Introduction

Risk is defined as an uncertain but potential element that always appears in the
technical, human, social and political events, reflecting changes in the distribution of
possible outcomes and subjective probability values and objectives, with possible
damaging and irreversible effects.

Risk Identification

Risk identification is a deliberate and systematic effort to identify and document the
Institutions key risks. The objective of risk identification is to understand what is at
risk within the context of the Institutions explicit and implicit objectives and to
generate a comprehensive inventory of risks based on the threats and events that might
prevent, degrade, delay or enhance the achievement of the objectives.

Risk identification includes hazard assessment, vulnerability studies, and risk analysis.
Hazard assessment identifies the probable location and severity of dangerous natural
phenomena and the likelihood of their occurring within a specific time period in a given
area. These studies rely heavily on available scientific information, including geologic,
geomorphic, and soil maps; climate and hydrological data; and topographic maps, aerial
photographs, and satellite imagery. Historical information, in the form of written
reports and oral accounts from long-term residents, also helps characterize potential]
hazardous events. To be most successful, hazard assessment requires data and scientific
teams trained to evaluate the data. In some countries, the lack of extensive historical
data on catastrophic events makes hazard assessment difficult. In the case of floods and
landslides, human factors can drastically impact the environment, and historical data
may be of little value. For earthquakes and tropical cyclones, the international research
community has collaborated significantly to pool resources and scientific knowledge to
develop global and regional hazard maps. Much work remains to be done on flood and
landslide mapping.

Vulnerability studies estimate the physical, social, and economic consequences that
result from the occurrence of a natural phenomenon of given severity. Physical
vulnerability studies analyze impacts on buildings, infrastructure, and agriculture. The
Applied Technology Council, for example, publishes detailed vulnerability curves for
the resistance of 50 different types of structural facilities to earthquake hazards (ATC,

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1985). Social vulnerability studies estimate the impacts of especially vulnerable groups,
such as the poor, single parent families, pregnant or lactating women, the mentally or
physically handicapped, children, and the elderly. Social vulnerability studies take into
account the public awareness of risk, the ability of groups to self-cope with
catastrophes, and the institutional structures in place to help them cope (Coburn,
Spence, and Pomonis, 1991). Economic vulnerability studies estimate the potential
impacts of hazards on economic assets and processes. These studies include indirect
losses (such as business interruption) and secondary effects (such as accentuated
poverty, higher unemployment, or increases in levels of external debt). The United
Nations Economic Commission for Latin America and the Caribbean (ECLAC) has
contributed significantly to this effort by publishing reports since 1972 on the economic
impacts of catastrophes in Latin America and the Caribbean (Caballeros and Zapata
Marti, 2000).

The risk analysis stage of risk identification integrates information from the hazard
assessment and the vulnerability studies in the form of an estimate of the probabilities
of expected loss for a given hazardous event. Formal risk analyses are time-consuming
and costly, but shortcut methods are available that give adequate results for project
evaluation (Bender, 1991). In the United States and Europe, a large part of the funding
for risk modeling comes from the private sector; major reinsurance companies
commission projects from private modeling firms such as EQECAT (www.eqecat.com)
and RMS (www.rms.com). However, these private sector initiatives require a guarantee
that investment in risk identification will lead to the development of insurance markets.

Risk Transfer

Risk transfer is the process of shifting the burden of financial loss or responsibility for
risk financing to another party, examples would be through insurance, reinsurance,
legislation, or other means (Mahul & Stutley, 2010). Munich Climate Insurance
Initiative (MCII) in 2009 presented to the UNFCCC Climate Talks a typology of risk
transfer mechanisms available in the global market.

A fundamental distinction between risk management policies in the developed world

and those in developing countries is the role of risk transfer. In developed countries,
entities other than the government absorb a portion of the risk of financing
reconstruction after a disaster, often an insurance company. The use of insurance, the

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primary risk transfer tool, has five key advantages: it permits the spreading of risk
between parties; it reduces the variance of risk for each person; it allows the segregation
of risk; it encourages loss reduction measures; and it provides a tool to monitor and
control behavior (Freeman and Kunreuther, 1997). Insurance is not the only option for
transferring risk. In dealing with natural disasters, a recent innovation in transferring
risk of loss from catastrophes is a hedging instrument known as catastrophe bonds.
Collectively, insurance and catastrophe bonds may be described as catastrophe
hedges. An extensive discussion of the use of catastrophe bonds in developed countries
with some insight as to how they may work for developing countries can be found in
Andersen (2001).

