94988 FINANCIAL PROTECTION AGAINST NATURAL DISASTERS An Operational Framework for Disaster Risk Financing and Insurance COVER PHOTO F&F Tower, Panama City FINANCIAL PROTECTION AGAINST NATURAL DISASTERS: FROM PRODUCTS TO COMPREHENSIVE STRATEGIES An Operational Framework for Disaster Risk Financing and Insurance 02 © 2014 International Bank for Reconstruction and Development / International Development Association or The World Bank 1818 H Street NW Washington DC 20433 Telephone: 202-473-1000 Internet: www.worldbank.org This work is a product of the staff of The World Bank with external contributions. The findings, interpretations, and conclusions expressed in this work do not necessarily reflect the views of The World Bank, its Board of Executive Directors, or the governments they represent. The World Bank does not guarantee the accuracy of the data included in this work. 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Table of Contents 05 Acknowledgments 07 Policy Messages PART 01 10 Section I: The Developmental and Financial Cost of Natural Disasters 13 The Policy Maker’s Burden: Financial Impact across Society 22 Section II: Disaster Risk Financing and Insurance - Tools for Financial Protection 23 Definition and beneficiaries of disaster risk financing and insurance solutions 29 Key considerations for financial protection 34 The private sector’s role in the disaster risk financing and insurance agenda 38 Section III: Evaluation of Progress Made on Financial Protection 38 Beginnings to 2005: Early experience in disaster risk financing at the international level 42 2005-2010: New approaches to financial protection under the Hyogo Framework 46 2010-Present: From products to strategies for financial protection 52 Section IV: Looking to the Future 52 Areas of focus for strengthening public financial management of disasters 55 Opportunities to expand the impact of disaster risk financing and insurance 56 Disaster Risk Financing in the Next Hyogo Framework for Action 03 04 Table of Contents PART 02 59 An Operational Framework for Disaster Risk Financing and Insurance 70 Annexes 70 Annex I: Expanded Decision Tree for Disaster Risk Financing and Insurance Engagement by Governments 72 Annex II: Some commonly asked questions when considering disaster risk financing and insurance 75 Annex III: Natural Disaster Losses 1990-2012, in 2012 US$ millions 76 Annex IV: Insurance and the financial resilience of countries 78 Annex V: Further Information on Disaster Risk Financing and Insurance Initiatives Discussed 79 Endnotes 81 Bibliography 84 Photo Credits 84 Abbreviations Acknowledgments This report was originally written in response to a request Ş Paolo Bazzuro, University Institute for Superior Studies Pavia by the United Nations Office for Disaster Risk Reduction Ş Charlotte Benson, Asian Development Bank (UNISDR), as the coordinating author of the Global Assessment Report on Disaster Risk Reduction 2015 Ş Tim Bishop, Organisation for Economic Co-operation and Development (GAR15). The primary objective of this report is to take Ş Rowan Douglas, Willis Re stock of the global progress on financial protection against Ş Juan Jose Durante, Inter-American Development Bank natural disasters over the last decade and bring together Ş Nick Harvey, Department for International Development, the latest thinking on disaster risk financing and insurance. United Kingdom This discussion will contribute to the drafting of the GAR15 Ş Michael Roth, Munich Reinsurance Company and, importantly, will help inform the deliberations for the Ş Monica Rubiolo, State Secretariat for Economic Affairs of successor agreement to the Hyogo Framework for Action, Switzerland (SECO) to be agreed upon at the 3rd World Conference on Disaster Ş David Satterthwaite, Oxfam Risk Reduction in March 2015. Ş Michael Schwarz, Swiss Reinsurance Company Ş Simon Young, Africa Risk Capacity The report was authored by Olivier Mahul and Benedikt Signer, with contributions from Laura Boudreau in addition Inputs and reviews from Bianca Adam, Cinthya Aramayo, to Hannah Yi, Sevara Atamuratova, Daniel Clarke, and Sofia Bettencourt, Jack Campbell, Samantha Cook, Julie Emily White (all from the World Bank-GFDRR Disaster Risk Dana, Marc Forni, Robert Reid, Benjamin Fox, Hector Ibarra, Financing and Insurance Program). Felix Lung, Barry Maher, Niels Holm-Nielsen, Rachel Sberro, Joaquin Toro, Ana Maria Torres, and Jose Angel Villalobos The report benefitted greatly from the contributions greatly enhanced the final report. Megan Cossey’s and review of the Working Group on Financial thorough editing ensured the final report remained Protection against Natural Disasters, bringing together readable. Design and Layout by Bivee LLC. representatives from the public and private sector with many years of experience in supporting countries The report has been prepared under the overall guidance vulnerable to natural disasters to implement financial of Francis Ghesquiere, Manager of the Global Facility for Disaster Reduction and Recovery (GFDRR), and Michel protection solutions. The working group includes: Noel, Practice Manager, Global Practice Finance and Markets. The team gratefully acknowledges funding support from GFDRR. The DRFIP is grateful to the Swiss State Secretariat for Economic Affairs (SECO) for support which enables deep engagements with selected middle-income countries around the world. This work has informed and shaped much of the operational framework presented in this document. 05 06 Policy Messages 1. Disaster risk financing and insurance helps /// 3. Financial protection requires strong /// minimize the cost and optimize the timing leadership by a country’s ministry of of meeting post-disaster funding needs finance. Disaster risk financing and insurance /// without compromising development goals, brings together disaster risk management, fiscal stability, or wellbeing. It promotes /// fiscal risk and budget management, public comprehensive financial protection strategies to finance, private sector development, and social ensure that governments, homeowners, small and protection. Strong stewardship by the ministry medium-sized enterprises, agricultural producers, of finance in coordination with other public and the most vulnerable populations can meet agencies is crucial to successfully advance post-disaster funding needs as they arrive. this agenda. 2. Disaster risk financing and insurance is an /// 4. The private sector is an essential partner. /// /// integral part of disaster and climate risk The private sector can bring capital, technical expertise, and innovative financial solutions management. The financial impact of disasters /// to better protect the government and society is best managed when integrated into holistic against natural disasters. risk management practices. It complements disaster risk management activities by securing 5. Disaster risk financing and insurance is a /// adequate financial resources to cover residual long-term agenda that requires political risks that cannot be mitigated and by creating will, technical expertise, and time. While /// the right financial incentives to invest in risk simple measures can quickly support improved reduction and prevention. By quantifying the financial protection, more complex financial financial and fiscal impact of risk, it elevates risk solutions and institutional change require management within the ministries that control technical expertise and political will. Partnerships public investment. can support governments on this path. 07 CHAPTER 01 01 PART 10 F I N A N C I A L P R OT E C T I O N A G A I N S T N AT U R A L D I S A S T E R S Section I: The Developmental and Financial Cost of Natural Disasters When record floods inundated large swaths of Global Assessment Report estimates that the actual Thailand, including its capital Bangkok, in the fall losses are at least 50 percent higher, once smaller of 2011, total damage and loss amounted to THB disasters are included (UNISDR 2013). The true 1.43 trillion (US$46.5 billion1), more than 13 percent impact of disasters is of course much higher still. of that year’s gross domestic product (GDP). But These financial loss figures only account for direct the financial impact on the government continued loss, excluding indirect3 loss and the wider economic long after the water finally receded. The floods and human effects of disasters. were estimated to reduce real GDP growth in 2011 The trends in losses hide a wide range of impact. by 1.1 percent from pre-flood projections, reduced Events that are comparable in terms of physical Thailand’s current account to US$11.9 billion from a parameters, total loss, or affected population, projected $20.6 billion, and caused a 3.7 percent loss have a vastly different macroeconomic impact in tax revenue from estimated pre-flood revenues depending on a country’s level of development, (World Bank and Government of Thailand 2012). size (geographic and population), and degree of Financial losses from natural disasters continue insurance penetration. The relative share of this to rise, with developing countries and their low- loss occurring in middle-income countries has seen income populations feeling the greatest effects. a steady upward trend over the past 30 years (in Direct financial loss reached an average of $165 2 2012 U.S. dollar; see Figure 2). The rapid growth /// /// billion per year during the last 10 years, with loss of assets exposed to hazards in middle-income exceeding $100 billion in six of those years (see /// countries—for example through urbanization and Figure 1). This compares to about $130 billion of /// new infrastructure—is likely responsible for much official development assistance in 2012. Yet the 2013 of this increase. PART 01 Figure 1 Direct disaster loss by income group $450 $400 $350 2012 US$, Billions $300 $250 $200 $150 $100 $50 $0 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 High-Income Economies Middle-Income Economies Low-Income Economies Source: Authors, with data from Swiss Reinsurance Corporation, country income groups according to World Bank definitions Figure 2 Relative distributions of direct loss between high-, middle-, and low-income countries across time (as percent of total annual direct loss) Percent of Total Annual Direct Loss 100% 80% 60% 40% 20% 0% 1981-85 1986-90 1991-95 1996-00 2001-2005 2006-12 High-Income Economies Middle-Income Economies Low-Income Economies Linear Trend: Middle-Income Economies Source: Authors with data from Swiss Reinsurance Corporation F I N A N C I A L P R OT E C T I O N A G A I N S T N AT U R A L D I S A S T E R S 11 12 F I N A N C I A L P R OT E C T I O N A G A I N S T N AT U R A L D I S A S T E R S Figure 3 Distribution of direct losses (1980-2012) on country income As a percentage of GDP, fast-growing middle-income groups as % of GDP countries suffer the most, with average annual direct loss at 2.9 percent of GDP, followed by low-income 3.0% countries (1.3 percent of GDP) and high-income countries (0.8 percent of GDP) (Munich Re 2013; /// 2.5% see Figure 3). Much of this trend is due to the Average percentage of direct losses /// rapid increase of assets in developing countries 2.0% with respect to GDP that do not take disaster risk into account during 1.5% construction, leaving them vulnerable to natural hazards. Although average direct loss relative to 1.0% GDP is less for low-income countries, this does not consider the most important impact—the loss 0.5% of lives, livelihoods and negative effects on human capital. 0% High-Income Middle-Income Low-Income Economies Economies Economies The concentration of loss in small countries, and particularly in small island developing states, leads Note: Loss figures from MunichRe NatCat Service; county groups according to World to even more severe macroeconomic effects. The Bank 2012 classification. Source: MunichRe, 2013a PART 01 Figure 4 Average annual loss from disasters as percentage of GDP in small islands developing states 10% Average Annual Loss from Disasters, % of GDP 9% 8% 7% 6% 5% 4% 3% 2% 1% 0% r a tu ga s s . s ji Do ds a s s u Ba ca as oa s ts ca Fi i ve nd nd nd iu ic ad la ev ua m ai .S an n m in rit Pa as di la la la en To N m ha Sa n m ed sl au al ag Is Is Is Va Ja d Gr lI M ,F an M ok on in ad al rg ia sh Co e m M s es Th Vi tt lo ar Ki n So M ro . St ic M Source: Prepared by World Bank, based on historical disaster damage reported in the EM-DAT Disaster Database (www.emdat.be), and for Pacific Islands on modeled annual losses from cyclones, earthquakes and tsunamis. devastation wrought by 2004’s Hurricane Ivan in (von Peter, et al. 2012).5 This compares to an average the Caribbean caused economic loss almost double for all countries of 0.8 percent decline in GDP the annual GDP of both Grenada and the Cayman growth per disaster occurrence and a cumulative, Islands as well as significant damage in Jamaica, permanent loss of 2.4 percent, emphasizing the a stark reminder of the catastrophic devastation heightened vulnerability of these countries. disasters can inflict (Young and Pearson 2008). Small island states across the Caribbean and Pacific The Policy Maker’s Burden: Financial bear average losses exceeding over 3 percent of Impact across Society their respective GDP every year (World Bank and United Nations 2010; Pacific Catastrophe Risk In mitigating the financial impact of disasters, Assessment and Financing Initiative [PCRAFI] 2011; /// experience shows that policy makers are primarily see Figure 4). Recent analysis has found that, on /// concerned with its effect on the government, average, in a small country the occurrence of a major homeowners and small and medium-sized disaster reduces GDP growth by 1.2 percent, with a enterprises (SMEs), farmers,6 and the poorest.7 cumulative permanent4 loss of 3.7 percent of GDP This segmentation is largely the result of the type F I N A N C I A L P R OT E C T I O N A G A I N S T N AT U R A L D I S A S T E R S 13 North America Europe 5.48% 18% 5% 3.06% 1.95% 0.55% $366.4 $108.7 82% $959.2 536.5 95% South America 38% 3.73% 0.52% $135.4 $19 62% Disaster Loss 1990-2012 AS % OF 2010 GDP, BY CONTINENT Percentage of 2010 GDP Weather-Related Losses in US$ Billion 6.52% by Percentage Total Losses Total Weather-Related Losses 3.87% 42% 58% Insured Losses Earthquake Losses $69.5 $41.2 12.23% Asia 1.06% 54% 46% $1292.9 $111.6 Oceania/Australia Africa 6.52% 3.87% 41% 1.05% 42% 0.07% 59% 58% $16.8 $1.1 $69.5 $41.2 World 5.34% Central America and the Caribbean are included in South America. 13% All amounts in constant 2012 dollar. Source for loss figures is SwissRe, total loss is the financial loss directly attributable to a disaster, but it does not include indirect 1.54% losses. GDP data from World Bank. Underlying loss data in the annex. $2841.1 $818.6 87% 16 F I N A N C I A L P R OT E C T I O N A G A I N S T N AT U R A L D I S A S T E R S of cost associated with a disaster—for example both to provide this support, social and political pressure homeowners and SMEs are concerned with building can make such support an implicit contingent damage. Table 1 summarizes some of the ways /// /// liability. These types of contingent liabilities are that natural disasters directly and indirectly affect often the most difficult for the government to assess the financial and developmental stability of these and can pose major fiscal risk. groups. These are then discussed in turn. Even in years without exceptional disasters, costs Direct financial impact can be significant. Between 1999 and 2011, the on the government government of Mexico spent on average $1.46 billion annually (2011 US$) on the reconstruction of The government’s central role in natural disaster emergency relief, recovery, and reconstruction public assets like roads and bridges and low-income implies a large and direct financial burden. housing following more frequent but less severe While this burden varies greatly across countries disasters (Government of Mexico and World Bank depending on the definition of the government’s 2012). In addition to replacement of the damaged contingent liability to natural disasters,8 there are assets, governments’ should consider higher costs many universal features. for improvement so they do not build back the risk. For example, about 25 percent of post-disaster During and directly after an event, the government resources approved by Mexico’s natural disaster is required to provide emergency relief to the fund FONDEN are generally allocated for the affected population. These costs tend to be small improvement of public assets, to strengthen their in terms of the event’s overall costs, but require resilience to future disasters. immediate mobilization of funds. Emergency relief for the 2011 Great East Japan Earthquake Government-sponsored social and economic represented less than 1 percent of total government support programs for individuals, SMEs, and farmers expenditures related to the event, but importantly can also be significant and even exceed the costs was first mobilized within just three days (Sato of reconstruction. This was the case in Japan after and Boudreau, 2012). Such speed is essential for a the 2011 earthquake, where economic and social successful government response. support programs (such as employment programs, Reconstruction of uninsured or underinsured public measures to support SMEs, housing grants, and infrastructure—including low-income housing— education assistance) cost more than direct repair typically accounts for the majority of public and reconstruction (Sato and Boudreau, 2012). spending following disasters. In some cases, middle- Finally, major natural disasters can trigger and high-income residents and SMEs exert pressure public contingent liabilities arising from state- for public support of reconstruction. The 1999 Marmara/Izmit Earthquake in Turkey generated owned enterprises and firms that are critical for fiscal costs in the range of $2.4 to $2.9 billion economic recovery from the event. Following the (2010 US$), with the largest direct cost (estimated 2011 Canterbury Earthquake, New Zealand’s then between $970 million and $1.6 billion) coming second-largest residential insurer, AMI Insurance, from the reconstruction and repair of housing found itself unable to meet the total value of claims stock, much of which was owned by middle- and resulting from the event. To ensure Canterbury’s high-income residents (World Bank 1999). While in recovery, the government decided to bail out many cases the government is not legally required and subsequently resell AMI, as well as to take PART 01 Table 1 Direct and indirect financial impact of natural disasters on different groups across society Government Homeowners and SMEs Direct Direct Ş&NFSHFODZSFTQPOTFBOESFDPWFSZFYQFOEJUVSFT FOVOJOTVSFEPS Ş3FDPOTUSVDUJPODPTUTEVFUPEBNBHFPǨPǐ Ş3FDPOTUSVDUJPOFYQFOEJUVSFTǨPSVOJOTVSFEVOEFSJOTVSFEQVCMJD underinsured assets; infrastructure, public buildings, and often low-income housing; Ş)FBMUIBOEPUIFSǨJOBODJBMDPTUTBTTPDJBUFEXJUIIVNBO Ş$PTUTǨPSJNQSPWFNFOUTPǨSFDPOTUSVDUFEJOǨSBTUSVDUVSF BTXFMM fatalities, injuries, and disabilities. as for relocation of at-risk population; Indirect Ş&YQFOEJUVSFPOTPDJBMBOEFDPOPNJDSFDPWFSZTVQQPSU programs; Ş-PTTPǨJODPNFMJWFMJIPPEEVFUPCVTJOFTTJOUFSSVQUJPO Ş3FBMJ[BUJPOPǨDPOUJOHFOUMJBCJMJUJFTUPTUBUFPXOFEFOUFSQSJTFT  unemployment or loss of wage earner; to firms that are critical to economic recovery, etc. Ş-PTTPǨJODPNFMJWFMJIPPEEVFUPFDPOPNJDEFDMJOF Indirect Ş*ODSFBTFECPSSPXJOHDPTUT Ş"EEJUJPOBMFYQFOTFTTVDIBTIFBMUIDBSFBOEQBZJOHǨPS Ş%FDSFBTFEUBYSFWFOVFEVFUPFDPOPNJDEJTSVQUJPOBOE alternative accommodation during reconstruction. declines in GDP growth; Ş0QQPSUVOJUZDPTUPǨEJWFSUJOHǨVOETǨSPNEFWFMPQNFOUBOE social programs to disaster response and reconstruction; Ş*ODSFBTFEEPNFTUJDJOUFSOBUJPOBMCPSSPXJOHDPTUT Ş1PUFOUJBMOFHBUJWFJNQBDUPOTPWFSFJHODSFEJUSBUJOH Ş*ODSFBTFEFYQFOEJUVSFTǨPSTPDJBMTVQQPSUQSPHSBNT TBǨFUZ nets); Ş.JHSBUJPOEVFUPEJTBTUFSJNQBDU MPTTPǨMJWFMJIPPET  Farmers The Poorest Direct Direct FOVOJOTVSFEPSVOEFSJOTVSFEBTTFUT Ş3FDPOTUSVDUJPODPTUTǨPSPǐ Ş3FDPOTUSVDUJPODPTUTǨPSEBNBHFEBTTFUT Ş3FTUPDLJOHSFQMBOUJOHSFIBCJMJUBUJPOPǨQSPEVDUJWFBTTFUTTVDIBT Ş3FQMBDFNFOUPǨMJWFTUPDL livestock or crops. Indirect Indirect Ş%FDSFBTFTJOFYQFOEJUVSFPOǨPPE BDDPNNPEBUJPO BOE Ş-PTTPǨJODPNFǨPSǨBSNFSTBOEPUIFSTVQQMZDIBJOBDUPST human capital (possibly combined with higher costs for due to interruption of crop/livestock/fish stock production; healthcare, education, etc); Ş-PTTPǨJODPNFǨPSǨBSNFSTBOEPUIFSTVQQMZDIBJOBDUPST Ş-PTTPǨTPDJBMTVQQPSUEVFUPCSFBLEPXOJOJOǨPSNBMTBǨFUZ due to economic decline and/or lack of access to markets; net systems such as family and community support; Ş*ODSFBTFECPSSPXJOHDPTUT Ş-PTTPǨJODPNFBOEVOFNQMPZNFOU Ş*ODSFBTFESJTLBWFSTJPOUPOFXBOEJOOPWBUJWFJOWFTUNFOUT  Ş*ODSFBTFECPSSPXJOHDPTUT leading to adoption of low-yield but safer seed varieties. F I N A N C I A L P R OT E C T I O N A G A I N S T N AT U R A L D I S A S T E R S 17 18 F I N A N C I A L P R OT E C T I O N A G A I N S T N AT U R A L D I S A S T E R S responsibility for all of its outstanding claims governments, increasing sovereign bond spreads (Benson and Mahul 2013). by 1 to 2 percent on average for up to nine months following an event (World Bank 2012c). Indirect financial impact on the government Following Hurricane Ivan in 2004, Grenada had to approach its creditors for a voluntary restructuring The macroeconomic costs of natural disasters, of public debt, extending its debt service payments including the immediate decline in GDP growth by 20 years and adding significantly to its overall and the cumulative, permanent GDP loss during cost of funds (ibid). the years following a major disaster, affect the government’s budget. The 2011 floods in Thailand Financial impacts on the population often increase reduced government revenues in 2011 and 2012 demand on pre-existing social programs, with a by 3.6 percent and 2.8 percent, respectively, based related increase in public spending on safety nets on pre- and post-flood projections (World Bank and other social programs such as unemployment and Government of Thailand 2012a). The impact benefits for those who lost their job. The 2010 on exports and imports of two droughts reduced earthquake in Chile caused a 3 percent (500,000 government revenues in Malawi by 9 percent in person) rise in the national poverty index to 19.4 fiscal year 1992/93 and by 11 percent in 1993/94. percent (exacerbating an existing trend), and At the same time, public expenditure rose by 30 an increase in the number of people considered percent,9 resulting in an increase in the fiscal deficit destitute by 80,000 to 700,000 (Muir-Wood 2011). of over 23 percent over these two years (Benson and Together, the direct and indirect financial effects Clay 2004). of disasters can seriously hurt public finances. The Natural disasters can also escalate borrowing costs, government’s fiscal balance weakens as expenditures especially for already highly indebted nations. For rise and the tax base shrinks, potentially generating example, nearly all countries in the Caribbean or worsening fiscal deficits. The country’s balance are highly indebted, facing high borrowing costs of payments deteriorates as exports decrease and Photo Credit: /// /// from 6 to 8 percent for 10-year bonds. Natural imports increase. Finally, long-term development NASA/NOAA GOES Project disasters raise the costs of borrowing for affected prospects suffer as the government diverts public Hurricane Irene, 2011 PART 01 funding from social and economic development the increased poverty rates in Chile, as discussed programs to fill these gaps. previously, were partly driven by the closure of small businesses following the earthquake (Muir-Wood Direct financial impact 2011). on homeowners and SMEs Indirect financial impact The middle class is projected to more than double on homeowners and SMEs globally from nearly 2 billion people today to 4.9 billion by 2030 (Kharas 2010). The middle class is Like the government, SMEs can suffer significant an essential driver of countries’ economic growth, economic loss from the indirect effects of disaster, and this group tends to have a significant portion usually totaling more than their losses from direct of wealth invested in property—specifically the damages. Interruptions to business can arise family home. In the United States, the primary from direct damage to the business’ property, or residence represents on average at least 58 percent from damage to infrastructure or other business of a family’s total assets for middle-class adults operations along the supply chain. Following the (Trawinski 2013). 