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Financing natural disaster risk in developing countries: the case of Honduras Munich Re-Germanwatch Briefing 2004 Insuring the Uninsurable: Climate Change and Insurance Reinhard Mechler IIASA May 10, 2004 Overview 1. 2. 3. 4. General remarks: risk financing for developing countries Honduras: effects after Hurricane Mitch Implications for climate change work Conclusions Loss financing in developing countries “Insurer of last resort” Public sector Private Sector Infrastructure Housing, machinery etc. “Reinsurer of last resort” MFIs Lending Portfolio Reserve fund Market for risk transfer Private sector: Low uptake of commercial insurance in lower-income countries Often not available Need insurance culture and institutions Expensive Government has to provide Ratio of insured losses to total losses according to country income groups for period 1985-1999 financing post-disaster 30% 29% 25% 20% 15% 10% 9% 5% 2% 1% 0% >9,361 3,031-9,360 761-3,030 GDP [USD] Source: Munich Re 2000 <760 Role of infrastructure High poverty- and growth relevance (clean water, roads, schools etc.) Bottlenecks in developing countries Adverse selection and moral hazard can be dealt with Issues in disaster management and loss financing • Disaster management (used to be) retroactive (ex-post) – Losses financed to large extent by international donors and MFIs – Financing gaps and time lags for developing countries – Little incentives for investments into ex –ante risk management International aid and development funding agencies, besides sharing consternation at delays, disruptions, and increased costs, have the strong view that wisely planned hazard and vulnerability reduction efforts and funding before a catastrophe pay excellent dividends in reducing economic impacts. Mitigation expenditures are a very small fraction of the funds spent on reconstruction in the aftermath of catastrophes (Pollner 2000: 44) • Objectives: – More emphasis on loss reduction (mitigation) – Reduction of vulnerability – Risk financing solutions • Disaster management (ex-ante+ex-post) as crucial element of sustainable development Risk financing (Risk transfer) • Benefits – – – – Quick compensation: Smaller financing gap Covariant risk transferred inter-regionally or internationally Incentives for loss reduction • Costs – Premia/costs considerable, usually larger than expected annual loss, creating opportunity costs – Costs annually – Costs today, benefits in future Current activities in Honduras • Workshop held in March for finance ministery, next meeting in May, strategy paper • Steps underway 1. Risk assessment, financial vulnerability 2. Analysis of current insurance arrangements in Honduras 3. Analysis of protection of uncovered liabilities: E(X)=10 million US$/year 4. Pool for support of poor and affected? Contingent credit arrangements? Honduras after Hurricane Mitch 1998 GDP in Honduras GDP GDP projected, BAU 5,800 Million constant 1997 USD 5,300 4,800 4,300 3,800 3,300 2002 2001 2000 1999 1998 1997 1996 1994 1993 1992 1991 2,800 1990 Source: World Bank 2002, 2003 Time lag: Transportation bottlenecks after Mitch [travel time to markets] Before After Source: World Bank 1999 Financing drives recovery Aid Aid and borrowing (% GNP) Net financial flows, IDA 18 15 12 9 6 3 1996 1997 1998 1999 2000 Low domestic savings, reliance on aid and borrowing Sources: World Bank 2002 Storm and flood hazard Honduras Storm and Flood Exposure 1 0.99 0.98 0.97 0.96 0.95 0.94 0.93 0.92 0.91 0.9 0 10 20 % Capital Stock Destroyed 30 40 Obligations of government 1. Reconstruction of public assets: roads, bridges, schools, hospitals: Exposed and uninsured public assets: 1.6 billion USD (=12.3% of total capital stock) according to bottom-up WB analysis 2001 2. Help private households and businesses with rebuilding 3. Provide relief to the poor Total assets/capital stock for 2004: 13.9 billion USD Risk assessment Storm/flood/landslide Probability 10% 2% 1% 0.5% 0.2% Expected loss Earthquake World Bank Probability 10% 2% 1.0% 0.5% 0.33% 0.25% 0.2% 0.10% Expected loss Return period (years) 10 50 100 200 500 Return period (years) 10 50 100 200 300 400 500 1000 Combined expected loss all types of hazards World Bank Assets: 1600 Mill USD Loss (%) Infrastr. loss (Mill. USD) 2.4% 39 4.6% 76 11.6% 189 17% 278 28.5% 465 0.5% 8.6 IIASA/Swiss Re Assets: 2600 Mill USD Loss (%) Infrastr. loss (Mill. USD) 0.8% 21 5% 130 12% 312 31% 806 0.4% 11.2 World Bank Assets: 1600 Mill USD Loss (%) Infrastr. loss (Mill. USD) 0.7% 11 1.6% 26 3.2% 53 3.8% 62 5.6% 92 0.04% 0.66 IIASA/Swiss Re Assets: 2600 Mill USD Loss (%) Infrastr. loss (Mill. USD) 0.1% 3 0.8% 21 1.4% 36 4.0% 104 0.06% 1.6 0.58% 9.3 0.49% 12.7 Hurricane Mitch 1998: 2,000 million USD in direct losses of total assets (private and public), 18% of capital stock > 100 year event Expected annual loss • Annualized costs to be expected over longer-term horizon, however: disasters are NOT annual, average events • Basis for calculation of risk financing arrangements: premium = expected losses + risk premium (loading factor for rare events + transaction costs + profit margin (eg of insurers)) Assessing financial vulnerability in Honduras Storm and flood risk One proposed risk financing structure for Honduras Source: Pollner 2000 Trade-off stability growth -could be solved by MFI interventionEl Salvador/No Insurance 3 2.8 2.6 Return 2.4 2.2 2 1.8 1.6 1.4 1.2 El Salvador/Insurance 1 1 2 3 4 5 6 7 8 9 10 11 7 8 9 10 11 3 Year 2.8 2.6 Return 2.4 2.2 2 1.8 1.6 1.4 1.2 1 1 2 3 4 5 6 Year Implications for climate change community • Climate change impacts no topic in Honduras, adaptation to current risk (=no regret option) • Country risk and financial vulnerability assessment done – however uncertainties have to be understood, can be baseline for CC scenarios • MFI willing to support: stimulation of pro-active behavior and mitigation (=adaptation/loss reduction) • Not only (re-)insurance, but mix of instruments • Pools, reserve funds • Contingent credit • Cat bonds • Potential Climate fund could build on these efforts! Thank you!