Coping with the financial impact of disasters: a macro-

perspectiveInsurance as a method for Disaster Risk Reduction in SEE

Macedonia, 23-24 April 2013

Richard Poulter, Researcher of Disaster Risk FinancingThe University of Copenhagen

Contents1. The macro level perspective: an introduction2. Disasters and development3. Disaster Risk Financing: A new paradigm4. Ex-post and ex-ante financing5. A weather derivative product6. Linking risk financing and disaster management7. The macro perspective – summing up

The disaster burden – fatalities

The disaster burden – damages

Disasters and development

Direct and indirect economic consequences

Type of impact Direct Indirect

Type of loss Fixed capital Cashflow

Economic consequence

Public assetsGovernment Buildings Public Infrastructure

Private assetsIndustrial infrastructureResidential Infrastructure

• Loss of tax revenue• GDP effects• Business interruption• Reallocation of

investments

Information

• Losses easy to calculate

• Response programs evaluated

• Insurers perform loss assessments

• Scare data

• Hidden effects

• Lack of recording

Coping with disasters: governments

In high-income countries, national action but limited economic shock

In low and middle-income countries, governments can pool and share risks, but still suffer from:Exhausted tax basesLimited donor assistance Inability to raise capitalGDP falls in the year of the event or the year afterBudget deficit increasesTrade balance worsens

Disaster Risk Financing:A new paradigm

Reactive (ex post)Proactive (ex-ante)

Government assistance (taxes)Kinship arrangementsDonor assistance

Insurance and reinsurance,catastrophe bond, index insurancecontingent credit, reserve fund

Turkey: Public-private insurance (2000)India+several countries: Index insurance derivatives and microinsurance (since 2004)Colombia: Contingent credit (2005)Mexico: Catastrophe bond (2006)Global: GIIF (2007)Caribbean regional insurance pool (2007)

All with donor involvement

The first step to developing a DRF strategyEstablish event contingent budgeting:

Funds are made available when a certain event occurs

This can lead to clarification over public disaster planning

The private insurance sector can also be used by government as a way to commit to a rules-based system for public expenditure

Timing of funds becoming available is key

Ex-post and ex-ante financing mechanisms

Type of risk

Loss of assets

-households/businesses

Loss of crops/livestock

– farms

Public assets, relief and reconstruction

expenditure

Post-disaster(ex post)

Emergency loans; Money lenders; Public

assistance

sale of productive

assets, food aid

Diversions; Loans from International Financial

InstitutionsPre-disaster (ex ante)

Non-market Kinship arrangements

Voluntary mutual arrangements budget item

Inter-temporal micro-savings food storage

catastrophe reserve funds, contingent

creditMarket-

based risk transfer

property and life insurance

crop and livestock insurance

Insurance or catastrophe bonds

Examples of disaster financing mechanisms

Contingent Financing – can be from the World Bank through a Development Policy Loan (DPL) with Catastrophe Deferred Drawdown Option (CAT DDO)

Sovereign Catastrophe Insurance Pool – Europa Re

Catastrophe Bonds – transfer risk to investors by allowing the issuer to not repay the bond principal if a major natural disaster occurs

Weather Derivatives – Provide financing from capital markets via index linked policies

Cashflows for DRF instruments

+

-

Capital Accumulation

Fund Paymenta) Reserve Fund

+

-

Credit Payment

Debt RepaymentAdministrative Costs

b) Contingent Credit

+

-

Insurance Payment

Premium

c) Insurance

Flow of Funds from Three Instruments

Linking risk financing and disaster risk management

Directly lead to adaptation through two channels: i) DRF provides financial compensation post event and

thus reduces the cost of follow-on consequences from slow reactions,

ii) DRF shares pre event risk by removing systemic risk inherent in decision making (i.e. What money should be spent on)

DRF can also indirectly lead to adaptation as the pre event premium provides an incentive to reduce risk (and reduce the premium)

Danger of maladaptation if agents rely on the financial security provided and relax preventive efforts

The macro perspective: summing up

Disasters impact middle-income countries through damages and slowing economic development

There are many hidden costs of disasters such as loss of tax revenue, lower GDP, reallocation of investments and a worsening of the trade balance

There has been a strong move from ex-post to ex-ante financing of disasters

The starting point is the establishment of event-contingent budgeting

Disaster risk financing can strengthen public disaster planning

Several market-based instruments are available, including national and international risk pools