Risk transfer is a critical component of a comprehensive program for most developing

countries. Japan, France, Spain, the United Kingdom, and the United States all use risk
transfer to link the various components of their natural disaster risk strategy. Insurance
is a major component of the risk management strategy of wealthier countries. In the
higher-income countries, 30 percent of the loss from natural hazards is insured. In the
poorer countries, insurance covers 1 percent of the losses from natural hazards. Existing
insurance programs have a limited range. For example, they are not used to finance the
post-disaster reconstruction of government-owned buildings. In most low-income
countries, the government relies on its power of taxation and on borrowing to fund the
reconstruction of government-owned facilities. In addition, the government continues
to fund the needs of the poor after a disaster, although the poor are not part of formal
insurance programs. In most countries in Latin America and the Caribbean, insurance
is designed to transfer the risk of property owners and businesses from the government
to the insurance program. In countries with a strong middle class and active privately
owned businesses, the use of the program can be an effective policy tool to reduce the
governments obligation to fund post-disaster needs.

Promising and Problematic Practices of Risk Transfer Strategies

The main attractions of a national risk transfer policy are shifting the risk of post
disaster reconstruction funding away from the government and providing incentives to
mitigate risk. There is considerable worldwide activity in promoting different schemes
to use the government as a tool to provide catastrophe risk shifting for homeowners and
others. The creation of the recent Turkish Catastrophe Insurance Pool is a good

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example. All existing and future privately owned property is required to contribute to
it. The payments made will contribute to a fund that will pay homeowners up to
US$28,000 in the event that a catastrophe damages their homes (Gulkan, 2001).
Proposals are being explored in Mexico, the Caribbean, Central America, and Africa to
engage the government in providing risk transfer options for farmers, homeowners, and
businesses in case of natural catastrophe losses (World Bank, 2000). The Caribbean
Disaster Mitigation Project commissioned a study to explore insurance options for
small states in the region (Pollner, 2000). The World Bank has proposed the creation of
a new insurance program for Honduras, and the Inter-American Development Bank,
pursuant to the Puebla-Panama Initiative, is considering regional insurance options for
Central America. The most recent World Development Report on poverty devotes
considerable attention to the role of insurance in enabling countries to better deal with
risk, including the risk from natural catastrophes (World Bank, 2000). Insurance also
has two key disadvantages. While there are instances where insurance has contributed
to loss reduction, there is an associated moral hazard that insured parties will actually
take fewer measures to reduce risk. Furthermore, it should be kept in mind that
insurance is costly and the funds spent on insurance have an opportunity cost since they
could be spent on other social projects, including risk mitigation measures.

The reduction of risk works to the benefit of the developing countries that directly bear
the losses from catastrophes and the international aid community whose mission is to
assist the long-term development and reduction of poverty in these countries. By
harnessing the private sector to cope with catastrophe risk, the international aid
community frees itself and its resources to implement its broader agenda of
development policies.

Barriers to Supplying Catastrophe Insurance

It is no coincidence that insurance is an economic tool used by wealthy countries. It

requires sophisticated financial institutions to operate and a complex series of laws,
regulations, and administrative agencies. These include the proper financial structure
of insurance companies to ensure their financial capacity to pay future claims, the
actuarial science (including the required information base) that underpins the setting of
premiums and reserves, legal knowledge about insurance contracts and the protection
they provide, the functioning of insurance distribution networks, and claims payment

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practices and proper legal institutions to enforce sophisticated contractual agreements.
In many developing countries, the lack of institutional regulatory structures hinders the
ability to acquire insurance. Designing major institutional reforms to permit the proper
operation of financial institutions is difficult. The components needed to implement an
adequate regulatory scheme for insurance industries are already known. Guidelines for
proper regulatory practices are maintained by appropriate agencies in developing
countries.

The National Association of Insurance Commissioners in the United States has detailed
information on proper regulatory practices (see www.naic.org). In addition to the
regulatory issues, there are concerns related to the fundamental structure of the market
for insurance. For example, many countries may be too small to provide adequate risk
diversification to properly support a national insurance scheme. Proposals to create
regional insurance markets hope to increase risk diversification and potential market
size, thereby making the market more attractive for the insurance industry and lowering
the cost of insurance. A larger potential market subject to a uniform regulatory scheme
may encourage the international insurance industry to help develop viable markets.
Regional proposals, like the World Banks initiative for a Central American insurance
market, are based on overcoming barriers to the supply of insurance.

