Mexico: Better assessment of disaster risks to minimize financial losses
June 25, 2012
- The Government of Mexico and the World Bank released a joint publication on “Improving the Assessment of Disaster Risks to Strengthen Financial Resilience”.
- Mexico is using innovative financial tools to prevent a harsh and lasting economic backlashing in case of a major disaster
As part of their joint effort to reduce the impact of the natural disasters, the Government of Mexico and the World Bank released a joint publication on “Improving the Assessment of Disaster Risks to Strengthen Financial Resilience”.
In this book – presented in the context of the G20 in Mexico- the importance of understanding risks and building risk financial strategies to protect citizens and reduce the impacts of natural disasters is underlined.
The publication shows what G20 member’s countries and guests such as Mexico, Turkey or Colombia, have done to manage disaster risk, and stresses that international partners and global cooperation play a major role in these issues.
"The report ‘Improving the Assessment of Disaster Risks to Strengthen Financial Resilience’ is the first deliverable under the G20 disaster risk management agenda," said Jose Antonio Meade, Finance Minister of Mexico.
It could happen to anyone
There is no economy that is immune when natural disasters strike. Mexico, for example, with five tectonic plates in its territory, is particularly exposed to earthquakes – there are more than 90 earthquakes a year with a magnitude of more than 4.0 on the Richter scale, according to the Mexican chapter in the publication.
And this month is the start of the hurricane season in the Gulf of Mexico and the Caribbean, another major risk factor for the country.
Natural disasters not only cause physical or human losses – they also affect the economy and hinder growth. In Mexico, the 1985 earthquake caused 6,000 deaths and the losses were estimated at 11.4 billion dollars, according to the publication.
The situation forced the government in 1985 to use its resources for reconstruction efforts, instead of, for example, expanding the country’s infrastructure. It was the event with the biggest economic loss between 1970 and 2010, followed by Hurricane Wilma in 2005 and Hurricane Alex in 2010.
Shortly after the quake, Mexico created its disaster risk management system. In the 1990s, the government initiated a natural disasters Fund, FONDEN, that is especially meant for disaster relief and reconstruction.
In 2006, Mexico became the first sovereign country to issue a catastrophe bond for earthquake risks – a risk transfer instrument that shares the financial risk of a major earthquake with international markets.
Mexico and its “impressive” database
And through FONDEN, Mexico has an “impressive” database and visualization tool to map out the risks in the country, according to Hector Ibarra Pando, World Bank Senior Financial Officer. It shows current data and values on what public infrastructure could be impacted by a natural disaster.
“This database is unique in the world,” says Hector Ibarra Pando, “ and it is a topic that the World Bank is trying to boost on an international level, that the governments have the capacity to quantify the exposures at a fiscal level in matters of public infrastructure.”
If the earthquake is of a magnitude greater than Mw 7.9, or the wind speed is above a pre-determined benchmark, then the amount of the bond is paid.
Innovative financial tools
The country has made important contributions in the disaster risk financing and insurance area and is now using innovative financial tools to prevent a harsh and lasting economic backlashing in case of a major disaster.
Indeed, Mexico was the first country to issue a so-called Multi Catbond through a World Bank Program. The Multi-Catbond is a flexible financial tool that insures Mexico both against earthquake and hurricanes in certain geographical areas.
“The way it works is that the trigger for the insurance is parametrically determined. If the earthquake is of a magnitude greater than Mw 7.9, or the wind speed is above a pre-determined benchmark, then the amount of the bond is paid,” says Luis de la Plaza, World Bank Lead Financial Officer.
Put simply, the Catbond is a type of financial account where international investors can put their money in – a total of US$290 million. In this case it is managed by the World Bank who plays the bridge between international markets and Mexico.
If nothing happens during the lifetime of the bond, (three years), the investors get the money back, plus interests. If a major disaster happens, the money gets immediately disbursed to Mexico.
Luis de la Plaza explains that the tool is crucial, as the payment is immediate. “What we have identified is that when a natural disaster happens, typically there is a gap of time in between when the catastrophe occurs and the money arrives, “ he adds. With this tool, that is not the case.
Next steps: prevention and risk reduction
And once Mexico has the money, in the case of a disaster, the next step is to see how it is spent effectively. The country has been focusing through FONDEN on building and improving a transparent and effective system to allocate resources for reconstruction and emergency response.
Additionally, Mexico has done progress on prevention and risk reduction -which can include safe building codes, or works on roads to be more resilient when confronted with a potential catastrophe – but there is still work ahead, according to Oscar Ishizawa, Disaster Risk Management Specialist.
“Mexico is now interested in working in prevention and risk reduction issues,” he says and explains that Mexico is currently working with the World Bank on analyzing how much it is investing in that area, what are the impacts of these investments, and how to improve and promote prevention and risk reduction at the federal and the state level.
Moreover, Mexico has requested the World Bank to undertake a collaborative technical review of the disaster risk financing and insurance strategy and seek options to further improve its strategy based on international best practices.
The project will rely on local experience, as Mexico has one of the most sophisticated disaster risk financing strategies among middle-income countries.
Looking at the need to better understand risks to inform decisions, the publication released during the G20 is meant as a wake-up call to Ministers of Finance as well as a guide for countries to improve decision-making and strengthen their financial resilience.
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