I put this graph up to emphasize the economic impact of national disasters has been increasing over time. The blue bars show the number of actual disasters and the red line shows the economic losses caused by these disasters. As you can see both have greatly increased over time and developing countries have been feeling the harshest impact.
Many developing countries view catastrophic risk management as rich countries luxuries and not a necessity. Most catastrophic risk management is done as a recovery and not pro-actively. Government will step in post disaster to handle a catastrophic event but they do not take as many defensive measures to lessen the occurence and severity rates. Political personnel tend to focus their time toward other current issues rather than the rare possibility of an event happening during their time in office. Due to this there is little political and financial incentives to take proactive measures. Taking a more proactive approach would help reduce the financial burden that a catastrophic event places on the economy of a country. Source: http://web.worldbank.org/WBSITE/EXTERNAL/NEWS/0,,contentMDK:20172785~menuPK:34457~pagePK:34370~piPK:34424~theSitePK:4607,00.html
So how do developing countries fund a catastrophe? They tend to rely on post disaster borrowing and international donations from other countries. Both of these means of financial assistance are not guaranteed. There is a lack of immediate financial assistance hinders the recovery process and results in a more long term effect to the economy. Over the past thirty years, the World Bank alone has donated over 40 billion dollars for natural disaster recovery, predominantly going to developing countries. This has encourage the bank to put a global initiative in place that improve a countries capability to reduce their exposure. The initiative touches on the idea of risk reduction and public intervention where applicable. Developing countries need to have a more proactive approach to catastrophic risk management that focuses on creating a post-disaster fund so there is a presence of immediate liquidity and less reliance is placed on outside resources. The reliance on loans from outside sources also creates a spill over effect that can start to effect other economies. The World Banks perfect situation would be for all countries to primarily use public funding and rely on private funding as a secondary source. Source:http://gfdrr.org/docs/Track-II_Catrisk_financing_Overview_booklet.pdf
On January 20, 2010, a representative of the aid group Partners in Health estimated that up to 20,000 people were dying each day due to the lack of medical care (specifically medical operations). Obviously, this earthquake was not forseeable or preventable but there are actions that could be put in place to lighten the impact of the disaster, such as enforced building codes, better power distributions, and immediate available capital. Haiti relied on . Source: http://www.redcross.org/portal/site/en/menuitem.94aae335470e233f6cf911df43181aa0/?vgnextoid=ac4cee53b5f47210VgnVCM10000089f0870aRCRD
Terrorism• Incredible variation in potential methodsusable.– Bombing, Dirty Bomb, Biological, Nuclear• Hard to predict.• University of Alabama research– “Our research won’t predict that an attacktargeting civilians at a public market will takeplace tomorrow at 9:30 a.m.”
Biggest Types of Losses Following aCatastrophic Event
Background• There is a trend of increasing lossesfrom natural catastrophic events sincethe early 1980’s– Increasing number of natural disasters– Increasing density of population
Landslides• Landslides currently are the onlyuninsurable natural disaster byprivate insurance companies• In recent years, it is estimatedlandslides have caused $1-2 billionworth of damage• Largest losses from landslides:– Structural and property damage– Casualties
Floods• According to the National Flood InsuranceProgram, floods are Americas most frequentand costly natural disaster• Losses from floods include:– Human mortality– Damage to personal property from flood water– Damage to real property (structural damage)• Includes inside walls, and the resulting mildew,mold, and fungus– Under FEMA, Damage due to mudflow• Flowing mud that inundates the home– Under commercial policies, businessinterruption
Blizzards and Snowstorms• Largest losses:– Economic losses• Property damage• Infrastructure damage• Loss of business activity– Insurance claims• Automobile– Livestock
Tornadoes• According to the Insurance InformationInstitute, tornadoes have accounted forover a quarter of all catastrophe lossesfrom 1987 through 2006.• Biggest losses:– Property• wind damage• Water damage– Human casualties• Lack of warning
Hurricanes• Hurricane Katrina of 2005 is the mostdestructive and costly hurricane inU.S. history• Largest Losses:– Property and infrastructure damage• Flood damage• Wind damage– Loss of lives
Fire• Biggest types of losses:– Personal property– Commercial property– Forest and wildlife– Human casualties
Terrorism• Biggest losses:– Human casualties– Disruption of business operations– Personal, real, and commercial property
Earthquakes• Largest types of losses:– Property losses– Damage from flooding– Public infrastructure
Most Costly Catastrophic Events in2008Most Costly Insured Catastrophe Losses in 2008Catastrophe When Where Insured LossesHurricane Ike September US, Caribbean $20 billionHurricane Gustav August US, Caribbean $4 billionTornadoes, rainfall,hailMay US $1.325 billionWinter stormEmmaFebruary Europe $1.321 billionSnow storms, ice January China $1.3 billionThunderstorms,hailMay US $1.1 billion
What is Involved in ManagingCatastrophic Risk?• 5 basic steps to useful riskmanagement program, regardless ofperil:– 1) Understanding current level ofexposure– 2) Assessing acceptability of risk– 3) Evaluating alternative risk mitigation– 4)Selecting an approach– 5) Implementing the approach
Managing Catastrophic Risk• While earthquakes are often considered themost terrifying of natural disasters,windstorms, including hurricanes andtornadoes, actually produce greater annuallosses than those of earthquakes.
