Policing f iscal risk from natural disasters
BIG UP Finance & Public Service Minister Dr Nigel Clarke and members of his team for taking steps to tackle the country’s fiscal risk of natural disasters.
Their actions to manage this class of risks are occurring when citizens, businesses, institutions, and other organizations in the public and private sectors are still struggling with the social, economic, and other fallout caused by COVID-19. Unfortunately, the pandemic risk caught Jamaica, like other countries, by surprise and unprepared to handle it despite the signs that it was likely.
The Finance Ministry’s successful placement of a US$185-million catastrophe Bond – or cat bond – with the World Bank’s help during the current hurricane season is a major accomplishment. Today’s shout-out contrasts with the implicit kudos that were implanted in the piece that I wrote on March 20 – ‘Risk Management Talk Finally Going Mainstream’ – which discussed parts of Dr Clarke’s 2021/22 budget presentation.
A cat bond is a high-yield debt instrument. It is designed to raise money for companies 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 bond activates a payout, the issuer’s obligation to pay interest and repay the principal is either deferred or completely forgiven. Cat bonds have short maturity dates of three to five years.
The placement of the cat bond in the global capital markets is a big deal that cannot be overstated. For example, a September 22 Severe Weather Europe Report said that “the Atlantic Hurricane Season 2021 has literally escalated in activity recently, as 12 named tropical storms, including five hurricanes formed in the last 40 days. That is more than the average number of named storms in one full season. Going into late September and October, the activity is gradually shifting to the Caribbean region and will soon be boosted by the incoming major Madden Julian-Oscillation or MJO.
“The MJO wave is the largest and the most dominant source of short-term activity in the tropical region. It is an eastward moving disturbance of thunderstorms, and it circles the Earth in the equatorial region in about 30 to 60 days. MJO has two parts: an enhanced rainfall (wet phase) on one side and the suppressed rainfall (dry phase) on the other side.”
Leading the process to tackle the fiscal risk of natural disasters, a task that the present finance minister’s predecessors ignored for over 30 years, did not stop when that goal was accomplished. He took to the pages of this newspaper last Sunday, after Haiti’s 7.2 magnitude earthquake and brush with Tropical Storm Grace, to share details about Jamaica’s disaster risk financing strategy and possibly to influence other policymakers to follow his lead.
That his article was written for publication during the most active part of the current hurricane season is a point that should also not be overlooked.
The opening statement of Dr Clarke’s article read: “The implementation and maintenance of a strategy to counter the fiscal risks of natural disasters are as important to Jamaica’s economic security as the preservation of foreign exchange adequacy and debt sustainability.”
Those words, in my opinion, are indisputable. A now-deceased Bank of Jamaica governor, in the aftermath of Hurricane Gilbert, sought in 1988, to appropriate the foreign exchange funds due to local insurers under their reinsurance contracts. His goal was to preserve what Dr Clarke called foreign exchange adequacy. Foreign reinsurers sent those sums of money to local insurers to pay policyholders’ claims.
The BOJ governor’s attempt to sequester those inflows occurred at a time when the finance ministry had taken minimal steps to reduce the country’s fiscal risks from natural disasters, even though it was well known that Jamaica was acutely exposed to earthquakes and hurricanes. My informant, who was present at the BOJ-insurer meeting, held in the central bank’s Nethersole Place boardroom, told me that one insurance company head was so angry with the proposal that he ‘bawled out’ the central bank governor.
Jamaica’s “multi-layered” disaster risk financing strategy, according to the finance minister, protects the country against “the fiscal shock that natural disasters inevitably cause, increases its resilience and ability to recover without too much significant impairment to its economic trajectory”. Addressing the fiscal risk of natural disasters should, he said, be “a permanent strategic priority for Jamaica”.
The finance ministry’s strategy to manage some of the risks associated with natural disasters can be applied to manage all kinds of risks by citizens, businesses, including SMEs, institutions, and organisations in the public and private sectors. This should be one of the many lessons that we learn from the ongoing pandemic.
Key elements of the finance ministry’s risk financing strategy include:
• Understanding the major risks to which the island is exposed. This was done by the collection and analysis of data. In the case of the cat bond, the Planning Institute of Jamaica identified the most destructive hurricanes that affected the island during the last 20 years as measured by their impact on gross domestic product. This was only one of many data sets that were studied.
In contrast, executives, and board members of a Spanish Town Road commodity board a few years ago, feigned ignorance that the premises were prone to flooding and that inventories increased substantially during the early part of the annual hurricane season. They blamed a low-level employee for the millions of dollars of uninsured inventory losses. In another case, according to an August 2019 report in this newspaper, the management of the National Solid Waste Management Authority, based on its argument that claims from residents in Riverton City were ‘frivolous,’ does not understand that its operations may it expose to big third-party liability claims.
• Working in partnership with other entities to transfer parts of the identified risks to risk-bearing entities, in the case of the cat bond, to the global capital markets in exchange for the payment of a premium.
• Building an efficient structure to manage and pay claims before catastrophe events occur.
The risk-financing strategy as outlined in Dr Clarke’s article last week is not dissimilar to what happens in transactions between sophisticated corporate insurance buyers and the insurance markets. It is a process that is worth emulating.
For most companies, according to a United Kingdom body of risk management and insurance experts, “insurance represents one of the biggest investments and their largest source of contingent capital for many companies. It protects them from events that might otherwise threaten output, jobs and even their future existence. It makes companies more secure as business partners and places to invest”.
Dr Clarke’s essay should be required reading for the folks in the insurance procurement unit of the finance ministry and persons appointed to the boards of government companies, private and public companies across Jamaica.