Foreign Policy Blogs

Time for Public-Private Partnership Innovations in Natural Disaster Insurance?

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(Nancy Ohanian / Tribune Media Services)

As the peak of El Niño wanes, it seems to signal the arrival of La Niña, and the impacts are having an extremely serious effect. Average global temperatures for July hit the 15th consecutive record-breaking surge: 0.87 ℃ higher than the average for the 20th century. This trend in global warming has heightened the probability of catastrophic natural disasters, challenging the risk management capability of governments.

In the Southern Hemisphere, one of the worst regional droughts in 35 years swept over southern Africa, leaving 23 million people in urgent need of humanitarian assistance, according to the Southern African Development Community (SADC). The international community, in response, pledged $2 billion worth of contributions to El Niño-affected countries. Yet, the UN Office for the Coordination of Humanitarian Affairs (OCHA) reports that $4 billion more is needed to make up for the total damage.

Meanwhile, the flood-inducing El Niño in North America bombarded Baton Rouge, Louisiana, with 6.9 trillion gallons of rain in just one week, causing 13 deaths and $20.7 billion worth of damage to more than 110,000 homes. Battling with the worst natural disaster since the superstorm Sandy, the Federal Emergency Management Agency (FEMA) urged affected residents to register for federal disaster relief funds for which more than 95,000 residents had applied as of 19th of August.

Nevertheless, FEMA’s limited resources, epitomized by the maximum grant of $33,000 per household, barely provide a safety net for the applicants. What is making the picture gloomier is the fact that only 42% of the FEMA-designated high-risk flood areas in Louisiana are insured through the National Flood Insurance Program; the number drops down to 12.5% in the neighboring vicinities.

Governments in the regions exposed to natural hazards are on the verge of failing to cope with the recent natural disasters’ enduring impacts on human life. The burdens, however, could be significantly lessened by action from the private insurance companies, namely their active engagement in the climate and natural disaster insurance industry in terms of workable Public-Private Partnership (PPP)-based arrangements.

The benefits of successful PPP in climate and natural disaster insurance are, in theory, synergetic. It ensures that governments at all levels can be certain of formal risk-transfer mechanisms upon the occurrence of contingent events, allowing for effective management of governmental budgets. In the insurance market, private insurance companies’ locally tailored products not only efficiently provide financial liquidity to insured individuals during the ex-post recovery process but also pre-emptively reduce the risks by altering these individuals’ ex-ante behaviors.

With well-functioning market mechanisms, the price (the rate) is gradually set and stabilized in a more transparent way, which incentivizes governments to set up more fairly priced policies. Partnering private insurance companies also benefit from taking advantages of the scale of PPP; it allows them to reduce operational and premium costs and to competitively enhance their capacity to deal with high volumes of client profiles and large-scale data analysis. In the end, insured individuals best-minimize their exposure to risks.  

Despite the assumed benefits, the engagement of private insurance companies with the climate and natural disaster insurance industry has, overall, been unenthusiastic. Whereas the average global weather-related losses rose by ten times from 1974 to1983 ($10 billion per year) compared with 2004 to 2013 ($131 billion per year), the average percentage for the losses that are insured dropped almost half over the last four decades. Attributing the decline to the increasing chance of being exposed to catastrophic natural disasters under intensifying climate change and urbanization, pundits propose that PPPs in climate and natural disaster insurance should be either reformed (in the case of existing PPPs) or updated to reflect the changes.

In the U.S., the debate over FEMA’s National Flood Insurance Program (NFIP) reform is becoming heated prior to next year’s reauthorization of the program. In the aftermath of post-Sandy, controversies over fraudulent claims as well as partnering private insurance companies’ moral hazards of exploiting marginal profits, both policymakers and pundits are looking for solutions to reduce the program’s $23 billion deficit and to improve its efficiency.

Some of the suggested reforms are highlighted here: the introduction of risk-based rates, the provision of assistance to socio-economically vulnerable residents in high-risk areas, including the provision of the right to be informed about records held on property, the strengthening of the program’s accountability in monitoring, evaluating, and enforcing the program’s provisions, the modernization of the PPP’s outmoded bureaucratic technology, and, lastly, the sharing (diverting) of the risk through the private insurance market (including reinsurance).

All these options, however, require the market to function effectively. For instance, calibration of current government premium rates in high-risk areas to risk-adequate ones should be well-designed to offer private insurance companies incentives to attenuate their market exit, while encouraging the residents living in high-risk areas to move to safe areas. Also, the ability of the reinsurance market to assume the NFIP’s risks through the purchasing of the primary policy provider’s coverage plans should be carefully assessed.

The successful market-based modernization of some of the world’s mature disaster management PPPs such as the NFIP should bring a positive message about the role of the international insurance market; for example, in helping developing countries to minimize their climate-related risks through the use of innovative financial products like catastrophe bonds.

Although the climate and natural disaster insurance industry is still in the inchoate phase of its development in many developing countries, several pilot programs (involving trials of innovative insurance products) are being administered in areas that are susceptible to natural disasters. Microfinance is one of the products that has been designed to protect people on low incomes in exchange for a premium that is tailored specifically to their needs. Weather index insurance is another that pays out benefits based on a predetermined event index, rather than on loss itself.

 

Author

Mark (Won Min) Seo
Mark (Won Min) Seo

Mark (Won Min) Seo is a freelance journalist who served as an editor for NYU’s Journal of Political Inquiry. He was also a former intern with the United Nations Department of Economic and Social Affairs. He has an MA in Politics from New York University.

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