Irrational Economist_ Making Decisions in a Dangerous World - Erwann Michel-Kerjan [116]
Across the developing world, highly exposed governments face financial gaps in providing relief to the poor. In filling these gaps, post-disaster donor funds earmarked for relief and reconstruction consistently fall short of the desired level. Faced with this situation, a few innovative governments are transferring their risks to the international markets. This is the case in Mexico, where government officials recently issued a catastrophe bond to transfer the exposure to natural disasters of the government’s catastrophe reserve fund directly to the financial markets and thus reduce the country’s risk of a large fiscal deficit following hurricane and earthquake disasters. It is also the case in the Caribbean island states, which have formed the world’s first multi-country catastrophe insurance pool to provide governments with immediate liquidity in the aftermath of hurricanes or earthquakes. International development organizations have committed funds to Haiti, for example, to ensure wide participation.
The possibilities for similar arrangements elsewhere in the world are significant, given the largely untapped potential for pooling uncorrelated risks of country governments ill prepared to respond to disasters with their own means.
BENEFITS, COSTS, AND CHALLENGES OF INSURANCE INSTRUMENTS
Insurance instruments provide security against the loss of assets, livelihoods, and even lives in the post-disaster period. They can also set incentives for reducing exposure and vulnerability, engage the private sector in vast markets, and, not least, spur economic development. For many in the developing world an insurance contract is viewed as more self-respecting than relying on humanitarian assistance. In the words of Oxfam expert Hari Krishna: “Communities value disaster insurance . . . because they see it as an instrument of dignity. Financial support to recover from a disaster becomes their right without sacrificing their self-respect. It is far more dignified to claim your right for recovery than to find yourself dependent on the ad hoc generosity of donors.”6
Switching from post-disaster humanitarian assistance to supporting insurance contracts ex ante is attractive not only to disaster victims but also to international financial and donor organizations. If coupled with incentives for preventing disaster losses, insurance programs can ultimately reduce the human and economic toll that disasters take on the poor. Indeed, switching to pre-disaster assistance for insurance can be an efficient long-term strategy because of its potential ultimately to reduce the need for post-disaster humanitarian assistance.
While the benefits of insurance are largely uncontested, they are paid for in high associated costs. Premiums for catastrophe insurance are calculated on the basis of anticipated losses, and also include the costs of doing business (which can be substantial in the developing world) as well as a contingency load for holding capital and assuming very uncertain risks. Owing to the high capital requirements for insuring systemic risks (events that impact whole regions at once), the contingency load for catastrophe cover is far higher than the insurance cover for health, life, and other nonsystemic risks. Moreover, data on very infrequent events is scarce, meaning that insurers must guard themselves against vagaries in the statistical estimates.
The high costs of catastrophe insurance present challenges to the international community, but its benefits in terms of reducing poverty present very real opportunities. For example, donors can leverage their limited humanitarian budgets by replacing post-disaster aid with support for catastrophe insurance, and climate-change negotiators can use risk-pooling