Cedric Stephens | Safeguarding income through insurance

Investment Week recently reported that almost half of the new, self-directed investors in the United Kingdom are not aware that losing money is a potential risk of investing, new research conducted for the Financial Conduct Authority, FCA, a non-bank regulator, has revealed.

‘Understanding Self-Directed Investors’, produced by BritainThinks for the FCA, found that 45 per cent of self-directed investors, defined as those “who are making investment decisions on their own behalf … without a financial adviser”, do not view “losing some money” as a potential risk of investing.

Some policyholders are astonished to learn that the risks covered by insurance are limited. Coverage seldom insulates them from not incurring financial losses when the insured event occurs. My awareness of the insurance runnings, when coupled with the news item, predictably led me to pose questions about another kind of loss associated with damage to insured property. Business owners, banks, company executives, and even insurance professionals, often overlook it.

Today’s article will focus on the loss of production capacity – or revenue – following physical damage in the context of last August’s fire at Jamalco’s Halse Hall plant in Clarendon. Jamalco mines bauxite and refines it into alumina, which is exported from the port at Rocky Point. The bauxite mining and alumina-producing company is a joint venture between General Alumina Jamaica Limited, a member of the Noble Group; and Clarendon Alumina Production Limited, a Jamaica Government-owned company.

Jamalco’s insurance arrangements are not managed in the same way as those of the typical government-owned company. They are, I assume, bundled into the global insurance structure of the Noble Group, for contractual and economic reasons. And they are, I suspect, excluded from the government’s public insurance procurement rules. Notwithstanding these issues, the efficacy of Jamalco’s insurance coverage to last August’s fire is a matter of public interest.

Last Wednesday’s Gleaner said that the company maxed out its fire insurance claim. This was a surprising observation given the disclosure that the subject of the fire is not expected to be rebuilt and refitted with plant and equipment until 2024. That headline was this newspaper’s interpretation of Finance Minister Dr Nigel Clarke’s statement to Parliament. He said that a “claim had been made for the full policy limit of US$250 million on Jamalco’s insurance following a fire”.

The incident occurred in the powerhouse, which acts as the engine of the plant. A press release from the company last year stated that “the powerhouse produces power, compressed air and steam for the refining operations”.

Temporary repairs are now under way to facilitate the resumption of production of alumina up to 50 per cent of capacity by June. Mining operations are expected to start “in the weeks before alumina production” and full production is expected to be achieved by this September.

Imagined insurance structure

Jamalco is part of the Noble Group, which operates in 50 countries. It is assumed that the property damage and business interruption (loss of earnings) insurance arrangements for this entity are a subset of the global insurance programme of the Noble Group.

1. Losses arising from physical damage to assets caused by fire and the resulting loss of earnings (income) are insured, subject to a maximum of US$250 million. It is not known how much of the US$250 million applies to property damage and how much to the loss of earnings.

2. Coverage is structured in a series of layers, for example: Layer 1 - US$100 million; Layer 2 - US$75 million over Layer 1; and Layer 3 - US$75 million over Layers 1 and 2 (that is, US$175 million).

3. A consortium of foreign insurers and reinsurers participate in the three layers.

Noble Group says on its website that it operates ‘an independent risk management framework’. Further, “We actively manage board-approved risks in the pursuit of Noble’s strategic objectives by adhering to the following principles:

• Risks are taken within defined risk tolerance levels approved by the board of directors.

• Risks are approved by accountable officers within a risk management governance process and framework relating to risk and return that has been approved by the board.

• Risks are monitored and managed regularly and reviewed by the executive management and board committees.

“Noble has an independent risk department that ensures its general risk principles are upheld by the chief risk officer, who has a reporting line to both the executive management and the board.”

Contingent capital

It is not known if a risk management structure like Noble’s exists in the local joint venture company that manages Jamalco’s operations, or in its supervising ministries. A UK body representing corporate insurance buyers, AIRMIC, said in a 2014 booklet: “For most companies, insurance represents one of their biggest investments and their largest source of contingent capital. It protects them from events that might otherwise threaten output, jobs, and even the future existence of the company. It makes companies more secure as business partners and places to invest. To understand the importance of insurance to the viability of a company, a policy should be treated as having a value equal to the limit of indemnity that is purchased. If a company pays £2 million to purchase a £100 million limit of indemnity, the contract should be viewed as being potentially worth £100 million”.

In the case of Jamalco, its property damage/loss of earnings insurance should, therefore, be viewed as a source of US$250 million in capital. Who is responsible for overseeing the risk management functions and processes in the interests of the Jamaican shareholders?

The finance minister was reported to have told Parliament that: “The expectation is that full restoration of the Clarendon plant will be financed by insurance proceeds without resorting to shareholders’ funds”. His use of the word ‘expectation’ is significant. It is in sharp contrast to the UK regulator’s recent criticism of insurers in that country for their failure to deliver “contract certainty or treating commercial customers fairly”.

Anthony Hilton of the Evening Standard was quoted in AIRMIC’s 2014 booklet, Efficacy of Business Insurance, as saying “companies need to wake up to the fact that a lot of watertight insurance cover out there is potentially full of holes and investors should be aware that a lot of companies whom the auditors say are going concerns, may well turn out not to be if their insurance fails”.

Members of the public will learn sometime in the future whether Jamalco’s US$250 million insurance arrangements for property damage and loss of earnings was sufficient for the losses that were suffered last August, and whether the minister’s expectations were realised.

Cedric E. Stephens provides independent information and advice about the management of risks and insurance. For free information or counsel, write to: aegis@flowja.com or business@gleanerjm.com