13 Aug FEMA Purchases a Catastrophe Bond
The Federal Emergency Management Agency has finally secured a reinsurance placement for the National Flood Insurance Program that for the first time is directly backed by capital markets investors. As of now, the Federal Emergency Management Agency (FEMA) has entered into a three-year reinsurance agreement that was effective starting August 1st, 2018.
In April, FEMA announced that they wanted to buy a catastrophe bond. A catastrophe bond works like reinsurance where the investor gets a return unless the disaster’s cost exceeds a certain threshold set by the government. However, the Federal Emergency Management Agency didn’t say how much the bond would pay out.
A catastrophe bond is a high-yield debt instrument that is usually insurance-linked and meant to raise money in case of a catastrophe such as a hurricane or an earthquake. If the insurance company or reinsurance company suffers a loss from a particular pre-defined catastrophe, then its obligation to pay interest or repay the principal is either deferred or forgiven.
When it comes to catastrophe bonds, they are generally not closely linked with the stock market or economic conditions. The bonds also typically offer a competitive yield compared to their risk. However, even though these bonds reduce risk to insurance companies, historically these transactions have resulted in a loss to investors.
The three-year reinsurance agreement, the coverage for a given flood event is $62 million in premium for the first year of coverage. In January, FEMA secured $1.46 billion in traditional reinsurance coverage from 28 reinsurance companies to cover any qualifying NFIP flood losses in excess of $4 billion per event.
With both of these reinsurance placements combined, the August 2018 placement enables FEMA to transfer $1.96 billion of the NFIP’s flood risk for the 2018 hurricane season to the private sector.
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