Insuring for Disaster

Natural disasters like the devastating earthquake in Nepal constitute a highly uncertain but quantifiable risk. No one can say for sure when a major earthquake will strike. But the fault lines are known. We need a new global system of disaster insurance, akin to how homeowners guard against calamity.

Relief teams and millions of dollars of aid are arriving in Nepal, but despite the best of intentions, emergency operations will be a desperate patchwork, and long-term rebuilding will be hampered by lack of funds, donor fatigue and red tape. That’s what happened in Haiti after the 2010 earthquake, in the Philippines after a string of recent typhoons, and in the West Africa Ebola epidemic. We need a better approach.

Even poor countries can take precautions, especially if international organizations help them to do it. Think of commercial airline safety, which, though not flawless, is high even in the poorest regions in the world. There is an integrated system that connects airplane manufacturers, airline companies, air-traffic controllers, global insurers and national and global regulators.

Catastrophes like earthquakes, typhoons, droughts, floods and epidemics pose quantifiable risks. These risks can’t be specified with the actuarial precision that underlies home and life insurance, but there is enough precision to allow for insurance coverage. For hundreds of years, Lloyd’s and other insurers have been diversifying the risks of even one-time events; natural hazards like earthquakes are not one-time events, but occurrences that return with calculable probabilities.

Suppose Nepal’s government could have gone shopping for earthquake insurance to cover the large-scale losses and public-sector response after a disaster. Potential underwriters would examine the probabilities of earthquakes at various magnitudes, using the historical record, seismic modeling and assessments of the vulnerabilities of the buildings.

The leading insurer, generally a reinsurance company, would then sell off its excess exposure to Nepal’s earthquake risk to other insurance companies, or even capital markets around the world via so-called catastrophe bonds and similar instruments. These risk carriers would receive part of Nepal’s premium payments, and be required to pay out to Nepal in the event of an earthquake. Nepal would be financially protected, and insurers would diversify the risk.

The original insurance underwriter would have made demands of Nepal, that it implement cost-effective earthquake-preparedness measures, like updated building and zoning codes; a disaster response plan; and emergency health systems. These steps would limit expected damages caused by natural disaster — and lower the premium and expected payout. Over time, underwriting benchmarks would be standardized around the world.

Most low-income countries and some rich ones as well are woefully unprepared for the quantifiable catastrophic risks they face, whether seismological shocks, climate-related catastrophes or epidemics. After each disaster, the afflicted countries and United Nations agencies must call on other countries to make ad hoc pledges of funds and response teams; there’s no global equivalent of the fire department. It’s often too little, too late.

How would a disaster insurance system work? World-leading reinsurers, such as Swiss Re, Munich Re and others, would bid to provide countries with the service. Governments would pay annual premiums, linked to actuarial assessments of risks, with international donor agencies like the World Bank helping to share the costs, based on the resources of the insured countries. For some large and unpredictable risks, where the private sector alone won’t provide cover, additional official financing would be blended with private funds, similar to what takes place in the United States with flood and crop insurance.

Cost-sharing with international agencies like the World Bank would have to be attractive enough for poor countries to obtain coverage on reasonable terms. For high-income donor countries, the upside would be a global system with reduced vulnerability and with less need to provide ad hoc post-disaster aid.

Insurance would reveal how vulnerable certain parts of the world are to rising costs of disasters, including those associated with global warming. But at least we’d be able to begin to account for this. It would provide a powerful way to drive mitigation and adaptation investments, a point emphasized in recent years by Rowan Douglas of the insurer Willis Group.

A global system of disaster insurance would of course not be perfect and would take time to implement, but could save many lives and livelihoods in the years ahead, and help vulnerable low-income countries like Haiti and Nepal chart a path to sustainable development.

Jeffrey D. Sachs is special adviser to the United Nations Secretary General on the Millennium Development Goals and director of the Earth Institute at Columbia University.

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