Risk management: Facility speeds Caribbean relief

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By:
Felix Salmon
Published on:

June marks the beginning of the hurricane season in the Caribbean, and every year there’s a chance that any given island will suffer devastating losses to infrastructure, property and life.

Hurricane insurance is expensive, and so Caricom, the grouping of Caribbean nations, has collective insurance for the islands as one of its highest priorities.

But there’s another problem with hurricane insurance: calculating losses can take months, and money for rebuilding often doesn’t arrive until the year after the hurricane hits. But emergency funds are most desperately needed in the weeks and months immediately after the disaster.

Parametric

Hence the Caribbean Catastrophe Risk Insurance Facility (CCRIF). It’s parametric, which means that the payout is linked not to damages but simply to a list of parameters, chief among them wind speed. If weather conditions in any of the insured countries qualify, the facility pays out in less than two weeks, an astonishingly short time compared with the waits of up to a year that are not uncommon in the world of Caribbean hurricane insurance payouts.

The CCRIF itself has enough reserves to cover the first $10 million in damages. After that, $90 million in hurricane risk is ceded to reinsurance companies. And, in a novel development, another $20 million in risk was ceded by means of a catastrophe swap orchestrated by the World Bank.

The World Bank was involved in the project from the start, and wanted to diversify the investor base beyond the reinsurance companies that normally underwrite such policies. Up against the clock, however, the team working on the deal had no time to put together a fully fledged catastrophe bond or sidecar. And so a cat swap was put out to tender. The World Bank entered into a swap using standard Isda documentation with the CCRIF, and then in turn did a back-to-back swap with a capital markets player.

Reinsurers to the rescue

It turns out, in this case, that the best pricing came not from an investment bank or a hedge fund but from Munich Re Capital Markets. It would seem that for the time being reinsurance professionals are more comfortable pricing hurricane risk than other investors. But that will change, and next year the CCRIF should be able to do its own swaps, without going back to back via the World Bank.

And even in this deal the risk being taken on by Munich Re Capital Markets is being hedged, ultimately, with investors looking for diversification. The amount of catastrophe instruments in the market is growing steadily and eventually it’s entirely conceivable that the Caribbean, like Mexico, will regularly issue catastrophe bonds of its own.