1999 Marmara/Ismit earthquake in Turkey, for example, businesses in the affected area reported A natural disaster shock to an uninsured middle being unable to resume production operations class homeowner can thus easily destroy much of for 35 days on average. In addition, these facilities a family’s wealth, up to nearly 60 percent in the did not return to operating at roughly pre-disaster United States. Disasters affecting a large, uninsured capacity levels until 18 months after the earthquake portion of a country’s middle class can have a (Munich Re 2013a). Business interruption decreases devastating social and economic impact on the GDP growth, stalls recovery, and hurts the local country as a whole. Additionally, most homeowners economy.11 go uninsured against natural disasters. In the United States, the National Flood Insurance Program Natural disasters can also cause significant provides highly subsidized rates for existing reductions in household income and investment in homes in flood prone areas.10 Yet the percentage human capital. A recent study found that average of homeowners in Louisiana with flood insurance household incomes in the Philippines declined by at the time of Hurricane Katrina ranged from only 6.6 percent in the year following a typhoon across all 7.3 percent to 57.7 percent in affected counties households exposed to average typhoon wind speeds (Kunreuther and Pauly 2006). Loss due to direct (Anttila-Hughes and Hsiang 2013).12 The same damages to homes accounted for 69.1 percent of study identified reductions in household spending economic loss from Katrina (Property Casualty and found particularly severe reductions in critical Insurers Association of America 2010). human capital investments such as education (13.3 percent) and health care (14.3 percent). The adverse effects of disasters on the middle class go far beyond the destruction of a family’s Direct financial impact on farmers home, however. SMEs—another key indicator of The agricultural sector is a socially and economically a thriving middle class—often go uninsured as well. In Chile, 70 percent of small businesses with important sector in many countries, particularly in property damages from the 2010 earthquake had no low-income countries. In many African countries for insurance, generating losses of up to $500 million example, the agriculture sector is a key contributor (2010 figures) that had to be shouldered by these to the overall economy. In addition to being SMEs. Indeed, the Organisation for Economic Co- important for the balance of trade due to import operation and Development (OECD) observed that and export of crops it is also a critical provider F I N A N C I A L P R OT E C T I O N A G A I N S T N AT U R A L D I S A S T E R S 19 20 F I N A N C I A L P R OT E C T I O N A G A I N S T N AT U R A L D I S A S T E R S of employment.13 Agricultural producers, such as little to no loss in this sector (Risk Management farmers, herders, and fishermen, are highly exposed Solutions 2005). to multiple, often systemic risks to production, Indirect financial impact on farmers including natural perils, crop and livestock diseases, and insect invasions. Brazilian farmers reported Similar to other economic sectors, farmers typically that regularly occurring risks—those occurring once also suffer indirect losses. Disasters can prohibit every few years—resulted in an average production access to markets, making it difficult for producers loss of 20-40 percent14 (Tüller, M, et. al. 2009). In to sell their crops. They may also lower demand for products with a corresponding decrease in the Kenya, the overall effect of the 2008-2011 drought earnings of producers. was estimated at $12.1 billion,15 with the majority (72 percent) of the losses falling on individuals, In addition, a combination of factors, including households, or businesses that owned livestock. the inherent riskiness of agricultural production, means that agricultural credit can be unavailable Recent events, such as the 2010 drought in Russia or carry high interest rates for smallholder reinforced the severe impact that large-scale natural farmers. The occurrence of a natural disaster may disasters can have on agricultural production, exacerbate these credit constraints by destroying even affecting global food prices. The damage to output, subsequently increasing default rates and wheat crops in Russia was so severe that the prime reducing lenders’ willingness to lend. In Peru, the 1998 El Niño created microfinance loan repayment minister banned exports to curtail rising domestic problems that lasted for years. In the north of the food prices. This in turn placed upward pressure country, the increased risk of default associated on wheat prices abroad as Russia represented 17 with such El Niño events increased interest rates percent of the global grain trade (New York Times by approximately three percentage points (Collier 2010). Additionally, a summer-long drought that and Skees 2012). Finally, the additional risks that affected much of the United States in 2012 cost the comes with investing in high-yield farming practices country around $20 billion in crop loss in that year (such as investing in improved fertilizer) are alone (Munich Re, 2013). often too great for vulnerable households to bear, resulting in the adoption of lower-risk, yet low-yield Natural disasters also destroy public infrastructure farming practices. and assets essential for agricultural production. The Great East Japan Earthquake, for example, destroyed Direct financial impact on the poorest 90 percent of fishing vessels (25,000 vessels in The poorest may own few physical assets, but what total) in the three most affected prefectures, which they do have is often highly exposed. People living alone accounted for 10 percent of the country’s in low-income communities tend to live in more annual production. Luckily for Japanese fishermen, hazardous locations, have fewer savings, and lack insurance for fishing vessels and fisheries helped insurance protection compared to those in higher- to cover the damages and loss (World Bank, income communities. In Katmandu, Nepal, almost unpublished working note). Most fishermen in 25 percent of houses in rapidly growing squatter developing countries are not so lucky; the 2004 settlements are located on steep slopes along the Indian Ocean Tsunami destroyed over 111,000 banks of three rivers. They regularly fall victim to fishing boats and generated over $520 million flooding during the monsoon season. Storm water in damages to fishermen in affected countries. 16 drains and sewage networks operate at only 40 The insurance industry, however, reported percent of their capacity, the result of blockages from accumulated debris and solid waste. Thus, whereas higher-income populations recover fully in addition to physical damage, residents are also much faster (Anttila-Hughes and Hsiang 2013). This susceptible to water-borne diseases (Baker 2012). long-term income loss also prolongs decreases in household expenditures, including on education and Finally, while in absolute terms the damage to poor healthcare. households may be small following a disaster, they are often the most devastating relative to income. The extremely poor are also exposed to breakdowns Subsistence farmers can be hit particularly hard with in local social safety nets. Community-based the destruction of crops or death of livestock often risk sharing mechanisms are burgeoning in the resulting in the complete loss of livelihoods. developing world, with the poor increasingly able to participate in local groups that provide loans Indirect financial impact or grants to households that have been exposed on the poorest to a shock. While these mechanisms perform The less visible financial impact on the poorest well for idiosyncratic shocks (such as the death is often the most detrimental and persistent. The of a breadwinner), they often break down after poorest households suffer more financially and for a systemic shock from a natural disaster. Formal longer periods of time than any other demographic. government-subsidized social safety nets may also In the Philippines, income loss following a typhoon struggle with increased demand during disasters if persists for years in low-income populations, they lack the capacity to expand support. F I N A N C I A L P R OT E C T I O N A G A I N S T N AT U R A L D I S A S T E R S 21 22 F I N A N C I A L P R OT E C T I O N A G A I N S T N AT U R A L D I S A S T E R S Section II: Disaster Risk Financing and Insurance - Tools for Financial Protection Governments can take steps to reduce the negative To sustainably reduce the financial impact of financial effects of disasters in a way that protects disasters governments should always consider ways both people and assets. The World Bank and the to reduce the underlying drivers of risk. Financial Global Facility for Disaster Reduction and Recovery protection complements risk reduction by helping (GFDRR) have developed a framework that guides a government address residual risk, which is either governments through a practical and comprehensive not feasible or not cost effective to mitigate. Absent approach to disaster risk management. a sustainable risk financing strategy, as laid out under Pillar 4, a country with an otherwise robust This disaster risk management framework brings disaster risk management approach can remain together necessary actions for building resilience, highly exposed to financial shocks, either to the including: risk identification; risk reduction; government budget or to groups throughout society. preparedness; financial protection; and planning for Financial protection helps a government manage disaster recovery (See Figure 5). This framework is those shocks without compromising development /// /// based on the fundamental principle of empowering progress, fiscal stability, and wellbeing. citizens and governments to understand their risks and make informed choices about how best to Disaster risk financing and insurance can also help address them. countries prepare for increased climate variability Figure 5 World Bank-GFDRR Disaster Risk Management Framework PILLAR 1: RISK IDENTIFICATION Improved identification and understanding of di- saster risks through building capacity for assess- ments and analysis PILLAR 2: RISK REDUCTION Avoided creation of new risks and reduced risks in society through greater disaster risk consideration in policy and investment PILLAR 3: PREPAREDNESS Improved capacity to manage crises through developing forecasting and disaster management capacities PILLAR 4: FINANCIAL PROTECTION Increased financial resilience of governments, private sector and households through financial protection strategies PILLAR 5: RESILIENT RECOVERY Quicker, more resilient recovery through support for reconstruction planning PART 01 and extreme events associated with climate change. comprehensive strategy can secure access to From a disaster risk financing perspective, while post-disaster financing before an event strikes, climate risks increase climate variability and ensuring rapid, cost-effective liquidity to finance uncertain extreme weather events, it does not recovery efforts. fundamentally alter the underlying challenges. Just Governments normally seek to strengthen the as financial protection is a critical component of any disaster risk management approach it also plays an financial resilience of the four different groups important role in helping countries become more identified using appropriate strategies for resilient to climate risks. each. The main beneficiary groups of financial protection include national and local governments; Definition and beneficiaries homeowners and SMEs; farmers; and the poorest of disaster risk financing and (see Table 2). The respective strategies include: /// /// insurance solutions ı Sovereign disaster risk financing aims to /// /// Historically, governments mostly addressed the increase the capacity of national and subnational financial effects of natural disasters on an ad-hoc governments to provide immediate emergency basis following events. Countries are increasingly funding as well as long-term funding for focusing on proactive planning before a disaster reconstruction and development. This policy strikes, however. This began with a handful of area also works with governments to account for industrialized countries, but is gradually being taken other contingent liabilities, such as government- up by governments from around the world. supported agricultural insurance or social protection schemes that will require payouts Disaster risk financing and insurance aims to following a disaster. Finally, it requires setting up increase the resilience of vulnerable countries systems for effectively allocating and disbursing against the financial impact of disasters. A the necessary funds. F I N A N C I A L P R OT E C T I O N A G A I N S T N AT U R A L D I S A S T E R S 23 24 F I N A N C I A L P R OT E C T I O N A G A I N S T N AT U R A L D I S A S T E R S Example: Contingent credit is a financial crop insurance program. As a result, farmers instrument that allows governments to secure receive the claims payments much faster and funds in advance of a disaster to be available have improved coverage of their assets. immediately in case of emergency. In 2008, the ı Disaster-linked social protection helps World Bank approved the first such loan, called /// /// governments strengthen the resilience of the a Catastrophe Deferred Drawdown Option poorest and most vulnerable to the debilitating (CAT-DDO). Contingent credit complements effects of natural disasters. It does this by other instruments such as national reserves to applying insurance principles and tools to finance high frequency, low severity events— enable social protection programs such as social for example Mexico’s natural disaster fund, safety nets to scale up and scale out assistance called FONDEN—and catastrophe risk transfer to beneficiaries immediately following disaster solutions to finance low frequency, high severity shocks. events—such as sovereign insurance pools created by Caribbean and Pacific island states. Example: The government of Ethiopia is To transfer risk to specialized risk carriers, the government of Colombia, for example, is building integrating disaster risk contingency planning on international best practice in insuring public and financing into the Productive Safety Net concessions for infrastructure worth $38 billion. Program, its food security safety net. Starting in 2006, the program began using disaster risk ı Property catastrophe risk insurance aims /// /// financing and insurance tools on a trial basis to to protect homeowners and SMEs against loss expand its capacity during extreme events. A arising from property damage. contingent financing window allowed Ethiopia to increase the number of beneficiaries of food Example: The Turkish Catastrophe Insurance assistance during the 2011 Horn of Africa drought Pool (TCIP), a public-private partnership from 6.5 to 9.6 million drought-affected people between the government of Turkey and the (World Bank 2013). domestic insurance industry, provides earthquake insurance to homeowners. TCIP increased While a government may not need to pursue catastrophe insurance coverage from less than all four policy options, disaster risk financing 3 percent of residential buildings to 23 percent and insurance strategies commonly build on nationwide and over 40 percent in urban areas. some combination of them. Together, they help Since its establishment in 2000, the TCIP has the government clarify, reduce, and manage its paid nearly 21,000 claims, totaling over $70 contingent liabilities to natural disasters.17 These million as of January 2014. options do so by using financial risk information to clarify the financial costs and benefits of disaster ı Agricultural insurance aims to protect /// /// risk reduction, retention, and transfer; by enabling farmers, herders, and fishermen from loss arising greater risk transfer to the private sector; and by from damage to their productive assets. providing strategies and tools for more responsible management of the remaining costs associated with Example: The Indian government adopted risk natural disaster risk. financing and insurance principles to transition its National Crop Insurance Program from a These interventions are not independent and can be social crop insurance scheme to a market-based aligned to bring about multiple wins. For example, PART 01 Table 2 Disaster risk financing and insurance policy areas and benefits Sovereign Disaster Risk Financing Property Catastrophe Beneficiaries: Governments Risk Insurance Beneficiaries: Homeowners & SMEs Ş*ODSFBTFTǨJOBODJBMSFTQPOTFBOESFDPOTUSVDUJPODBQBDJUZ through improvements to: Ş1SPWJEFTBDDFTTUPDPNQFOTBUJPOǨPSQIZTJDBMQSPQFSUZ - Resource mobilization, allocation, and execution; damage and indirect losses arising from that damage. - Insurance of public assets; Ş*ODSFBTFTBXBSFOFTTBOEVOEFSTUBOEJOHPǨǨJOBODJBM - Social safety net financing. vulnerability to natural disasters. Ş4NPPUIQVCMJDFYQFOEJUVSFBDSPTTZFBSTCZSFEVDJOH Ş)FMQTEJTUSJCVUFSJTLBOECVSEFOPǨSFDPWFSZCFUXFFOQVCMJD the volatility of the cost of disasters, and hence protects and private sectors. the stability of public finances. Ş$BOJODFOUJWJ[FJOWFTUNFOUJOSJTLSFEVDUJPO Ş$MBSJǨJFTDPOUJOHFOUMJBCJMJUZBSJTJOHUISPVHIEJTBTUFS exposure of public assets, the private sector and state- owned enterprises, and the poor. Ş1SPWJEFTJODFOUJWFTǨPSJOWFTUNFOUJOSJTLSFEVDUJPO Agricultural Insurance Disaster-Linked Social Protection Beneficiaries: Farmers Beneficiaries: The Poorest Ş1SPWJEFTBDDFTTUPDPNQFOTBUJPOǨPSQSPEVDUJPOMPTTFT Ş.JUJHBUFTTIPDLTCZQSPWJEJOHDPNQFOTBUJPOǨPSMJWFMJIPPE and damage to productive assets. or asset losses through flexible social safety nets. Ş)FMQTEJTUSJCVUFSJTLBOECVSEFOPǨSFDPWFSZCFUXFFOQVCMJD Ş*ODSFBTFTBXBSFOFTTBOEVOEFSTUBOEJOHPǨWVMOFSBCJMJUZ and private sectors. to natural disasters. Ş*ODSFBTFTBXBSFOFTTBOEVOEFSTUBOEJOHPǨǨJOBODJBM Ş$BOJODFOUJWJ[FJOWFTUNFOUJOSJTLSFEVDUJPO vulnerability to agricultural risks. Ş4BǨFHVBSETWVMOFSBCMFQFPQMFǨSPNǨBMMJOHJOUPQPWFSUZ Ş$BOJODFOUJWJ[FJOWFTUNFOUJOSJTLSFEVDUJPO Ş"MMPXTǨPSUIFBEPQUJPOPǨIJHIFSZJFMEJOHŔCVUSJTLJFSŔ farming methods. Ş*ODSFBTFTBDDFTTUPǨJOBODJBMTFSWJDFTBOENBSLFUT for low-income households (insurance, banking, savings). F I N A N C I A L P R OT E C T I O N A G A I N S T N AT U R A L D I S A S T E R S 25 26 F I N A N C I A L P R OT E C T I O N A G A I N S T N AT U R A L D I S A S T E R S if a government decides to establish a risk financing financing per se, it is a prerequisite for effective use pool to retain some amount of agricultural risk— of disaster risk financing strategies and tools. Many meaning this pool will cover certain pre-determined governments have chosen to include improving the losses—this same entity could be used to absorb a quality and availability of financial risk information layer of risk from a cash transfer program that will and the adoption of financial risk analytical tools need to deliver significantly more payouts in case of as policy objectives in their overall disaster risk a disaster. This allows the government to build on financing and insurance strategies. For example, the initial investment in developing a risk financing financial risk analytics helped policy makers in the entity for multiple uses. Philippines to understand the all-important details The need for financial risk information and risk when deciding between financial instruments for analysis to enable progress in disaster risk financing a sovereign risk transfer transaction. This helped and insurance highlights a fifth, crosscutting policy the government identify the most appropriate and area: financial disaster risk analytics. Financial risk financially efficient strategies to fund disaster losses, analytics empowers governments to take more based on the country’s risk profile and political informed decisions by bridging the gap between raw constraints faced (see also Clarke and Poulter 2014). risk data and information that is useful to policy makers. While this is not a type of disaster risk Disaster risk financing and insurance across policy fields Figure 6 DRFI at the nexus of related fields Disaster risk financing and insurance sits at the nexus of four major policy practices: ı Disaster risk management, in terms of how it contributes to building resilience; ı Public financial management, in terms of how Disaster & Climate Risk it addresses the impact of shocks on public Management finances; ı Financial sector development, in terms of how it builds a strong financial sector for risk transfer; and Disaster Risk Public Financial Financial Sector ı Social protection, in terms of how it supports Financing Management Development & Insurance contingent financing to reach the poorest. Thus, disaster risk financing and insurance strategies are best advanced when integrated into broader strategies in one or more of these fields. Indeed, strong public financial management of Social Protection disaster risk is particularly important to support the execution of broader disaster risk management strategies. Specifically, disaster risk financing and insurance programs: PART Figure 7 Five characteristics of cost-effective financial protection strategies that build resilience 01 Appropriate Risk Information Ownership Discipline Financial Resilience Cost of Capital Timeliness ı Brings about an awareness among financial The World Bank has identified five characteristics authorities of the need to include disaster risk that together build financial resilience across considerations in public investments; society which are improved through disaster risk financing and insurance. These characteristics are ı Puts a price tag on risk, clarifying the costs not outcomes of one specific project or intervention, and benefits of investing in risk reduction, risk but an integrated set of features which support each retention, and risk transfer initiatives; and other towards strengthening financial resilience (see Figure 7; World Bank-GFDRR Disaster Risk /// /// ı Ensures that the government is financially Financing and Insurance Program Strategy 2015- prepared to enact a swift post-disaster response. 2019). Characteristic 1: Appropriate risk information. Characteristics that build /// /// Appropriate risk information allows public and financial resilience private decision makers to assess the underlying Sovereign disaster risk financing benefits price of risk, and clarify costs and benefits of investing in risk reduction or risk financing. A governments in many different ways. These include lack of knowledge about a country’s exposure to increased transparency and financial discipline, risk—and about the ‘cost’ of this risk—can lead improved risk pricing through market signals, and to sub-optimal investment decisions to protect greater access to capital at the time it is needed welfare. Putting a price on risk is also crucial to (Dana and von Dahlen 2014). elevate disaster risk management to the Ministry F I N A N C I A L P R OT E C T I O N A G A I N S T N AT U R A L D I S A S T E R S 27 28 F I N A N C I A L P R OT E C T I O N A G A I N S T N AT U R A L D I S A S T E R S of Finance and integrate risk considerations in Characteristic 4: Timeliness of post-disaster /// public investments. Moreover, better information financing. Different levels of post-disaster /// on the potential impact of disasters can help funds need to be available at the appropriate time overcome behavioral biases, such as the reticence following a disaster to cover relief, response, of businesses and households to buy catastrophe and reconstruction efforts. In the aftermath of a risk insurance. Disaster risk financing and insurance major disaster, for example, the government does can also provide the short-term incentives for large not require money for the entire reconstruction scale investments in risk assessments that enable program at once. The rapid mobilization of funds to evidence-based decision making in disaster risk support relief efforts is crucial to limit humanitarian management beyond financial protection. costs. This rapid response can also save money; Characteristic 2: Ownership of risk. Clarifying /// /// for example well-targeted early interventions in who is responsible for risk—clearly establishing the slow-onset disasters such as drought cost a fraction contingent liability of the national and subnational of emergency aid after a famine develops. While government, donors, the private sector, and immediate liquidity is crucial to support relief and households—overcomes challenges such as the early recovery operations, the government has Samaritan’s Dilemma. The absence of clear rules more time to mobilize the majority of resources regarding the share of costs for response and for the reconstruction program. Likewise, reconstruction assumed by the national government businesses and households need to have access to can turn into a disincentive for the businesses and timely financing following a disaster, for example households to invest in risk reduction or purchase through catastrophe risk insurance and/or post- catastrophe risk insurance, and cab trigger delays disaster credit. in post-disaster response and recovery. Clearly established rules for the amount and timing of Characteristic 5: Discipline. Disaster risk /// /// payouts under social protection programs give financing helps governments, businesses, and predictability to vulnerable households, enabling households plan in advance of a disaster and better planning and budgeting. agree ex ante on rules and processes for securing funds through their budget (budget mobilization) Characteristic 3: Cost of capital. Access to and spending this money (budget execution). /// /// capital is necessary for effective emergency response This creates greater discipline, transparency, and and reconstruction as well as for investment accountability in post-disaster spending. Market- in risk reduction and prevention. Yet different based financial mechanisms further contribute sources of money come with different costs. to this. For example, a government needs to have Disaster risk financing policies can secure access to disaster financing for governments, businesses reliable and independent rules for payout in order and households before an event strikes and ensure to transfer risk to international financial markets; timely and cost-effective financial resources to insured homeowners know precisely what they are support post-disaster recovery and reconstruction eligible for through their contractual agreement with activities while minimizing the cost of these funds their insurer (insurance policy). Discipline is also through an optimal use of financial instruments important for a government to be able to credibly such as reserves, contingent credit, risk transfer commit when it will not act and thus facilitate solutions, and post-disaster credit. ownership of risk. PART 01 Figure 8 Timing of post-disaster funding needs Relief Recovery Reconstruction Resource Requirements ($) Time Source: Ghesquiere and Mahul (2010) Key considerations for they simply address different needs. For example, financial protection following a disaster a government could issue bonds or raise taxes in order to pay for reconstruction. A government can access many different sources Such measures provide access to very large sums of financing for post-disaster response and of money but take a long time to become available. reconstruction. Some of these options can be Insurance, on the other hand, can be much more mobilized by the government following a disaster, expensive but can help governments manage the such as budget reallocations or credit. Others need volatility of unplanned demands on budgets by to be established before a disaster hits, for example spreading the cost of disaster across time. This contingent credit lines or insurance. For some presents governments with a trade-off in managing options the government mobilizes money at the costs and risk. sovereign level—including contingency funds— while