J. Linnerooth-Bayer

Insurance for assisting adaptation to climate change in developing countries: a proposed strategy

Abstract This paper suggests a two-tiered climate insurance strategy that would support developing country adaptation to the risks of climate variability and meet the intent of Article 4.8 of the United Nations Framework Convention on Climate Change (UNFCCC). The core of this strategy is the establishment of a climate insurance programme specialized in supporting developing country insurance-related initiatives for sudden- and slow-onset weatherrelated disasters. This programme could take many institutional forms, including an independent facility, a facility in partnership with other institutions of the donor community, or as part of a multi-purpose disaster management facility operated outside of the climate regime. Its main purpose would be to enable the establishment of public—private safety nets for climate-related shocks by assisting the development of (sometimes novel) insurance-related instruments that are affordable to the poor and coupled with actions and incentives for pro-active preventive measures. A second tier could provide disaster relief contingent on countries making credible efforts to manage their risks. Since it would be based on precedents of donor-supported insurance systems in developing countries, a main advantage of this proposed climate insurance strategy is its demonstrated feasibility. Other advantages include its potential for linking with related donor initiatives, providing incentives for loss reduction and targeting the most vulnerable. Many details and issues are left unresolved, and it is hoped that this suggested strategy will facilitate needed discussion on practical options for supporting adaptation to climate change in developing countries.

Sovereign financial disaster risk management: The case of Mexico

Abstract In 2006, Mexico became the first transition country to transfer part of its public-sector natural catastrophe risk to the international reinsurance and capital markets. The Mexican case is of considerable interest to highly exposed transition and developing countries, many of which are considering similar transactions. Risk financing instruments can assure governments of sufficient post-disaster capital to provide emergency response, disaster relief to the affected population and repair public infrastructure. The costs of financial instruments, however, can greatly exceed expected losses, and for this reason it is important to closely examine their benefits and alternatives. This paper analyzes the Mexican case from the perspective of the risk cedent (the Ministry of Finance and Public Credit), which was informed by analyses provided by the International Institute for Applied Systems Analysis (IIASA). The rationale for a government to insure its contingent liabilities is presented along with the fiscal, legal and institutional context of the Mexican transaction. Using publicly available data, the paper scrutinizes the choice the authorities faced between two different risk-transfer instruments: reinsurance and a catastrophe bond. Making use of IIASAs catastrophe simulation model (CATSIM), this financial risk management decision is analyzed within the context of a public investment decision.

Disaster safety nets for developing countries: Extending public-private partnerships

Abstract In developed countries, public—private partnerships involving insurance companies and governments often provide security against the human and economic losses of disasters. These partnerships, however, are neither available nor affordable in most highly exposed developing countries. In this paper we examine recent innovations in financial risk management that extend traditional public—private partnerships to include NGOs, international financial institutions and other donors. Importantly, these partnerships provide secure financial arrangements to low-income communities before disasters strike and thus relieve the uncertainty and anxiety of depending on ad hoc post-disaster aid for recovery and even survival. We examine three examples of extended partnerships: the Turkish Catastrophe Insurance Pool; the Andhra Pradesh microinsurance program and an index-based weather derivative for farmers facing drought in Malawi.

Stakeholder Views on Flood Risk Management in Hungary's Upper Tisza Basin

With escalating costs of flood mitigation and relief, a challenge for the Hungarian government is to develop a flood mitigation and insurance/relief system that is viewed as efficient and fair by the many stakeholders involved. To aid policymakers in this task, this article reports on a recent study to elicit stakeholder views on flood risk management in the Upper Tisza Basin, including views on appropriate means of reducing losses and for transferring the residual losses from the direct victims to taxpayers or an insurance pool. This study is part of a project to develop an integrated approach to flood risk management coordinated by the International Institute of Applied Systems Analysis (IIASA) in collaboration with Swedish and Hungarian researchers. The discussion begins by describing the background of flood risk management problems in the Upper Tisza Basin. The results of interviews carried out with selected key stakeholders and the results of a public survey eliciting views on flood risk management are reported. The final section draws conclusions on incorporating stakeholder views into a flood risk management model, which will be used to illustrate policy paths at an upcoming stakeholder workshop. The conclusions are also of direct interest to Hungarian policymakers.

Catastrophe risk models for evaluating disaster risk reduction investments in developing countries.

Major natural disasters in recent years have had high human and economic costs, and triggered record high postdisaster relief from governments and international donors. Given the current economic situation worldwide, selecting the most effective disaster risk reduction (DRR) measures is critical. This is especially the case for low- and middle-income countries, which have suffered disproportionally more economic and human losses from disasters. This article discusses a methodology that makes use of advanced probabilistic catastrophe models to estimate benefits of DRR measures. We apply such newly developed models to generate estimates for hurricane risk on residential structures on the island of St. Lucia, and earthquake risk on residential structures in Istanbul, Turkey, as two illustrative case studies. The costs and economic benefits for selected risk reduction measures are estimated taking account of hazard, exposure, and vulnerability. We conclude by emphasizing the advantages and challenges of catastrophe model-based cost-benefit analyses for DRR in developing countries.

