# **Explanation 1: Prices of catastrophe insurance are "high" and quantities of risk transfer are "low" because the provision of risk identification and of forecasting is insufficiently developed**

Forecasting the location, frequency, duration and magnitude of future catastrophic events is a key element of preparedness. Indeed, risk identification is the most important component of risk management, since risk-reduction and preparedness policies directly depend on the original assessment of risk. This is particularly important in the case of natural disasters which are characterized by their low frequency and difficult predictability.,<sup>0</sup> In the agriculture sector, longterm climate forecasts are essential to switching crops and reducing losses. In several Latin American countries, such as Peru and Brazil, meteorological forecasts and agronomic research into versatile hybrid crops have combined to significantly reduce crop destruction during drought years." Risk identification and forecasting of future catastrophic events require the use of costly techniques which include the study of historical records, topographical information, remotesensing imagery and aerial photography and the development of highly sophisticated forecast models. However, institutions in charge of research and prevention of disasters are inexistent or grossly under-funded in the Caribbean region (Charveriat, 2000, p. 93), although this may be changing with the recent creation of two regional risk management institutions (Box 2.2).22 In addition, the private sector may not find it profitable to invest in technologies with high fixed costs for the sake of providing catastrophe insurance/reinsurance to the somewhat limited market of small Caribbean economies. As a consequence, insurance and reinsurance companies are likely to under-invest in risk modeling technology in the Caribbean region. Although an increasing number of Caribbean-based companies are promoting the use of technology by allocating significant portions of their budgets to acquisitions and upgrades, most of them do not as yet have access to the relevant tools and equipment.

Forecasting the location, frequency, duration and magnitude of future catastrophic events is also a key element in pricing catastrophic risks. In the absence of the appropriate technology that can identify and forecast risk in the Caribbean region, intemational reinsurers have set catastrophe premiums in the Caribbean region close to those that apply in developed countries -primarily on the basis of losses experienced in the large, diversified economies of the United States, Europe and Japan where most of their exposure is concentrated. To substantiate, while there was no major catastrophic event in the Caribbean in the early 1990s, reinsurance premiums more than doubled in the region because of losses experienced by insurance and reinsurance companies in the aftermath of Hurricane Andrew and the Northridge Earthquake.

Private markets, by themselves, do not provide high quality, publicly available information on risk, which lowers the level of preparedness and increases the damages of catastrophic events. Consequently, low preparedness contributes to explain the "high" costs of and "low" demand for catastrophe insurance/reinsurance. In the Caribbean region, the public sector, possibly as a regional initiative, could provide incentives to the private sector, including universities,'<sup>3</sup> to foster

> 10 For instance, when the Soufriere Hills volcano in Montserrat became active again **in** 1996, its last eruption had occurred 250 years before. In the case of El Nino, the frequency is higher: there have been three recognized episodes of El Nino over the last twenty years: 1982-83, 1991-92 and 1996-97.

> " Mjelde, Hill and Griffiths (1998, p. 1093) reported in Charveriat, 2000, p. 73. 12 For more on this issue see also World Bank, 2002 (b) and (c) which provide an in-depth analysis of the institutional shortcomings in natural risk management in the Caribbean region.

> 13 For example, Professor William Gray of Colorado State University makes publicly available forecast regarding the occurrence of hurricanes. Some information is also available from specialized departments of insurance companies.

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