Integrating Mitigation with Risk Transfer Instruments

1
Integrating Mitigation with Risk Transfer
Instruments
Howard Kunreuther Wharton
School University of Pennsylvania E-mail
kunreuther_at_wharton.upenn.edu George
Deodatis Dept. of Civil Engineering Columbia
University E-mail deodatis_at_civil.columbia.edu   A
ndrew Smyth Dept. of Civil Engineering Columbia
University E-mail smyth_at_civil.columbia.edu

Paper Presented at World Bank Conference
on Financing the Risks of Natural Disasters A
New Perspective on Country Risk Management June
2-3, 2003 Washington, DC
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Objectives of Paper
Motivating Question What are the financial
benefits to national governments by encouraging
or requiring property owners to invest in
cost-effective mitigation measures? Why is this
Interesting? Previous studies have focused on
benefits of mitigation to individual property
owner. World Bank has a stake in promoting
cost-effective mitigation measures to avoid large
expenditures after a major catastrophe.
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Outline of Paper

• Defining cost-effective mitigation
• Role of risk-transfer instruments
• Combining mitigation with risk transfer
  instruments to governments
• Case study of Turkey
• How World Bank can promote mitigation using risk
  transfer instruments
• Future Research

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Defining Cost-Effective Mitigation

• Cost of Mitigation (C) (e.g. 65,000)
• Discounted Expected Benefits from Mitigation
  (B)
• Reduction in direct losses
• Reducing indirect losses
• Avoiding relocation of residents
• Avoiding business interruption risk
• Reducing losses to neighboring structures
• Reducing financial costs from catastrophic
  losses
• Decision Rule
•   If B gt C then mitigation is cost-effective
• If B lt C then mitigation is not
  cost-effective

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Building Collapse
Nearly all the fatalities and injuries can be
attributed to building collapse. EERI Report
(Oct. 99)
From BBC News
Photo by Nano Seeber
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Role of Risk Transfer Instruments

• Individual Purchasing insurance 
• Reward policyholder with lower premiums for
  adopting mitigation measure
• Other factors influencing protective decisions
• Underestimation of risk
• Myopia (short time horizons)
• It will not happen to me
• Budget constraints
• Government Insurer
• Provide funds to compensate disaster victims
  following a catastrophic event.
• Increase capacity for providing more coverage to
  individuals at risk

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Using Exceedance Probability Curve to Show
Benefits of Mitigation
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Questions government can address using EP curve

• What types of mitigation measures are most
  appropriate for dealing with the hazard(s) that
  the country faces?
• What types of risk transfer mechanisms are
  appropriate for reducing the magnitude of
• claim payments following a major disaster?

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Case Study Protection Against Earthquake in
Istanbul

• Chances Istanbul will have strong earthquake in
  next 30 years 62
• Possible losses to apartment buildings in
  Istanbul from severe earthquake
•         5,000 complete structural failure
•         40,000 significant structural damage

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Turkish Insurance Program

• Turkish Catastrophe Insurance Pool (TCIP) created
  in September 2000.
•  
• Current status of insured private property (May
  14, 2003)
•        1.9 million insurance policies in Turkey
  
•        776,755 purchased by Istanbul residents
• TCIP has purchased excess of loss reinsurance
  through a consortium of 60 different companies
•        840 million in place

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Pilot Study

• Located in Caddebostan
• Built in 1968, seismic code of 1967
• Z-3 soil (relatively stiff)
• Moment resisting reinforced concrete frame with
  no shear walls
• Existing concretes yield limit of 16MPa
• Retrofitting concretes yield limit of 25MPa

• Nonlinear (Bilinear model)
• Highly representative of residential buildings in
  and around Istanbul

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Retrofitting Solution 1 (Braced)
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Fragility Curves (Braced)
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EP Curves for 30 Apartment Buildings
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Reinsurance Cost to Turkish Government With and
Without Mitigation

• 30 Buildings (Based on Actuarial Risk)
• Without mitigation 16,179
•  With mitigation 3,507
•  
• 30,000 Buildings (Based on Administrative Cost
  of 1.5 x Actuarial Risk)
•  Without mitigation 24.3 million
•  With mitigation 5.3 million
• Savings to Turkish Government 19 million.

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Role of World Bank in Encouraging Mitigation

• Premium Reductions Linked with Government
  Mitigation Loans
•   
• Provide funds for mitigation through some type of
  long-term loan.
• Insurance premiums are lowered to reflect
  benefits of mitigation
• May have to subsidize low-income residents
•  
•  
• Issuing Catastrophe Bonds to Governments
•   
• Can one require cost-effective mitigation as a
  condition for a cat bond?
• What are the prices of these new financial
  instruments likely to be?
• How can one combine reinsurance with capital
  market instruments?

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Future Research Questions

• What role can land-use planning play in
  supplementing mitigation measures for reducing
  future disaster losses?
• What role can government institutions play in
  aiding low income families?
• What role can microcredit institutions (e.g
  Grameen Bank) play at individual and community
  level?
• What is the role of informal mechanisms (e.g.
  group-based insurance systems) in spreading
  coverage over a large area to diversify risk?
• How can other mechanisms (e.g. social investment
  funds and safety nets) help in managing disaster
  risk?

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Conclusions and Summary

• Mitigation measures have many benefits to
  individuals and countries 
•         Reducing direct physical damage
•         Indirect benefits to residents and
  businesses
•         Financial benefits to country
•  
• Risk transfer instruments can aid country in
  disaster planning
•  
• Mitigation measures can reduce countrys cost of
  risk transfer mechanisms
•  
• World Bank can encourage mitigation and provide
  risk transfer instruments
•  
• Need to combine many policy instruments for an
  effective risk management strategy 
•         cost-effective mitigation measures
•         land-use planning
•         risk transfer instruments
•         reconstruction programs