Disaster Risk Reduction and Financial Protection: What is Missing, What Can Work? The Case of Latin America and the Caribbean Kari Keipi, IDB London, 15 November 2006
The Imperative of Reducing Risk 1. Increasing gap to finance disaster losses makes traditional focus on emergency response and reconstruction unsustainable: Disaster losses annual growth rate of 20% since 1980 – while the GNP growth has been only 3-4%/year in Latin America and the Caribbean 2. The solution is to improve integrated risk financing combining the reduction of risk with the ex-ante financing of residual risk 3. Prevention investments are needed to break the vicious cycle of disasters-reconstruction- disasters-new reconstruction
Resource Gap to Finance Reconstruction: The Disaster Deficit Index The index deals with the economic loss that the • analyzed country could suffer when faced with the occurrence of a catastrophic event and the implications in terms of needed resources to confront the situation. The index has been prepared for the 50, the • 100 and the 500 year events. Interpretation: When the DDI is greater than • 1.0 this means the economic incapacity of the country to cope with extreme disasters even where indebtedness is carried to a maximum. The greater the DDI , the greater the gap.
Resource Gap for Reconstruction for Selected Countries DDI and probable maximum loss in 100 years L 100 (US$ million) 2000 DDI 100, 2000 3.53 4479 PER 2.45 1 361 DOM 3773 1 .90 SLV 1 .77 JAM 845 1 .33 COL 3254 1 .1 4 ECU 783 M EX 0.86 6273 350 TTO 0.76 CHL 0.41 800 CRI 0.37 852 GTM 0.31 431 ARG 0.1 0 1 87 0 1 2 3 4 0 1 000 2000 3000 4000 5000 6000 7000
Challenges to Risk Management Despite rising awareness and some progress, the countries are not sufficiently addressing the risk disasters pose to development. A number of factors generally restrain countries from adopting adequate risk management: – Disaster prevention is considered a cost, not an investment – Incentives that shape both government and private behavior, do not favor vulnerability reduction – Governments seldom have a well established financing plan for contingent disaster liability – Risk is not transferred through insurance
Country Actors, Regional Organizations and Donors in Disaster Risk Management INFLUENCING ACTORS IN COUNTRIES DONORS Government -- Ministries of : — Humanitarian — Finance and Planning organizations — Interior and Defense — Bilateral entities — Health, Education and Environment — Multilateral — Tourism, Industry, Energy, agencies Agriculture, Public Works — South-South Cooperation Local Governments Power — Municipalities and Townships and Trust between Civil Society REGIONAL Players — Community Organizations ORGANIZATIONS — General Public — Commercial Private Sector — CDERA — Financial Sector — CAPRADE — Media — CEPREDENAC — Academia, etc — CCCC — Universities — Others BARGAINING
Avoiding Moral Hazard • An imperative for risk reduction and ex-ante risk financing is a clear definition of who assumes what parts of risk • If no such definition exists, every one will have an incentive to try to “pass on” the reconstruction bill: – Private sector seeks bailout by the government – Government seeks help from international donors • There is a moral hazard problem of relying ex-post help by others: No incentive to mitigate future events • The government should avoid policies that create or contribute to the moral hazard problem • The government should define what part of any risks it will NOT cover for the private sector as part of an integrated risk financing strategy
Corporate Social Responsibility of Private Businesses If the risk bearer is clearly identified private businesses will have an incentive to contribute to disaster risk management • Prevention • Response – Employee protection – Employee rescue – Business continuity – Philanthropy with humanitarian entities – Competitiveness – Support to emergency – Overall: Maintenance action by the state of environment conducive to – Participation in investment and trade reconstruction finance
Government Incentives to Private Risk Reduction Objective: Raise awareness of private decision makers to • impulse their investments in risk reduction, in order to: Improve competitiveness and growth – Provide increased safety for the poor – Reduce burden to government – Criteria: • Targeted, with public good benefits • Temporary to avoid permanent dependency • Effective to demonstrate significant risk • reduction Not used for profit seeking •