other options transfer risk to international To efficiently address the funding needs arising from markets, like the use of reinsurance or catastrophe disasters, a number of considerations are therefore bonds. important. First, understanding the timing of needs is essential. In the aftermath of a major disaster, the These financing options all differ in terms of their government will not require the money needed for cost of use, amount of money available when a the entire reconstruction program at once. While disaster hits, and speed of access. Alternative immediate liquidity is crucial to support relief and instruments are not inherently better or worse, early recovery operations, the government has more F I N A N C I A L P R OT E C T I O N A G A I N S T N AT U R A L D I S A S T E R S 29 30 F I N A N C I A L P R OT E C T I O N A G A I N S T N AT U R A L D I S A S T E R S time to mobilize the majority of resources for the For example, market-based risk transfer can be an reconstruction program (see Figure 8). This has /// /// effective but expensive proposition for governments clear implications on the design of cost-effective, that otherwise have access to sufficient sovereign financial management of disasters. financing. Yet, they can effectively reduce volatility of disaster impact on government accounts by A second consideration is the cost of different spreading the cost over time, and therefore promote sources of money. Table 3 provides an indicative cost budget stability. In addition, the swiftness at which multiplier for different financial risk instruments. risk transfer instruments can provide liquidity This multiplier is defined as the ratio between the without requiring access to credit makes them cost of the financial product (such as the premium attractive to some governments. This is particularly of an insurance product, or the expected net present the case for small states that generally do not value of a contingent debt facility) and the expected have sufficient capacity to build reserves and are restricted in their access to credit due to already payout over its lifetime. A ratio of two indicates high debt ratios. that the overall cost of the financial product is likely to be twice the amount of the expected payout Taking these considerations into account, a made. These multipliers are only indicative and government can combine different instruments to aim to illustrate the cost comparison of financial protect against events of different frequency and products. The speed at which funds can be obtained severity. Such risk layering ensures that cheaper is also determined by the legal and administrative sources of money are used first, with the most processes that drive their use (Ghesquiere and expensive instruments used only in exceptional circumstances. For example, insurance can provide Mahul 2010). Table 3 Costs and benefits of different instruments for financing post-disaster expenditure INDICATIVE COST DISBURSEMENT AMOUNT OF FUNDS INSTRUMENTS (MULTIPLIER) (MONTHS) AVAILABLE E X - POST FINANCING Donor support (humanitarian relief) 0-1 1-6 Uncertain Donor support (recovery and reconstruction) 0-2 4-9 Uncertain Budget reallocations 1-2 0-9 Small Domestic credit (bond issue) 1-2 3-9 Medium External credit (for example emergency loans, bond issue) 1-2 3-6 Large E X - ANTE FINANCING Budget contingencies 1-2 0-2 Small Reserves 1-2 0-1 Small Contingent debt facility (for example CAT DDO) 1-2 0-1 Medium Parametric insurance 1.5 and up 1-2 Large Alternative Risk Transfer (for example CAT bonds, weather derivatives) 1.5 and up 1-2 Large Traditional (indemnity-based) insurance 1.5 and up 2-6 Large Source: Ghesquiere and Mahul (2010) PART 01 Figure 9 Three-tiered risk layering strategy for governments International Assistance Low Frequency/ High Severity Risk Transfer Sovereign Risk Transfer (e.g. Cat Bond/Cat Swap, (re)insurance) Insurance of Public Assets Contingent Credit Lines Post Disaster Credit Risk Retention High Frequency/ Low Severity Government Reserves, Contingency Budget / Funds Emergency Funding Reconstruction Source: Authors, building on Ghesquiere and Mahul (2010) cover against extreme events, but is not appropriate appropriate to the relative probability of events. For to protect against low intensity events that recur example, a government could decide to purchase regularly. In such a case the government could more expensive risk transfer instruments—such as consider setting up a dedicated contingency fund to catastrophe bonds—to ensure immediate liquidity retain this lowest layer of risk (see Figure 9). /// /// for emergency response to extreme events. But it will raise the much larger amounts needed for A comprehensive financial protection strategy for reconstruction through budget reallocations and the government generally brings together pre-and from capital markets through bond issues. post-disaster financing instruments that address the evolving needs for funds—from emergency Historically, many governments have relied on post- response to long-term reconstruction—and are disaster (ex-post) funding sources. Governments F I N A N C I A L P R OT E C T I O N A G A I N S T N AT U R A L D I S A S T E R S 31 32 Box 1 Challenges and opportunities for public financial management can access these resources without previous of a successful disaster risk financing and insurance agenda financial arrangements that often require highly Section II detailed the financial strain that disasters place on governments’ budgets. technical expertise and experience. However, even In principle, countries can take advantage of both pre- and post-disaster sources of when such post-disaster arrangements are cheaper financing for disasters, but the use of proactive financial protection instruments requires than pre-arranged financing sources, they can take a certain level of experience for advance planning within the government. a long time to negotiate (such as emergency loans), Strong public financial management of natural disasters depends on the ministry of can be highly variable and unpredictable (like finance’s capacity to develop financing solutions before a disaster hits. This requires donor assistance), and can endanger development strong public financial management experience and trained officials, including the ability programs that often take many years of preparation to conduct complete fiscal forecasts that incorporate different disaster scenarios and that are then regularly monitored. This includes a comprehensive overview of the aggregate (for example due to budget reallocation). On the fiscal risk arising from various contingent liabilities, for example from natural disasters or other hand, risk financing instruments that the from large state-guaranteed infrastructure projects. These elements for fiscal monitoring government establishes before a disaster hits (ex- are, however, not found in most countries. An analysis of over 350 Public Expenditure ante) can avoid these drawbacks but they do require and Financial Accountability (PEFA)19 assessments—international assessments reviewing advanced planning, and can be more expensive and the condition of national public financial management systems—show that most low- and middle-income countries either monitor the government’s fiscal position only once a limited in their amount. year, with a consolidated overview often missing or incomplete, or do not do any kind of regular monitoring at all. Nevertheless, promoting the use of private insurance in both the public and private sector Adopting a proactive risk financing approach also has multi-year budget implications. is crucial to increasing financial resilience Multi-year forecasts for revenues, medium-term expenditure totals for mandatory expenditure, and potential debt financing would need to be in place. This medium- across society. Insuring public assets can help term budget framework is led by the ministry of finance, but requires other ministries better manage the explicit contingent liability of to complete the budget plan with specific line items. Information from diagnostic tools governments and limit the volatility on government such as the PEFA confirms, however, that most developing countries do not have good accounts. For example, some middle-income medium-term budget frameworks in place, which makes it more complicated to ensure countries such as Colombia, Mexico, and Panama that future expenditure is aligned with longer-term, strategic investment decisions. already require that public assets have property While post-disaster financing mechanisms, such as increasing taxes and borrowing, insurance coverage against natural disasters. do not require advance planning, they do rely on strong capacities in areas like tax Promoting competitive property insurance markets administration and debt management. Here, too, evidence indicates that the challenges are significant. For example, increasing the tax burden in the wake of the kind of helps shift the burden of post-disaster recovery economic contraction often seen after a disaster can be almost impossible in countries from households and SMEs to specialized risk without a well-organized system for defining tax policy and tax administration. Even carriers like insurance companies and contributes to where processes for budget mobilization are in place, officials may not be familiar with increasing the economy’s resilience. Governments their use as they are only activated in exceptional circumstances. can build an enabling environment for insurance Contribution by Monica Rubiolo, State Secretariat for Economic Affairs of Switzerland markets and provide basic risk market infrastructure as public goods. This can include catastrophe risk assessments, supporting the growth and building the capacity of domestic insurers while supporting the sale of reliable, cost-efficient insurance products, as in the example of the South East Europe and Caucasus Catastrophe Risk Insurance Facility. This brings the additional benefit of building a deeper financial sector. PART 01 The essential role played by hazards. Numerous countries, such as Colombia, ministries of finance in disaster risk Indonesia, Panama, and Peru, have established financing and insurance fiscal risk management divisions within the ministry of finance tasked with the identification, In many countries, disaster risk management has quantification, disclosure, and management of traditionally been seen as an agenda belonging to fiscal risks associated with natural disaster. These specialized agencies such as the national disaster teams are often best placed for leading the disaster management agency, civil protection, or the risk financing and insurance agenda, in partnership ministry of environment. In this case the disaster risk financing and insurance agenda can be an with other public entities for respective policy entry point for the ministry of finance to engage areas—for example, the ministry of agriculture in disaster risk management, which, in turn, can for agricultural insurance programs or disaster inform development that is resilient to disaster risk management agencies for risk reduction and and climate risks through better integration of risk preparedness measures—as well as the private considerations in public investments.18 sector and the international community. (Box 1 /// /// discusses some of the public financial management While risk financing cuts across different considerations that lydership by the ministry of government agendas, successful disaster risk finance can help overcome). Anchoring financial financing and insurance measures are almost always anchored in and driven by the country’s protection to disasters within the ministry of finance ministry of finance. In a growing number of also supports comprehensive approaches to fiscal developing countries, the ministry of finance and debt risk management, and allows governments’ is adopting integrated approaches to risk to build on existing capacity in managing other management, including those addressing natural contingent liabilities such as debt. F I N A N C I A L P R OT E C T I O N A G A I N S T N AT U R A L D I S A S T E R S 33 34 F I N A N C I A L P R OT E C T I O N A G A I N S T N AT U R A L D I S A S T E R S Even where dedicated risk management teams are Providers of risk capital not in place, the ministry of finance is typically best placed, and benefits the most from, implementing As a provider of risk capital, the private sector disaster risk financing. In this case other units (including insurers, reinsurers, banks, and investors) within the ministry of finance, for example those is a crucial risk bearer. To guard against insolvencies dealing with budget management, asset and liability from larger-than-expected losses—and to comply management, debt management, economic policy, with regulatory requirements that maintain the or sometimes insurance divisions or insurance financial stability of the industry—insurance companies must have sufficient capital. Capital in supervisors can make sensible homes for the agenda. the reinsurance market alone is estimated at over Depending on the counterpart within the ministry $500 billion.20 of finance the focus of the disaster risk financing engagement is likely to differ. In addition, convergence between insurance and reinsurance markets and capital markets through The private sector’s role in the emergence of alternative risk transfer solutions the disaster risk financing (such as catastrophe bonds and catastrophe swaps) and insurance agenda has allowed the pool of catastrophe risk-bearing capital to increase flexibly over the past decade. The private sector plays an essential role in the For example, investors such as pension funds who ongoing development of, and access to, disaster typically would not have interacted with the world risk financing and insurance solutions. It does of catastrophe risk have had the opportunity to this primarily by providing capital and technical expertise, and by driving innovation. The private put their capital to work in instruments such as sector also plays a crucial role through public- catastrophe bonds. Risk takers such as insurance and private partnerships in insurance programs, for reinsurance companies have been able to increase example in the delivery of payouts to beneficiaries as their capacity to underwrite risk by passing excess well as in the education of consumers. risk on to new capital sources. PART 01 Box 2 Global Index Insurance Facility Established in 2009, the Global Index Insurance Facility (GIIF) is a multi-donor trust fund, jointly operated by the IFC and the World Bank, supporting the development and growth of local markets for weather and disaster index-based insurance in developing countries, primarily Sub-Saharan Africa, Latin America and the Caribbean and Asia Pacific. GIIF’s implementing partners have issued more than 600,000 policies to cover farmers, pastoralists and micro-entrepreneurs with US$119 million in sums insured and reached over one million with information and access to index insurance. GIIF's objective is to expand the use of index insurance as a risk management tool in agriculture, food security, disaster risk reduction and access to finance. Index insurance is a relatively new but innovative approach to insurance provision that pays out benefits on the basis of a pre-determined index (e.g. rainfall level, seismic activity, livestock mortality rates) for loss of assets and investments, primarily working capital, resulting from weather and catastrophic events, without requiring the traditional services of insurance claims assessors. It also allows for the claims settlement process to be quicker and more objective. Source: http://www.ifc.org/GIIF The availability of risk-bearing capital in the Providers of technical expertise insurance and capital markets has allowed a and innovation number of developing country governments to transfer excess risk to private sector risk carriers The private insurance sector also offers extensive such as international reinsurance companies. technical expertise in quantifying and managing Furthermore, this pool of capital has shored up risk accumulations—the total combined risks that domestic insurance markets in developing countries could be involved in a single loss event, designing by allowing accumulated catastrophe risk to be products, underwriting catastrophe exposure, passed out of the country and into the international and settling claims. Drawing on this expertise can markets. It is notable, for example, that an help overcome the challenges that impede the estimated 95 percent of the $8 billion of insured development of catastrophe insurance markets in loss incurred in the aftermath of the devastating developing countries. These challenges include 2010 Chilean earthquake was passed out of the a lack of data and trained people, the high cost domestic market and onto international reinsurers. 21 of offering products, and a generally low level of Access to international reinsurance can support the awareness and understanding of catastrophe risk sustainable growth of a domestic insurance market. exposure. Private sector insurance companies and banks can improve catastrophe risk modeling, the Within domestic markets, private sector entities collection of data on the cost of extreme events, that provide risk-bearing capital help individuals, and the promotion of risk awareness through businesses, and the government manage shocks. educational programs. The Global Index Insurance At the business and household level, a developed Facility is one example of how the World Bank helps domestic insurance market for property catastrophe bring this private sector expertise to developing risk can speed household and business recovery countries (Box 2). through provision of rapid financial liquidity following an event; use premiums to signal risk Developed country insurance and reinsurance and promote risk reduction; and reduce the burden companies can transfer established tools, products, on the fiscal budget in the aftermath of a disaster and methodologies to developing country insurance by reducing the need for state compensation of markets as a way to support their growth. For businesses and individuals. example, in 2009 the World Bank-supported F I N A N C I A L P R OT E C T I O N A G A I N S T N AT U R A L D I S A S T E R S 35 36 F I N A N C I A L P R OT E C T I O N A G A I N S T N AT U R A L D I S A S T E R S South-East Europe and the Caucasus Risk sector insurance companies to develop the Insurance Facility resulted in the establishment of a catastrophe risk models, underwriting platform, specialized regional reinsurer, Europa Reinsurance and design insurance products to stimulate Facility (Europa Re). The initiative is working to market development. build a sustainable mass market for standardized catastrophe risk insurance products in participating Finally, the private sector has proven its ability countries in South-East Europe. It does this by to innovate to overcome market development offering options for reinsurance, standardized challenges. This led to the design of new products products, and web-based tools for underwriting and tools increasing the efficiency of product and accumulation management through Europa offerings and access to coverage for previously Re. The facility is using expertise from private excluded groups. PART 01 Box 3 Examples of technical contributions from the private sector Quantification of risk /// /// Although catastrophe risk modelling has been undertaken in the academic, public, and private spheres, it is the private sector that has driven this discipline forward the most. High resolution probabilistic catastrophe risk modelling (detailed computer simulations to quantify loss that could be sustained from a particular disaster) was first developed in response to the needs of the private insurance industry, for pricing and accumulation management.22 These sophisticated modelling tools are now being used in less developed insurance markets around the world, and the improved understanding of risk they enable also informs disaster risk management beyond financial protection. Risk-based pricing /// /// One way the insurance industry has managed its catastrophe risk exposure is through risk-based pricing. Insurance companies calculate premiums on the basis of modelled expected loss. The cost of cover then serves as a signal of the risk customers are exposed to and provides an economic incentive to minimize this risk. This could include investing in disaster resistant construction and retrofitting, and settling outside of risk prone areas. Introducing technical and transparency standards /// /// Cooperation with the private sector can play an important role in instilling and strengthening technical and transparency standards in public financial management. To access insurance, governments need a solid damage assessment methodology and transparent handling of payouts. Through adopting terms and conditions based on international standards for the insurance contracts themselves, governments can also bring international best practice to domestic insurance markets. In Colombia, the government uses standardized terms and conditions from international insurance market best practices to purchase catastrophe insurance for its public buildings. The government of Mexico has in place an indemnity-based excess-of-loss insurance contract since 2011. In order to place the contract with the private markets, it was necessary for the government to develop transparent and robust processes for loss reporting. Such improvements will have applications well beyond the contract itself.23 Product expansion /// /// The private sector led the development of risk-transfer products that trigger—meaning they pay-out—based on predetermined parameters such as wind speed instead of loss estimates. The development of these parametric products has increased access to insurance to areas and consumers that could not have been reached effectively using a traditional claims-based model of insurance provision. For example, the first weather insurance product in India, and indeed in the developing world, was a rainfall insurance contract underwritten and designed in 2003 by ICICI-Lombard General Insurance Company for groundnut and castor farmers (Clarke, et al., 2012). This pilot, supported by technical assistance from the World Bank, spurred rainfall insurance product offerings from other insurers, such as IFFCO-Tokio and the public insurer Agriculture Insurance Company of India, leading to a high rate of growth in the number of farmers insured between 2003 and 2007. As a result of this private sector-led pilot, the government of India launched a pilot of the Weather-Based Crop Insurance Scheme in 2007, now a largely compulsory, publicly-subsidized program that insures more than 10 million farmers for a range of crops. While the private sector plays a key role in the design of new products, experience has shown that the public sector is needed to reach the critical mass required to sustainably scale up such products and initiatives and hence encourage innovation by the private companies. Similar innovations also supported sovereign risk transfer via parametric products for developing country governments. Sovereign risk transfer initiatives that have used parametric products include: the catastrophe bonds issued by the government of Mexico in 2006, 2009, and 2012 for earthquake and hurricane risk; the first- ever multi-country regional risk pool, established in 2007 as the Caribbean Catastrophe Risk Insurance Facility; the Pacific Catastrophe Risk Insurance Pilot in 2013; and the African Risk Capacity in 2014. Private sector partnerships can also unlock new delivery channels, for example by making agricultural insurance products available to farmers as a bundle with seed purchases. F I N A N C I A L P R OT E C T I O N A G A I N S T N AT U R A L D I S A S T E R S 37 38 F I N A N C I A L P R OT E C T I O N A G A I N S T N AT U R A L D I S A S T E R S Section III: Evaluation of Progress Made on Financial Protection Governments have used public policy to mitigate against disaster shocks or on increasing post- the financial impacts of disasters for nearly a disaster liquidity. century. The U.S. Federal Crop Insurance Program But patterns have emerged in the kinds of challenges was established in the 1930s to support farmers that countries encountered while innovation has suffering from the combined effects of the Great taken place in waves, pushing the boundaries Depression and the Dust Bowl, one of the worst of disaster risk financing and insurance. This ecological disasters in American history. Japan’s section provides a broad overview of progress and Earthquake Reinsurance Scheme dates back to evolution in disaster risk financing in developing 1966. Governments established these and similar countries since the beginning of the millennium, programs in recognition of the need for public when an increasing awareness of proactive financial support to better protect residents, SMEs, financial protection against devastating natural and agricultural producers against the economic disasters had started to take hold.24 Too much has impact of natural disasters and agricultural risk. happened to capture here comprehensively, but key developments will highlight the lessons learned Initially, this kind of public policy was mostly from this period (see Figure 10 on the following limited to industrialized countries. But over the past /// /// page). Building on these lessons, this paper then two decades, interest in financial protection has presents an operational framework for financial surged around the world, receiving greater attention protection. from developing country governments, the private sector, donors, and international organizations. As Beginnings to 2005: Early a result, over the past decade, developing countries experience in disaster risk financing have started to catch up—and even get ahead—in at the international level developing and implementing public policy for At the beginning of the 21st century, most financial protection, mostly through learning-by- governments relied primarily on ad-hoc financing doing and with support from international partners. secured after an event to respond to natural This path, however, has not been linear. Progress