Cedric Stephens | Controlling the fiscal risk associated with natural disasters | Business

Big up Finance and Civil Service Minister Dr Nigel Clarke and members of his team for taking action to tackle the country’s fiscal risk from natural disasters.

Their actions to manage this class of risks occur when citizens, businesses, institutions and other organizations in the public and private sectors continue to grapple with the social, economic and other fallout caused by COVID-19. Sadly, the risk of a pandemic took Jamaica, like other countries, by surprise and was not prepared to handle it despite signs that it was likely.

The successful placement by the Department of Finance of a US $ 185 million catastrophe bond (or cat bond) with assistance from the World Bank during the current hurricane season is a major achievement. Today’s cry contrasts with the implicit congratulations that were implanted in the article I wrote on March 20 – “Risk Management Talk Finally Going Mainstream” – which dealt with parts of the 2021 budget presentation / 22 from Dr. Clarke.

A cat bond is a high yield debt instrument. It is designed to raise funds for businesses or governments in the event of a natural disaster. A cat bond allows the issuer to receive funding from the bond only if specific conditions, such as an earthquake or tornado, occur. If an event protected by the obligation activates a payment, the issuer’s obligation to pay interest and repay principal is either deferred or canceled entirely. Cat bonds have short maturities of three to five years.

Placing the cat bond in the global capital markets is big business and cannot be overstated. For example, a September 22 Severe Weather Europe report stated that “the Atlantic hurricane season 2021 has literally intensified its activity recently, with 12 named tropical storms, including five hurricanes formed in the past 40 days. This is more than the average number of named storms in a full season. From the end of September and October, activity gradually shifts to the Caribbean region and will soon be boosted by the arrival of the great Madden Julian-Oscillation or MJO.

“The MJO wave is the largest and most dominant source of short-term activity in the tropics. It is a disturbance from thunderstorms moving east, and it circles the Earth in the equatorial region in about 30 to 60 days. MJO has two parts: enhanced precipitation (wet phase) on one side and suppressed precipitation (dry phase) on the other side.

Leading the process of tackling the fiscal risk of natural disasters, a task that the predecessors of the current finance minister ignored for more than 30 years, did not stop when this goal was achieved. He took to the pages of that newspaper last Sunday, after the 7.2 magnitude earthquake in Haiti and brushed against Tropical Storm Grace, to share details on Jamaica’s disaster risk financing strategy and possibly to influence other policy makers to follow his lead.

The fact that his article was written for publication during the busiest part of the current hurricane season is a point that should also not be overlooked.

The opening statement of Dr. Clarke’s article read: “Implementing and sustaining a strategy to counter the fiscal risks of natural disasters is as important to Jamaica’s economic security as it is to preserving the country’s economy. currency adequacy and debt sustainability.

These words, in my opinion, are indisputable. A governor of the Bank of Jamaica, now deceased in the aftermath of Hurricane Gilbert, sought in 1988 to appropriate foreign currency funds owed to local insurers as part of their reinsurance contracts. His goal was to preserve what Dr Clarke called currency adequacy. Foreign reinsurers sent these sums of money to local insurers to pay policyholders’ claims.

The BOJ governor’s attempt to sequester these entries came at a time when the finance ministry had taken minimal steps to reduce the country’s fiscal risks from natural disasters, even though Jamaica was well known was heavily exposed to earthquakes and hurricanes. My informant, who was present at the BOJ-insurers meeting, which was held in the boardroom of central bank Nethersole Place, told me that an insurance company chief was so angry against the proposal that he “yelled” the governor of the central bank.

Jamaica’s multi-tiered disaster risk financing strategy, according to the finance minister, protects the country from “the fiscal shock that natural disasters inevitably cause, increases its resilience and ability to recover without undermining its economy too much. economic trajectory ”. Addressing the fiscal risk of natural disasters should, he said, be “an ongoing strategic priority for Jamaica”.

The Ministry of Finance’s strategy for managing some of the risks associated with natural disasters can be applied to manage all kinds of risks by citizens, businesses, including SMEs, public and private sector institutions and organizations. This should be one of the many lessons we are learning from the ongoing pandemic.

Key elements of the Ministry of Finance’s risk finance strategy include:

• Understand the major risks to which the island is exposed. This was done through data collection and analysis. In the case of the cat bond, the Planning Institute of Jamaica identified the most destructive hurricanes to hit the island in the past 20 years, measured by their impact on gross domestic product. This was just one of many datasets that were studied.

In contrast, a few years ago the managers and board members of a Spanish Town Road board of directors pretended to ignore that the premises were prone to flooding and that stocks had risen considerably in the beginning. of the annual hurricane season. They blamed a low-level employee for the millions of dollars in uninsured inventory losses. In another case, according to an August 2019 article in that newspaper, the leadership of the National Solid Waste Management Authority, based on their argument that the claims by residents of Riverton City were “frivolous,” fail to understand that its operations may be exposed to major civil liability claims.

• Work in partnership with other entities to transfer part of the risks identified to the risk-bearing entities, in the case of cat bond, to the global financial markets in exchange for the payment of a premium.

• Build an effective structure to manage and pay claims before a catastrophic event occurs.

The risk finance strategy as outlined in Dr. Clarke’s article last week is reminiscent of what happens in transactions between sophisticated corporate insurance buyers and the insurance markets. It is a process that deserves to be emulated.

For most companies, according to a UK organization of risk management and insurance experts, “Insurance is one of the most important investments and their biggest source of eventual capital for many companies. It protects them from events that might otherwise threaten production, jobs and even their future existence. This makes companies safer as business partners and places of investment ”.

Dr Clarke’s essay should be required reading for members of the finance ministry’s insurance purchasing unit and those appointed to boards of directors of government entities and private and public companies in Jamaica.

Cedric E. Stephens provides independent information and advice on risk management and insurance. For free information or advice, write to: [email protected] or [email protected]

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