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Regulators and activist investors are only starting to grope with the effects of climate change on risk in the financial system. Flood insurance underwriters have been trying to do that for decades. Yet flood finance is still a mess.
This is particularly true in the US, where flood risk has been quasi-nationalised through a Federal operation called the National Flood Insurance Programme.
The public deplores climate change and is mesmerised by TV images of flood disasters. Paying to defend against flood risk, moving away from flood zones, or sending off regular flood insurance premium payments is less interesting though.
Even all those pictures of wrecked towns and submerged cars do not seem to do the trick. Swiss Re, the Zurich based reinsurance giant, estimates that only one in six homes in the US has flood insurance.
And the true cost of the government’s NFIP has been less than fully transparent. According to the agency that runs it, there are more than 5.1m NFIP policies in force currently, which provide $1.3tn of coverage for homeowners and commercial structures.
The programme collects $4.6bn in annual premiums, fees and surcharges. Payments depend on an arcane combination of analysis of flood plains, the presumed condition of buildings and flood defences, and whether a policy has been in place long enough to be “grandfathered” with special rates.
Over the years Congress has woven a web of cross-subsidies among policyholders and explicit subsidies from the government’s general budget to ensure that policyholders in flood zones can have “affordable” insurance.
It is extremely difficult to figure the actual cost of the system, as standards, practices and reporting change from year to year. It would be safe to say the NFIP has received tens of billions in subsidies, and there is consensus that reforms, starting with more accurate mapping of flood risks, are necessary for the programme to continue.
Which it will not, after September 30, unless the “NFIP 2.0”, an extensive rewriting of the existing law, is passed as part of the vast “reconciliation bill” for government spending now jammed between factions in the House and Senate. Given unusually extensive TV time this year of floods in Louisiana and the Northeastern states, I would hazard that NFIP 2.0 has a better chance of becoming law than much of the reconciliation package.
That would be the case even though few, if any, in Congress have much idea how NFIP works, or the amount of money some people make off the programme. Take, for example, the NFIP’s catastrophe bond issuance.
Since 2018, the NFIP has issued some $1.775bn in catastrophe bonds to reinsure its financial risks from catastrophic events. Investors promise to participate in losses above a certain point of total claims.
They put up cash collateral in the form of money market funds or World Bank issued securities to ensure the NFIP will get paid. Then, over the three-year life of the NFIP cat bond, they are paid, according to one leading investor in the paper “around 5.5 per cent a year, taking into account the possibility of a total loss.
Still think about that. The US government is paying that 5.5 per cent fee even though any loss above the NFIP’s own capital and premiums could, hypothetically, be covered by new government borrowing at perhaps one-tenth the fee paid to insurers.
The cat bond investors are not charities. If losses “attach” to the bonds they would have to raise rates or lower their insured risks to make up the costs.
“This is just a way to manage the budget,” admits one insurance underwriter who has profited from the NFIP. “We were worried about Hurricane Ida [in Louisiana this year], but it turned out that the models overestimated losses by two and a half times. So that was good.”
It seems it is not in the government’s or the insurers’ interest to talk too much about the NFIP. Besides, the non-disclosure agreements between the NFIP and the insurers are among the strictest in the trade.
More analysis of the financial effects of climate change would be good, so the costs are borne in a correct, economic and equitable way. From what I see of disclosure in the flood insurance world, though, we are a long way from understanding how to do that.
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