disasters. The limited public sector experience in often took place in steps and spurts of activities disaster risk financing and insurance remained as countries experimented with new tools and mainly confined to industrialized countries. Historically, the establishment of publicly-supported approaches. Advances in different areas of disaster catastrophe and agricultural insurance programs risk financing have often taken place at the same followed in the wake of major natural disasters. time in different countries as governments were looking to address their unique challenges, from In 1966, the Japanese government established a their own starting point. For example, some public-private earthquake insurance program for countries began by looking to develop strong homeowners. The scheme relied on the Japan domestic insurance markets to absorb disaster risk, Earthquake Reinsurance Company, an earthquake while others focused on protecting their budget reinsurance pool backed by the government. In the PART 01 United States the government has been providing management that eventually led to the government federally-administered residential flood insurance establishing the Natural Disaster Fund (FONDEN) through the National Flood Insurance Program, in 1996 as a mechanism to support post-disaster set up in 1968 in response to a long history of flood reconstruction of damaged public infrastructure. loss and increasing challenges in finding private Since then, FONDEN has evolved into an inter- sector firms willing to insure flood risk. Similarly institutional vehicle that finances and plays a central the California state government established the role in all stages of the disaster risk management California Earthquake Authority as a public-private cycle. Similarly, following the 1999 Marmara organization to provide earthquake insurance when earthquake, the Turkish government established the California’s insurance companies stopped writing Turkish Catastrophe Insurance Pool as a compulsory earthquake coverage following the 1994 Northridge earthquake insurance system for all residential earthquake, the costliest earthquake in the history buildings located on registered land in urban areas. of the United States (OECD, 2013). In France, the Catastrophes Naturelles insurance system was With few exceptions, agricultural insurance established in 1982 to mitigate the effect of disasters programs were in their infancy or performing poorly on the local or national economy through insurance across developing countries. Following a period and by providing incentives for risk reduction and from 1950 onwards that saw major growth in public avoidance measures (Government of Mexico and sector multi-peril crop insurance programs that World Bank, 2012). ended up performing poorly, developing countries For most developing countries, however, these began to shift from public to market-based programs types of policy options were neither available nor in the 1990s, often promoted under public-private feasible. Underdeveloped insurance markets, low partnerships (Mahul and Stutley, 2010). The most technical and financial capacity of governments, and important changes in this new wave of catastrophe a longstanding culture in many countries of dealing and agricultural insurance programs came about with disasters mainly as a humanitarian issue in the role played by the private sector. Newer meant that financial management remained mostly models were often built around public-private impromptu. Governments often relied on limited partnerships, which take advantage of private sector and uncertain means such as disaster funds, budget insurance companies’ established financial and reallocation, and on donor assistance. Yet in many technical capacity. This development was in part countries with recurrent disasters donors have been due to significant strides in the private sector’s unwilling to contribute to a pooled disaster fund ability to quantify, price, and manage catastrophe when they did not trust the existing operational and risk, increasing its willingness to carry such risk.25 fiduciary procedures. The role of the ministry of The increased ability to analyze infrequent events finance was confined to approval of expenditures and understand the uncertainty in that analysis led and identification and mobilization of funding to a significant dampening in global reinsurance sources after an event. prices and enabled new risk transfer products. Early adopters came mostly from upper middle- Nonetheless, many agricultural insurance pilots income countries where major natural disasters done by the private sector—usually implemented initiated change. For example, the 1985 Mexico with support from donor partners and mainly for City earthquake, which caused over 10,000 deaths, index-based crop insurance—still failed to scale sparked a national dialogue on disaster risk up sustainably. F I N A N C I A L P R OT E C T I O N A G A I N S T N AT U R A L D I S A S T E R S 39 40 F I N A N C I A L P R OT E C T I O N A G A I N S T N AT U R A L D I S A S T E R S 1999 2000 2001 2002 2003 2004 2005 2006 Sovereign 1996 Mexico first- Disaster Risk Mexican Fund for ever sovereign Financing Natural Disasters catastrophe bond & Insurance (FONDEN) ($160 million) Agricultural India’s first weather Mongolia index- Insurance index insurance based Livestock pilot by ICIC- Insurance Program Lombard General Insurance Co. Property Turkish Taiwan Residential Indonesian Catastrophe Catastrophe Earthquake Earthquake Risk Insurance Insurance Pool Insurance Program Reinsurance (TCIP) Pool (MAIPARK) established Disaster-Linked Social Protection International UN Office for Hyogo Framework Dialogue Disaster Risk for Action I Reduction (UNISDR) Munich Climate established Insurance Initiative by Munich re- established Figure 10 Historical evolution of disaster risk financing and insurance in developing countries since 200027 PART 01 2007 2008 2009 2010 2011 2012 2013 2014 Caribbean World Bank Mexico indemnity- IDB launches Pacific Catastrophe Central American Catastrohpe Risk launches contingent based excess-of- contingent credit Risk Insurance Pilot countries join Insurance Facility credit product for loss insurance for product for natural CCRIF (CCRIF) natural disasters public assets disasters JICA launches Loan with a contingent credit African Risk Catastrophe product for natural Capacity sells Deferred Drawdown disasters (SECURE) first policies for Option - Cat DDO) sovereign drought Weather derivative risk insurance Malawi index-based with Uruguay, weather derivative intermediated by World Bank Pacific Catastrophe Risk Assessment and Financing Initiative India large-scale Launch of Global Kenya and Ethiopia Vietnam agricultural Kenya crop and Weather-Based Index Insurance index-based insurance pilot livestock insurance Crop Insurance Facility by the livestock insurance public-private Scheme World Bank, IFC, Modified Area Yield partnership under and private Sector Crop Insurance development Partners Scheme in India Romanian Indonesia flood Micro-insurance South East Europe Catastrophe micro-insurance Catastrophe Risk and Caucasus Insurance Scheme Organization Catastrophe Risk Manizales, Colombia (MiCRO) established Insurance Facility earthquake property insurance Phillipines CLIMBS micro-insurance First disaster-linked HARITA pilot in HARITA in Ethiopia contingent financing Ethiopia with expands to R4, protection for “insurance for work” building on PSNP Productive Safety option for farmers infrastructure Net Program (PSNP) in Ethiopia Global Facility for AOSIS proposes World Economic Sendai Dialogue Political Champions World Disaster Reduction “Multi-Window Forum publishes Group for Resilience Development and Recovery Mechanism to report “A Vision for G20 adopts DRFI on Insurance Initiative Report 2014 established Address Loss and Managing Natural agenda set up by major stresses role of Damage from Disaster Risk” develop partners DRFI Climate Change OECD/G20 and donors Impacts” Methodological Framework F I N A N C I A L P R OT E C T I O N A G A I N S T N AT U R A L D I S A S T E R S 41 42 F I N A N C I A L P R OT E C T I O N A G A I N S T N AT U R A L D I S A S T E R S Mongolia is a notable example of successful community began to support financial protection activity in a low-income country during this time. 26 measures before disasters hit and at the same time A combination of droughts and severe winters the 2005 Hyogo Framework for Action (HFA) went between 1999 and 2002 led to a loss of 35 percent into effect, promoting more proactive disaster of the country’s total livestock. In the face of a risk management. significant negative impact on GDP and economic growth the government set up a public-private 2005-2010: New approaches partnership with domestic insurance companies to financial protection under to provide affordable index-based livestock the Hyogo Framework insurance to herders (Cummins and Mahul, 2009). The Hyogo Framework for Action provided As of 2014, the program covers approximately 16 greater clarity and a holistic structure for putting percent of herders nationwide (19,500 herders into place disaster risk management measures out of approximately 120,000 herders), and has by countries, donors, and international partners. successfully scaled up from three pilot provinces While it did not emphasize financial protection as to cover the entire country, reducing the impact a priority action for governments, it took note of of livestock mortality on herders’ livelihoods, the growing realization of the need for disaster risk and providing the government with a vehicle to financing (see Box 4). Overall, the HFA provided transfer part of its fiscal exposure to international /// /// an opportunity to encourage greater innovation reinsurance markets. in disaster risk financing and insurance within Challenges and lessons the framework of new approaches to disaster risk management. During this period policy makers in developing countries began to recognize the benefits of New kinds of financial instruments to help address proactive planning for the financial management common problems in risk financing resulted in a of disasters. Early signs of success showed that string of market-based products for developing setting up financial protection measures could help countries, including parametric catastrophe bonds developing countries better manage the financial and weather derivatives for national governments; impact of natural disasters. The international disaster-dedicated contingent credit; and regional Box 4 Disaster risk financing in the Hyogo Framework for Action The Hyogo Framework for Action recognized a role for risk transfer and the need for some sort of financial tool or reserve to support effective response and recovery. HFA’s Priority for Action #4 alludes to financial risk transfer as an important step to reducing underlying disaster risk factors. Paragraph 19 (k) calls for promoting “the development of financial risk-sharing mechanisms, particularly insurance and reinsurance against disasters.” The framework also states the need to set up “financial reserves and contingency mechanisms … to support effective response and recovery when required.” Disaster risk financing as a proactive agenda to manage and reduce financial risks is, however, not reflected in the monitoring questions for reducing the underlying risk factors. The HFA did not explicitly discuss disaster risk financing as a priority agenda for governments, nor was it recognized as a core component of the disaster risk management agenda. At the time the framework was drafted, disaster risk financing was still not very well understood nor viewed as a priority. Countries, the international community, and others involved in thinking about financial protection were only just beginning to realize the extent to which it is a fundamental component of comprehensive disaster risk management. PART 01 Box 5 Regional risk pooling for Caribbean States Caribbean countries have been at the forefront of developing new risk transfer tools to address some of the natural hazards they face, including hurricanes and earthquakes. The region has historically faced numerous challenges in absorbing the financial impact of natural disasters in the traditional insurance marketplace, including a limited ability to diversify risk, limited budgetary capacity, insufficient vulnerability reduction measures, limited reserves of domestic insurance capital, high insurance costs, and issues with underinsurance (existing but inadequate insurance coverage by policy holders). In 2007, 16 Caribbean island countries came together to form a regional risk insurance pool, the Caribbean Catastrophe Risk Insurance Facility (CCRIF), with technical assistance from the World Bank and initial capitalization by the international donor community and the World Bank. CCRIF is a first-of-its-kind government risk-sharing platform, aimed at assisting members manage part of their catastrophe risk exposure through access to affordable and effective insurance coverage against natural disasters. For almost all Caribbean governments, a direct hit by a major hurricane or earthquake is the largest single risk it faces. Prior to CCRIF, the economic aspects of disasters had gone largely unmanaged by governments, which had mostly relied on post-disaster humanitarian assistance from donors. With CCRIF, the member governments have developed a parametric insurance mechanism that enables them to share their risk between all participating countries and provides rapid payouts—similar to business interruption insurance—to finance an initial disaster response while maintaining basic government functions immediately following an event. By pooling their risks into a single diversified portfolio, member countries’ insurance costs are significantly lowered, with pricing reduced by half or more of what it would cost if countries were to purchase the same coverage individually and directly from global markets. CCRIF retains a significant level of risk thanks to initial capitalization from the participating countries, bilateral donors, and the World Bank, and transfers part of its risk to the international reinsurance and capital markets. CCRIF was the first ever multi-country risk pool and was well received by the reinsurance market. The success of CCRIF, which thus far has made eight payouts totaling more than $32 million to seven member governments, brought about the development of a regional catastrophe risk pool in the Pacific and Africa as well as ongoing discussions on disaster risk financing solutions among the Indian Ocean island countries. Contribution by Simon Young on behalf of CCRIF risk pooling mechanisms. Product innovation multiple geographic regions in Mexico) catastrophe remained the focus until the end of the decade. bonds issued by the Mexican government in 2009, worth $290 million, and in 2012, worth $315 million, Between 2005 and 2008 a number of new financial under the World Bank’s newly established MultiCat instruments emerged to help developing countries Program (World Bank, 2012a). access international financial markets. In addition, private sector innovations from the 1980s and Launched in 2007, the Caribbean Catastrophe Risk 1990s were increasingly being used by developing Insurance Facility (CCRIF) was a groundbreaking countries. In 2006, Mexico became the first government risk-sharing platform aimed at middle- or low-income country to issue a sovereign assisting member countries to manage part of their catastrophe bond as part of its disaster risk catastrophe risk exposure (see Box 5). /// /// financing strategy.28 The $160 million parametric29 catastrophe bond, called CatMex, transferred The last decade has also seen international earthquake risk to the international capital markets. organizations offering new financial instruments to This set the foundation for further multi-hazard support developing countries to access affordable (adding hurricane risk), multi-region (triggers in funds. In 2008, the World Bank introduced a F I N A N C I A L P R OT E C T I O N A G A I N S T N AT U R A L D I S A S T E R S 43 44 Box 6 Providing contingent lines of credit for disaster contingent loan for disaster response, called risk financing the Development Policy Loan with Catastrophe Deferred Drawdown Option, or Cat DDO (see /// Contingent credit is one type of financial instrument to help governments secure Box 6). Created first and foremost to encourage funds in advance of a disaster. /// investment in risk reduction by governments and Starting with the World Bank’s first approval of a loan with a Catastrophe to engage ministries of finance in disaster risk Deferred Drawdown Option (CAT-DDO) to Costa Rica in 2008, other international management, the Cat DDO is a quick disbursing organizations have started offering contingent credit as a disaster risk financing contingent line of credit that provides middle- product that not only increases financial resilience but helps incentivize better disaster risk management polices overall. To date, the World Bank has approved income countries with immediate access to funds Cat-DDOs in nine countries for a total value of $1.38 billion. These loans include: $7 following a major natural disaster. An active million to the Seychelles in 2014; $102 million to Sri Lanka in 2014; $250 million to national disaster risk management program is one Colombia in 2011; $50 million to El Salvador in 2011; $66 million to Panama in 2011; prerequisite to qualifying for this financing. $500 million to the Philippines in 2011; $100 million to Peru in 2010; $85 million to Guatemala in 2009; $150 million to Colombia in 2008; and $65 million to Costa Catastrophic risk insurance programs for property Rica in 2008. and agriculture were increasingly tested during The Inter-American Development Bank (IDB) launched its Contingent Credit Line for this period and improved in developing countries Natural Disasters in 2012 to help countries cover urgent financing needs that arise with a continued emphasis on public-private immediately after a natural disaster. This complements the 2009 Contingent Credit partnerships. The government would take on Facility for Natural Disasters, a more restrictive facility created to help countries the public role to jumpstart domestic insurance deal with catastrophic natural disasters. markets through policies that stimulated demand In 2013, the Japan International Cooperation Agency (JICA) established a program for catastrophe and agricultural insurance products called the Stand-by Emergency Credit for Urgent Recovery (SECURE). Similar to and that increase disaster risk awareness among the other contingent credit lines, SECURE provides post-disaster financing of up the population. The private sector, meanwhile, to JPY10 billion or 0.25 percent of GDP, whichever is less, immediately following a provided distribution channels, insurance expertise, natural disaster, based on prior agreement with JICA. and financial capacity. For instance, after setting up Contingent credit triggered by natural disasters has been successful in bringing the Turkish Catastrophe Insurance Pool in 2000, about a dialogue on broader disaster risk management and has been instrumental the government of Turkey legally abolished its in engaging the ministries of finance on the disaster risk management agenda. obligation to fund the reconstruction of residential For example, in order to be eligible for a World Bank-provided contingent credit line, the borrowing country must implement a comprehensive disaster risk dwellings in the aftermath of an earthquake, management program, which the Bank then monitors on a periodic basis. This strengthened its building construction codes, and is often the first time that finance ministry officials are brought to the table with improved supervision of these new construction other agencies dealing with disaster risk management. A contingent credit loan standards. By 2013, the pool had sold more than can also be the cornerstone of developing an integrated sovereign disaster 6 million policies, compared to the only 600,000 risk financing and insurance strategy. As a concrete and fairly quick product to establish, a contingent line of credit can be an important deliverable for a covered households when it was first set up. 30 government as it is building a comprehensive financial protection strategy. Partnerships between governments, the private sector, and international organizations contributed to overall improved performance of agriculture insurance programs. In 2005, the government of India started to explore ways to improve its National Agriculture Insurance Scheme. Building on international best practice and in-country experience, the government of India has since been PART 01 at the forefront in driving innovation in agriculture households when flooding in Jakarta reached a insurance. With technical support from the World predefined level. Bank, this included the use of mobile phone New developments during this period, in particular and satellite technology to improve the quality, index-based insurance products, were embraced timeliness and reliability of yield data gathered enthusiastically, yet despite the initial enthusiasm through crop-cutting experiments—increasing the the experience yielded mixed results. In agriculture accuracy of crop yield estimates; and improved insurance, for example, index-based insurance pilots index and product design for weather index have faced challenges to reach large scale outreach. insurance products. Key reasons included underinvestment in the data Innovative disaster risk financing and insurance market infrastructure and lack of government products and partnerships help micro-insurance involvement.33 In Malawi, a rainfall index-based or disaster-linked social safety net programs to crop insurance pilot was initially offered directly to benefit the poor. In 2005, Ethiopia established groundnut farmers in 2005 but was subsequently the Productive Safety Net Program, now one of redesigned to be bundled with loans due to low the largest disaster-linked food security programs uptake. Still, the product was not able to scale in Sub-Saharan Africa, to provide cash and food up beyond the pilot phases.34 The same rainfall transfers to its chronically food-insecure population. index was used to structure a weather derivative Since 2006, several disaster risk financing and contract for Malawi in 2008, yet the contract was insurance tools have been piloted and implemented not renewed beyond 2012. Other examples include to support Ethiopia’s safety net program. For a flood micro-insurance product in Indonesia that example, the program includes a 20 percent was not renewed in 2010 after a one-year pilot. subnational-level contingency budget to scale up Limited uptake has stunted the performance of the Romanian Catastrophe Insurance Scheme—closely coverage beyond the capacity of the core program modeled after Turkey’s—that was launched in during harsher droughts. In 2010, a federal-level 2008 in partnership with insurance companies Aon contingent financing window became a permanent Benfield, Guy Carpenter, Stellar Re, and Willis Re feature of the program. to provide property insurance for homes against In 2007, Oxfam, together with a group of partners earthquakes, landslides, and floods. 