Managing Catastrophe Risks of Natural Disasters at the Country Level: The World Bank Prospective

1. Distance Learning Course for Insurance Supervisors Managing Catastrophe Risks of Natural Disasters at the Country Level: The World Bank Prospective Eugene N. GurenkoSenior Insurance Specialist email: egurenko@ifc.orgWorld Bank/IFC Insurance UnitWashington DC April 28-29, 2002

2. Key Messages • Catastrophe Risk Management is an Integral Part of Good Governance and of Best Insurance Supervision Practices • World Bank Plays an Active Role in Assisting its Client Countries in Building Effective Catastrophe Risk Management Systems • Risk Pooling and Clearly Defined Allocation of Catastrophe Risk Between the Insurance Industry and the Government can be a Effective Way to Reduce Countries’ Financial Exposures to Natural Disasters

3. Key Objectives of an Insurance Supervisor: • Ensure company’s solvency, i.e., its ability to meet its claims; • Ensure the availability of insurance coverage at fair market rates for individuals and corporate users; • Meet other social and economic objectives such as raising insurance awareness, professional standards in the industry, affordability and insurance penetration concerns, etc.

4. Low frequency but high severity events which endanger the financial health and solvency of insurance companies. Frequently, in the aftermath of cat events, the industry is no longer able or willing to continue to provide insurance coverage for cat type risks (the Northridge, September 9/11, Florida Hurricanes). Mismanagement of catastrophe risk has numerous highly adverse social, economic and political implications for the affected countries. Characteristics of Catastrophe Risk

5. Impact of the Luthar Storm in France and the Northridge EQ on Domestic Insurers 2001: 11 September* 1994: Northridge Earthquake 1992: Hurricane Andrew 1999: Storm Lothar Loss ratio in California in earthquake policy for 1994: 1,200% (source Wharton)

6. 80 70 60 50 40 30 20 10 0 US$ 160 bn 1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 Economic losses (2000 values) of which insured losses (2000 values) Trend of economic losses Trend of insured losses Insured and Uninsured Losses from Natural Disasters (in US Billions)

7. Impact of National Disasters on Insurance Companies • Potential insolvency • Premiums raised • Closed down of companies

8. Key Challenges Faced by the Bank in Building Risk Transfer Systems • Lack of risk awareness at the government level and among population; • Undeveloped insurance sector; • Excessive reliance on the government as the reinsurer of last resort; • Low country incomes; • High degree of uncertainty with regard to expected economic losses.

9. Designing Effective Risk Management Programs for Government Clients • Risk Identification and Measurement • Extensive use of stochastic catastrophe risk models employing the latest scientific research on natural hazards and utilizing stock inventory and vulnerability data (EQECAT, RMS, AIR) • Loss control programs • Loss prevention programs/national mitigation efforts/enforcement of building codes, construction supervision. • Risk transfer/risk financing • Reinsurance • Government • Insurance Industry

10. Country Assets(people, housing, factories, schools…) Flood, Earthquake, Wind…. Risk Analysis Expected Annual Loss Loss Exceedance (PML’s) Risk Transfer Cost/Benefit Revise Strategy Reinsurance/Alternative Risk Financing Strategies Lower Risk Mitigation, Land use planning Achieve Risk Management Objectives? No No (Risk Transfer/Financing) (Risk Reduction) Yes Manage Position National Catastrophe Risk Management Source: EQE

11. World Bank’s Role in Building National Risk Transfer Systems • Vulnerability of the world’s poor to natural disasters underpins the World Bank’s work on risk transfer and risk financing. • By ensuring that sufficient liquidity exists after a disaster, risk transfer mechanisms can help to speed economic recovery and reduce government exposure to natural disasters.

12. World Bank’s Role in Building National Risk Transfer Systems • Catastrophe risk management can also assist countries in the optimal allocation of risk in the economy, thus contributing toward higher economic growth, better mitigation and more effective poverty alleviation.

13. World Bank’s Role in Building National Risk Transfer Systems • The latest examples include Bank’s involvement in the design of the Turkish Catastrophe Insurance Pool, preparation of the launch of the Disaster Pool in the Caribbean, studies of economic vulnerabilities to natural hazards in Honduras, India, Bangladesh, Pakistan and Sri Lanka, feasibility studies on parametric weather insurance in Morocco, Mexico and Turkey.

