Financial Planning for Catastrophes: What Nations Can Do

November 3, 2010

Interview with Olivier Mahul, Program Coordinator for Disaster Risk Financing (DRF) at the Global Facility for Disaster Risk Reduction (GFDRR) 

November 3, 2010 — The East Asia Pacific region sustains billions of dollars in disaster losses annually. Even as governments struggle to recoup their losses, nature is increasing the frequency and ferocity of its destruction. As always, it is the poor that are hit hardest and small island nations that suffer the most: the 2009 tsunami in Samoa wiped out 20% of its country’s GDP whereas an earlier hurricane in 1991 led to losses of a magnitude of 248% of GDP. (see table below).

Any attempt at Disaster Risk Management today must include some financial arrangements to help nations and poor householders alike to access financing in the immediate aftermath of a disaster and to help offset the risk of some disaster through new insurance mechanisms. Since 2006 GFDRR has co-financed 17 technical assistance projects and is working in 33 countries on DRF.

Question: What was the financial impact of natural disasters in Asia Pacific during 2009?

Olivier Mahul: In 2009 economic losses in Asia from natural hazards was US$15.77 billion. Insured economic losses in Asia from natural hazards were US$1.57 billion (current). Only 10% of economic losses from natural disasters are insured in Asia. If developed countries like Japan and South Korea are excluded, this percentage falls below 3%.

Have you done any studies on the long term financial impact on GDP from natural disasters for any countries in the region?

For most large economies, while the death toll can be unfortunately large, the economic impact of rapid-onset disasters (e.g., tropical cyclones, earthquakes) on GDP is somewhat limited because disasters usually do not affect the entire country. The story is completely different for small countries/islands, where the entire economy can be whipped out by an earthquake (see Haiti in 2010) or a tropical cyclone.

What percentage of the losses sustained by countries in the region can be realistically offset by Disaster Risk insurance mechanisms?

Countries should develop a comprehensive disaster risk financing strategy based on a three tier approach:

i.national reserves for small but recurrent disasters (e.g., landslides, etc.)

ii.contingent credit for larger but less frequent events (e.g., large floods)

iii.risk transfer instrument such as insurance for infrequent major disasters (say, occurring once every 10 years or less frequently).

Most Asian countries (governments, small and medium enterprises (SMEs), households) sustain most of their losses because the domestic insurance markets are under-developed. Disaster insurance can help (i) households and enterprises to protect their dwellings, (ii) governments to protect their budget against major fiscal impact due to natural disasters.

Can you compare the region's level of disaster risk insurance with that in developed countries?

Catastrophe insurance penetration in Asian developing countries is very low. It is estimated that insured catastrophe losses are up to 10 times lower than in developed countries. For example less than 5% of the losses cause by the Aceh Tsunami in 2004 where insured, and less than 1% of the losses cause by the Yogyakarta earthquake in Indonesia in 2006 were insured. Likewise, the vast majority of the economic losses caused by the floods in Pakistan are uninsured and will have to be borne by households with possibly some assistance from the government and the international community.

Since insurance depends on the state of the market in every country, can the World Bank really help to boost financial risk markets in developing countries? Or is risk financing really another mechanism for lending to developing countries?

The World Bank can help countries increase their financial resilience to natural disasters, as part of the broader disaster risk management agenda. The Caribbean Catastrophe Risk Insurance Facility helps 16 Caribbean islands to access immediate liquidity in case of a major disaster. A similar initiative (jointly with the Asian Development Bank) is under preparation in the Pacific region. The Bank also helps deepen local property catastrophe insurance markets (Turkish Catastrophe Insurance Pool (TCIP) in Turkey), helps the herders access livestock insurance against dzuds (harsh winters) in Mongolia, and help Indian farmers access crop insurance.

What is the most cost effective way for governments to offset climate-related financial risks? We have seen a quadrupling in the annual rate of disasters in this region in the last decade. 

Climate related risks need double management. First, disaster risk reduction and climate change adaptation can help countries reduce expected climate-related losses. However, these investments cannot fully insulate the countries against major disaster losses. Disaster risk financing in general and insurance in particular can help reduce the direct and indirect cost of disasters. For example, experience shows that delays in post-disaster emergency and early recovery activities affect mostly the poor and have long term developmental impact. These delays are sometimes due to lack of financial resources. Insurance can help countries access immediate resources after a disaster.

How does a regional risk insurance program, currently being developed for the Pacific Islands, bring greater benefits than emergency funding mechanisms already in place?

This initiative aims to provide the Pacific island countries with cost-effective and sustainable financial solutions to complement the post-disaster donor assistance. It builds on the three tier approach:

i.national reserves,

ii.contingent credit, and

iii.regional risk pooling through the proposed Pacific Disaster Reserve Fund.

The regional pooling mechanism, Pacific Disaster Reserve Fund, is under discussion. It would provide the affected countries with immediate budget support in case of a disaster. You can read more about the Pacific initiative here (300kb pdf).

Is it feasible for nations to invest in risk financing instruments when they have millions of poor and semi-poor people in need of basic necessities? 

Disasters have a major impact on the long-term development of countries. In particular, disasters affect disproportionally the poor because they do not have the financial capacity to absorb unforeseen losses. Investments in disaster risk reduction should be the priority. However, these investments cannot fully insulate the country against the economic impact of natural disasters. Financial instruments offer the countries the opportunity to secure funds, before the occurrence of a disaster, to be readily available when a disaster strikes. These financial instruments complement (and do not replace) post-disaster donor assistance.