35 including the reinsurer Swiss Re, launched the Horn of Africa Risk Transfer for Adaptation (HARITA) Challenges and lessons project in Ethiopia. A pilot program to address Increasingly, tailored financial products opened the needs of small-scale farmers through drought new opportunities for thinking about proactive insurance, credit, and risk reduction, HARITA financial protection in developing countries. allowed farmers to pay for insurance through labor, Experiences, however, showed that stand-alone an idea based on “food-for-work” programs.31 In financial instruments are not silver bullets; they 2009, Indonesian insurer Wahana Tata piloted cannot solve all the challenges associated with the the first-ever flood micro-insurance product in impact of disasters and must be integrated into a Jakarta in partnership with reinsurer Munich Re comprehensive disaster risk management strategy. A and Germany’s development agency.32 Designed as greater understanding of the need for more strategic livelihood coverage against floods, the aim of the risk management began to emerge towards the product was to provide immediate cash to insured end of the decade. Efforts at better integrating the F I N A N C I A L P R OT E C T I O N A G A I N S T N AT U R A L D I S A S T E R S 45 46 F I N A N C I A L P R OT E C T I O N A G A I N S T N AT U R A L D I S A S T E R S disaster risk financing and insurance agenda into reveals the full potential financial impact faced the greater disaster risk management agenda was a by the government—is crucial for disaster risk turning point for the development of comprehensive financing and insurance. financial protection against natural disasters in developing countries (Ghesquiere and Mahul, 2010-Present: From products to 2010). Yet, this understanding of disaster risk strategies for financial protection financing as a broader strategic agenda, and as a core By 2010, disaster risk financing and insurance component of disaster risk management, was still practitioners had started working with a number at its early stages. To move toward comprehensive of governments to design comprehensive disaster financial protection programs, political and risk financing strategies rather than focusing on institutional challenges, such as political resistance individual products (Mahul & Ghesquiere, 2010). to financial risk management policies with perceived uncertain payoffs, had to be overcome. But the Increasingly, the international community has political support needed for sustained government recognized the disaster risk financing and insurance commitment usually only materialized in the agenda’s importance in disaster risk management, aftermath of a disaster and often remained focused public financial management, and financial sector on specific, politically-attractive financial products. development agendas. Development banks, such as the Asian Development Bank, the Inter-American While stand-alone products may not be ideal from a purely financial perspective, the traction Development Bank, and the World Bank, began and interest they tend to create at a high level integrating financial protection into their disaster amongst policy makers can enable more strategic risk management frameworks. The G20 discussed discussions on disaster risk management and risk financing on their agenda under the Mexican financial protection more broadly. For example, Presidency in 2012, supported by the World Bank under the larger umbrella of the Pacific Catastrophe and the OECD. The Sendai Dialogue at the 2012 Risk Assessment and Financing Initiative (PCRAFI), International Monetary Fund (IMF) and World the prospect of participating in a regional risk pool Bank Group Annual Meetings demonstrated a provided incentives for Pacific island countries to commitment by development partners at the highest participate in long-term initiatives to improve the levels. In addition, the 2014 World Development financial resilience of their budget. Such initiatives Report: Managing Risk for Development, included technical assistance to improve budget emphasized the role of risk management, including execution following shock events, the development disaster risk financing and insurance, as a powerful of emergency procurement procedures to enable instrument for the international development disaster response agencies to respond rapidly, and a agenda. long-term risk assessment program. Moreover, the international community began to In many cases, a limited understanding of countries’ consider disaster risk financing and insurance, disaster risk restrained governments that were especially market-based risk transfer mechanisms, looking towards more comprehensive approaches. as an effective part of climate change adaptation Here a clear role emerged for the international strategies. This built on earlier initiatives such as the community to support countries in better 2005 Munich Climate Insurance Initiative launched understanding their disaster risks and supporting by MunichRe, and a proposal in 2008 by the Alliance policy makers in dealing with the uncertainty of Small Island States for an insurance mechanism inherent in risk management. It also became clear to address damages from climate change. In 2013, that accurate financial risk information—which the UN established an international mechanism PART Box 7 Post-disaster budget execution 01 Sustainable and effective disaster risk financing and insurance strategies can help governments raise funds to address potential financial needs and manage fiscal volatility after a disaster hits. Equally important are the administrative and legal procedures to ensure that the available resources are used effectively in the aftermath of a natural disaster, including a legal framework for declaring emergencies, a clear process for budget appropriation and execution, as well as fiduciary control and management of funding channels during an emergency. In Mexico, the Natural Disaster Fund (FONDEN) is the centerpiece and operator of the government’s disaster risk financing and insurance strategy, combining several financial instruments for various sources of funding, depending on the timing and amount of funding needs as well as the cost of securing said funds. The main role of FONDEN, however, is to ensure coordination between federal, state, and municipal governments and the private sector. For example, following a disaster, FONDEN’s coordination and budget execution role includes collecting information on affected public infrastructure and services; managing and allocating disparate requests for funds based on a transparent damage and loss assessment methodology; coordinating administrative capacities across geographical locations; and monitoring the use of funds and reconstruction progress. to promote a comprehensive approach to address Strong developments in sovereign disaster risk loss and damage associated with the effects of financing also reflect increasing engagement by climate change. At the same time, the European ministries of finance. Colombia, along with Panama Commission produced a discussion paper (Green and the Philippines, was among the first countries Paper) on insuring against natural and man-made to develop a national disaster risk financing and insurance strategy, which integrates disaster-related disasters. contingent liabilities into existing disaster risk The same year, the Political Champions Group and fiscal risk management agendas (World Bank for Disaster Resilience—a collaboration between and Government of Colombia, 2013). Colombia’s major donor countries to strengthen resilience strategy focuses on improving financial risk in development planning—introduced a new information and quantification; improving budget management of disaster risk through multiple initiative to develop stronger partnerships financial instruments (including a disaster risk between governments and the private sector to use management fund, a contingent line of credit market-mediated insurance solutions as a way to from the World Bank, and possibly a market-based increase the resilience of vulnerable populations earthquake risk transfer solution); and scaling up to the economic effects of natural disasters. The the insurance of public assets. For the latter, the expert groups supporting this initiative includes strategy paved the way for a group approach to representatives from the U.K. Department for insuring central government buildings in addition to International Development, the U.S. Agency for increasing insurance requirements for government International Development, the World Bank, the concessions in transport infrastructure such as International Labor Organization, the German roads and ports.36 The public financial management Agency for International Cooperation (GIZ), the aspects of disaster risk financing are becoming Swiss State Secretariat for Economic Affairs, the increasingly important as countries realize the need European Commission, and insurance companies for effective post-disaster budget execution (see /// Box 7). Swiss Reinsurance Corporation, Munich Re Group, /// Willis, and Allianz. So far the group has identified Governments across South and Central America opportunities to stimulate disaster risk insurance have maintained the region’s strong pace of in Bangladesh, Haiti, Kenya, the Philippines, and innovation. In Peru, the Ministry of Finance has Senegal. begun to develop a national disaster risk financing F I N A N C I A L P R OT E C T I O N A G A I N S T N AT U R A L D I S A S T E R S 47 48 F I N A N C I A L P R OT E C T I O N A G A I N S T N AT U R A L D I S A S T E R S strategy, which includes a strong focus on the In January 2014, Tonga received the first payout of insurance of public assets and improving domestic US$1.27 million within two weeks of cyclone Ian insurers’ earthquake risk-carrying capacity. The reaching landfall. The speed of the payout proved countries of Central America committed to join the important in supporting the government of Tonga to CCRIF risk pool. This initiative is complementing effectively launch initial relief efforts. already ongoing disaster risk financing efforts in the region. For example, when Panama established a In 2013, Indian Ocean island states started exploring sovereign wealth fund in 2012, it designated disaster a similar scheme. In Sub-Saharan Africa, the losses larger than 0.5 percent of GDP (excluding African Risk Capacity was set up as a specialized insurance coverage and the amount of contingent agency of the African Union states as an extreme credit lines) as one of three reasons for a payout. weather insurance scheme to estimate and disburse immediate funds to countries hit by severe drought. This shift in Latin America reflected a wider trend Following the example of the CCRIF, the African of governments looking to their neighbors to Risk Capacity, a pan-African risk pool to manage share experience, access expertise, and in some drought risk, launched in spring 2014. In addition cases establish joint risk financing mechanisms. to looking outward, governments have also begun The Pacific Catastrophe Risk Insurance Pilot to focus on applying disaster risk financing and launched in 2013, building on work started in 2007. insurance strategies at the subnational level (see /// The pilot allows the six participating countries37 Box 8). /// to pool risk and access earthquake and tropical cyclone parametric risk coverage from reinsurance Significant developments are also taking place in companies, providing governments with immediate insurance programs focused on the most vulnerable liquidity in the aftermath of a severe natural disaster. groups of society. In 2011 Oxfam partnered with Box 8 Strengthening subnational disaster risk financing capabilities A significant share of the public cost of disaster recovery and reconstruction ultimately falls on local governments. For example, they often must pay for the repair of provincial, district, and community roads, schools, health clinics and other infrastructure within their remit. Local governments may face additional pressures to support the recovery of local businesses and livelihoods, speeding the restoration of local economies. While local governments in developing countries are often required by law to make budgetary provisions for post-disaster needs, they typically have limited discretionary financing, and what little funds they do have are quickly spent in the event of a disaster. As a consequence, reconstruction efforts can extend over a number of years, exacerbating the indirect economic and social costs of a disaster. State-owned enterprises can face similar challenges and pose additional contingent liabilities to national governments. Over the past decade, there has been an increasing recognition of the need to address this issue by strengthening local, as well as national, disaster risk financing capabilities. National governments can help stimulate this growth at the local level by providing explicit incentives for uptake and through regulatory and legislative reforms supporting the growth of financially sustainable risk transfer solutions tuned to the needs of local government. For instance, in addition to limiting the availability of post-disaster federal funds for states that continuously do not insure their assets, Mexico also incentivizes states to build reserve funds, similar to its national-level program FONDEN by providing seed funding. Colombia has begun to improve guidelines on insurance requirements for concessions at the subnational level, modeled after the 2013 reform of insurance requirements of national government concessions. In Indonesia, provincial and municipal governments voluntarily insure critical public assets (World Bank, 2011). International Financial Institutions are supporting the development of disaster risk financing and insurance strategies and risk transfer schemes tailored to the subnational level. The Asian Development Bank, for example, has been focusing on climate risk adaptation in megacities and is currently developing disaster risk financing and insurance instruments at the city level in Indonesia, the Philippines, and Vietnam. Contribution by Charlotte Benson, Asian Development Bank Box 9 How risk modeling and analytics are informing disaster risk financing in Mexico The government of Mexico developed the probabilistic catastrophe risk modelling software R-FONDEN to improve the effectiveness of Mexico’s disaster risk management system. Combined with actuarial analysis of historical loss data, this tool helps inform decision making about the government’s risk financing and insurance strategy, and provides risk visualization. An in-depth understanding of its risks allowed the Mexican government to develop a comprehensive financial protection strategy relying on risk retention and transfer mechanisms, including successfully accessing international reinsurance and capital markets. To identify assets exposed to natural disasters—including roads and bridges, hospitals, schools, hydraulic infrastructure, and low-income housing—and the potential financial impact of their destruction, R-FONDEN was developed in three steps: 1) Data Gathering: The required database was prepared, including hazard information, an asset inventory with the key variables such as building characteristics /// /// required for evaluation of vulnerability and loss of infrastructure, and the integration of historical loss data to complement simulated data. 2) Catastrophe Risk Modeling: The government, together with the Universidad Nacional Autónoma de México (UNAM), developed hazard models for earthquakes, /// /// tropical cyclones, and floods, and vulnerability functions for all types of infrastructure. Together with the exposure database this enabled the government of Mexico to carry out deterministic and probabilistic risk modeling used to inform financial analysis of probable disaster loss. 3) Financial Analysis: Finally, the government carried out actuarial analysis of the simulated risk data and historical losses to develop and fine tune the federal /// /// disaster risk financing strategy for public infrastructure—including both risk retention and risk transfer. This also includes the development of a decision support tool to facilitate this process in the future. As a result, R-FONDEN has informed the development of the federal disaster risk financing strategy and helped improve individual insurance policies for federal agencies. For instance, it enabled the design of an insurance program for the Ministry of Transport in charge of federal roads and bridges, a scheme that previously was difficult to insure due to insufficient asset information. the World Food Program to build on the HARITA public-private partnership, MiCRO includes Swiss insurance project in Ethiopia, designing the Rural Re, Guy Carpenter, Mercy Corps, CaribRM (a Resilience Initiative, or R4, a large-scale initiative Caribbean specialist consultancy), and Fonkoze. that has expanded coverage to Senegal. The In 2013, CCRIF began broadening its reach into initiative focuses on developing tools to help the micro-insurance territory by supporting a trial of most vulnerable people build livelihoods resilient to a parametric personal weather-insurance product the effects of natural disaster, such as ‘insurance for in Grenada, Jamaica, and St. Lucia, supported by work’, and will soon roll out in two more countries Munich Re under the Munich Climate Insurance in the region.38 Similarly, the government of Kenya Initiative.40 is looking to complement its Hunger Safety Net Increasingly, the use of financial decision making Program—which currently provides cash transfers tools empowers governments to make more to the 100,000 most vulnerable households in four informed decisions. For example, financial decision northern counties—with a mechanism to rapidly tools can be used to evaluate potential fiscal risk scale up payments to the affected area immediately caused by an earthquakerisk transfer options following shock events such as drought. to protect public debt portfolio. Or they allow In 2011, MiCRO (Microinsurance Catastrophe governments to analyze the costs and benefits Risk Organization) was established to provide of different financial product and their potential micro-insurance coverage to women-owned impact on its medium-term budget. A coherent micro-enterprises in Haiti.39 MiCRO’s coverage was methodology has started to emerge to help bundled with loans from Fonkoze, Haiti’s largest governments assess the economic costs and benefits microfinance institution. If triggered by a natural of alternative risk financing strategies (Clarke and disaster, its payouts can be used to repair homes Poulter, 2014). See Box 9 for an example of how /// /// or businesses and replace inventory that has been risk information is helping financial decision making destroyed or damaged. Set up as a donor-capitalized in Mexico. The development of many of these new F I N A N C I A L P R OT E C T I O N A G A I N S T N AT U R A L D I S A S T E R S 49 50 F I N A N C I A L P R OT E C T I O N A G A I N S T N AT U R A L D I S A S T E R S tools is being spearheaded by the World Bank’s initiative focuses on public-private partnerships Disaster Risk Financing and Insurance Program. and approaches agricultural insurance as one component of an overall integrated agricultural Meanwhile, it has also become clear that in order risk management strategy. It also looks to take to develop sustainable large scale agricultural advantage of investments made in developing insurance markets the public and the private sector the agriculture insurance markets to bring about need to work closely together, with each playing multiple benefits. For example, investments in data key, differentiated roles. The past decade saw and risk financing can be used to improve existing numerous private sector agricultural insurance cash transfer programs by making it technically pilots implemented in developing countries, usually possible to automatically increase welfare payments with support from donor partners and mainly for to the poorest and most vulnerable rural households index-based crop insurance (World Bank, 2005). following a disaster. However, only a few, notably the crop insurance programs in India and the index-based livestock Challenges and lessons insurance program in Mongolia have scaled up to Overcoming institutional challenges to disaster sustainable programs, due to close involvement risk financing and insurance requires well-defined by the government. In contrast, the private sector- institutional accountability and responsibility, led weather index-based insurance pilot in Malawi together with a strong champion at the highest did not successfully address all challenges such as level of government. Over the past five years, low demand from farmers, and the pilot failed to ministries of finance have been increasingly achieve scale. taking the leadership in the development of Experience suggests that sustainable, scaled up disaster risk financing strategies, collaborating agricultural insurance should be based on an equal with other government entities such as disaster partnership between the public and private sectors. risk management agencies, insurance supervisors, The public sector is essential in the provision of and ministries of social welfare or agriculture. public goods, such as agriculture data and risk Additionally, the idea of a central government financing structures, which allow national insurance agency responsible for risk management has companies pass on agriculture risk to international been proposed by international organizations reinsurance markets. Government should also foster and the private sector. For example, The World an enabling legal and regulatory environment to Development Report 2014 recommends setting up unlock the innovative potential of the private sector, national risk boards, an institutional reform already work to improve the technical capacity building of in place in Singapore and under consideration in local insurance companies, and ensure products Jamaica, Morocco, and Rwanda. Yet there is still developed for farmers are of high quality. Finally, the much work to do in bridging the gap between public sector can implement policies to support the international recognition and actually implementing wide scale outreach of agriculture insurance, which such an agenda in the countries that need it the is essential to achieving the market size required for most. While a number of developing countries are sustainability (see Box 10). /// /// leading the way in this field, in many others progress remains extremely limited. Building on lessons learned from more than 20 years of experience in supporting agricultural insurance, Awareness has been growing of the need for in 2013 the World Bank launched a new initiative institutional arrangements and mechanisms to on Agricultural Insurance as part of its Disaster complement the financial instruments used to Risk Financing and Insurance Program. This secure funds. Often overlooked, these administrative Box 10 Munich Re’s experience in agricultural insurance Providing appropriate risk management tools for agriculture is a key challenge for development. Agricultural insurance can play a vital role in that process by providing cover against natural perils, serving as collateral for agricultural loans and providing a safety net for investments. While agricultural insurance systems have been successfully implemented in recent decades, this was mostly in industrialized countries. One key requirement is the integration of insurance in the broader context of agricultural development and risk management. Sustainable agricultural production methods and use of the best available production techniques specific to each site are prerequisites of insurance. Second, only systems based on public-private partnerships have proved to be successful and sustainable, whereas purely private or purely state-organized systems have often failed. In such public-private partnerships the government, farmers, and the insurance industry play complementary roles: Ş The government provides the enabling legal and regulatory framework. It can also provide part of the financing for risk premiums and administrative costs, invest in creating, auditing, and managing the required data, and facilitate market penetration through premium subsidies and state reinsurance for catastrophe losses. This helps keep insurance terms affordable for farmers. Ş Farmers finance part of the risk transfer through insurance premiums. They also retain part of the risk in the form of a deductible or as basis risk in the case of index products. Agricultural producers also have a crucial role in making such insurance programs sustainable through overall agricultural risk management. Ş Insurance and reinsurance companies take on roles as risk carrier and take care of the marketing and administration of insurance policies. They also manage the portfolio, develop new products, and carry out loss adjustment. Especially in developing countries, where insurance companies are often short of risk capital, reinsurance arrangements are essential to maintain adequate solvency margins for insurance companies. Besides much-needed capital, global reinsurers also bring international expertise and experience to developing countries. *OTVSBODFQSPWJEFSTBOESJTLDBSSJFSTDBOBMTPXPSLUPHFUIFSPOKPJOUNBSLFUBQQSPBDIFT ǨPSFYBNQMFQPPMJOHBMMPǨUIFDSPQSJTLTPǨPOFDPVOUSZŔPSFWFOTFWFSBM TNBMMFSDPVOUSJFTŔBOEJOUIBUXBZBDIJFWFBCFUUFSTQSFBEPǨSJTL#VJMEJOHPOVOJǨPSNUFSNTBOEDPOEJUJPOTTVDIBOBQQSPBDIDBOCFBHPPEXBZUPHVBSBOUFFUIF sustainability of the system. Contribution by Joachim Herbold, Senior Underwriter and Agricultural Risk Expert, Munich RE and legal dimensions—such as a legal framework for sector, investing in building insurance markets declaring emergencies, a clear process for budget in developing countries helps unlock access to appropriation and execution, and fiduciary controls previously unavailable markets and allows further of post-disaster funding channels—are essential diversification of their current portfolios, which are to an effective and timely response. For example, highly concentrated in developed countries. the government of Indonesia had to pass a new However, it also became clearer that financial government regulation (PP 45/2013) in 2013 to protection needs to be complemented by prevention explicitly allow its Ministry of Finance to purchase and risk reduction. The insurance industry has been insurance with funds allocated in the national warning that in some high-risk areas, such as parts budget (World Bank, forthcoming). of the United Kingdom and the U.S. state of Florida, Key lessons learned emerged during this period. climate change already threatens the insurability Financial protection can help groups across society of catastrophe risk. Here the government plays a understand, price, and manage financial risk. The crucial role—such as through adequate government government and the private sector share roles regulation of both insurance markets and land and an interest in managing financial impacts use planning—to avoid market failure (Geneva faced by the government and in empowering Association, 2013). For rapidly urbanizing developing homeowners, businesses, and agricultural producers countries this is an important reminder to integrate to access risk transfer solutions. For the private risk early in development and land use planning. F I N A N C I A L P R OT E C T I O N A G A I N S T N AT U R A L D I S A S T E R S 51 52 F I N A N C I A L P R OT E C T I O N A G A I N S T N AT U R A L D I S A S T E R S Section IV: Looking to the Future Governments of developing countries have made ministry of finance typically leads the disaster significant progress in implementing disaster risk risk financing policy agenda, the expertise and financing solutions. Much has been learned, and collaboration of other public entities such as these lessons have informed the first operational ministries of agriculture or public works is essential disaster risk financing and insurance framework for implementation. Bringing together these to help governments structure work on financial different agencies is an important role for ministries resilience, laid out in this document. But disaster of finance to play. Challenges can also arise if the risk financing and insurance is a sophisticated legal liability for financing damages is not clear agenda with complex institutional and technical between national and subnational governments. aspects. Many challenges that have emerged over Finally, the design of national financial protection the years remain unsolved while at the same time strategies must be careful of the kind of incentives there has been a real growth in innovation and new they may unwittingly generate; for example, a opportunities. national-level program might discourage subnational governments from investing in risk reduction. Areas of focus for strengthening public financial management Disaster risk financing funds: A dedicated /// /// of disasters disaster fund can form the backbone of the government’s ability to manage the financial impact Institutional of natural disaster risk. It provides not only financial resources solely dedicated to allowing risk retention Legal environment: The legal environment but it can also anchor the