An original version of this article was published in Guernsey Press, September 2015
Mark Helyar, Partner at Bedell Cristin Guernsey, looks at catastrophe – or ‘cat’ – reinsurance, Guernsey’s fastest growing and ethical investment sector.
Insurance companies (such as your own household insurer) are responsible for paying out claims for a variety of natural risks which can cause damage, for example in the case of extreme weather events, flooding, volcanoes, earthquakes, tidal waves and other risks which are known in the insurance markets as “natural perils”.
The insurance market employs many scientists and modellers who assess the risk and probability of different types of natural event happening in different places in the world. They also look at unnatural perils such as man-made explosions, environmental pollution events and contamination, for example by escape of radioactive materials. Their analysis is then used together with underwriters to set the premiums which must be paid for different types of insurance policy cover. The really big events, like hurricanes and major earthquakes, or failures of nuclear power stations, are called “catastrophe” or CAT risks because they are so large and beyond the means of smaller insurers to pay out. The provision of structures to facilitate these types of CAT coverage remains Guernsey’s fastest growing financial sector.
Beyond your household insurer lies another market, the so-called reinsurance market. Your household insurer buys reinsurance from that market in order to offset some of its higher risks. Reinsurance is cheaper than ordina ry insurance (mainly because it covers more remote risk). So if an insurer were liable to pay claims of £100 million as a result of widespread flooding, for exam ple, the reinsurance market might repay the insurer in the higher layer, for example from £50 million of its loss up to £100 million. In return the reinsurer charges a premium which is less than the equivalent premium charged to the consumer, and your insurer carries less risk , so your insurance is correspondingly cheaper.
Insurers across large urban areas where there are frequent large storms and natural disasters which can cause widespread damage (such as the South Eastern USA), carry liabilities stretching too many billions of dollars. Recent events like the Tianjin blast in China is estimated to cost $1.5 billion in claims. Hurricane Katrina’s losses in the private insurance market in the USA were a staggering $41.7 billion. Despite these huge payments, the insurance and reinsurance markets paid out as they promised and did not collapse. This is because premiums are set at levels which enable reinsurance companies to make profits when the risk is analysed over a long period, and the risk was spread widely rather than concentrated amongst a few insurers and reinsurers.
Even though these CAT risks are considerable, there are many investors willing to put capital into the market because of the potential longer term returns. They also have favoured the reinsurance markets because natural disasters are not correlated with the investment markets, so when shares go down in price, the returns from insurance and reinsurance markets do not alter significantly in relation to the stock market. This can help to offset or stabilise losses in the usual investment markets, which have been more than a little unreliable in recent years.
In Guernsey there is a substantial and rapidly growing market which enables reinsurance transactions to provide for different types of CAT cover. These include issuing private or public listed bonds (or loans) on the Channel Islands Securities Exchange, or providing bespoke cell transactions for fully collateralised reinsurance.
Increasingly investors are looking at CAT reinsurance as another class of ethical investment. CAT cover pays out when people have suffered some of nature’s worst and most devastating damage, from tsunamis and earthquakes to tropical cyclones and tornadoes. The coverage helps people to rebuild their homes, their local infrastructure and businesses. It also thereby reduces pressure on the costs of emergency aid and pressure on the remainder of the public in a country to fund such measures through higher taxation or international aid. Guernsey’s insurance and reinsurance sector has quietly and efficiently provided cover for all manner of natural and man-made disasters in recent times, from the Christchurch earthquake in New Zealand, the Fukushima plant failure in Japan to the Deepwater Horizon incident in the Gulf of Mexico.
From Guernsey’s perspective this growing sector also tends to attract highly sophisticated and professional corporate investors who are using the jurisdiction for its highly regarded regulatory framework and cutting edge professional expertise, rather than to gain simple tax advantages. As these structures are annual in nature and attract taxation in the jurisdiction of the investors, there is no tax roll up or tax loss to any foreign government.
This is a great benefit to Guernsey as it represents a sector which is not susceptible to the rather simplistic and politically driven current criticisms based around tax competition between the onshore and offshore world. Growth in sustainable professional service industries of this type is vitally important for Guernsey and its reputation at this time. Our law firm, Bedell Cristin, continues to play a central and leading role in development of the sector.