Natural Disaster Insurance for Sovereigns: Issues, Challenges and Optimality

IMF Working Papers, January 17, 2020

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Canonical URL: Natural Disaster Insurance for Sovereigns: Issues, Challenges and Optimality

Natural disasters are a source of economic risks in many countries, especially in smaller and lower-income states, and ex-ante preparedness is needed to manage the risks.
The paper discusses sovereign experience with disaster insurance as a key instrument to mitigate the risks; proposes ways to judge the adequacy of insurance; and considers ways to enhance its use by vulnerable countries.
The paper aims to inform policy decisions on disaster insurance through simulations of natural disasters and various insurance options.

Sovereign decisions on optimal risk transfer involve balancing trade-offs between growth and debt, based on government risk preferences and country risk exposure.
The choice of optimal insurance for smaller countries is more constrained by cost considerations due to their higher exposure, likely resulting in underinsurance.
Donor grants could help smaller countries achieve a more optimal protection.
Optimal insurance packages are those that are least costly relative to expected payouts (i.e. have the lowest insurance multiple).
The packages with the lowest insurance multiple are those that insure less severe (more frequent) disasters.

Incorporate ex-ante disaster insurance into sovereign risk-management frameworks to reduce reliance on post-disaster financing.
For smaller and lower-income states, consider combining sovereign insurance purchases with donor grants to address cost constraints and reduce underinsurance.
When evaluating insurance options, prioritize packages with the lowest insurance multiple (least costly relative to expected payouts), recognizing these will typically cover more frequent, less severe events.
Use government risk preferences and country-specific risk exposure to guide the design and extent of risk transfer strategies, balancing effects on growth and debt.

Disaster aid, Environment, Financial institutions, Foreign aid, Insurance, Insurance companies, Natural disasters, Options
Keywords (as listed): agency GSIS, Caribbean, catastrophe risk insurance program, debt growth tradeoffs, Disaster aid, Insurance, Insurance companies, insurance coverage, insurance package, insurance premium, natural disaster insurance, Natural disasters, optimal insurance for sovereigns, Options, options country, utility function, WP

Source: Natural Disaster Insurance for Sovereigns: Issues, Challenges and Optimality, Aliona Cebotari and Karim Youssef, January 17, 2020.