development of a more /// /// varies significantly between countries and can comprehensive disaster risk financing and insurance either support or restrict the development of strategy. However, the development of a dedicated disaster risk financing and insurance solutions. fund requires discussion and agreement with the For example, while some countries have a legal ministry of finance and, in many cases, with the requirement to insure public assets, others prohibit legislative branch, bringing political considerations the use of public funds to purchase insurance. into play. Similarly, administrative and legal dimensions are crucial for post-disaster decisions such as Technical declaring emergencies and budget appropriation and Risk information and risk analytics for execution. /// evidence-based decision making: Even /// Cooperation in the public sector: Disaster /// /// when governments are aware that they face a risk financing and insurance cuts across significant, often open-ended, contingent liability numerous agendas, including those of disaster from disasters, they mostly lack the information, risk management, public financial management, expertise, and tools to understand and quantify financial sector development, and, increasingly, financial and fiscal disaster risk. The government social protection. Often, numerous public agencies may not know what kind of data is needed, such as oversee different aspects of these policy agendas, historical records of how disasters affected public emphasizing both the need for and challenge of finances in the past and information for probabilistic coordinating between these players. While the financial and actuarial analysis such as modelled Box 11 Challenges of assessing risk for risk financing and insurance Successful financial protection solutions rely on underlying risk data. Yet appropriate risk modelling tools are still lacking in countries that need them the most. Lack of appropriate solutions and tools for developing countries: Disaster risk financing requires sophisticated risk modelling tools generally unavailable for low- and often also middle-income countries. Their development requires substantial seed investment for example for the collection of the required data on exposed assets, even before there is a reasonable certainty that the government will use the tools once completed. Where financial risk models do exist, they are usually not tailored to answer governments’ specific disaster risk financing questions and needs, such as modelling for collapsed buildings, fatalities, impact on crops and food security, and taking into account the homeless population. Almost always developed for the insurance industry, these models often only assess the impact on “insurable” assets, excluding, for example, low-income housing. Exposure data may also rely heavily on official census data that often excludes infrastructure and public buildings and disregards unofficial settlements—such as shantytowns or squatter towns—that regularly suffer the most damage in a disaster. Even where countries can access risk modelling tools, they go out of date quickly; some are even born obsolete or inaccurate. For example, many models rely on census data that can be 10 years old. Even if growth trends are used to update figures, using old census data to collect information on exposure in fast growing countries is potentially inaccurate. Lack of disaster risk information in developing countries: Disaster risk financing solutions are only as reliable as the risk models that support them, and the latter are /// /// only as good as the data used to develop them. Unfortunately, developing countries often lack adequate data to build and validate risk assessment tools, not least because gathering the necessary data sets requires large investments. If not already available, exposure data—such as information on public and private assets—are the hardest and most expensive to gather and organize. Use of satellite imagery is often the only way to gather up-to-date exposure data, but the cost of acquiring such images can be prohibitive for developing countries, unless companies such as Google provide information already in their possession free of charge for development purposes, including disaster risk financing. Data on exposure may be scattered among different government ministries and other organizations, and may be kept in precarious conditions. For example, when the Pacific Catastrophe Risk Assessment and Financing Initiative (PCRAFI) undertook a risk assessment in the region in 2012, some of the only existing maps about crops in the South Pacific were available in a single paper copy in the archive of the Secretariat of the Pacific Community in Suva, Fiji. Data sharing is often not the norm: Even within the same government, different ministries may not share data, and are even more reluctant to share data with /// /// international organizations for the purpose of developing risk assessment models. Data are still seen in many countries as a source of power not to be relinquished lightly, often for security concerns. And when countries do share data, they often receive no reward for their efforts such as usable feedback or products based on the data. Looking ahead: Developing countries are increasingly requesting support in managing the fiscal costs of natural disasters. New financial instruments and strategies /// /// are needed, however, to help governments increase post-disaster financial response capacity, and build domestic catastrophe insurance markets. Probabilistic risk assessment and catastrophe risk modelling are important tools that empower policy makers to take better-informed decisions in financial protection. Technical support helps countries collect the underlying data and build the required models. More work is also needed to bridge the gap between catastrophe risk data and informed decision making, establishing the link from technical outputs to financial analysis that is useful to nontechnical decision makers. Simplifying complex technical data and providing key financial figures ensures that policy makers have the information they need to make the best decisions about financing disaster risk. Contribution by Paolo Bazzurro, Professor, University Institute for Superior Studies Pavia, Italy F I N A N C I A L P R OT E C T I O N A G A I N S T N AT U R A L D I S A S T E R S 53 53 54 F I N A N C I A L P R OT E C T I O N A G A I N S T N AT U R A L D I S A S T E R S disaster losses. It may also lack the expertise needed most ministries of finance, disaster risk financing to quantify its contingent liability to disasters, which can leverage existing capacity while contributing often requires heavy statistical and financial lifting towards bringing together these different sources of as well as analytical tools that are only recently risk for comprehensive fiscal risk management. becoming available to governments as they are being Increasing the evidence: In recent years, the developed for the public sector through institutions /// /// number of developing country governments such as the World Bank. The private sector and adopting pre-disaster financial protection international institutions have a critical role to play measures has increased rapidly along with the in training governments to use financial risk data number of available tools. Yet, actual evidence and analytical tools. See Box 10 for a more detailed on impact, effectiveness, and efficiency is still discussion of these challenges. limited. Initiatives such as the World Bank’s Impact Ability to comprehensively manage fiscal risk: /// /// Appraisal Program are tackling this need for The ability of ministries of finance in developing improved evidence. But monitoring and evaluation countries to manage fiscal risk is often limited, if must be included as an essential component in all it exists at all. Without a proactive approach to disaster risk financing and insurance programs to managing fiscal risk in general, ministries may also build the evidence base and to establish meaningful lack the mindset, knowledge, and institutional indicators. support to integrate fiscal risks from natural Operational disasters. Such a shift often requires technical and financial support from international organizations Post-disaster budget execution of sovereign /// and donors. By building on ongoing government disaster risk financing: Many countries lack the /// work in areas such as debt or commodity risk dedicated mechanisms, experience, and expertise to management that are already better known to effectively allocate, disburse, and monitor recovery PART 01 and reconstruction funds following disasters. For Subnational disaster risk financing and /// example, limited experience with and awareness of insurance agendas: Expanding disaster risk /// emergency procedures for public procurement can financing and insurance to the subnational level lead officials to apply business-as-usual procedures, will not only increase the financial resilience of leading to costly delays. Part of the challenge for regional or local governments, but it also reduces countries that want to implement a sovereign the potential financial burden on the central disaster risk financing and insurance strategy, government. This often requires additional including setting up budget execution systems investments in building capacity and expertise, to address specific post-disaster challenges, is which tend to be weaker at the subnational level. that it requires strong collaboration between the Integrating disaster risk financing and disaster risk ministry of finance and the public entity tasked with management into city-level planning has become spending the money, such as local governments particularly urgent in the face of rapid urbanization. or public infrastructure maintenance agencies. In In Asia, for example, unprecedented levels of addition, the system must balance policy makers’ economic and population growth have led to a rise concerns for fast disbursement with the public’s and in megacities—cities with over 10 million people— donors’ needs for transparency and accountability. that tend to be located near coastlines and rivers, For example the government of Mexico established making them highly vulnerable to rising sea levels a post-disaster loss reporting mechanism managed and other effects of climate change. by its Natural Disaster Fund (FONDEN), which lets affected states access timely payments Financial protection against climate risk /// directly from FONDEN, reducing time-consuming which is exacerbated through climate coordination problems. change: Disaster risk financing and insurance /// should be considered an integral part of Opportunities to expand the comprehensive climate change risk management, impact of disaster risk financing in part because it provides tools to manage the and insurance financial impact of climate risks that cannot be prevented or reduced. Inherently designed for Social safety net programs and disaster risk /// managing losses and damages caused by uncertain financing: Few developing countries are currently /// events, disaster risk financing and insurance supporting their social safety nets by disaster risk can help countries prepare for increased climate financing strategies to help governments manage variability and extreme events expected to the potential cost of scale up following disasters. increase with climate change. From a financial risk management perspective, while climate risks One challenge to increasing this critical link is to may lead to an increase in uncertain extreme forge the partnerships required—such as between weather events it does not fundamentally alter ministries of finance and officials working in public the underlying challenge of managing contingent welfare agencies—to financially and institutionally liability from natural hazards. Just as it is a critical adapt safety nets to expand during and after component of any disaster risk management disasters. Additionally, since it is low-income approach, financial protection plays a crucial role countries who would benefit the most from linking in helping countries become more resilient to safety nets to disaster risk financing and insurance climate risks. Disaster risk financing instruments strategies, it is essential that the international can also support measures to reduce vulnerability community provide technical and financial support by quantifying risk and providing price signals to to make this happen. climate adaptation investments. F I N A N C I A L P R OT E C T I O N A G A I N S T N AT U R A L D I S A S T E R S 55 56 F I N A N C I A L P R OT E C T I O N A G A I N S T N AT U R A L D I S A S T E R S Disaster Risk Financing in the Next forum and OECD are taking it up as an important Hyogo Framework for Action topic. Signed in 2005, in the early stages of the field of The successor to the Hyogo Framework for Action, disaster risk financing and insurance, the Hyogo to be agreed on in early 2015 after the original Framework for Action acknowledged a role for risk expires, provides an opportunity to recognize and financing in risk reduction as well as the importance integrate financial protection as a core priority of financing in the post-disaster phase (see Box 3). /// /// for action in countries’ disaster risk management agendas. Drawing on the experience captured in this Looking back, however, it is clear that Hyogo did not reflect the full scope and significance of disaster background paper, four key activities emerge that risk financing and insurance, and is no longer governments could consider including under such a representative of the importance that governments priority for action. and the international community give to this area. As already discussed, monitoring and evaluation For example, since then, the Asian Development tools and indicators for disaster risk financing and Bank, Inter-American Development Bank, and insurance programs and instruments are still largely the World Bank have all incorporated disaster risk financing as core pillars of their disaster risk lacking, but a concerted effort is underway to create management frameworks for engagement with and improve them. The results of these efforts governments. Other global policy groups like the could be reflected in the outcome and impact-level G20, Asia Pacific Economic Cooperation (APEC) indicators selected for the second Hyogo framework. Table 4 Recommended treatment of financial protection in HFA2 PRIORITY FOR REDUCE FINANCIAL IMPACT OF NATURAL DISASTERS ON THE GOVERNMENT AND SOCIETY ACTION: K EY A CTIVITIES : I Improve understanding and assessment of public contingent liabilities related to natural disasters II Develop national financial protection strategies to be implemented through a dedicated Disaster Risk Management Fund. Leverage private financial institutions to offer affordable, sustainable, cost-effective financial solutions, including insurance, to III governments, homeowners, SMEs, and agricultural producers. IV Integrate disaster risk considerations into the design of social protection programs. Table 5 Expanded recommendations for financial protection in the successor to the Hyogo Framework for Action PRIORITY FOR REDUCE FINANCIAL IMPACT OF NATURAL DISASTERS ON THE GOVERNMENT AND SOCIETY ACTION: K EY A CTIVITIES : I Improve understanding and assessment of public contingent liabilities related to natural disasters. (a) Promote the availability, quality, and consistency of risk data. (b) Develop and promote catastrophe risk pricing models such as probabilistic catastrophe risk and actuarial models. (c) Assess implicit and explicit contingent liabilities of the state to disasters and improve their integration in fiscal risk management. (d) Establish transparent, timely, and effective post-disaster loss reporting mechanisms. (e) Build the required capacity and technical expertise for disaster risk financing and insurance. (f) Strengthen the use of financial risk information to guide risk reduction activities. II Develop national financial protection strategies to be implemented through a dedicated disaster risk management fund. (a) Assess potential post-disaster (short-term and long-term) funding gaps. (b) Develop and use financial decision making tools to assess the costs and benefits of disaster risk financing options. (c) Develop a national strategy for financial protection to clarify contingent liability, secure immediate liquidity following disasters for the short-term, and ensure longer-term reconstruction financing. (d) Establish a national disaster fund with dedicated resources. (e) Adopt pre-disaster budget management and post-disaster budget execution mechanisms for natural disasters. III Leverage private financial institutions to offer affordable, sustainable, cost-effective financial solutions, including insurance, to governments, homeowners, SMEs, and agricultural producers. (a) Quantify potential property and agricultural disaster losses and identify losses incurred by public and private stakeholders. (b) Develop public market infrastructure (such as systems for collecting and managing data or modeling catastrophe risk) to better develop domestic catastrophe risk insurance and agricultural insurance markets. (c) Improve supervision and regulation of domestic catastrophe risk insurance markets. IV Integrate disaster risk considerations into the design of social protection programs to protect the most vulnerable. (a) Quantify potential disaster-related financial losses on the poorest and the fiscal impact that disasters pose for social protection programs. (b) Secure contingent funding by the government for social protection programs against disasters. (c) Complement social protection programs with insurance principles and private sector products. (d) Improve the process for identifying beneficiaries and assessing their eligibility for post-disaster payouts. F I N A N C I A L P R OT E C T I O N A G A I N S T N AT U R A L D I S A S T E R S 57 02 PART An Operational Framework for Disaster Risk Financing and Insurance Part two seeks to tie together the experience and financing and insurance to help solve the challenges collected knowledge from partners in the public of disaster and its impact. Some of these solutions and private sector in order to create a practical for urgent, short-term problems can be implemented operational framework for governments looking immediately while decision makers consider long- to establish or improve disaster risk financing term and more comprehensive financial protection and insurance programs. As a framework for the policies. For example, in many cases before the development and implementation of cost-effective ministry of finance can use risk transfer, an existing and sustainable solutions it aims to provide a law must first be revised or replaced, a goal that may practical approach and a comprehensive overview take several years to accomplish. Eventually, the of policies for the public financial management of development of a strategy around ongoing activities disasters by governments. can help the government build a comprehensive approach to the financial management of disasters. Years of sustained dialogue and working with This could take place in an iterative manner, governments and the private sector—in particular refining policy objectives—and actions to achieve insurance and reinsurance companies—have created these objectives—during the implementation of the structure of this framework. For the World Bank disaster risk financing and insurance activities, and alone, it builds on more than 15 years of intensive complementing other disaster risk management partnerships with over 60 countries worldwide. It investments. complements more conceptual work undertaken by partners such as the OECD Methodological Framework The operational framework also introduces a common language to enable and strengthen the on Disaster Risk Assessment and Risk Financing and international cooperation often required between the 2014 World Bank World Development Report on governments and their partners, as well as between Managing Risk for Development. governments themselves as they seek to exchange This framework should serve as a practical guide experiences and good practice. A structured, supporting decision makers looking at disaster risk consistent way of approaching disaster risk F I N A N C I A L P R OT E C T I O N A G A I N S T N AT U R A L D I S A S T E R S 59 60 F I N A N C I A L P R OT E C T I O N A G A I N S T N AT U R A L D I S A S T E R S financing helps governments better identify and policy makers situate this instrument in the larger implement their priorities, and enables international context of financial protection and disaster risk development partners and the private sector to management. Second, governments may also be better support them in doing so. seeking help in achieving a particular development goal, such as protecting smallholder farmers The operational framework, however, is not a against drought or ensuring access to immediate blueprint for action, and as such does not provide post-disaster liquidity for central or subnational detailed guidance on how to carry out each step. governments. Given the nuanced and specific challenges faced by countries, this requires a sustained commitment In both cases, this operational disaster risk financing by countries and their partners that responds to a and insurance framework provides decision makers country’s specific needs. For example, low-income with a practical guide for beginning relevant countries constrained by a lack of capacity may not discussions with all stakeholders—from government be able to use financial instruments in the same way agencies and taxpayers to donors and private as middle-income countries. Small island developing insurance companies—and to gain an understanding states subject to financial shocks where the loss of how the work might evolve over time. As a can exceed their annual GDP face vastly different second step, it helps governments to identify and challenges than large middle-income countries prioritize policy options and the necessary actions trying to safeguard low-income populations against to implement these choices, depending on the disasters. particular situation and timeframe While the overall goal of disaster risk financing The Operational Disaster Risk Financing and Insurance and insurance—to increase the financial resilience Framework is presented in three components: (i) an of society to disasters—is common across all overview of the core technical steps in developing countries, experience has shown that governments and implementing financial protection solutions become interested in disaster risk financing and (see Figure 11); (ii) a decision process for insurance primarily for two different reasons. governments engaging in the disaster risk financing First, governments are often looking to address a and insurance process, which brings together the Photo Credit: /// /// particular problem through implementing a specific technical steps with the guiding policy questions Nicholas Kingston, product or financial instrument such as risk transfer (see Figure 12); and, (iii) an overview of actions Cairo, Egypt to international markets; the challenge is to help governments can consider for each of these steps PART 02 Figure 11 Operational Disaster Risk Financing and Insurance Framework: Core technical steps Risk assessments for financial protection quantify potential disaster impacts based on historical and simulated data. This of- ten requires investments in the necessary underlying hazard, exposure, and vulnera- bility data. This also includes building an ef- fective interface between the policy maker and underlying technical models. PRE-DISASTER Assess Risks Effective post disaster re- sponse and recovery relies on access to sufficient and timely Sustainable financial protec- resources following a disaster. tion requires reducing under- lying drivers of this risk. This includes: (i) Arranging the required It complements risk reduc- financial resources for the tion by managing residual Reduce government to meet its Arrange Financial risk which is not feasible or Underlying Risk contingent liabilities not cost effective to mitigate. Solutions It also creates incentives to (Links to DRM) (ii) Developing catastrophe invest in risk reduction and risk and agricultural insur- prevention by putting a price ance markets, building on on risk and clarifying risk own- Public-Private Partnerships ership. (iii) Develop rules and arrange financing instruments for Deliver Funds scalable social protection to Beneficiaries POST-DISASTER Resources should reach beneficiaries in a timely, transparent, and accountable fashion. This requires effective administra- tive and legal systems for the appro- priation and execution of funds for the government budget, insurance distribution and settlement (often through private channels), as well as social protection programs. F I N A N C I A L P R OT E C T I O N A G A I N S T N AT U R A L D I S A S T E R S 61 62 F I N A N C I A L P R OT E C T I O N A G A I N S T N AT U R A L D I S A S T E R S to increase the financial resilience of the four main overall disaster risk management strategy. Annex I groups of beneficiaries and illustrative examples contains an extended decision tree to guide policy from international experience (see Figure 13 and /// makers through this process. Figure 14). As the first step in implementing disaster risk The second component (see Figure 12) lays out /// /// financing and insurance solutions, policy makers a decision process for a government interested in should clarify the overall development goals and financial protection, with decisions to be made on identify the intended beneficiary of their risk both the policy and the technical side. This process financing policy. As discussed earlier, most often seeks to first identify and prioritize the key policy this is one or multiple of four main groups of objectives of the government and subsequently beneficiaries of financial protection policies: the develop the required actions to achieve them. This (national or subnational) government, homeowners decision process guides policy makers through a set and SMEs, farmers, and the poorest and most of fundamental questions that determine the shape vulnerable in