As climate change poses escalated disaster risk, more and more countries are turning to the reinsurance sector for risk transfer protection. At the same time, the reinsurance sector is turning to technology to increase efficiency and accuracy of the reinsurance policies. This collision of disaster risks and technology-based solutions has situated the government with a seemingly increased reliance on the private sector for mitigating the costs of disasters – a reliance that will be interesting to watch develop.
A quick note: reinsurance is insurance for insurance companies. It allows private companies to cover correlated risks that they normally wouldn’t be able to cover. For example, most private companies don’t offer flood insurance because flooding is often felt by more than one policy holder at once and the insurance company cannot afford the extensive amount of payouts that would occur at the same time in the same space. That’s where reinsurance comes in. Reinsurance companies can afford to cover correlated risks in one area by offsetting it with coverage in another area that won’t be triggered by the same payout event.
Over the past couple of years, reinsurance has become a staple in mitigating the costs of climate based disasters. In the United States, one of the most prominent reinsurance programs covers flood damage on a national level – a risk that the private sector has traditionally avoided taking on. The U.S. Federal Emergency Management Agency (“FEMA”) originally adopted a reinsurance program to cover the National Flood Insurance Program (“NFIP”) in 2016 and has renewed the program each year. NFIP provides flood insurance to property owners to reduce the socioeconomic impacts of climate disasters, and while NFIP has been around for over 50 years, it wasn’t until recently that the reinsurance sector became involved. The original authority to pursue this program came from the Biggert-Waters Flood Insurance Reform Act of 2012 and Homeowners Flood Insurance Affordability Act of 2014.
The introduction of new technology to the reinsurance sector is promising for the growth and effectiveness of the industry. However, the more that government begins to rely upon the private reinsurance markets for public services, the more legal concerns may arise. 0000
NFIP has been successful in the past couple of years. In 2019, the 1.32 billion was secured from twenty-eight private reinsurance companies have contracted with FEMA to indemnify the agency from individual flood losses across the country. In 2018, NFIP secured 1.46 billion dollars from the private markets to cover flood losses throughout the year. Additionally, FEMA has secured another 500 million dollars in reinsurance coverage through a flood catastrophe bond titled FloodSmart Re Ltd. (Series 2018-1) that is backed by more than 35 investors. Catastrophe bonds are another insurance mechanism in which investors take on the risk of specified catastrophes at attractive rates. If the specified catastrophe occurs, the issuer gets the money invested to pay for the losses. If the catastrophe doesn’t occur, the investors retain their principal and any interest. FloodSmart Re Ltd. is the first catastrophe bond to offer protection to NFIP.
There are advocates for continuing the role of private reinsurance in government programs. For example, U.S. Congressman Blaine Luetkemeyer re-introduced the Taxpayer Exposure Mitigation Act – a bill that proposes to mandate offsets of climate disaster costs to the private market. The proposed text that will be heard by Congress reads, “the Administrator shall annually cede a portion of the risk of the flood insurance program under this title to the private reinsurance or capital markets, or any combination thereof, and at rates and terms that the administrator determines to be reasonable and appropriate….” Ultimately the bill establishes a formula to determining the “probable maximum loss target” and requires that FEMA enters into the appropriate contracts to cover that target.
While Congress prepares to decide whether the federal agency should continue to engage with the private markets for public services, the reinsurance sector is quickly engaging new technologies in order to accurately analyze and price the policies. For example, Bermudian reinsurance technology specialists have developed a software that can price and underwrite a reinsurance policy in “under 10 seconds.” Insurwave is the newest addition in marine insurance that utilizes blockchain to create insurance contracts. More generally, many researchers have predicted that blockchain is the future of smart contracts that will make reinsurance more transparent and more accurate.
The introduction of new technology to the reinsurance sector is promising for the growth and effectiveness of the industry. However, the more that government begins to rely upon the private reinsurance markets for public services, the more legal concerns may arise. Topics such as privacy and the legality of smart contracts have already surfaced in regard to insurance technology. When that is combined with the fact that some legal scholars don’t think that government should be involved with private insurance provision in the first place, tension can develop. The potential for increased government reliance on the rapidly changing private sector of reinsurance shall likely pose legal questions regarding privacy and efficacy of the contracts. Scholars and practitioners should pay attention to these developments as they arise in the near future.
Hannah M. Petersen, 4 February 2019