Nightmare on risk street

The great thing about technology and telecommunications is that we can sit in our living rooms and be able to see and relate to events taking place many thousands of miles away “live and direct.” Last week we were able to witness the devastation caused by the wildfires in Southern California that have destroyed over 3,400 homes, killed at least 20 persons and burnt over 750,000 acres and it is only because of the cool wet weather that moved in that firefighters were eventually able to contain the fires. The public at large whether here in Trinidad and Tobago or elsewhere see insurance as an unnecessary evil and burden and it is only when some unforeseen event takes place that insurance is seen in a different light — in fact as a godsend. When premiums are paid year after year without a claim, the ordinary consumer sees it as monies lost rather than seeing it as having gotten peace of mind and a value product for a mere fraction of the amount at risk. This is the very principle of insurance where the losses of the few are paid for through the collective premiums of the many so that the burden of the losses can be made light.

In life there is no situation that is without risk. When you leave your home there is always a chance that you will not get to where you are going — you could meet in an accident and no matter how small the risk is there is always risk present. We can minimise risk by taking precautionary measures but only in very rare cases can we completely eliminate risks. Insurance business is about measuring risks and taking risks but there is volatility involved and they too sometimes get their sums wrong. Although many commentators speak about financial services and the close linkages between bank and insurance products, there are higher risks associated with insurance and it is for this reason that many banks prefer to stick to their core business but act as facilitators for insurance and not run the risks themselves. Clearly, the wildfires in Southern California can be deemed a catastrophe since few could have predicated the scale and extent of what occurred. Statistics suggest that when a catastrophe strikes the cost to the insurance industry is usually no more than 12 percent - 15 percent of the economic losses. The conclusion that can be drawn is that there is low insurance penetration, ie few people buy insurance cover since they simply do not have the disposable income or that the catastrophe has hit a relatively depressed area and although the economic losses are high the payout by the insurance industry is comparatively low. This is not likely to be the case in Southern California. If anything the situation is likely to be the complete opposite.

We are dealing with affluence and a high concentration of values. A significantly higher proportion than the worldwide 12 percent - 15 percent of economic losses will be insured and there is every reason to believe that many of the properties consumed in the fires will be insured and will be carrying relatively high values. The problem of the insurance companies is that the properties represent the best class risks — affluent homes with very low risk compared to businesses with industrial equipment and this is the type of risks that insurance companies fall over themselves to underwrite. They will maximise their risk — carrying and putting their capital and assets on the line. They might not have reckoned for what transpired over the past week where the losses can run into the many billions and some companies could well have got their sums wrong since they could find themselves too heavily committed and without adequate reinsurance arrangements. All insurance companies have to make these informed judgment calls since they have to consider catastrophic events affecting their risk portfolios. When they run out of reinsurance, cover the losses then revert to their balance sheets and they must be strong enough to withstand such unforeseen events and if they are unable to absorb these losses they could find themselves in serious financial difficulty and unable to satisfy all their claimants.

Insurance companies can handle large single claims since they are good at spreading such risks through reinsurance but the problem of dealing with a series of claims arising out of one event like the 9/11 event or a Category 5 hurricane or a severe earthquake or wildfires burning over 3,000 expensive homes can prove very challenging. There was an estimate that suggested losses could run into at least US$10 billion and while it is still too early to say whether the figure is realistic there is no doubt that the insured losses will be high as a percentage of economic losses. We may not have bushfires in Trinidad and Tobago that can match the Southern California wildfires but we are exposed to flooding and windstorms and even a bigger threat of earthquakes which many citizens simply find hard to appreciate. These catastrophes can greatly affect our insurance companies. These are risks that the insurance companies run and while they can make decisions based on the historical past, who is to say that we cannot experience an event that is out of the ordinary, and the reinsurance arrangement prove to be inadequate. Insurance companies’ greatest concerns are not the individual risks but the number of losses that can arise out of a single event as in the case of a catastrophe.

We would do well in Trinidad and Tobago to appreciate that life is a risk and therefore we must treat with risk from an informed standpoint. We must learn from events happening elsewhere and take steps that are necessary to minimise these risks, recognising that risks are never totally eliminated and there are no guarantees that nothing would ever go wrong.
E-mail: daquing@cablenett.net