society. Second, historical information and direction of the country’s disaster risk financing and risk assessments help identify the financial and insurance engagement, embedded within an impact on these groups and the underlying causes Figure 12 A decision process to guide governments in building financial resilience DRFI Work Process Policy: Financial Protection Strategy & Action Plan What do I want to do/ Why do I want How will I go about achieving these are my overall goals? to do this? development goals? Start Who do I want What do I want Who will pay How will the How can I to be protected? them to be and how? funds reach implement these protected against? the beneficiaries? policy decisions? Identify and prioritize Idenfity and prioritize Identify source Identify delivery Identify necessary beneficiaries financial impact and of funds channels human, technical, underlying problems financial resources driving this impact and partnerships Assess Risks Arrange Financial Deliver Funds Solutions to Beneficiaries Implementation Technical: Operational Framework Monitoring & Evaluation PART 02 driving these effects, for example recurring budget comprehensive financial protection strategy and volatility caused by emergency spending following action plan. hurricanes and reconstruction of uninsured public Bringing together the four main policy areas of assets. disaster risk financing and insurance as discussed Following this, officials will have to consider earlier in the operational framework provides a possible solutions. These include mechanisms to more detailed matrix of policy objectives that policy manage financial risk and mobilize the required makers can consult (see Figure 13). This also /// /// places individual activities in the larger context, resources, such as risk transfer to international potentially leading to multiple wins. For example, markets or deciding to rely on post-disaster scalable social protection and agricultural insurance budget reallocations. Decision makers must also can work hand in hand, often drawing on the same determine how these funds will reach the intended distribution systems and indexes to trigger payouts beneficiaries. Finally, they must establish the and protect different segments of the population. required resources and partnerships to implement these policies. Once these policy decisions are made Figure 14 presents illustrative examples of /// /// and the government is addressing its immediate how governments are implementing disaster concerns, it can consolidate all of them into a risk financing and insurance solutions. Annex F I N A N C I A L P R OT E C T I O N A G A I N S T N AT U R A L D I S A S T E R S 63 64 F I N A N C I A L P R OT E C T I O N A G A I N S T N AT U R A L D I S A S T E R S GOVERNMENT ACTIONS FOR FINANCIAL GOVERNMENT ACTIONS FOR FINANCIAL PROTECTION OF THE STATE PROTECTION OF SOCIETY BENEFICIARIES GOVERNMENT - NATIONAL AND SUBNATIONAL HOMEOWNERS AND SMES ACTIONS (SOVEREIGN DRFI) (PROPERTY CATASTROPHE RISK INSURANCE) Ş Collect and manage risk and loss data Ş Collect and manage risk and loss data Ş Assess and legally establish the state’s contingent Ş Quantify potential disaster-related loss from property liabilities to disasters damage Ş Quantify potential disaster-related loss from fiscal and Ş Quantify potential disaster losses on low-income budget perspective households (including farmers), in addition to the impact of losses on welfare and human development A SSESS R ISKS Ş Assess potential post-disaster (short-term and long- term) funding gaps Ş Identify share of loss incurred by public and private stakeholders Ş Situate financial protection in overall disaster risk management agenda Ş Assess capacity and solvency of domestic insurance markets Ş Understand level of demand from target population for risk transfer products Ş Develop financial decision-making tools Ş Promote domestic demand for insurance through reducing cost to beneficiary Ş Develop a national strategy for financial protection within broader fiscal risk management - Public provision of risk market data and risk financing structures - Secure immediate liquidity for budget support following disasters through risk layering using - Compulsory versus voluntary schemes financial instruments such as reserves, contingent - Awareness/education of consumers about credit, and catastrophe risk transfer insurance products - Secure longer-term reconstruction financing, such - Financial incentives through premium subsidies or A RRANGE F INANCIAL as a public asset insurance program tax breaks S OLUTIONS Ş Develop domestic supply of insurance - Assess legal and regulatory environment and insurance supervision to allow private sector to develop private insurance solutions while also protecting consumers - Risk data collection, management, and sharing - Indemnity and Index-based product development - Insurance pools Ş Establish a national disaster fund Ş Develop risk market infrastructure to support delivery channels Ş Establish transparent, timely, and effective disaster declaration and post disaster loss - Underwriting and claims settlement process D ELIVER F UNDS TO reporting mechanisms B ENEFICIARIES - Delivery channels through insurance intermediaries Ş Establish post-disaster budget execution mechanisms - Alternative delivery channels: Banks, micro-finance to transfer funds from national to subnational level and Intermediaries, nongovernmental organizations, etc. from the Ministry of Finance to line ministries L INKAGES TO DISASTER Ş3FEVDF6OEFSMZJOH%SJWFSTPǨ3JTL RISK MANAGEMENT Figure 13 Operational DRFI Framework: Actions for governments to build financial resilience across society FARMERS THE POOREST (AGRICULTURAL INSURANCE) (DISASTER-LINKED SOCIAL PROTECTION) Ş Collect and manage risk and loss data Ş Collect and manage disaster risk and loss data Ş Quantify potential disaster-related loss from property damage Ş Quantify potential disaster-related losses on the poor (welfare impact) Ş Quantify potential disaster losses on low-income households Ş Quantify potential disaster-related loss through social protection on (including farmers), in addition to the impact of losses on welfare and government budget (fiscal impact) human development Ş Identify share of loss incurred by public and private stakeholders Ş Assess capacity and solvency of domestic insurance markets Ş Understand level of demand from target population for risk transfer products Ş Promote domestic demand for insurance through reducing cost Ş Secure contingent funding for disaster linked social protection to beneficiary Ş Enhance cash transfer programs with insurance principles and scalability - Public provision of risk market data and risk financing structures mechanism, including transparent rules for payout - Compulsory versus voluntary schemes Ş Develop eligibility criteria for post-disaster component - Awareness/education of consumers about insurance products Ş Determine targeting mechanism for beneficiaries - Financial incentives through premium subsidies or tax breaks Ş Develop domestic supply of insurance - Assess legal and regulatory environment and insurance supervision to allow private sector to develop private insurance solutions while also protecting consumers - Risk data collection, management, and sharing - Indemnity and Index-based product development - Insurance pools Ş Develop risk market infrastructure to support delivery channels Ş Develop systems and processes to enable effective execution of scalability component - Underwriting and claims settlement process Ş Improve assessing eligibility of beneficiaries for post-disaster payouts and - Delivery channels through insurance intermediaries targeting of payouts - Alternative delivery channels: Banks, micro-finance Intermediaries, nongovernmental organizations, etc. Ş1SPNPUF*NQSPWFE3JTL*OǨPSNBUJPO F I N A N C I A L P R OT E C T I O N A G A I N S T N AT U R A L D I S A S T E R S 65 66 F I N A N C I A L P R OT E C T I O N A G A I N S T N AT U R A L D I S A S T E R S BENEFICIARIES GOVERNMENT - NATIONAL AND SUBNATIONAL HOMEOWNERS AND SMEs ACTIONS (SOVEREIGN DRFI) (PROPERTY CATASTROPHE RISK INSURANCE) The government of Colombia included the assessment of contingent In Taiwan, China, the Residential Earthquake liabilities from disasters in the government’s 2011 fiscal risk Insurance Fund has developed an earthquake management strategy. risk model to strengthen the independence and professionalism of earthquake risk assessments. In Mexico, R-FONDEN—a probabilistic catastrophe risk modeling tool— creates probabilistic simulations of potential material and human losses The preparation of the Southeast Europe and from disasters. Caucasus Regional Catastrophe Risk Insurance Facility includes extensive multi-hazard country risk Morocco developed a probabilistic catastrophe risk modeling tool to assessments for climate and geological hazards. help the government prioritize risk reduction investments. A SSESS R ISKS The Philippines has developed a catastrophe risk model to evaluate options for risk transfers and insurance to reduce the fiscal burden of disasters. The Pacific Risk Information System, under the Pacific Catastrophe Risk Assessment and Financing Initiative, includes a database of over 3.5 million geo-referenced buildings and infrastructure in 15 Pacific island countries. It was used to develop the Pacific Catastrophe Risk Insurance Pilot. Contingent lines of credit provide developing countries with funds The Turkish Catastrophe Insurance Pool, a public- immediately following disasters. Products are offered by the World private partnership with the domestic insurance Bank, IDB and JICA. industry, provides compulsory, affordable earthquake insurance to homeowners, and has The first multi-country risk pool, the Caribbean Catastrophe Risk catastrophe insurance coverage from less than 3 Insurance Facility, established in 2007, offers 16 small island states percent to over 40 percent of residential buildings A RRANGE F INANCIAL countries over $150 million in hurricane and earthquake coverage. in urban areas. S OLUTIONS In 2006, Mexico transferred $450 million of earthquake risk to financial The Japanese public-private earthquake insurance markets by combining the world’s first government catastrophe (cat) program for homeowners relies on the Japan bond ($160 million) with parametric reinsurance ($290 million). Earthquake Reinsurance Company, an earthquake In Colombia, the government uses standardized terms and conditions reinsurance pool backed by the government. informed by international best practices to purchase catastrophe insurance for its public buildings. The government of Mexico established a post-disaster loss reporting A public-private partnership, the Turkish mechanism managed by the Natural Disaster Fund (FONDEN). Affected Catastrophe Insurance Pool relies on the domestic states can therefore access timely payments from FONDEN, reducing insurance market for the distribution and time-consuming coordination problems. settlement of claims. D ELIVER F UNDS TO In the Cook Islands, the establishment of the government’s Disaster MiCRO’s coverage in Haiti is bundled with B ENEFICIARIES Emergency Trust Fund has served to reduce delays in emergency loans from Fonkoze, the country’s largest response. microfinance institution. A collective voluntary insurance scheme against earthquakes in Manizales, Colombia uses the property tax system to collect insurance premiums. Mexico’s natural disaster fund FONDEN has evolved to include financial After setting up the TCIP, the government of accounts to finance investment in risk reduction. It promotes informed Turkey legally abolished its obligation to fund the L INKAGES TO decision by requiring state governments to complete a risk assessment reconstruction of residential dwellings following DISASTER RISK (including development of a risk atlas) before becoming eligible for risk earthquakes. It also strengthened building MANAGEMENT reduction project financing. construction codes and ensured they were adhered to. Figure 14 Operational DRFI Framework: Illustrative examples of financial protection FARMERS THE POOREST (AGRICULTURAL INSURANCE) (DISASTER-LINKED SOCIAL PROTECTION) India has developed detailed agricultural risk assessment tools to help In the Philippines, a survey is mapping out the poorest communities, making policymakers better understand the economic consequences of drought, it easier to deliver social welfare support, including assistance following a quantify its effects, and investigate the impact of risk coping strategies, at disaster, to those most in need. both the farm and state levels. Kenya’s Hunger Safety Net Program is investing in poverty mapping to In Mongolia, livestock census and surveys are used to inform the government understand levels of household vulnerability. The International Livestock about the economic and fiscal impact of adverse weather events, and in the Research Institute developed models to understand drought risk in design and pricing of index-based livestock insurance policies. northern Kenya Africa Risk View, the technical model underlying the African Risk Capacity risk pool, combines existing rainfall-based drought early warning models with data on vulnerable populations to form a standardized approach for estimating the cost of responding to food insecurity across the continent. The Index-Based Livestock Insurance Pilot in Mongolia protects the livelihoods The Productive Safety Net Programme (PSNP) in Ethiopia aims to help the of 11,000 herders, or 22 percent of all herders in piloted provinces in 2012. rural poor facing chronic food insecurity to resist shocks and become food self-sufficient. The PSNP includes including continent grants with the World India’s weather-based crop insurance has been in place since 2007 for 11 Bank for emergency scale up. growing seasons, with 11.6 million farmers and $370 million covered in the most recent season. The national crop insurance program, operating since Insurance products offered through the ‘Center for Agriculture and Rural 2010, offers more than 1.1 million farmers a total of $67 million coverage in Development Mutual Benefit Association (CARD MBA)’ in the Philippines are yield crop insurance. mandatory for members of a network of institutions including CARD NGO and CARD Bank, providing scale and preventing adverse selection. In Morocco, the government and the agricultural mutual insurance company have established a crop insurance program for cereal crops that currently covers 700,000 hectares and will soon be extended to fruit trees. Distribution of insurance policies in the Moroccan multi-peril crop insurance HARITA, (since renamed to R4), was launched in Ethiopia in 2007 as a pilot program takes place either by linkage to loans made by Crédit Agricole or by program to address the needs of small-scale farmers through drought direct marketing of MAMDA, the sole provider of agriculture insurance in the insurance, credit, and risk reduction, allowing farmers to pay for insurance country, structured as a mutual. through labor, an idea based on “food-for-work” programs. The national crop insurance program in India uses GPS-enabled mobile phones and video recording technology to improve crop-cutting experiments and the accuracy of claims assessments, which also reduces fraudulent claims. Claims settlement takes place through direct payment to bank accounts. Indian farmers’ agricultural insurance premiums are now based on their Members of PSNP households must participate in productive activities individual risk profile after the national crop insurance program moved to to build more resilient livelihoods, such as rehabilitating land and water a risk-based “actuarial regime”. This allows farmers to see the riskiness of resources and developing community infrastructure, such as rehabilitating planting different crops and choose appropriately. rural road and building schools and clinics. F I N A N C I A L P R OT E C T I O N A G A I N S T N AT U R A L D I S A S T E R S 67 68 F I N A N C I A L P R OT E C T I O N A G A I N S T N AT U R A L D I S A S T E R S VI contains links to additional information for Once a strategy has been developed, the government these examples. can formulate an action plan outlining specific steps it will take to implement its policy goals over the The government of Colombia, followed by next two to three years. While the government’s Panama and the Philippines, was among the longer-term strategy is likely to remain in place for first governments to develop and publish a five to ten years, the action plan should be a living comprehensive disaster risk financing strategy. document; the government may want to regularly Engaged in identifying and managing the fiscal risk review and update it, reflecting changes and developments in implementation. posed by natural disasters since the mid-2000s, the Risk Management Unit of the Ministry of Finance Monitoring and evaluation is crucial during the led the strategy’s preparation (see Table 6). strategy’s implementation to identify what works, what doesn’t work, and why, and subsequently refine In the Philippines, the National Treasury within the the policy goals and actions. This includes both Department of Finance finalized a national financial monitoring progress as well as evaluating the impact protection strategy in 2014 (see Table 7). thereof and results achieved. Continuous feedback Table 6 Government of Colombia's policy strategy for public financial management of disaster risk The Ministry of Finance seeks to assess, to manage, and to reduce its contingent liability related to natural OVERARCHING GOAL: disasters to support achievement of macroeconomic stability and fiscal balance. 1. Improve identification and understanding of fiscal risk due to natural disasters; 2. Strengthen financial management of disaster risk, including the implementation of innovative financial P OLICY O BJECTIVES : instruments; and 3. Enhance catastrophe risk insurance for public assets. To achieve its objective of enhancing catastrophe risk insurance for public assets over the next five to ten years, the Ministry of Finance will: 1. Build an information system on public buildings, including information on physical characteristics of buildings and insurance policies already in effect; Example of longer-term 2. Partner with other public agencies and authorities to establish a centralized system for purchasing and actions to achieve Policy managing insurance for government buildings, starting with the health and education sectors; Objective 3: 3. Improve insurance requirements for buildings and road infrastructure concessions, that align with international reinsurance market technical standards; and 4. Share the Ministry of Finance’s experience by providing best practice insurance guidelines to subnational governments, in collaboration with the country’s disaster risk management agency. Source: Government of Colombia, 2013. PART 02 Table 7 The government of the Philippines’ national strategy for disaster risk financing and insurance The Department of Finance seeks to (i) sustain economic growth and protect development gains from OVERARCHING GOAL: disaster shocks; and (ii) reduce the impact on the poorest and most vulnerable and prevent them from falling into a cycle of poverty. 1. National Level: Improve the financing of post-disaster emergency response, recovery, and reconstruction needs. 2. Local Level: Provide local governments with funds for post-disaster recovery and reconstruction efforts. P OLICY O BJECTIVES : 3. Individual Level: Empower poor and vulnerable households and owners of small and medium-sized enterprises to quickly restore their livelihoods after a disaster. 4. Risk Analytics: Use disaster risk data to support decision making on financial protection. To achieve its objective of improving the financing of post-disaster funding needs at the national level, the Department of Finance will: 1. Improve the financing of post-disaster emergency response, recovery, and reconstruction needs; Examples of actions to achieve Policy Objective 1: 2. Build up multi-year reserves through annual contributions to a response contingency fund set aside for post-disaster response efforts; and 3. Use risk transfer to access international private reinsurance and capital markets Source: Government of the Philippines, 2014. from monitoring and evaluation enables an iterative While it can offer countries many possibilities in process with regular refinement and adjustments to addressing the financial impact from disasters, both the strategy and action plan. This is important financial protection policies cannot be sustainable not only when directly looking at the benefits unless they are integrated into a larger framework and cost of risk financing instruments. A better of risk reduction activities. Once a government is understanding of the public finance implications of addressing the most direct human suffering from risk financing instruments helps understand their disasters, financial protection can help protect true value. While a $3.2 million payout by CCRIF society against many of the direct and indirect to St. Lucia following a 2010 hurricane may have effects that cannot be reduced or prevented. only represented 0.7 percent of total expenditure, Improved evidence to better understand the benefit this was an estimated 49.3 percent of the total and costs of alternative risk financing activities contingency budget available (Bevan and Cook, helps governments develop more effective risk 2014). management strategies overall by deciding when it Disaster risk financing and insurance is only one is prudent to invest in risk financing and when other aspect of comprehensive disaster risk management. options should be chosen first. F I N A N C I A L P R OT E C T I O N A G A I N S T N AT U R A L D I S A S T E R S 69 70 F I N A N C I A L P R OT E C T I O N A G A I N S T N AT U R A L D I S A S T E R S Annex I: Expanded Decision Tree for Disaster Risk Financing and Insurance Engagement by Governments Do I have Determine and YES sufficient financial prioritize specific risk and other problems to information address in the to identify short-* and long-term solutions to these NO problems? Identify financial YES impacts, such as Am I aware of the direct impact on underlying factors government’s causing this budget; impact impact? on the poor, etc. NO Does diagnostic Do I understand the YES reveal sufficient YES Conduct in-depth information financial impact diagnostic on underlying of natural disasters of risk financing factors to identify needs on my country? NO financial problems NO and solutions? Conduct YES Does diagnostic preliminary reveal any diagnostic financial impacts of financial that concern me? impact NO * If there are concrete actions that could reduce financial risk in the short-term, begin implementation of these actions in parallel. Define a short- Do I have human, Define a set of to medium-term technical, Do I understand YES YES long-term policy action plan and financial the short-term objectives (next for the next resources as well BEGIN actions required 5-10 years) and to implement this 2-3 years to as partnerships IMPLEMENTATION a strategy to implement policy in place to achieve them strategy? NO objectives as set implement the NO out in strategy action plan? SEEK ADDITIONAL SUPPORT YES Benefits of seeking more MAINTAIN STATUS information QUO outweigh costs? NO F I N A N C I A L P R OT E C T I O N A G A I N S T N AT U R A L D I S A S T E R S 71 72 F I N A N C I A L P R OT E C T I O N A G A I N S T N AT U R A L D I S A S T E R S Annex II: Some commonly asked questions when considering disaster risk financing and insurance Why should the government invest governments if they hope to access international in risk market infrastructure? (And reinsurance markets, which require a high standard of data to develop and price insurance products. what does that mean anyway?) If these companies have concerns about how Risk market infrastructure is the public goods the data is audited, they will charge significantly and institutions to align incentives of the private higher premiums. sector with those of the beneficiary. Specifically An enabling legal and regulatory framework for this requires building or improving systems for insurance market development is also crucial. Policy collection, auditing, financing, and managing data; makers need to decide on the legal foundation for product distribution, underwriting, and portfolio catastrophe risk insurance products and determine and claims management; as well as adapting the capital and reinsurance requirements for the country’s legal and regulatory framework insurance companies underwriting the risk. For to support catastrophe risk insurance markets. example, the World Bank Global Index Insurance Public investment in this infrastructure can lower Facility assisted the Conférence Interafricaine des the cost of insurance for beneficiaries, enable the Marchés d'Assurances—the regional body of the development of insurance markets, and encourage insurance industry for 14 countries in francophone demand while avoiding the possible disadvantages Africa—in drafting amendments to their current and sustainability issues that direct premium regulation to allow for micro-insurance, including subsidies can create. Often, government already agricultural index insurance. This has been ratified possesses such data, but it is not accessible for the by all 14 ministers of finance. purpose of developing insurance solutions. Banking regulations may also be relevant, since High quality data41 is indispensable for developing insurance markets, as it forms the basis for effective linking agriculture insurance to loans to the rural and sustainable insurance solutions for all segments sector is often an effective way of achieving large of society. Agricultural insurance products for scale outreach of agriculture insurance. In India, low-income farmers or herders, for example, are for example, all loans to the rural sector must be usually built on indices that use agricultural or accompanied with insurance. This protects rural climatic data.42 Only an index that accurately banks against agricultural shocks; protects the reflects conditions experienced by the farmer is farmer through insurance; and can increase rural likely to provide cost-effective, reliable protection