Managing Catastrophic Risk• New building codes– International Building Code– Wind Borne Debris Codes– Florida Building Code• Computational fluid dynamicsprograms– Wind flow patterns can be modeledaround proposed and existing buildings
Managing Catastrophic Risk• Terrorist Risk Management Program– Phase I: Threat identification and initial siteassessment– Phase II: Detailed risk assessment• Determine the impact of a particular terrorist event(ie: blast and explosion analysis, progressivecollapse analysis, chemical, biological, andradiological threat assessment)– Phase III: Risk management• Protection of facility and occupants• Emergency planning and disaster recovery• Reduction of financial risk
Why Insuring Against Risks isComplicated?1. New Threats2. Priorities3. Sunk Costs4. Expensive
How Are Catastrophic RisksManaged in Other Countries?
• Rich countries’ luxuries• Post-disaster recovery by government• Little political incentiveCatastrophic Management inDeveloping Countries
Catastrophic Management inDeveloping Countries• Private funding– Post-disaster borrowing– International Donations• Lack of immediate cash hinders recovery– Creates spillover effect• World Bank has donated 40 billion fornatural disaster recovery over the past 30years• World Bank Global Initiative
Real Life Example: Haiti• Most deprived nation of the WesternHemisphere• No national building code• Limited water and power distributionshampered relief efforts• Over 250,000 fatalities, many due to lackof medical care (20,000 a day)• As of March 2010, RedCross has raised over100 million in reliefefforts.
The U.S. General AccountabilityOfficeStudy of systems in France, Germany, Italy,Spain, Switzerland and the UK undertaken.Each was found to have developed and employed acombination of public and private approaches to deal withcatastrophes but only three impose government-mandatedinsurance that cover disaster risk.Accounting standards and tax laws in each of the sixcountries studied allowed insurance companies toestablish tax-deductible reserves for future catastrophicevents, although there can be significant differences in thereserving approaches used in each country.
Alternative Risk Transfer• Purpose of Alternative Risk Transfer(ART) is for Insurance Companies toensure that they have enough liquidity topay for claims filed in the event of acatastrophic loss• Some methods of ART include:– (1) Contingent Surplus Notes (CSNs)– (2) Exchange Traded Catastrophic Options– (3) Catastrophe Bonds– (4) Sidecars
Alternative Risk Transfer• Contingent Surplus Notes (CSN)– Allows insurance company to pay for a catastropheover an extended period of time• (1) Insurance company sets up a trust which buys U.S.Treasuries and sells the notes to investors• (2) Investors receive interest from bond + additionalinterest from insurance company for the added risk• (3) At time of a catastrophe, Insurance company haslegal right to substitute its own notes (CSNs) for theU.S. notes – giving Insurance Co. immediate liquidity– Interest and principal are still paid on the notes, but now theinvestor has taken on a greater risk of financial default
Alternative Risk Transfer• Exchange Traded Catastrophe Options– Began on the Chicago Board of Trade in 1992• Discontinued in 1999 because it lacked a viable market• How it worked:– Speculators sold options to Insurance Companieswho were paid when the specified index ofcatastrophic losses reached a certain value• E.g. Insurance Company is paid at the strike price of itscontract– Alternatively, there were put options, whereInsurance Companies bought the right to sellshares to investors at the strike price
Alternative Risk Transfer• Catastrophe Bonds (Cat Bonds)– Risk-linked securities that transfer risk to investors– Floating rate bond structure– Typically returns LIBOR plus a spread to investors– If triggered (catastrophe occurs) the principal paidto an insurer is forgiven and used to pay claims– Appeal to investors because they are largelyuncorrelated with other assets in a portfolio– Typically rated below investment grade (BB andB)
Alternative Risk Transfer• Reinsurance Sidecars (or just Sidecars)– Financial structures that are created for investors totake the risk and return of a group of policies– Insurer only pays premiums if the investors placesufficient funds to ensure they can meet claims– Investors’ liability limited to funds they put in– Rose in popularity after Hurricane Katrina• Raise funds from capital markets investors• Avoid existing reinsurers with past liabilities• Avoid new reinsurers with lengthy and expensive “rampup” period