Coping with the financial impact of disasters: a macro-perspective Insurance as a method for Disaster Risk Reduction in SEE Macedonia, April 2013 Richard Poulter, Researcher of Disaster Risk Financing The University of Copenhagen

Contents The macro level perspective: an introduction Disasters and development Disaster Risk Financing: A new paradigm Ex-post and ex-ante financing A weather derivative product Linking risk financing and disaster management The macro perspective – summing up

The disaster burden – fatalities

The disaster burden – damages

Disasters and development

Direct and indirect economic consequences Type of impactDirectIndirect Type of lossFixed capitalCashflow Economic consequence Public assets Government Buildings Public Infrastructure Private assets Industrial infrastructure Residential Infrastructure Loss of tax revenue GDP effects Business interruption Reallocation of investments Information Losses easy to calculate Response programs evaluated Insurers perform loss assessments Scare data Hidden effects Lack of recording

Coping with disasters: governments In high-income countries, national action but limited economic shock In low and middle-income countries, governments can pool and share risks, but still suffer from: Exhausted tax bases Limited donor assistance Inability to raise capital GDP falls in the year of the event or the year after Budget deficit increases Trade balance worsens

Disaster Risk Financing: A new paradigm Reactive (ex post)Proactive (ex-ante) Government assistance (taxes) Kinship arrangements Donor assistance Insurance and reinsurance, catastrophe bond, index insurance contingent credit, reserve fund Turkey: Public-private insurance (2000) India+several countries: Index insurance derivatives and microinsurance (since 2004) Colombia: Contingent credit (2005) Mexico: Catastrophe bond (2006) Global: GIIF (2007) Caribbean regional insurance pool (2007) All with donor involvement

The first step to developing a DRF strategy Establish event contingent budgeting: Funds are made available when a certain event occurs This can lead to clarification over public disaster planning The private insurance sector can also be used by government as a way to commit to a rules-based system for public expenditure Timing of funds becoming available is key

Ex-post and ex-ante financing mechanisms Type of risk Loss of assets - households/businesse s Loss of crops/livestock – farms Public assets, relief and reconstruction expenditure Post-disaster (ex post) Emergency loans; Money lenders; Public assistance sale of productive assets, food aid Diversions; Loans from International Financial Institutions Pre-disaster (ex ante) Non-market Kinship arrangements Voluntary mutual arrangements budget item Inter- temporal micro-savings food storage catastrophe reserve funds, contingent credit Market- based risk transfer property and life insurance crop and livestock insurance Insurance or catastrophe bonds

Examples of disaster financing mechanisms Contingent Financing – can be from the World Bank through a Development Policy Loan (DPL) with Catastrophe Deferred Drawdown Option (CAT DDO) Sovereign Catastrophe Insurance Pool – Europa Re Catastrophe Bonds – transfer risk to investors by allowing the issuer to not repay the bond principal if a major natural disaster occurs Weather Derivatives – Provide financing from capital markets via index linked policies

Cashflows for DRF instruments

Linking risk financing and disaster risk management Directly lead to adaptation through two channels: i) DRF provides financial compensation post event and thus reduces the cost of follow-on consequences from slow reactions, ii) DRF shares pre event risk by removing systemic risk inherent in decision making (i.e. What money should be spent on) DRF can also indirectly lead to adaptation as the pre event premium provides an incentive to reduce risk (and reduce the premium) Danger of maladaptation if agents rely on the financial security provided and relax preventive efforts

The macro perspective: summing up Disasters impact middle-income countries through damages and slowing economic development There are many hidden costs of disasters such as loss of tax revenue, lower GDP, reallocation of investments and a worsening of the trade balance There has been a strong move from ex-post to ex-ante financing of disasters The starting point is the establishment of event-contingent budgeting Disaster risk financing can strengthen public disaster planning Several market-based instruments are available, including national and international risk pools