Insurance and Disaster Risk Finance

Natural disasters such as floods, droughts, earthquakes, and extreme heat have become more frequent, with higher economic costs, due to climate change, urbanization, population growth and growing construction in high-risk areas. An average of more than 400 natural disasters occur worldwide each year, placing millions of people at risk, particularly those living in middle- and low- income countries. In 2023, these disasters globally claimed 74,000 lives and resulted in $250 billion of losses. These disasters pressured government budgets, disrupting development and investment in long-term resilience. They destroyed livelihoods, and jeopardized key sectors like agriculture and food production, transport, energy, tourism, and industry. Vulnerable groups, including low-income households, rural communities, and displaced people are disproportionately affected, exacerbating social inequalities and complicating recovery efforts. Across the developing world, nearly one in five people are at risk of disasters from which they will not fully recover.

Insurance could play a greater role in managing the financial impact of natural disasters. Insurance can offer financial protection against damage to physical assets and lessen impacts on economic activity and livelihoods. It can also provide incentives for adaptation, risk mitigation and preparedness before a disaster. Insurance companies also contribute to capital market development. As institutional investors with assets of almost $40 trillion, they deploy long-term capital in the real economy to support long duration projects, such as for infrastructure projects.

However, in most developing countries the development of insurance markets is constrained due to limited access to data and technical capacity and weak legal and regulatory frameworks, among others. Growing frequencies and scale of disasters impacting availability, affordability, and insurability is a major concern.  Developed markets also face issues of growing disaster risks reducing the affordability of insurance or even causing insurer market exits where they are unable to charge risk-based premiums.

The public sector and private sector must work together in developing effective markets to protect vulnerable economies and populations with sustainable and affordable solutions.

Disaster risk finance and insurance products shift the financing of response from reactive to proactive approaches. Insurance cannot finance all disaster losses, but it can be part of a risk layering approach that allows countries to prioritize the use of different financial solutions where they are most economically efficient, for example disaster funds for smaller losses, contingent loans for medium-sized disasters, and risk transfer for large events at the sovereign level. At the same time, different solutions and interventions are required for different target groups and objectives. Solutions need to be developed for individuals and businesses and integrated into provision of broader financial services.

Disaster risk finance and insurance mechanisms shift the financing of disaster response from reactive to proactive approaches, equipping governments with tools including those from the World Bank Group Crisis Response Toolkit as well as insurance and other market-based risk transfer mechanisms. They enhance countries’ resilience to shocks through public-private partnerships and building a set of complementary disaster risk financing mechanisms to ensure that governments have the financing and systems in place to respond to shocks and protect the most vulnerable in society.

The World Bank is advising over 70 countries on needed policy reforms, with more than 20 implementing climate-risk strategies based on World Bank assessments. These transform technical data on hazard and exposure into information on the economic and financial costs of disaster events, as well as the associated gaps in financial protection. Governments use this information to decide financial protection policy priorities and assess the best combination of financial instruments to meet them.

In Morocco, World Bank analysis supported the design and implementation of a disaster- risk-finance strategy. The government combined market-based catastrophe insurance with solidarity principles to safeguard both insured and uninsured households against disasters. Following the 2023 earthquake, the Solidarity Fund released $300 million to cover eligible losses, with $275 million from sovereign parametric reinsurance arranged in 2020 and renewed in 2023. This type of insurance protects against a specific event with a set payout based on magnitude of the event, rather than based on losses. This structure allows much faster payouts for beneficiaries with more predictability for insurers.

In Somalia, a consortium of 13 local insurers and 11 financial institutions are mobilizing finance for the poorest and most vulnerable pastoralist households in the Horn of Africa, an area afflicted by food insecurity and frequent droughts. A combination of digital bank accounts, savings accounts, and livestock insurance has benefited over 1.5 million people in two years, with 56% of policyholders being women.

Indonesia is protecting around 11,000 buildings, such as schools, hospitals, government offices by transferring risk to domestic and international insurance markets through its state assets insurance program (ABMN). This program enabled rapid repairs and minimized public service disruption during the 2020 Jakarta floods and the 2021 Mamuju earthquakes.

Malawi has invested in strengthening its social safety nets through private sector parametric reinsurance. With World Bank financing and technical support, the government designed a safety net with capability for scaling up in a crisis. A contingency fund provides emergency cash transfers in response to moderate droughts, and a macro/sovereign risk transfer instrument covers the cost of larger scale-ups for more severe droughts. Malawi’s efforts mark the first time an insurance product has directly backed a shock-responsive component of a social protection program in Africa, providing a model for other low-income countries.

Turkey is addressing market failures and low insurance penetration through public-private partnership. The Turkish Catastrophe Insurance Pool (TCIP) aims to develop the market and offer affordable insurance. The government provides a financial guarantee and enabling environment, while allowing companies to compete for operating the TCIP; private insurers then act as agents. TCIP is mandatory for urban areas and now insures more than 50 percent of the population. TCIP has also achieved efficiency and speed of payouts, as demonstrated following the 2023 earthquake. The World Bank supported establishment of the TCIP through a combination of technical assistance and lending, including contingency finance.