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Latin American nations are experimenting with new financial tools that provide on-the-spot cash when earthquakes, hurricanes, floods and other disasters strike.
International donors had pledged $5 billion after an earthquake killed 230,000, yet six months later, less than 10 percent of that sum had arrived.
But one institution served as the Haitian government’s instant cash machine. The Caribbean Catastrophe Risk Insurance Facility is an insurance pool made up of 16 small nations in the Caribbean basin. It delivered nearly $8 million to the Haitian government within 15 days of the quake.
“The money played a substantial role in keeping the Haitian government running in the weeks and months after the crisis,” said Simon Young, an insurance executive and supervisor of the insurance pool, known as the CCRIF.
Haiti is one of a handful of Caribbean and Latin American nations experimenting with disaster risk financing. The term refers to a set of relatively new financial tools — including insurance pools, catastrophe bonds (“cat bonds”) and contingent credit lines — that provide on-the-spot cash when earthquakes, hurricanes, floods and other disasters strike. Countries can even buy coverage for outbreaks of bird flu or acts of terrorism.
Until recently, disaster insurance was only affordable for richer countries often in the form of cat bonds. They came to prominence in the 1990s following Hurricane Andrew, which caused $15 billion worth of damage in South Florida, bankrupted many insurance companies and sent premiums soaring.
Disaster insurance protects against infrequent but extremely heavy losses. Because the pool of clients is small, insurance and reinsurance companies must therefore keep huge amounts of capital on hand, which drives up the cost of premiums. To make policies more affordable, cat bonds were developed as a way to transfer risk from governments and insurance and reinsurance companies to a broad pool of private investors.
Cat bonds usually pay better-than-average interest rates and allow investors to diversify their portfolios since natural disasters are unrelated to the ups and downs of financial markets. Governments or institutions pay annual premiums but receive the entire value of the bonds if catastrophe strikes. In such cases the bond holders, which often include hedge funds, pension funds and other institutional investors, lose all their money.
But these securities remain too costly for many small, developing countries. They can also seem bewildering to average citizens, politicians and Wall Street types alike. As one investor told The New York Times Magazine: “My boss won’t let me buy bonds that I have to watch The Weather Channel to follow.”
Amid global warming and urbanization, factors which may be contributing to more frequent and costly natural disasters, the World Bank began exploring ways to make catastrophe insurance more affordable. The bank’s campaign received an inadvertent boost in 2004 when Hurricane Ivan tore through Grenada, causing damages equal to 200 percent of that tiny Caribbean island nation’s GDP. In the immediate aftermath of the storm, tourism and tax dollars dried up and as they waited for foreign aid, government officials were hard-pressed to maintain essential services.
“This caused a lot of additional problems as Grenada tried to recover,” said Francis Ghesquiere, the World Bank’s lead coordinator for disaster risk management in Latin America and the Caribbean. “That’s why the World Bank designed the CCRIF.”
The CCRIF functions as a mutual insurance company controlled by the 16 participating countries. Their annual payments plus contributions from donor countries form an investment pool. The CCRIF can then transfer some of the risks these nations face to international financial markets. In return, member countries receive catastrophe insurance with discounts of up to 50 percent.
Payouts are immediate because the CCRIF avoids the slow, complicated process of calculating on-the-ground losses. Instead, it uses highly sophisticated parametric models in which pre-defined earthquake magnitudes and hurricane wind speeds within certain geographic areas lead to automatic payouts.
The arrangement is not perfect. There was some grumbling in 2007 following Hurricane Dean, which caused major damage to Jamaica, Dominica and St. Lucia — but not enough damage to trigger CCRIF payouts. To skeptics, the CCRIF payment of $7.75 million to Haiti might seem more like a rounding error than a rescue package given that damage and reconstruction costs could hit $14 billion.
But the CCRIF was not designed to cover all or even most losses. “It’s more of a liquidity instrument” to keep governments functioning in the wake of disasters, said Issam Abousleiman, head of banking products at the World Bank.
He notes that two other World Bank instruments are catching on in Latin America. The bank's Multi-Cat program allows member countries to buy insurance for, as the name suggests, multiple perils. Mexico used the program to issue $290 million in cat bonds to protect Mexico City from earthquakes and Pacific and Atlantic coast resort areas from hurricanes.
Another World Bank program allows governments to immediately borrow millions of dollars during national emergencies. To qualify countries must demonstrate progress in disaster preparedness. In exchange for upgrading monitoring systems for earthquakes and volcanic eruptions, for example, Colombia now has access to a $150 million line of credit. When a hurricane in Guatemala provoked widespread flooding last year, the country received $80 million from the World Bank within 48 hours.
But beyond Latin America and the Caribbean, disaster risk financing has been a tough sell. The tiny island states of the Asia Pacific, for example, have yet to endorse the World Bank’s proposal for a CCRIF-like catastrophic insurance pool for that region. “It’s hard to get 20 governments around a table and get them to agree to pay annual premiums over the long term,” said the World Bank’s Ghesquiere.
Part of the problem is that disaster insurance can be difficult for politicians in impoverished nations to justify. Why shell out millions, the thinking goes, when lighting may not strike? Also at play is a history of dependency.
Though they now endorse disaster risk financing, foreign governments, multi-lateral banks and private aid groups in the past mainly rode to the rescue in the aftermath of catastrophes. As a result, there was little incentive for countries to invest in catastrophe insurance.