The Government’s Role in Financing Disaster Risks to Households and Businesses

1. The Government’s Role in Financing Disaster Risks to Households and Businesses Session 3World Bank Institute International Institute of Applied System AnalysisJ. L. Bayer and R. Mechler Financial Strategies for Managing the Economic Impacts of Natural Disasters 1 1

2. Questions • How do households, farms and other businesses in developing countries cope with disaster losses? • To what extent do their governments assist with reconstruction and rehabilitation, what we call collective loss sharing? • To what extent do they engage in risk transfer? • What types of institutional arrangements determinethe extent of collective loss sharing and risk transfer forthe private sector? What roles can the government play? • Under what conditions are disaster risks to households and businesses insurable? What role are advanced computing technologies playing? • How can private and public responsibility be combinedin a national or regional insurance system? Financial Strategies for Managing the Economic Impacts of Natural Disasters

3. Loss Sharing and Risk Transfer for the Private Sector Disaster Loss Financing • Collective Loss • Sharing • For example • FONDEN calamity fund • Risk Transfer • For example • Insurance • Micro-insurance • Weather hedges Financial Strategies for Managing the Economic Impacts of Natural Disasters

4. Losses Reimbursed From Insurance and Government Assistance as a percentage of direct losses 100% 90% 80% 44% 51% Non- 57% 57% 61% 70% reimbursed 60% 84% losses 50% State aid 40% 30% 20% Insured 10% losses 0% Sudan floods '98 Poland floods '97 Kobe earthquake '95 Umbria earthquake '97 Easter floods England '98 Northridge earthquake '94 IIASA: Linneroth-Bayer et al. 2003 Mantaye 2000 Financial Strategies for Managing the Economic Impacts of Natural Disasters

5. Insurance uptake is function of income Need insurance culture and institutions Expensive Private Insurance in Low-income Countries Source: Munich Re 2000 Financial Strategies for Managing the Economic Impacts of Natural Disasters

6. Insurability of Disaster Risks • Risks are insurable if • They can be identified and quantified and • Insurers unrestricted in setting premiums; • However, insurance may not be available because of • Little demand • Adverse selection. Kunreuther (1998) Financial Strategies for Managing the Economic Impacts of Natural Disasters

7. Risk Transfer for Households and Businesses in Developing Countries? Commercial insurance is costly and plagued by moral hazard, therefore it is advisable only if • It is affordable or there is assistance to very poor households, farms and other businesses • There are no less costly alternatives • It is tied to loss reduction Financial Strategies for Managing the Economic Impacts of Natural Disasters

8. Public-private Insurance Systems for Developing Countries? • Public-private insurance systems are in place mainly in developed countries • US, France, Norway, New Zealand and Japan • Some important exceptions: • Turkish Catastrophe Insurance Pool(TCIP) • Puerto Rican reserve fund • Proposed for Caribbean Financial Strategies for Managing the Economic Impacts of Natural Disasters

9. The US National Flood Insurance Program Credit from US treasury (No taxpayer support) • Public Insurance • Voluntary • Risk based • Community must qualify Extensive post-event government assistance to disaster victims Financial Strategies for Managing the Economic Impacts of Natural Disasters

10. The French All-hazards System Taxpayer support If losses exceed capacity CCR public reinsurance • Private insurance • All hazards • Bundled • Flat-rate premiums with cross subsidies Financial Strategies for Managing the Economic Impacts of Natural Disasters

11. The Turkish Catastrophe InsurancePool (TCIP) • Main features of the TCIP • Mandatory insurance policies • Privately administered, public fund • Premiums based on risk • Insurance necessary for additional public post-event assistance • Support from the international community Financial Strategies for Managing the Economic Impacts of Natural Disasters

12. Risk Transfer for Public Assets Proposed for the East Caribbean and Honduras Source: Pollner 2000 Financial Strategies for Managing the Economic Impacts of Natural Disasters

13. Micro-insurance and Other Schemes • Public-private systems not an option for many developing countries • Unaffordable • Little knowledge of the risks • Lack of institutions and insurance culture • Micro-insurance schemes may be an alternative • Disaster insurance in India • Livestock insurance against sudden loss in Bangladesh • Banks • Weather hedges • One major issue is covariant risk, need for reinsurance Financial Strategies for Managing the Economic Impacts of Natural Disasters

14. Loss Mitigation • Loss-sharing or risk-transfer schemes should be coupled with incentives for loss reduction, e.g., • The US flood insurance program – communities must qualify; • The French system provides decreasing compensation with recurring claims; • The Turkish calamity fund reduces premiums for households that take prescribed measures. • Still role for government with top-down measures Financial Strategies for Managing the Economic Impacts of Natural Disasters