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Satish Raju | Updated on January 17, 2018

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How insurance can help cushion disaster losses

Forest fire in Uttarakhand or Canada; floods in UK or Chennai; earthquakes in Ecuador or Manipur — natural disasters are always in the news. As governments and society scramble to cope with financial consequences of disasters, it is time to look at insurance as an important component of a disaster-financing framework. This is particularly relevant as the insurance protection gap — losses not covered by insurance — is quite significant in India, estimated at over 90 per cent of total natural disaster-related losses.

Insurance penetration is low in India. Premiums as a share of GDP stand at 0.7 per cent, against a global average of 2.7 per cent; but this is expected to outpace economic growth over the next several years. This also implies the protection gap, particularly for natural disasters, will remain quite high during this period.

Checking tragedy

Pre-event financing by way of transferring catastrophe risk into insurance markets can help close this gap. Insurance instruments for this purpose include catastrophe risks pools, parametric or weather-indexed products, catastrophe bonds and insurance-linked securities.

The insurance sector employs sophisticated climate and geological models to determine vulnerabilities to natural disasters. Thus, insurance risk-pricing carries important market signals, and informs policymakers of their overall preparedness. It also allows for improved contingency planning and targeted investment in risk reduction measures.

This stands in some contrast to the national and state disaster relief funds (NDRF, SDRF) in India. Over the years, there has been a mismatch in the use of these funds, with under-utilisation by some States going hand-in-hand with emergency drawals from other sources of funds. The implicit opportunity cost of unutilised funds lying in reserve, and the explicit cost of emergency funding may often go unrecognised by policymakers. A recent example of such emergency funding is the imposition of ad-hoc taxes and a bond-issuance plan by Ecuador following the earthquake in April.

The financial burden of disasters is borne by individuals and organisations, but more often than not, the most significant impact is on the government. Relief funds provided by the government go towards emergency measures and rehabilitation.

The NDRF and SDRF cannot be used for permanent restoration or long-term reconstruction of infrastructure damaged by natural disasters. Insurance instruments, and in particular weather-indexed and parametric products, can not only provide immediate funding in the event of disasters, but also the flexibility to governments to utilise such funds for reconstruction.

A growing number of successful government-led insurance programmes around the world points to their relevance in an increasingly climate-change impacted scenario.

On that cue, catastrophe risk transfer into insurance markets should be considered by both the Centre and State governments in India as it provides stability in planning and budgeting and complements existing relief funds.

Rating agencies too are beginning to look at the impact of natural disasters on government finances and consequent sovereign ratings.

Tweaks in policy, such as allowing a small part of the SDRF allocations to be utilised by States to purchase insurance can leverage a much higher level of financing to become available for funding post-disaster works.  

The writer is Head, Global Partnerships, South Asia, Swiss Re

Published on July 27, 2016

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