The FINANCIAL -- Floods, earthquakes, hurricanes and droughts continue to ravage countries and destroy lives and economies. The gap between insured and total losses is widening, while many disaster-prone countries lack financial preparedness. Governments are uniquely exposed to these risks. Innovative insurance tools and solutions can help bridge this gap, but it's crucial to arrange them before catastrophe strikes, says a new Swiss Re publication launched at the World Bank /IMF annual meetings in Lima.
In "Disaster risk financing: Smart solutions for the public sector" Swiss Re shows that the economic cost of natural catastrophes has grown markedly in the last 40 years. The protection gap – the difference between economic and insured losses – remains large despite the availability of innovative insurance solutions. Narrowing this gap helps strengthening a country's financial resilience.
"The insurance industry is already rising to the challenge of underinsurance in both developed and developing countries through innovative risk management measures," said Swiss Re's Group Chief Executive Officer Michel M. Liès. "The risk landscape is becoming more and more complex as the world becomes more interdependent. No country can afford to be left unprotected."
On average only about 30% of catastrophe losses have been covered by insurance over the last 10 years. That means that about 70% of catastrophe losses – or USD 1.3 trillion – have been borne by individuals, firms and governments, according to Swiss Re.
Governments typically shoulder the cost of relief and recovery, but also pay for reconstruction of infrastructure and, in the case of underinsured individuals or businesses, they even fund private rebuilding efforts. Yet, most governments will seek the funds only after a catastrophic event, and often revert to increasing taxes, borrowing or soliciting international aid, often incurring high costs and delays. These events can wipe out years of hard-earned development gains. Rating agency Standard & Poor's recently published a report warning that a country's disaster preparedness could be linked to its credit rating going forward.
More needs to be done
As a first priority, governments should enable a functioning insurance market. This will help absorb a major part of disaster losses suffered by individuals and businesses. Pre-event financing solutions can alleviate the remaining financial burden on governments. Post-disaster financing (such as debt financing or donor aid) should only come into play to cover residual losses once all other risk transfer solutions have been exhausted.
"For risk protection to be effective, funds need to be quickly available in the wake of a natural catastrophe, meaning that financing arrangements must be in place already beforehand," says Martyn Parker, Chairman of Swiss Re's Global Partnerships, a unit that works with public sector clients. "Financial preparedness lowers the volatility of the state budget and improves planning certainty for the public sector, besides making a country more attractive to investors."
The study – launched at the World Bank /IMF annual meetings in Lima – points to a number of countries working in collaboration with insurers to innovative solutions. Mexico, for example, is a pioneer in securitising earthquake and hurricane risk. Uruguay has developed an ingenious risk transfer mechanism to mitigate the risk of low rainfall on its hydroelectric power generation. Central American and Caribbean governments have insured their risk against hurricanes and earthquakes The Africa Risk Capacity insures several countries against drought risk.