Hurricane Beryl and Catastrophe Bonds – Somewhat Hit or Miss?
While the Caribbean is half a world away, there’s no escaping the fact there are local implications arising from Beryl’s impact. No matter where - whether it’s wind, water, drought, fire, flood or pestilence - lessons learned from the increasing amplitude and frequency of global catastrophe events have to be factored into local responses. Nature does not discriminate.
Over the modern (300+ year) history of insurance as a risk transfer tool, insurance-linked securities (of which catastrophe bonds are part) are a very recent development in response to the recognition that catastrophe events were exposing the limitations of traditional (re)insurance products.
Also known as parametric insurance, since the late 1990s these financial tools have been promoted as both a combined (hybrid) construct for ‘complete’ risk transfer programs, or a standalone alternative to traditional insurance (e.g. where no direct damage is involved, but non-physical loss is likely such as reduced yield or revenue).
Swiss Re, a leading global reinsurer and insurance market research house has produced a (relatively) simple ‘guide’ to what the product is all about - ?
But, like most aspects of insurance and the response to climate change, things are not this simple.
As the name suggests, parametric insurance payments are triggered by a parameter. These include wind speed, rainfall (or lack thereof) and temperature, sustained over a given time period. And, as the product has developed, the triggers have become more refined (including those based on multi-dimensional metrics and/or with graduated payment based on a severity range) to the point where there is an array of trigger/payment options to choose from ?- whether that be in constructing basic parametric products all the way through to complex catastrophe (cat) bond offers.
And, it is in connection with the latter that it is somewhat surprising to note that the beginning of the 2024 Caribbean hurricane season has, with Hurricane Beryl, thrown up concerns about the product because Beryl didn’t reach the pay-out threshold for the Jamaican Government’s cat bond - ?
The risk/reward equation is as complex, if not more so, than traditional underwriting and, for both seller (the ‘insured’, i.e. governments, (re)insurance companies and large corporates) and buyer (the ‘insurer’, i.e. investors in capital market instruments), it is not for the unsophisticated or faint-hearted.
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Jamaica’s 2024 Hurricane Season Cat Bond Barometric Thresholds and Lowest Hurricane Beryl Track Pressures
You have to know what you are doing and, in the end, consciously accept the trade-off inherent in parametric solutions which, in their purest form, are there to reduce but not eliminate the pain of exposure to peak events.
After-all, like an auction, the seller has a reserve price and buyers bid with a maximum in mind; the trade complete only when both meet. The same applies to the transfer of risk, and the implication that somehow less economically advantaged countries should be cut some slack[1] with Beryl being outside expectations (the earliest Category 5 hurricane, ever), demonstrates a lack of appreciation of how these tools are constructed, the sophisticated advisers involved (incl. the World Bank), and the fact that, in the end, it remains best guess as to where the parameters are struck and what that means for the ‘unknown’ risk component – which is what the investor margin is all about and will rise & fall over the investment period/cycle as experience dictates.
In my region (Oceania) we differ only on the margin to other parts of the world, and are unnervingly similar to the Caribbean when it comes to cyclone/typhoon exposure. Also sponsored by the World Bank, a number of Pacific island countries have issued (subscribed to generic) cyclone cat bonds and, in doing so, straddle the same risk/reward continuum.
Like traditional insurance, cost/availability will eventually rebalance to ‘acceptable’ levels/stability but only where exposed nations take a broad view and invest in mitigation initiatives as part of a comprehensive, globally-driven set of responses that provides them the means to do so (e.g. increased resilience of the built environment, constant availability of life’s staples and continuity of supply chains) while effectively addressing the root causes.
Parametric products, like insurance, are, and always will be, an essential but ultimately imperfect response to the risk of natural catastrophes; with risk quantification remaining an inexact science. They are not, and never will be, a replacement for this inescapable truth.
[1] In addition to the traditional recourses available for improper advice.