Financing natural disaster risk in developing countries: the case of Honduras

1. Munich Re-Germanwatch Briefing 2004Insuring the Uninsurable:Climate Change and Insurance Reinhard Mechler IIASA May 10, 2004 Financing natural disaster risk in developing countries:the case of Honduras

2. Overview • General remarks: risk financing for developing countries • Honduras: effects after Hurricane Mitch • Implications for climate change work • Conclusions

3. Loss financing in developing countries “Insurer of last resort” Private SectorHousing, machinery etc. Public sectorInfrastructure “Reinsurer of last resort” Market for risk transfer Reserve fund MFIsLending Portfolio

4. Private sector: Low uptake of commercial insurance in lower-income countries • Often not available • Need insurance culture and institutions • Expensive • Government has to provide financing post-disaster Source: Munich Re 2000

5. 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

6. 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

7. 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

8. Current activities in Honduras • Workshop held in March for finance ministery, next meeting in May, strategy paper • Steps underway • Risk assessment, financial vulnerability • 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?

9. Honduras after Hurricane Mitch 1998 Source: World Bank 2002, 2003

10. Time lag: Transportation bottlenecks after Mitch[travel time to markets] Before After Source: World Bank 1999

11. Financing drives recovery Low domestic savings, reliance on aid and borrowing Sources: World Bank 2002

12. Storm and flood hazard

13. 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

14. Risk assessment Hurricane Mitch 1998: 2,000 million USD in direct losses of total assets (private and public), 18% of capital stock > 100 year event

15. 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))

16. Assessing financial vulnerability in Honduras Storm and flood risk

17. One proposed risk financing structure for Honduras Source: Pollner 2000

18. Trade-off stability growth-could be solved by MFI intervention-

19. Implications for climate change community • Climate change impacts no topic in Honduras, adaptation tocurrent 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!

20. Thank you!