14. Quantifying the Uncertainty: The Role of World Bank • Independent Estimates of Countries’ Economic Exposures and Vulnerability to Natural Disasters; • Quantification of Economic Benefits from Different Risk Transfer/Risk Hedging Arrangements; • Selection of Best Risk Transfer and Financing Programs

15. Quantifying the Uncertainty: The Role of World Bank • Review of premium rates and assistance in the design of risk transfer instruments • Determination of expected survivability of insurance/reinsurance pools for given levels of exposure and capitalization • Provision of risk funding facilities • Design of Legal and Institutional Frameworks for Risk Management

16. Table 1 Reported Natural Catastrophe Exposures in Asia, 1996-2000 1 GDP - loss intensities - South Asia reported percentage reported government 2 revenues pct. GDP pct. revenues country incidents assessed losses [$ mill.] India 73 $9,176 2.25% 12.15% 19.2% $407,850 $75,500 Pakistan 22 0.0% $52,280 $9,150 Afghanistan 20 0.0% $3,895 Bangladesh 7.65% 66.03% 48 8.3% $2,879 $37,650 $4,360 Sri Lanka 9 0.0% $11,625 $2,185 Bhutan 0 0.0% $430 $165 Nepal 0.84% 7.58% 15 26.7% $52 $6,250 $690 187 7.7% $12,107 $519,980 $92,050 3.58% 0.2859

17. National Responsibility / Accountability Risk Mgmt. Claims, solvency, operations, risk financing Coordination-Natural Disaster s Building codes, land use, disaster management Sales & Service Claims Distribute policies, collect premium, service claims Risk financing Equity Reinsurance Gov”t. Reinsurer/Capital Markets Insured Insurer Risk allocation, rating plan, pricing, transfer Loss probability & severity Expected Annual Loss 100,200,500 yr. loss Loss parameters Inventory Vulnerability Hazard Buildings Infrastructure Agriculture Potential loss GDP NATURAL PERILS: EARTHQUAKE, FLOOD, WIND, DROUGHT National Catastrophe Risk Management Source: EQE

18. TCIP: Historical Background • Low EQ insurance penetration - about 2% outside Istanbul and 15% within Istanbul; almost 0% in low-income, middle-class segment of property market • Highly competitive, poor underwriting standards, systemic links with the banking system • Low capital base and low level of reserves against earthquakes in the domestic insurance industry

19. TCIP: Historical Background • Poor prospects of expanding EQ coverage since Disaster Law mandated funding of replacement of dwellings nearly free of charge • Insufficient technical capacity in pricing and managing catastrophic risk in the industry • Continuous government financial exposure to EQs • Inadequate understanding and management of EQ risk by households and contractors

20. TCIP’s OBJECTIVES • Ensure most domestic dwellings have EQ insurance. • Reduce government fiscal exposure. • Transfer most of catastrophe risk to international reinsurance and capital markets. • Overtime, build up TCIP’s capital base to insure against larger events • Encourage risk mitigation and safer construction practices

21. TCIP: Main Highlights Legislation • Amendment of the Disaster Law: • no more government interest-free loans to homeowners • Enactment of Earthquake Insurance Decree Law: • EQ insurance is made compulsory • TCIP is created as the sole-source provider of EQ coverage • TCIP was required to become operations on September 27,00

22. TCIP: Main Highlights Legislation • Pending Enactment by the Parliament of Earthquake Insurance Law • introduces penalties • enhances the Decree law

23. TCIP: Main Highlights • Around 2 million policies • Compulsory EQ cover for all registered residential dwellings • Stand-alone product, separate from fire (homeowner’s) insurance • Cover up to $20,000 per dwelling & none for contents • 15 rating categories based on hazard zone and the type of buildings

24. TCIP: Main Highlights • Cover in excess of TCIP (>$30,000) is obtainable from private insurers • Private insurers distribute TCIP policies acting as agents, i.e. assume no risk of loss • To eliminate “penny claims” and reduce administrative and reinsurance costs of the pool, a deductible of 2% is introduced. • Online (web-automated) policy underwriting and data management • Independent (hired by TCIP) loss adjusters are used in claim settlement

25. TCIP: Main Highlights • Independent (hired by TCIP) loss adjusters are used in claim settlement • Outsource extensively/no public sector employees • Premium reserves held in creditor-proof escrow accounts, with at least 50% invested in foreign assets • Overall protection against losses up to $1 billion in the first 5 years • If claims exceed TCIP’s available financial resources, the GOT will step in

26. TCIP: Main Highlights

27. GOVERNMENT SPONSORED CATASTROPHE INSURANCE POOLS AND FUNDS Source: Guy Carpenter

28. Conclusions • Risk assessment technology and financial market development create new options for government risk management • Catastrophe risk pooling with government acting as a reinsurer of last resort can be an attractive solution for managing the country’s risk exposure to natural disasters • Foundation for a unified country plan for managing cat risk is a must • A “bottoms- up” high quality risk analysis is essential for decision making and risk capital financing