lending, leading to increased productivity. with low basis risk (see also next question on index insurance). Policy makers play an important role What is index insurance in establishing a framework for data collection, and should I consider it? auditing,43 financing, and management, as well as equal access to this data by all market participants. Unlike traditional insurance indemnity-based products that requires the assessment of individual For example, the government can support losses following an insurable event, index-based investments in audited area average yield data— (including parametric) insurance policies make average crop yield in a given area, controlled payouts based on a predetermined trigger, such for quality and accuracy, that indicates harvest as crop yield estimates, in a given geographical size—enabling the construction of indexes that area. Other triggers could be based on the reliably protect farmers. Reliable data auditing location or intensity of a natural hazard, such as and data management are also necessary for wind speed, rainfall levels, or ground acceleration from earthquakes. The particular index used can achieving this scale and can reduce the cost paid be tailored to the availability of data, such as for insurance by beneficiaries in many different using a parametric index when only hazard data ways. As governments make policy decisions, they are available (which pays out on a given hazard should limit public subsidy programs to those that event), but using a modeled loss index when minimize distortions of market price signals and exposure data are available (which pays out in keep in mind that premium subsidies are not always line with loss modelled using actual exposure economically efficient. data and the parameters such as wind speed from the actual event). Parametric coverage demands Often practitioners focus on public subsidy improved accuracy of hazard risk data collection programs as a way of making insurance more systems because of the heavy reliance on objective affordable and achieving scale. There are, however, measurement of weather and hazard parameters. several disadvantages to providing direct premium subsidies. For example, they can lead policyholders Index insurance offers several advantages in to underinvest in risk reduction activities—such relation to traditional or indemnity insurance, such as irrigation or diversifying crops—or to investing as quicker payouts, lower administrative costs, in nonviable crops as they are insured against crop and reduced moral hazard and adverse selection . failure. In addition, subsidies by the government are For example, at the micro-level it allows domestic often not sufficiently targeted to reach the poorest insurance companies to offer simple and transparent in society and once put in place they are politically solutions to farmers to transfer weather risks such very difficult to phase out. Direct subsidies, as drought, excess rainfall, or low temperatures. however, could be justified as part of a social safety net program, where the government uses the But index insurance is not without its challenges. In insurance industry as a delivery system to distribute particular basis risk, implicit in all index insurance, is financial assistance to households in need. Rather the risk that the index measurement will not match than, or in addition to, providing direct premium individual losses. For example, an insured individual subsidies, governments or donors can invest in or asset may experience a loss from a disaster that overcoming market inefficiencies that in developing does not reach the threshold of the set trigger and countries often cause underinvestment by insurance hence does not lead to a payout. Alternatively, a companies. payout could be triggered without any damage and losses incurred. Improved accuracy of hazard For example, the government could provide data collection systems, increased openness and subsidies by paying for risk-related data; acting as centralization of historical data, and better quality a reinsurer of last resort; or enforce or encourage risk assessments could reduce basis risks, enabling the buying of insurance. For instance, many large- a more efficient and effective use of parametric scale agricultural insurance programs in low- and insurance. For any government it is crucial to middle-income countries, such as in India or China, understand basis risk given the proposed insurance have achieved scale in part due to insurance being options, and to carry out a cost-benefit analysis of bundled with agricultural credit on a compulsory different potential indexes with different levels of basis. Turkey’s national catastrophe risk insurance basis risk. program, which currently protects over six million households, achieved scale in part due to coverage What role do premium subsidies being compulsory for homeowners. play in disaster risk financing and insurance? The government of India significantly subsidizes the cost of providing data to the country’s private Achieving scale is fundamental to the sustainability agriculture insurance market. Similarly, the of insurance programs at the country level, as government of Mongolia pays for the collection of this enables costs to be spread among numerous all data used in its Index-Based Livestock Insurance policyholders. Government policies play an Scheme and provides it to accredited insurance important role in increasing outreach and companies. It also provides a fully-financed social F I N A N C I A L P R OT E C T I O N A G A I N S T N AT U R A L D I S A S T E R S 73 74 F I N A N C I A L P R OT E C T I O N A G A I N S T N AT U R A L D I S A S T E R S safety net to all farmers at no additional cost that In addition to aggregation and scale, catastrophe kicks in when major losses exhaust insurance risk pooling can accumulate financial reserves over payouts. In addition, government extension workers time, allowing participants to self-insure or cover provide education to herders about livestock the first loss from these funds. By increasing risk retention—which reduces the probability of an insurance and how it can complement holistic herd insurance payout—participants can achieve a further risk management. reduction in insurance premiums (Cummins and Mahul, 2009). How can catastrophe risk pools benefit a disaster risk financing The Pacific Catastrophe Risk Insurance Pilot, launched in 2013, illustrates how risk pooling can and insurance program? reduce premium costs. Country policies were placed By aggregating risk into larger, more diversified on the international reinsurance market as a single, diversified portfolio, significantly reducing the portfolios, catastrophe risk pooling at the national cost of catastrophe coverage compared to the cost or regional level between countries can reduce the of individual governments maintaining reserves cost of accessing international insurance markets. or independently purchasing insurance. The six Pooling risks generates diversification benefits that participating Pacific island countries have obtained are reflected in reduced insurance premiums (see an estimated 50 percent reduction in premium Figure 15 which illustrates a total premium and its payments compared to what they would pay if components before and after risk pooling). buying the same coverage individually. Figure 15 How insurance premiums benefit from risk pooling and improved risk data Uncertainty Loading Cost of Capital (reserves and cost Uncertainty Loading of risk transfer) 1. Lower reinsurance costs due to better Cost of Capital structured and diversified portfolio (reserves and cost 2. Joint reserves to retain the first of risk transfer) aggregate loss Operating Costs Economics of scale in operating costs Operating Costs (e.g. fixed costs) Annual Expected Loss Annual Expected Loss Underlying risk is unchanged Technical Insurance Premium Technical Insurance Premium Ş Before risk pooling Ş After risk pooling Ş Weak risk information Ş Improved risk information Source: World Bank-GFDRR Disaster Risk Financing and Insurance Program Annex III: Natural Disaster Losses 1990-2012, in 2012 US$ millions TOTAL LOSS INSURED LOSS A FRICA $ 16,821 $ 1,073 E ARTHQUAKES $ 6,895 $ 93 W EATHER - RELATED $ 9,926 $ 981 A SIA $ 1,292,907 $ 111,601 E ARTHQUAKES $ 596,857 $ 46,521 W EATHER - RELATED $ 696,050 $ 65,080 E UROPE $ 366,363 $ 108,682 E ARTHQUAKES $ 65,379 $ 4,502 W EATHER - RELATED $ 300,984 $ 104,181 N ORTH A MERICA $ 959,159 $ 536,499 E ARTHQUAKES $ 48,746 $ 22,237 W EATHER - RELATED $ 910,413 $ 514,263 O CEANIA/ A USTRALIA $ 69,515 $ 41,243 E ARTHQUAKES $ 29,456 $ 22,690 W EATHER - RELATED $ 40,059 $ 18,554 S OUTH A MERICA $ 135,448 $ 18,988 E ARTHQUAKES $ 51,017 $ 9,747 W EATHER - RELATED $ 84,431 $ 9,242 W ORLD $ 2,841,077 $ 818,554 E ARTHQUAKES $ 798,350 $ 105,788 W EATHER - RELATED $ 2,042,728 $ 712,766 Source: Swiss Reinsurance Corporation; all figures rounded to nearest million F I N A N C I A L P R OT E C T I O N A G A I N S T N AT U R A L D I S A S T E R S 75 76 F I N A N C I A L P R OT E C T I O N A G A I N S T N AT U R A L D I S A S T E R S Annex IV: Insurance and the financial resilience of countries The full story of disaster losses cannot be told insignificant when insurance coverage reaches 60 without looking at the financial vulnerability of percent of disaster losses.45 countries. For example, the macroeconomic cost of In the absence of strong indicators on the financial natural disasters is directly related to a country’s vulnerability of countries, non-life insurance development of property catastrophe insurance penetration can be seen as a proxy for this aspect of markets. Analysis has shown that following a major financial resilience. The level of non-life insurance natural disaster, average decline in GDP growth penetration, however, varies widely around the (0.8 percent) and cumulative permanent loss (2.53 world (see Figure 16). percent) are driven by uninsured losses, whereas the effects of insured losses are insignificant (von A comparison of a number of recent catastrophic Peter, et. al., 2012). The pivotal role played by the disasters highlights the low percentage of direct private insurance sector is further highlighted by loss insured, especially in low- and middle-income findings that show cumulative GDP loss becoming countries (see Figure 17). Figure 16 2012 Penetration of non-life insurance, premiums as percentage of GDP 5% Premiums as % of GDP 4% 3% 2% 1% 0% North America Oceania Europe Latin America Asia Africa World & Caribbean Source: Authors with data from Swiss Reinsurance Corporation. While this gives an indication of the state of development of insurance markets, it is important to note that catastrophe risk insurance is a small fraction of overall non-life insurance. Figure 17 Insured versus uninsured loss of selected events Uninsured Losses Insured Losses 100% 80% Total Economic 60% Losses 40% 20% 0% ) 0) 6) ) ) am 01) 4) ) ) ) ) am 9) 1) 3) EQ 2) ) 1) ) 99 99 10 10 04 98 05 85 01 01 01 00 9 9 00 00 01 20 20 20 0 19 19 19 19 19 20 19 0 i2 2 2 r2 2 2 i2 i2 rm (EQ ty ar ge it ia h EQ Q at r na Q o an m itc i (E en m Ci th r ad (E rid Pa iti ( ( ja i un Iz nd tr m M sh Lo n ile m o un lv Gu ia th Ka a Q ic du Tsu Ts U a la Ka Ar Sa Ch s st Ts (E or ex H (H ne ea Q & U ki Q ( N Q n ey E Q M to (H do an s Q Z (E Sa ( (E (E Q ra (S rk (E Q a ew S. In ce (E a di an (E a Q Tu bi ce n U. si In O N (E S. pa t o m on ne an is U. ic an or lo Ja k H ex do Fr Pa di Co ad M In In lv Sa El Source: World Bank Disaster Risk Financing and Insurance Program. F I N A N C I A L P R OT E C T I O N A G A I N S T N AT U R A L D I S A S T E R S 77 78 F I N A N C I A L P R OT E C T I O N A G A I N S T N AT U R A L D I S A S T E R S Annex V: Further Information on Disaster Risk Financing and Insurance Initiatives Discussed INITIATIVE FURTHER INFORMATION Index-based livestock insurance in Kenya and Ethiopia http://livestockinsurance.wordpress.com/index/ http://www.gfdrr.org/gfdrr/sites/gfdrr/files/Chapter_14-Turkey-Disaster_Risk_Management_in_ Turkish Catastrophe Insurance Pool Turkey.pdf India National Agricultural Insurance Scheme http://siteresources.worldbank.org/EXTDISASTER/Resources/India_mNAIS_Final.pdf India Weather-Based Crop Insurance Scheme http://elibrary.worldbank.org/doi/pdf/10.1596/1813-9450-5985 http://www.wfcatprogrammes.com/c/document_library/get_ Romanian Catastrophe Insurance Scheme file?folderId=39377&name=DLFE-2517.pdf Mongolia Index-Based Livestock Insurance Program http://gfdrr.org/sites/gfdrr.org/files/ DRFI_Mongolia%20IBLIP_Final.pdf Pacific Catastrophe Risk Assessment and Financing Initiative http://pcrafi.sopac.org/ Ethiopia Horn of Africa Risk Transfer for Adaptation (HARITA) http://unfccc.int/files/adaptation/application/pdf/swiss_re.pdf http://www.munichre.com/en/media-relations/publications/press-releases/2010/2010-10-11- Philippines CLIMBS micro-insurance product press-release/index.html African Risk Capacity http://www.africanriskcapacity.org/ Malawi weather-based crop insurance http://siteresources.worldbank.org/EXTDISASTER/Resources/MalawiDerivative_Final.pdf MAIPARK http://www.maipark.com/content/display/background Malawi sovereign weather derivative http://siteresources.worldbank.org/EXTDISASTER/Resources/Malawi_WeatherInsurance_Final.pdf Munich Climate Insurance Initiative http://www.climate-insurance.org/front_content.php?idcat=858 Jakarta flood micro-insurance product https://www.gfdrr.org/sites/gfdrr.org/files/ DRFI_WRC_Paper_FINAL_April11.pdf Caribbean Catastrophe Risk Insurance Facility http://ccrif.org/ Alliance of Small Island States proposal of a multi-window http://unfccc.int/files/kyoto_protocol/application/pdf/aosisinsurance061208.pdf insurance mechanism http://siteresources.worldbank.org/EXTDISASTER/ Government of Colombia disaster risk financing and insurance Resources/8308420-1342531265657/8764015-1392600612835/FINAL_Colombia_Policy_ strategy policy note Strategy_for_Public_Financial_Management_of_Natural_Disaster_Risk.pdf Mexico Natural Disaster Fund (FONDEN) https://www.gfdrr.org/fondenmexicosnaturaldisasterfundareview Vietnam Agricultural Insurance Pilot http://cgd.swissre.com/features/Agricultural_reinsurance_in_Vietnam.html Southeast Europe and Caucasus Regional Catastrophe Risk http://www.worldbank.org/projects/P110910/south-east-europe-caucasus-catastrophe-risk- Insurance Facility insurance-facility?lang=en and http://www.europa-re.com/ Endnotes necessitated public support for reconstruction of private assets and social and economic recovery programs. 1 All dollar amounts are U.S. dollars unless otherwise 9 Aggravating factors included an election and the indicated. incoming government’s efforts to honor its commitments, especially to universal free primary education (Benson and 2 Direct loss refers to the financial cost of destruction Clay 2004). directly attributable to a natural disaster, such as the value of damage to buildings, infrastructure, cars and other 10 In 2006, the expected benefits outweighed the costs of durable goods, and crops. purchasing such insurance. 3 Indirect loss refers to the wider economic or social 11 See Hallegate 2014 for a more in-depth discussion of the consequences arising from direct damage, such as welfare impact of indirect disaster costs. business interruptions, decreased tax revenue, loss of employment, or rise in poverty levels. 12 The authors define average typhoon wind speeds in the Philippines based on a catalogue of typhoons affecting the 4 A cumulative output loss or a permanent reduction of Philippines from 1979-2008. a country’s GDP from its pre-disaster predicted rate of growth. 13 For example, agriculture is a centerpiece of the Kenyan economy, generating approximately 24 percent of annual 5 This analysis uses Munich Re’s natural disaster (NatCat) GDP and approximately 50 percent of revenue from data on direct losses from natural disasters from 1960- exports. It is also an important source of employment, with 2011. The analysis considers as “major” natural disasters over 70 percent of the population living in rural locations; those above a threshold defined by a minimum of 100 14 million are farmers and herders. fatalities or $250 million in losses in constant 2011 U.S. dollars. Small countries are those with landmass at or 14 Based on a survey including 30 cooperatives, 220 large below the median size of all countries (roughly that of farms, and 20 corporate farms. Honduras). 15 http://www.gfdrr.org/sites/gfdrr.org/files/Kenya_PDNA_ 6 In this report the term “farmers” refers to all agricultural Final.pdf producers. Using the definition of the World Development 16 http://www.fao.org/NEWSROOM/en/news/2005/89775/ Report 2008 on Agriculture for Development, agriculture index.html. Jan 8, 2014. consists of crops, livestock, agroforestry, and aquaculture. 17 Note that disaster risk financing and insurance 7 Disaster-linked social safety nets and cash transfers are instruments do not, as a primary function, reduce liabilities. usually aimed at the poorest groups in society, who often They reduce contingent liabilities—that is uncertain do not own any assets or livestock, and who cannot afford liabilities—by transferring the volatility of the cost to third insurance products. For example, agricultural insurance parties. Risk is transferred, loss is not. very often is targeted at groups earning a very low income, yet this is still a distinctly higher segment of society than 18 The importance of sound fiscal risk analysis and beneficiaries of social protection programs. management practices is underscored by the recently revised IMF Fiscal Transparency Code. 8 Contingent liabilities involve spending obligations arising from past events that will be incurred in the future 19 For more detail on PEFA Assessments see www.pefa.org if uncertain discrete future events occur. Contingent liabilities can be further separated into explicit and implicit 20 Aon Benfield, Reinsurance Market Outlook, 2014 contingent liabilities. Explicit contingent liabilities are 21 Munich Re NatCat Service legal or contractual obligations, such as government guarantees. Implicit contingent liabilities are moral or 22 An accumulation of risk occurs when a portfolio expected but not legally required public obligations contains a concentration of risks that might give rise to arising from public expectations or pressures, such as the exceptionally large losses from a single event. bailout of banks (Cebotari et al 2009; Schiavo-Campo and Tommasi 1999). The variation in governments’ contingent 23 For an additional discussion of the potential for disaster liability to natural disasters across countries is driven in risk financing to support discipline in public financial great part by legally required or socially and politically management, also see Dana and von Dahnen, 2014. F I N A N C I A L P R OT E C T I O N A G A I N S T N AT U R A L D I S A S T E R S 79 80 F I N A N C I A L P R OT E C T I O N A G A I N S T N AT U R A L D I S A S T E R S 24 Innovations in disaster risk financing and insurance in 35 http://www.wfcatprogrammes.com/c/document_ developed countries are not discussed for the purposes library/get_file?folderId=39377&name=DLFE-2517.pdf Feb of this paper. For disaster risk financing and insurance 7, 2014. products and schemes in ASEAN countries, see WB/ 36 http://go.worldbank.org/Y8QYKWYBA0 Feb 7, 2014. GFDRR 2012 report “Advancing Disaster Risk Financing and Insurance in ASEAN Member States: Framework and 37 The six participating countries are Cook Islands, the Options for Implementation.” See also the 2013 OECD Marshall Islands, Samoa, the Solomon Islands, Tonga, report “Disaster Risk Financing in APEC Economies: and Vanuatu. Practices and Challenges.” 38 http://www.oxfamamerica.org/static/media/files/ 25 This period was also marked by private sector R4_Rep_Jul_Sept2013_WEB.pdf. Feb 7, 2014. innovation in risk financing instruments for large corporations, insurers, and governments of industrialized 39 http://www.swissre.com/about_us/global_ countries, instruments that eventually became accessible partnerships/Swiss_Re_provides_Haitis_micro_ entrepreneurs_wproceeds.html. Feb 7, 2014. to governments of developing countries (such as insurance-linked securities). 40 http://www.artemis.bm/blog/2013/08/30/personal- parametric-weather-insurance-trialled-in-caribbean-by- 26 When Mongolia first created its Index-based Livestock ccrif/. Feb 7, 2014. Insurance Program the World Bank classified Mongolia as a low-income country. In 2008, its classification changed to 41 From an insurance perspective, data is high quality if lower-middle-income. it is reliable (so that it properly reflects the actual loss), timely (so that claims can be paid quickly), relevant (so the 27 This timeline is not intended to be an exhaustive list. product offers reliable protection), audited to international Rather, based on discussions between the authors and reinsurance standards, and cost-effective. international experts and practitioners, the products and programs on the timeline show key milestones that paved 42 Farm-level multiple peril crop insurance is generally the way for new developments and innovations in disaster not feasible for small farmers and herders as the low risk financing and insurance. sums insured and high cost of auditing data make the schemes uneconomic. Index insurance, on the other hand, 28 Countries have previously issued catastrophe (cat) has the advantage of being typically cheaper to deliver, bonds to protect property insurance pools, such as a 2001 but the quality of the index insurance product depends cat bond issued by the California Earthquake Authority significantly on the quality of the index, which in turn and the 2003 cat bond issued to protect the Taiwanese depends on the quality of the underlying data. Residential Earthquake Insurance Pool. 43 Data auditing is the process of controlling data quality 29 A parametric trigger makes a payment upon the and assessing how the data is fit for the given purpose. occurrence of a predetermined event. 44 Moral hazard means that an insured party is less likely to invest in risk reduction because loss will be borne by the 30 http://www.tcip.gov.tr/zorunlu-deprem-sigortasi- insurance company. Adverse selection means that only istatistikler.html. 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F I N A N C I A L P R OT E C T I O N A G A I N S T N AT U R A L D I S A S T E R S 83 84 F I N A N C I A L P R OT E C T I O N A G A I N S T N AT U R A L D I S A S T E R S Photo Credits If not indicated otherwise, photos used in this publication have been sourced from the following locations with full rights: World Bank Flickr Website United Nations Flickr Website All images in this publication require permission for reuse. Abbreviations ADB Asian Development Bank ARC African Risk Capacity CARD MBA Center for Agriculture and Rural Development Mutual Benefit Association CAT DDO World Bank Loan with Catastrophe Deferred Drawdown Option CatMex Mexico sovereign parametric catastrophe bond (2006) CCRIF Caribbean Catastrophe Risk Insurance Facility CLIMBS Philippines micro-insurance product DFID U.K. Department for International Development FONDEN Mexico Natural Disaster Fund GFDRR Global Facility for Disaster Reduction and Recovery HARITA Ethiopia Horn of Africa Risk Transfer for Adaptation IDB Inter-American Development Bank JICA Japan International Cooperation Agency MiCRO Microinsurance Catastrophe Risk Organization OECD Organisation for Economic Co-operation and Development PCRAFI Pacific Catastrophe Risk Assessment and Financing Initiative PEFA Public Expenditure and Financial Accountability PSNP Ethiopia Productive Safety Net Program SECURE JICA Stand-by Emergency Credit for Urgent Recovery SME Small and Medium Enterprise SOE State Owned Enterprise TREIF Taiwan Residential Earthquake Insurance Fund UNFCCC United Nations Framework Convention on Climate Change UNISDR United Nations Office for Disaster Risk Reduction Disaster Risk Finance helps countries improve financial resilience against natural disasters by implementing sustainable and cost-effective financial protection policies and operations. It supports governments, businesses, and households to manage the financial impacts of disaster and climate risks without compromising sustainable development, fiscal stability, or wellbeing. Financial protection complements investments in risk reduction, prevention, and building resilience. It addresses residual risk, which is either not feasible or not cost effective to reduce or prevent. Only by looking at the financial impact of disasters comprehensively can governments build the financial resilience of society as a whole. This publication proposes an operational framework to guide countries in developing and implementing such comprehensive financial protection policies. It also takes stock of the progress in the field to date. The Disaster Risk Financing and Insurance Program is a joint program of the World Bank’s Finance & Markets Global Practice and the Global Facility for Disaster Reduction and Recovery (GDFRR). DRFIP has provided advisory services on disaster risk financing and insurance to more than 40 countries worldwide. The program works along four priority areas to support four main beneficiary groups governments, farmers, homeowners and SMEs, and the poorest and most vulnerable. With support from the Swiss State Secretariat for Economic Affairs (SECO), the DRFIP is working with selected middle-income countries to strengthen financial resilience and protect their fiscal balance. This is one component of the broader Swiss-World Bank Group partnership on fiscal risk management for middle income-countries, which also includes a component on government debt and risk management. ABOUT GFDRR The Global Facility for Disaster Reduction and Recovery (GFDRR) helps high-risk, low-income developing counties better understand and reduce their vulnerabilities to natural hazards, and adapt to climate change. Working with over 300 national, community level, and international partners GFDRR provides grant financing, on-the-ground technical assistance helping mainstream disaster mitigation policies into country level strategies, and thought leadership on disaster and climate resilience issues through a range of knowledge sharing activities. GFDRR is managed by the World Bank and funded by 21 donor partners. WWW.GFDRR.ORG