes, the Federal Emergency Management Agency (FEMA) collected US$1 billion in reinsurance recoveries. FEMA has expanded that purchase in 2018 and FEMA recently approved a US$500 million catastrophe bond[1] to transfer risk away from NFIP and onto the global markets. The ‘FloodSmart Re bond’ will only cover exposure to officially named US storms, leaving a hole in coverage for other flooding events. It is, nevertheless, a start. It’s likely that FEMA will purchase additional coverage to further globalise the risk associated with flood risks. What is missing in the federal reform bill is specific authorisation for mortgage lenders to accept private flood insurance. Consumers have the benefit of lower prices and better coverage from the private flood policies that have been tested in Florida and other gulf states during the past several years. What is needed is for Congress to direct private mortgage lenders to accept these private flood policies so that more and more consumers get the benefits of this competitive product. The more private flood insurance that gets sold, the more the risk to US taxpayers is reduced.

Whether the risk comes from rising waters or high winds, governments are well served to take advantage of the historically low reinsurance rates while recognising the fundamentally new, long term capital structure that has changed the nature of that global market to the benefit of consumers. Global capital is abundant and can ease the financial blow caused by these catastrophic events and begin to de-risk government.  

[1] Artemis, FEMA’s FloodSmart Re cat bond expands to $500m of reinsurance for the NFIP, http://www.artemis.bm/blog/2018/07/25/femas-floodsmart-re-cat-bond-expands-to-500m-of-reinsurance-for-the-nfip/ (accessed 17 August 2018)

John Huff
John Huff is the President and CEO of the Association of Bermuda Insurers and Reinsurers. In 2016, he served as president of the National Association of Insurance Commissioners (NAIC). He has over 25 years of experience within the insurance sector.