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ILS market keeps an eye on Florence as flooding continues

ILS market keeps an eye on Florence as flooding continues

Insurance-linked securities are not expected to be materially exposed to Hurricane Florence, but the market is watching to see whether the National Flood Insurance Program’s recently issued catastrophe bond comes into play, according to Fitch Ratings Inc.

“As Hurricane Florence completes its pass through the U.S. mainland, Fitch Ratings expects that the storm will represent an earnings event for the private insurance industry with limited or no rating actions due to the event,” the Chicago-based ratings firm said in a statement Thursday. “Substantial insured losses from water-related claims are likely to be incurred by the National Flood Insurance Program, private flood insurance carriers and auto insurance writers with a modest level of losses ceded to the traditional reinsurance and insurance-linked securities (ILS) markets.”

Loss estimates are difficult because substantial portions of the Carolinas remain difficult to access, the firm noted. Insured losses resulting from Florence’s winds and storm surge will range from $1.7 billion to $4.6 billion, not including the impact of the ongoing flooding caused by the storm’s unprecedented precipitation, according to Boston-based catastrophe risk modeling firm AIR Worldwide, while Boston-based catastrophe modeler Karen Clark & Co. estimated that insured losses would be $2.5 billion.

“Wind speeds from Florence diminished as the storm approached the U.S. coast, and Florence was downgraded to a Category 1 hurricane before making landfall in North Carolina,” Fitch said. “The level of wind-related damage to property is expected to be modest as a result of the significant decline in wind speeds, limiting losses to primary property insurance writers.”

Flood losses are expected to significantly contribute to overall losses from Florence as storm surge and historic levels of rainfall inundated both coastal and inland areas, according to the firm.

“Flood risk in the U.S. is almost entirely assumed by the NFIP as standard homeowners’ insurance policies typically do not cover the peril,” Fitch said. “The private market for flood insurance is limited to a handful of surplus lines writers, admitted companies and Lloyd’s of London syndicates. Additionally, a significant portion of total flood-related losses will likely be uninsured as the takeup rate for flood insurance in the affected counties is relatively low, particularly for inland areas that are not typically considered at high risk.”

The NFIP has shifted some of the risk to the private markets in recent years, including via a 2018 reinsurance program that covers the organization for 18.6% of losses between $4 billion and $6 billion and 54.3% of losses between $6 billion and $10 billion.

“If the heavy flood damage from Florence breaches the attachment level of the program, it would be the second consecutive year that the program experienced losses,” Fitch said, noting that the NFIP recovered its entire $1.042 billion layer of coverage in 2017 amid Hurricane Harvey losses.

But the ILS market is not expected to be materially exposed to Florence, the firm said.

“Collateralized reinsurance and ILS funds that participate on lower layer quota share reinsurance or retrocession agreements with cedents that were particularly exposed to the region would be the most likely source of potential modest loss in the ILS market,” the report stated.

“The catastrophe bond market is most directly exposed to U.S. wind-related risks with transactions typically attaching higher in cedents’ risk transfer programs,” Fitch continued. “The diminished level of expected wind losses from Florence limit the catastrophe bond markets’ exposure to the storm. One catastrophe bond that the market is watching is the NFIP’s FloodSmart Re 2018-1, issued in August 2018, which provides the organization with $500 million of third-party collateralized limit. If flood losses incurred by the NFIP from Florence increase past the bonds attachment point of $5 billion, third-party investors could be at risk of partial loss of principal.”

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