Global Assessment Report on Disaster Risk Reduction 2013
From Shared Risk to Shared Value: the Business Case for Disaster Risk Reduction

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declines in the long term, the primary gains from the smoothing obtained from reinsurance, contingency loans and catastrophe bonds are obtained by delaying losses (Hsiang and Jina, 2012

Hsiang, S.M. and Jina, A.S. 2012.,Development after Disaster., Background Paper prepared for the 2013 Global Assessment Report on Disaster Risk Reduction., Geneva,Switzerland: UNISDR.. .
). Insurance alone and in itself, in other words, does not enable disaster-affected countries to catch up and cannot substitute for investments in risk reduction (Hamdan, 2012

Hamdan, F. 2012.,Incentive and Extensive Disaster Risk Drivers and Incentives for Disaster Risk Management in the MENA region., Background Paper prepared for the 2013 Global Assessment Report on Disaster Risk Reduction. Geneva, Switzerland., Geneva,Switzerland: UNISDR. .
In principle, insurance should also act as a powerful incentive for disaster risk reduction. An insurance premium should represent the economic value of risk, which in a perfect market would equal the expected loss plus transaction costs (Galegatti et al., 2008). However, perfect markets do not exist and whether owing to an inadequate or inaccurate assessment of risks or to government intervention in the market, insurance premiums do not necessarily reflect a realistic pricing of risk (GAR 13 paperNguyen, 2012

GAR13 Reference Nguyen, T. 2012.,Insurability of Catastrophe Risks and Government Participation in Insurance Solutions., Background Paper prepared for the 2013 Global Assessment Report on Disaster Risk Reduction., Geneva,Switzerland: UNISDR..
Click here to view this GAR paper.
Classic problems surrounding insurance include moral hazard and adverse selection i , both related with information asymmetry in the market (Galegatti et al., 2008). If insurance pricing reflects real risk,
insurance can facilitate risk reduction investments, for example, as in the case of the California Earthquake insurance (see Box 13.1 below). When lower premiums are set, for example, for earthquake-resistant properties, this provides an incentive to invest in retrofitting and earthquake-resistant design, thus avoiding moral hazard and adverse selection.
Although risks in developed markets, such as Europe, Japan and the United States of America, are modelled with precision by the commercial risk modelling industry, this is often not the case in new and emerging insurance markets. At the same time, although sophisticated risk models enable the insurance and reinsurance industry to calculate premiums, data from these actuarial models are rarely available to those who purchase insurance policies, generating information asymmetry. The accuracy of loss estimates and the translation of those into premiums cannot be easily verified by the insurance buyers. Developments of public disaster databases and risk models have the potential to start to bridge this information asymmetry (see Chapter 15 for examples).
Box 13.1 National and regional insurance mechanisms in the United States of America
The US National Flood Insurance Programme (NFIP) provides subsidised flood protection insurance to properties located in designated special flood hazard areas. In addition, the government was not allowed to purchase reinsurance. As a result, it had accumulated debts of US$17.8 billion by 2007. Legislation requires the NFIP to offer subsidised premiums even to homes that suffer repetitive losses, thus decreasing or negating risk reduction investment for those properties and resulting in an estimated 25–30 percent of claims paid for repetitive losses.

In addition, policy-holders often stop paying their insurance and instead rely on the government’s relief support as soon as mortgage lenders, who are supposed to control this, have transferred their account to capital markets and thus lose oversight. In such cases, debt-based private ownership—in this case, housing at risk of flood damage—once again increases public liabilities. The government recognised this problem and in June 2012, passed legislation that will phase out NFIP subsidies on properties with repetitive losses, introduce minimum deductibles as well as allow for a rezoning of areas to correspond more closely to new risk assessments, all which are expected to avoid moral hazard and have positive impacts on risk reduction investment.

In contrast, the California Earthquake Authority has proven a successful public-private partnership (PPP), where risk-based pricing and cost-effective structures have ensured a solvent programme that offers affordable premiums. Actuarially sound methods were used while benefitting from government reinsurance and support. Recently, the adoption of a building code for retrofitting existing structures is trying to link with lower insurance premium offers to lower the cost of insurance in general.In doing so, a double incentive for insurance purchase and risk mitigation strategies would be created that would ultimately benefit the insurance market, the insured and government budgets.

(Source: Orie in GAR 13 paperOrie and Stahel, 2012

GAR13 Reference Orie, M. and Stahel, W.R. 2012.,UNISDR Case Study Report., Background Paper prepared for the 2013 Global Assessment Report on Disaster Risk Reduction., Geneva,Switzerland: UNISDR..
Click here to view this GAR paper.
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