August 30, 2017

ILS can help to narrow the flood risk protection gap: Miller, JLT Capital Markets

The insurance-linked securities (ILS) market and providers of capital market backed reinsurance capacity can help with the job of narrowing the flood risk protection gap in the wake of hurricane Harvey, according to Rick Miller Managing Director – Co-Head of Insurance Linked Securities at Jardine Lloyd Thompson Capital Markets.

As hurricane Harvey’s flood waters start to recede in some areas, as the storm continues to move eastwards, thoughts now shift to rehabilitation & repair, Miller said, meaning, “The risk protection gap related to flood will once again become obvious.”

The ILS and capital market investors in reinsurance are ready and able to assist in working to address the flood risk protection gap, according to Miller.

“The ILS industry has made it known (since Katrina) that it can provide capacity via parametric covers to address issues related to contingent business interruption, community interruption, and other categories of claims where proving an insurable interest may be challenging. This includes coastal and overland flood,” he explained.

Miller cites the example of the New York MTA, which purchased a source of parametric protection for its subway tunnels in the aftermath of superstorm Sandy, aware that the capital markets were willing to price and take on a parametric flood related risk.

That resulted in the $200 million MetroCat Re Ltd. (Series 2013-1) parametric catastrophe bond and the New York MTA followed that with a more recent $125 million MetroCat Re Ltd. (Series 2017-1) parametric cat bond transaction, reflecting the organisations confidence in utilising the capital markets and ILS investors as a source of insurance protection.

Commenting directly on Harvey, Miller said; “Despite the historical desire by the ILS community to provide capacity at an actuarially sound rate, the tradable cat bond market will not likely be triggered by this event. Academically, the bond which had the most volatility was in fact a parametric trigger based on Mb of pressure designed to provide cover for Mexico.”

There Miller is referring to the Fonden 2017 cat bond, which looks to have had a close shave with hurricane Harvey.

Miller is convinced that the ILS market is ready to support efforts to increase flood insurance coverage in the region affected by Harvey, offering risk capital to back parametric structures to provide insurance, or indeed as reinsurer to back primary insurers efforts to narrow the risk protection gap.

“If retail demand, community demand, and commercial demand increase after Harvey to try and reduce this risk protection gap, the ILS market exists to take the other side of that trade,” Miller stated.

Continuing, “The “premium” or price for that cover may be expensive relative to the premium offered by the government subsidized NFIP program, but making the public aware of the market clearing price of this environmentally driven negative externality may influence the future development of housing stock (or zoning regulations) within Houston and the surrounding areas.”

Risk capital is available to take on more U.S. flood risk, be that from the government by de-risking the NFIP through reinsuring it, or as parametric flood coverage for commercial exposures, or as reinsurance protection to help and support primary insurers as they underwrite more flood policies.

There are opportunities for flood risk protection gaps to be narrowed with the help of the ILS market and capital market investors, as there are for other protection gaps around the world.

As was written yesterday, there are clear opportunities for parametric catastrophe bonds to be used to provide flood disaster relief payouts, based on forecasts of extreme rainfall such as were seen as Harvey approached Texas. Forecast-based triggers could mobilise capital rapidly before an event strikes, while parametric triggers based on the actual recorded rainfall could have paid out after say 20 inches of rain, offering much needed relief money at just the time it is required by local authorities.

This parametric trigger technology combined with capital market efficiency could be put to work in many ways to help provide capital to aid disaster response, as well as to provide insurance and reinsurance for commercial interests. That’s not even getting into the assistance that collateralized re/insurance products could provide as well. ILS markets can play a vital role here.

While the investors backing ILS have such a strong appetite for assuming more catastrophe risk, as evidenced by recent cat bond market activity, it would be prudent to put efforts to harness this appetite into motion, to the benefit of regions at risk of Harvey-like flooding.

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