Protection pressure

The Caribbean by its geography faces diverse risks of a catastrophic nature — hurricanes, floods, earthquakes, volcanic eruption and even the possibility of a tsunami, however, remote.

In some instances, the risks are cumulative since a number of countries/islands are subjected to the same castrophic event — eg a hurricane can affect more than one country since it can be more than 100 miles wide.

The prognosis in the short/medium term is that the region including the southern/eastern seaboard of the United Sates can expect above average activity and severity from hurricanes.

Insurance companies in our region are “price takers” in the sense that they must be heavily reliant on reinsurance protection from the international insurance and reinsurance community that determine cost and availability.

In recent times the international insurance community in an effort to risk-manage their own exposures from natural catastrophes have been requiring insurance companies to provide detailed information in accordance with risk exposure models — a relatively new feature.

While better risk assessment may allow for informed decisons, there is the downside and danger that the information may have the effect of reducing the available capacity from the region when it is most needed as decisions will ultimately be based on these risk models.

Since capacity from the international market is not open-ended but rather it is finite — the region will be competing for such capacity which will be sold at the highest price – the old axiom of supply and demand leaving the region short on such essential coverage if they could not afford the price or the risks deemed too high.

The insurance companies, on the other hand, have had to protect their exposures against these catastrophic events where price volatility makes it difficult to plan in the medium/long term.

In addition, when they lay- off their risks on a proportional basis they are required to retain as a charge against their own capital the risk of a catastrophic event exceeding what their reinsurers provide.

In short, their own reinsurers impose a limit on an event basis while the local insurers are required to provide full cover to their own clients. Hurricane Ivan is living testimony of what could go wrong in such instances.

The Caribbean region since Hurricane Andrew has been the subject of price volatility ranging from premiums of a high of 2.5% for those islands in the northern chain to a low of .7% to the most southerly.

During the past decade, prices have fluctuated widely and the availability of insurance/ reinsurance capacity has been a challenge. Studies have been conducted by various multi-lateral agencies to see whether alternative strategies could be found that would ensure relative price stability and at the same time guarantee capacity.

The international insurance and reinsurance markets have a good appreciation for the natural catastrophic risks across the region. They respond by availing themselves of market conditions.

However, decision-making is not done in isolation and those international insurance/reinsurance companies have now taken an approach of dedicating capital to different parts of the world.

In such cases, exposure limits are pre-determined at board/management level and our Caribbean region is usually left competing for capital allocation, which could effectively squeeze us out.

While this paper specifically deals with the mechanism of risk transfer, there are risks that may not meet the insurance standard, which, then leave a burden on the state and donors in the event of a catastrophe.

For insurable risks, there are opportunities for the insurance industry as some of the faster growing economies in the region expand but at the right price/terms and conditions. The regional insurance industry is playing its part but it is heavily dependant on the international insurance community as regards reinsurance. Admittedly new capital and better capitalization of existing insurance companies can go some way in addressing tight market conditions

Insurance companies in the Caribbean have challenges to provide coverage against perils of nature. They are heavily reliant on the international reinsurance market and as price takers are subject to both price and capacity volatility.

Insurance companies in the Caribbean have to compete with the south/ eastern United States for reinsurance support in particular for windstorm exposure on the basis of price and availability.

The international insurance and reinsurance markets already limit their losses out of a single event, leaving local companies to carry residual exposure. Hurricane Ivan proved that residual risks are real and can cause failure.

The insurance- buying public or policyholders are already risk takers in a real sense as they must absorb the first dollar of losses ranging 1%-2% up to as high 5 % of the value insured.

Some large risks, in particular in the energy sector, have a cap placed on them so they carry residual risks not by choice

However, not all risks will qualify for insurance as they do not meet underwriting standards and therefore they are uninsured and this is a vulnerable sector of the national community. Governments do not generally buy insurance cover for their properties and certainly so in the case of infrastructure which are likely to suffer the most in natural disasters. Treating with the effects of natural disasters require collaborative efforts through risk improvements/mitigation: . building codes hurricane straps, better construction, land use by hazard mapping.

Losses will be minimized and can be absorbed or digested more readily. Insurance companies, for instance, can grant rate reductions subject to international market conditions.

The private sector insurance industry has overtime been involved in discussions to find alternatives or supplementary to traditional insurance coverages. It has explored pooling or a reinsurance mechanism for the region but abandoned the concept on account of exposures and the long-term sustainability of such an arrangement, which, in turn, would have a heavy reliance on the international reinsurance market

While there is no denying that the region has some way to go to achieving best practice in terms of regulatory framework, attention is being paid to this at the present time and in the future the situation is likely to change. The domestic insurance industry will be better regulated with injection of some new capital but that on its own is not likely to improve the situation in any meaningful way with regard to the provision of coverage against catastrophic risks.

Cat bonds and other derivatives have been under discussion for the better part of the past decade in particular for high level cover with low frequency but this has not reached very far. Discussions must continue since at some time on account of international market conditions might favour these alternative mechanisms.

In addition governments in the region should be persuaded to deal with comprehensive strategies to mitigate risks : proper land use planning, building codes, for instance, and including transfer to the private insurance sector where feasible.