FEATURE STORY

Pay Now or Pay Later? Making Financial Sense of Disasters

September 27, 2016


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A woman helps clean up after the 2015 earthquakes in Nepal. Photo: Samir Jung Thapa/Asian Development Bank


How natural disasters are paid for makes a big difference to the total economic cost. Ministries of finance receive countless financial protection proposals from reinsurers and banks, but often lack the technical expertise and quantitative tools to evaluate their suitability.

Recent research by the World Bank Group has made this a little easier. An integrated framework has been developed and tested for assessing potential financial protection strategies, requiring only basic technical capacity and readily-available data. Its real innovation is its use of actuarial, economic, and financial theory to condense some of the key benefits and weaknesses of each financial instrument into simple numbers. This allows instruments and strategies to be directly compared and can guide governments and their development partners in choosing an appropriate low-cost approach for financial protection against disaster.

For instance, different governments face different risks, different economic and fiscal environments, and different institutional capacities to manage public finance. And, instruments can differ in cost, speed, accuracy, and flexibility. When structuring a disaster risk financing strategy, these elements all matter.

Early comparative financial analysis and planning, the research finds, can save substantial money. Application of the framework to one drought-prone African country suggested that financing disaster-response costs through a combination of budget reallocation, reserves, and insurance could reduce the cost of response by a quarter, as compared to waiting for humanitarian aid to arrive. And analysis in a small island state exposed to tropical cyclones shows insurance to be more than twice as cost-effective as emergency budget reallocations. This research illustrates how the tradeoffs and uncertainties of financial instruments can be evaluated and used to inform decision making.

The Disaster Risk Financing and Insurance Program, a partnership of the World Bank and the Global Facility for Disaster Reduction and Recovery, is working with over 60 countries around the world to develop, implement, and learn from ex-ante financial protection solutions against disasters. And, these solutions work.

Financial and Budgetary Instruments

Goal

Ex ante instrument
(arranged before a disaster)

Ex post instrument
(arranged after a disaster)

Risk retention
(changing how or when one pays)

Contingency fund or budget allocation
Line of contingent credit

Budget reallocation
Tax increase
Post-disaster credit

Risk transfer
(removing risk from the balance sheet)

Traditional insurance or reinsurance
Indexed insurance, reinsurance, or derivatives
Capital market instruments

Discretionary post-disaster relief

SourceClarke and Dercon (2016)

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