Cedric Stephens | How catastrophe bonds work

At each Mass, Catholics include among their intercessory prayers an invocation for God’s protection. This is to prevent or minimise the threats to this and other islands in the region from of natural disasters.

The prayer takes on more significance during each hurricane season.

It also makes sense at the secular level. These events are regular features of our lives. Acceptance of this fact can be the starting point for the development and execution of plans to minimise disasters’ impact on individuals and institutions.

This is preferable to adopting a fatalistic attitude and doing nothing, which was one of the findings of a local study.

As we enter the last five weeks of the current hurricane season, it is not too early to begin planning for the next one. The potential severity and constancy of the threats from natural hazards impose an obligation to develop short- and long-term plans to minimise them.

Last-minute planning at all levels should be avoided. Even my harshest non-life insurance critics would agree.

Finance Minister Dr Nigel Clarke – perhaps more than any of his predecessors – appears to be a believer in the doctrine of macroeconomic resilience to natural disasters based on what he has said and, more importantly, on what he has done.

According to a World Bank Group paper, ‘Economic Resilience: Definition and Measurement’: “The welfare impact of a disaster does not only depend on the physical characteristics of the event or its direct impacts in terms of lost lives and assets. Welfare impacts also depend on the ability of the economy to cope, recover, and reconstruct and therefore to minimise aggregate consumption losses.

“Macroeconomic resilience has two components: instantaneous resilience, which is the ability to limit the magnitude of immediate production losses for a given amount of asset losses, and dynamic resilience, which is the ability to reconstruct and recover.

“Welfare impacts also depend on micro-economic resilience, which depends on the distribution of losses; on households’ vulnerability, such as their pre-disaster income and ability to smooth shocks over time with savings, borrowing, and insurance, and on the social protection system, or the mechanisms for sharing risks across the population.

“The (economic) welfare disaster risk in a country can be reduced by reducing the exposure or vulnerability of people and assets (reducing asset losses), increasing macroeconomic resilience (reducing aggregate consumption losses for a given level of asset losses), or increasing microeconomic resilience (reducing welfare losses for a given level of aggregate consumption losses).”

Last Wednesday’s news about a World Bank US$15-million grant taking the Government a “step closer to inviting investors to take part in a catastrophe bond that could become active before the next hurricane season” is more meaningful in the context of the paper quoted in the previous paragraphs.

Most of the funds will be used by our Government to cover the annual premiums to satisfy the obligations of the catastrophe bond.

Jamaica is poised to follow Mexico’s example. On October 10, 2017, The Wall Street Journal reported that Mexico had received US$150 million from a catastrophe bond that it had issued two months earlier after a 8.1 magnitude earthquake.

A catastrophe bond, or cat bond, is a financial instrument. It was invented during the 1990s. It pays the issuer – in this case, the Government of Jamaica, via the Ministry of Finance – a fixed amount when a pre-defined disaster risk occurs.

A Category 3 hurricane and a magnitude 7.0 earthquake are examples of disaster risk.

Cat bonds offer investors, such as hedge funds, pension funds, and mutual funds, the opportunity to earn an attractive return on their investment in exchange for assuming disaster risks. Bonds are issued for a fixed period, usually three years.

Should the specified disaster occur, the investors would lose the principal, and the issuer would receive that money to cover its losses.

Catastrophe bonds use triggers with defined parameters that must be met to start accumulating losses. Only when these specific conditions are met do investors begin to lose their investment. Inviting investors to participate in a cat bond for Jamaica’s disaster risks is one of several things that the Government is now doing to achieve macroeconomic resilience, which, in my opinion, is just as important as GDP growth.

Space constraints prevented me from including information about some non-financial impacts that result from catastrophic events in last week’s article. Non-financial impacts are usually ignored because they are hard to measure. For example, persons suffering from disaster-related mental-health issues are usually not counted among victims.

Two years after Hurricane Maria, the experiences of Puerto Ricans provide a rich data source. The folks at the Office of Disaster Preparedness and Emergency Management, ODPEM, particularly members of the Health Planning Sub-committee, should carefully study what happened there in planning for future interventions.

Mental-health providers, according to the September 2019 issue of Monitor on Psychology, “were left scrambling to address post-traumatic stress disorder, depression and other psychological fallout” post-Maria. In a survey conducted one year after the hurricane, it was found that “one-fifth of the residents reported needing mental-health services and 13 per cent said that they started new or higher-dose prescriptions to treat emotional problems”.

I saw nothing on ODPEM’s website to suggest that Jamaica’s national disaster plan had been developed to respond effectively to the mental-health issues like those that occurred in Puerto Rico in the wake of the hurricane two years ago.

Given the scale of death and destruction caused by Hurricane Dorian, one is left to ask, what were the mental-health impacts in Abaco and Grand Bahama?

 Cedric E. Stephens provides independent information and advice about the management of risks and insurance. For free information or counsel, write to aegis@flowja.com.