Sources for Disaster Finance Disaster Prevention Disaster Response Macro (public sector) Micro(households) Macro (public sector) Micro (households) Ex post Ex post • Taxes • Government • Taxes • Government support • Borrowing • Budget diversions • Relatives/friends incentives • Borrowing • International Aid • Reformulation of • Work harder, less • International existing loans consumption • New borrowing • Borrowing aid • Savings • International aid • Sell assets __________________ ______________ • Domestic and international aid Emerging Instruments for Low Ex ante Ex ante Income Groups arrangements arrangements • • Reserve fund • Savings Collective Insurance • • Insurance • Insurance Parametric insurance • instruments Microcredits • Cat bonds • Systems for loans and savings • Weather derivatives
Financing of Disaster Loss Layers Residual Loss Remaining risk that is impractical or not cost effective to transfer or finance through loans Financing High Loss Layer Risk Transfer Loans •Disaster Insurance/Reinsurance •Contingent Credit (e.g. GDL of IDB) •CAT Bonds � Emergency Loans (e.g IRF of IDB) •Exchange Traded � Reconstruction Loans Weather Derivatives Prevention and Financing of Low Loss Layer Prevention Funding Loss Financing •Formal and Informal Risk Coping � Prevention and Mitigation Funds through self-Financing � Development Funds: Municipal, Social, Rural, Environmental � Calamity Funds � Mitigation Loans � Reserve Funds � Prevention Loans e.g via Disaster Prevention Sector Facility •Transfers of Government Budget & � International Aid Development Funds � Reformulation of Existing loans
Risk Transfer Prerequisites for a functioning insurance market: • Acceptable quality of risks (building standards, regional planning etc.): A combination of awareness, regulations and control. Without basic risk management in place, the insurance market will abstain from covering risks perceived to have a too high hazard. • Quantifiable exposures: In the Caribbean, especially flood and storm surge exposure data and suitable hazard models are missing.
Risk Transfer: Case of Jamaica Insurance rate increases • Jamaica and the Caribbean in • between 200%-300% in the general have been more active in transferring private mid 1990’s have discouraged risk to the international prudent risk hedging both in insurance markets than Latin the public and private sector. America. For many homeowners the • 30% of insured losses after • answer has been to reduce or Ivan (2004) were property eliminate their coverage. damage and 70% related to Housing stock of low income • business interruptions ($2.7Bn total damage) communities are often not built according to building However, the majority of • property damage from Ivan codes, which makes them occurred to properties that difficult to insure. were either not insured or uninsurable. Source: Smith-Warner, 2005
Breaking the Vicious Circle • The imperative of reducing risk through prevention – choosing right instruments • The government has to define its own liability and those parts of risk it will NOT cover • Mainstreaming management of contingent liabilities of government in fiscal and budget planning • Businesses must practice corporate social responsibility • Strengthening risk transfer through local insurance industry and making use of opportunities in international insurance and capital markets
IDB Dialogue with Countries 1. Country risk evaluation. Prioritize countries at high risk to disasters. 2. Country programming papers. Include disaster risk management as an important action item for the region 3. Country strategies. Development agenda in countries with high risk must focus on risk management. Evaluate institutional capacity.
Challenge for the IDB 1. Weak demand for disaster prevention by countries 2. Coordination of regional programs to address disaster risk in an inter- related world 3. Use of disaster indicators and country risk assessments for country strategies and programming 4. Provision of financing for prevention and response
IDB Financial Instruments BEFORE EMERGENCY AFTER Disaster Prevention Immediate Emergency Reconstruction loans s Facility: $5 million Response Facilty: $20 t n Re-orientation of million e loans under execution m Operations with risk u Possible budget r Re-orientaction of loans reduction components t support through s under execution or activities n Policy Based Loans I k Possible contingent n credit through Disaster Prevention a Emergency Technical Guarantee B Fund Cooperation to the Disbursement Loans Country Offices’ Technical Cooperations Technical discretion: $200,000 Cooperations
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