Will we be spared?

Trinidad and Tobago is still considered at the lower end of the scale as regards a direct hit from a hurricane, in much the same way that the New York area, in particular, and the north-eastern United States in general have a low probability but a very high severity in terms of damage, should such an occurrence take place.

While the experts are predicting a very active season as regards the number of storms to be expected, there is the universal view among the commentators that the season is not likely to be as bad as last year which was clearly the worst on record.

What is certain is that catastrophic losses will continue as we live in the path of hurricanes as well as being in an active seismic zone. All we can do is to take appropriate measures to minimise losses since natural hazard risks cannot be totally eliminated.

The regional media have been reporting steps taken by various governmental agencies for the impending hurricane season from evacuating persons living along coastal areas to providing safe shelters on higher ground. In Florida, it was recently reported that there were sales on items like generators and shutters even with a waiver of the state sales tax which merely shows the extent to which these persons take pro-active measures. We would do well to emulate and learn from other peoples’ experiences.

Action is not confined only to individuals taking steps in preparation for an active hurricane season but governments have also been in the financial markets purchasing catastrophe — Cat Bonds as in the case with Mexico. What are Cat Bonds? Before explaining Cat Bonds it would be useful to understand how catastrophe reinsurance works.

This is the conventional mechanism by which the insurance industry transfers catastrophic losses to the international reinsurance market. In our case, a local insurance company retains a dollar limit for a single event which represents the aggregation of a number of claims. For example, in the case of a hurricane an insurer may be presented with many claims for which it will have a share for its own account and when the sum total of all these claims exceed the dollar limit threshold then catastrophe reinsurance will be triggered.

These claims have to be adjusted and agreement reached with every policyholder as to the settlement amount, Therefore, there will be a time lag between the event and when catastrophe reinsurance will come into play with reimbursement from reinsurers, which is indeed, based on the principle of indemnity. In the case of Cat Bonds they can be either parametric (tied to a loss index) or loss-based but generally parametric bonds are the dominant type. The trigger may be tied to indicators and in the case of hurricanes or earthquake it is relatively simple in that the Bond is payable upon the occurrence of the event, regardless whether losses are suffered or not. If for example, the trigger is a Category 3 hurricane, as long as the Hurricane Centre makes a determination that the winds have reached that intensity then the Bond can be disbursed swiftly without even assessing losses.

Unlike traditional insurance where there can be uncertainty with coverage availability and price fluctuation from year to year to the domestic insurance company, the Bond issuer does not incur credit risk and obtains multi-year coverage at a fixed cost.

In order to obtain Cat Bonds, there must be capital markets that have accurate disaster risk models and who are willing to price these instruments. These Bonds can be another source of risk management alongside the traditional reinsurance market which is well known for price volatility. Up to the present time, there has been no interest for Cat Bonds and insurance transfer has been the sole vehicle for managing catastrophe risks.

The multi-lateral agencies have been promoting discussions on alternative financing options not as a substitute for insurance but rather a support for the current transfer mechanism. Cat Bonds are the best known among these financing options but there are others — weather derivatives which are used primarily to cover high probability but low-impact events and are more a hedging mechanism along the same lines as contingent credit. Contingent credit arrangements guarantee that liquidity and interest payments do not begin until the credit is accessed while in the case of Cat Bonds payments begin when the Bond is issued.

Insurance is an indispensable part of the overall strategy to deal with risks in our region and policyholders play an integral role in that they are the first line in the risk taking with between 1%-2% of the sum insured (not the size of the claim) before insurance coverage is triggered. Thereafter, the insurance market and the international reinsurance market assume the risks. In the changing environment, there is a forecast that the situation is likely to get worse in the short/medium term and therefore there is an imperative for risk management at all levels to reduce financial losses.

The advice is to ensure that adequate insurance is in place and to take all steps to keep water courses cleared for quick run-off of water. Insurance is essentially post-loss financing but policyholders must act as if they carried no insurance and therefore it is incumbent on everyone to take every precaution to minimise losses. Inconvenience and trauma accompany losses and insurance does not compensate but only deals with reimbursement of financial losses suffered.

We have to sit tight for the next six months and hope that we are spared.