Improving Public Finance in Developing Economies through Catastrophe Risks Management Strategies By Víctor Cárdenas Consultant Specialist - PDF

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(Advisory on Climate Change and Catastrophe Risks Management for Countries) Improving Public Finance in Developing Economies through Catastrophe Risks Management Strategies By Víctor Cárdenas Consultant

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(Advisory on Climate Change and Catastrophe Risks Management for Countries) Improving Public Finance in Developing Economies through Catastrophe Risks Management Strategies By Víctor Cárdenas Consultant Specialist 2nd Conference of the OECD InternaFonal Network on the Financial Management of Large scale Catastrophes Bangkok, Thailand, September 2009 Agenda 1. Background 2. The taxonomy of losses 3. Who finance the losses? 4. Why Governments need risks management? 5. Building a risk management strategy 6. Op2mizing the sources of capital 7. A brief summary of the Mexican experience 8. Finals remarks 2 Background Natural disaster implies a impera2ve challenge for the public finance in governments, par2cularly in developing economies. According to the World Bank, during the last decade, more than one billion people were affected by natural disaster. Disasters represent a major source of risk for the poor in developing countries. According to the United Na2ons from 2000 to 2006, the average was 365 disasters, represen2ng an increase of 87%. More than 95% of all deaths caused by natural disasters occur in developing countries; and losses due to natural disasters are 20 2mes greater (as a percentage of GDP) in developing countries than in industrialized countries. According to the World Bank with data of Munich Re on average, 92,6% of economic loss was retained by governments of developing economies in the last decade. 3 Background Focusing in financial consequences, in developing economies a natural catastrophe could be comparable with liquidity crunch. GDP Growth rate before and a_er a Liquidity Crisis GDP Growth rate before and a_er a Natural Catastrophe Asia (1997) Mexico (1995) Russia (1998) Brazil (1999) Ecuador (1998) Mexico (1985) Honduras (1998) India (1990) 4 The menu of financial alterna2ves for risks financing is in2mate linked with the nature of losses, par2cularly from the policy maker perspec2ve. Governments through regula2on and financing creates an implicit or explicit risk management policy. Emergency costs (shelter, food, medical help, etc) Taxonomy of losses RegulaFon Business interrup2on (e.g. taxes) Central and sub nafonal Governments Financing Private infraestructure (housing, buildings, etc) Public Infrastructure (buildings, dams, electricity system) 5 Taxonomy of losses: who finance the losses In order to understand who is finally financing catastrophe losses, consider for example the year 2005, Mexico was affected for 3 hurricanes: Emily, Stan and Wilma. What is difference between them? Public and Private parfcipafon in the risks financing during hurricane season of 2005 in Mexico 6 Governments without an ex ante strategy of risk financing could rise the catastrophe cost for themselves and the en2re economy. A_er a disaster popula2on expects a quick answer from the government, typically through post disaster subsidies, however these are cost inefficient, because: they are not targeted, allocated in haste under poli2cal pressure without proper oversight. require considerable administra2ve costs to deliver. finance post disaster projects with low economic return. Addi2onally these type of help is: Why governments need risks management? ineffec2ve as they take too long to deliver and result in prolonged wai2ng periods for disaster vic2ms. insufficient, as the government never has enough resources to help everyone in need, hence they are allocated on first come first served basis. inequitable as the poorest segments of popula2on most affected by disasters receive only a small frac2on of assistance. 7 Why governments need risks management? A na2onal catastrophe risk financing strategy improve the public finance, minimizing all the costs and liabili2es related to the catastrophe. From government perspec2ve, beside the current risk poriolio that includes: currency risk, interest rate risk, oil price and commodi2es prices among others. Natural catastrophe cost should be include within the na2onal budget. Government fiscal exposure to natural disasters is more and more viewed as an integral part of overall government con2ngent liabili2es. A growing recogni2on of differen2al social and economic impacts of natural disasters ( the adverse effect on the poor). An ex ante strategy allows to op2mize the sources of capital for risks financing minimizing the financial vulnerability of the public finance. A financial ex ante strategy, as part of integral strategy minimizes casual2es and deaths. Therefore, financial solu2ons for natural disasters become more prevalent public policy in many developing economies. 8 Building a risk management strategy Strictly private & confiden2al Governments should work in parallel in two fields: as regulator and as risk manager of its own risks. Regula2on should develop an ins2tu2onal frame for risk management strategies performance. Recognize within the na2onal budget poten2al liabili2es that comes from catastrophes. Promote insurance development as well as promote new financial products. Create teams inside the government with skills in risk management As risks manager, the government in its different levels of government (na2onal and sub na2onal) should create an integrated system defined by four elements: Risks iden2fica2on Risk assessment Risk mi2ga2on Risk Financing 9 Building a risk management strategy Strictly private & confiden2al Governments should work in parallel in two fields: as regulator and as risk manager of its own risks. Prob. Losses Develop a na2onal inventory of assets and data collec2on of hazards Develop or apply analy2cal models of assets vulnerability Improve by retrofijng assets against natural hazards Build a broad menu of source of capital for risk financing Risks iden2fica2on Risk assessment Risk mi2ga2on Risk Financing Risks Management Services for Sovereigns (Advisory on Climate Change and Catastrophe Risks Management for Countries) 10 Op2mizing the sources of capital A op2miza2on of the mix of capital sources for risks financing implies combine the current na2onal budget, capital of insurance companies, the capital markets and con2ngent debt, consequently minimizing the cost of risks financing. RetenFon Insurance Policies RetenFon Cat Bond Insurance Policies RetenFon Agencies RetenFon Central Gov. Insurance Policies of Agencies Cat Bonds Insurance Policies Central Gov. Cat Bonds Intertemporal RetenFon (confngent Debt) 11 Development of Mexico s Risks Management Strategy Mexico is transi2ng toward a integral catastrophe risks management strategy, for private & public sectors including agricultural. 1985, Ministry of Finance develop a specific regula2on for earthquake reserves in insurance companies. 1997, Ministry of Finance developed the first calamity fund in La2n America for financing of reten2on. 2001, Mexico through the World Bank started an financial assessment of catastrophes vulnerability. 2006, Ministry of Finance developed the first catbond in developing economies against earthquake for expenses expenses. 2006, Ministry of Finance develop a specific regula2on for hurricane reserves in insurance companies. 2009, Ministry of Finance concludes catastrophe risks assessment on public assets exposure. 1985, Mexico City earthquake, 9000 deaths and 8 billions of US dollars in losses. 2000, by law federal agencies buildings should be insured. 2002, Ministry of Finance developed the first retrofijng and preven2on fund in La2n America. 2005, Ministry of Finance through a state insurance developed the first weather deriva2ve in La2n America for agricultural proposes. 2007, Ministry of Finance developed the first risks assessment on exposure of public assets against natural disasters. 2009, Ministry of Finance developed the first catbond in developing economies against hurricane and earthquake for emergency expenses. (1) Op2mize the mix of capital for risk financing, covering emergency expenses and reconstruc2on, (2) promote the insurance industry depth for the private sector. 12 Concluding remarks Catastrophe risk management is a key element in development of a op2mal public finance performance. There is strong evidence of benefits from catastrophe risk management at the country level and regionally. Catastrophe risks management can improve public finance through capital and reinsurance markets. It is possible to create strategies in the short, medium and long term, gejng results in a short term frame. There are several capital sources, like capital markets, these kind of sources can create a diversified strategy for risk financing inside the public finance of developing economies. 13 Contact info Strictly private & confiden2al For further informa2on, please visit: Victor Cárdenas Consultant Specialist 14
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