General risk constraints

The risk evaluation process is integrated with procedures for handling vague and numerically imprecise probabilities and utilities. A body of empirical evidence has shown that many managers would welcome new ways of highlighting catastrophic consequences, as well as means to evaluate decision situations involving high risks. When events occur frequently and their consequences are not severe, it is relatively simple to calculate the risk exposure of an organization, as well as a reasonable premium when an insurance transaction is made, relying on variations of the principle of maximizing the expected utility. When, on the other hand, the frequency of damages is low, the situation is considerably more difficult, especially if catastrophic events may occur. When the quality of estimates is poor, e.g. when evaluating low-probability/highconsequence risks, the customary use of quantitative rules together with unrealistically precise data could be harmful as well as misleading. We point out some problematic features of evaluations performed using utility theory and criticize the demand for precise data in situations where none is available. As an alternative to traditional models, we suggest a method that allows for interval statements and comparisons, which does not require the use of numerically precise statements of probability, cost, or utility in a general sense. In order to attain a reasonable level of security, and because it has been shown that managers tend to focus on large negative losses, it is argued that a risk constraint should be imposed on the analysis. The strategies are evaluated relative to a set of such constraints considering how risky the strategies are. The shortcomings of utility theory can in part be compensated for by the introduction of risk constraints.

A Systems Approach to Modeling Catastrophic Risk and Insurability

This paper describes a spatial-dynamic,stochastic optimization model that takes account ofthe complexities and dependencies of catastrophicrisks. Following a description of the general model,the paper briefly discusses a case study of earthquakerisk in the Irkutsk region of Russia. For this purposethe risk management model is customized to explicitlyincorporate the geological characteristics of theregion, as well as the seismic hazards and thevulnerability of the built environment. In its generalform, the model can analyze the interplay betweeninvestment in mitigation and risk-sharing measures. Inthe application described in this paper, the modelgenerates insurance strategies that are lessvulnerable to insolvency.

The financial management of catastrophic flood risks in emerging economy countries

This article examines the potential of pre- and post-disaster instruments for funding disaster response and recovery and for creating incentives for flood loss mitigation in countries with emerging or transition economies. As a concrete case, we discuss the disaster recovery arrangements following the 1997 flood disaster in Poland. We examine the advantages and limitations of hedging instruments, which are instruments for transferring the risk to investors either through insurance or capital market-based securities. We compare these mechanisms with financing instruments whereby the government sets aside funds prior to a disaster or taps its own funding sources after the event occurs. We show how hedging instruments can be designed to create incentives for the mitigation of damage to public infrastructure using the flood proofing of a water-treatment plant on the hypothetical Topping River as an illustrative example. We conclude that hedging instruments can be an attractive alternative to financing instruments that have been traditionally used in the poorer, emerging-economy countries to fund disaster recovery. Since very poor countries are likely to have difficulty paying the price of protection prior to a disaster, we suggest that international lending institutions consider innovations for subsidizing these payments.

Global change, natural disasters and loss-sharing: Issues of efficiency and equity

Global change in the form of climate warming, demographic developments, land use and capital movements to vulnerable regions will likely contribute to the already increasing human and economic losses from natural disasters. As countries in both the developing and developed world contemplate increasing losses from natural disasters, and as the victims relate these losses to human culpability, questions of burden-sharing for preventing and absorbing human and financial losses are becoming increasingly topical. This paper provides an overview of two forms of state and market burden-sharing at the local and global levels: collective loss-sharing after a major disaster by the state or the international community and the pre-disaster transfer of risk through insurance and other hedging instruments. With the recent attention given to the role of the private sector for apportioning and preventing disaster losses, we examine the efficiency and equity arguments for both collective loss-sharing and private risk transfer. We give special attention to the potential for governments of poor countries to transfer their natural disaster risks to the insurance and reinsurance markets, and to the international capital markets with newly developing hedging instruments, such as catastrophe bonds. We suggest that, under certain conditions, subsidized risk transfer can be an efficient and equitable way for industrialized countries to assume partial responsibility for the increasing disaster losses in poor countries, in addition to their role in aiding the economies of these countries.

Financial instruments for disaster risk management and climate change adaptation

The International Panel on Climate Change (IPCC) has called for a new balance between reducing the risks from climate extremes and transferring them (for example, through insurance) as means for effectively preparing for and managing disaster impacts in a changing climate. This paper elaborates on this balance with an overview of disaster risk financing mechanisms and how they contribute to disaster risk reduction and climate change adaptation in developing countries. We suggest a risk management approach that targets risk reduction and risk financing to different layers of risk, including a layer that represents a possible limit to adaptation. By reviewing traditional post-disaster financial arrangements, such as government compensation, and non-traditional pre-disaster instruments, such as index-based insurance, we show how risk financing can complement and stimulate risk reduction. We discuss the benefits of financial instruments, including the provision of post-disaster finances for recovery and pre-disaster security necessary for climate adaptation and poverty reduction. These benefits come at a cost, and we discuss the risks, challenges, and future prospects of risk financing in developing countries.