Background

Natural disasters and climate change impacts have caused heavy damages and losses to
all sectors. It is the public sector however that absorbs a large portion of the financial
costs of disasters. Damages to public buildings and critical infrastructures for example,
are considered contingent liabilities of the government which they are responsible to
repair or replace. In addition, the government spends huge amount of money for
emergency response and relief, as well as in efforts for recovery and reconstruction.
Oftentimes, these losses are disproportionate to the total annual financial allocation of
national and local governments and guzzle up funds allocated for social services and
development projects. Swiss Re (2012) estimates that natural disasters caused US$126
Billion in economic losses in 2011, and US$186 Billion in 2012 worldwide. A big
chunk of these losses are shouldered by the public sector. The Thailand floods of 2011

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for example, resulted in US$46.5 billion of economic losses and required the Thai
government to spend almost 5 per cent of its annual revenues for response and recovery
efforts (World Bank, 2012). ASEAN countries suffer annual damage of over US$4.4
billion each year because of disastersan amount equivalent to more than 0.2 percent
of the regions total GDP (World Bank, 2012).

Losses and Lessons from Thai Floods of 2011

Thailand is considered a low risk area from typhoons. But from June 2011 to October
2011, five consecutive typhoons entered Northern Thailand bringing heavy rainfall up
to 40% above normal average of the same period, which by definition is considered an
extreme weather event. The extreme weather events caused severe flooding in the
Northern provinces that spread southward and inundated 65 of Thailands 77 provinces.
The flood lasted for five months causing 813 deaths, 13.5 million people were affected,
2 million people evacuated, 1 million homes destroyed. The total losses amount to US$
46.5 Billion and is officially considered the most expensive flood event in history in
terms of economic losses. The government spent US$25 Billion for relief and recovery.
The business sector suffered a staggering loss amounting to US$7.4 Billion. Over 1,215
factories in 7 major industrial estates were submerged to floodwaters causing
unprecedented losses mainly due to business interruptions in the global supply of
electrical, computer, automotive parts and products. The insurance industry paid out
US$10 Billion of insured losses which greatly aided the financial burden of the public
and private sector and supported the recovery efforts in the country.

Source: Department of Disaster Prevention and Mitigation (DDPM) Thailand

Ministry of Finance (Thailand) 2012. Report on the worst flood in Thailand 2011

Iglesias, Gabrielle 2012. Lessons on Resilience from the 2011 Central Thailand Floods

Munich Re 2011. Topic Geo 2011

Natural disasters have always caused negative impacts on public finances. According
to Reto Schnarwiler (www.swissre.com, 2012) governments shoulder the biggest chunk
of financing cost after every disaster event. The government therefore should find ways
to protect itself from suffering heavy financial burden and recover quickly from
calamities. The cost of disasters is increasing and will continue to rise with the increased
frequency and magnitude of hydrometeorological disasters. Schnarwiler (2012) added

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that no country can fully insulate itself against extreme weather events due to climate
change; therefore countries prone to natural disasters should consider transferring their
risks to capital markets.

Rationale for the Research

Increasing trend of hydro-meteorological disasters.
Climate change induced extreme weather events.
Reduced loss of human lives, escalating economic losses.
Need for better mitigation, preparedness & insurance cover.
2011 recorded the highest catastrophe-related economic losses in history - of USD 370
billion and cost the global insurance industry USD 116 billion (Swiss Re).

Dhaka is ranked no one vulnerable city in the world. This is high time to work
extensively on Risk identification and successful transfer mechanisms. The ever
increasing incidents of natural catastrophe and their impacts on peoples lives, global
economy and livelihood are huge. Over the past decade millions were killed, billions
were affected and trillions of dollars were in damage just as the result of natural
disasters.

Fig: Climate change Vulnerability Index 2013

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8
Methodology

Methods for Identifying Risks

Risk identification starts with understanding the Institutional objectives, both implicit
and explicit. The risk identification process must identify unwanted events, undesirable
outcomes, emerging threats, as well as existing and emerging opportunities. By virtue
of an Institution's existence, risks will always prevail, whether the Institution has
controls or not. When identifying risks, it is also important to bear in mind that "risk"
also has an opportunity component. This means that there should also be a deliberate
attention to identifying potential opportunities that could be exploited to improve
Institutional performance.

In identifying risks, consideration should be given to risks associated with not pursuing
an opportunity, e.g. failure to implement an IT system to collect municipal rates. Risk
identification exercise should not get bogged down in conceptual or theoretical detail.
It should also not limit itself to a fixed list of risk categories, although such a list may
be helpful.

Risk management uses formulas and templates to narrow in on and to identify risk.
Which formulas and templates are used, is often determined by the industry that they
are being practiced in. Some common methods of risk identification are: brainstorming,
flowchart method, SWOT analysis, risk questionnaires and risk surveys.

Brainstorming

When objectives are stated clearly and understood by the participants, a brainstorming
session drawing on the creativity of the participants can be used to generate a list of
risks. In a well facilitated brainstorming session, the participants are collaborators,
comprising a team that works together to articulate the risks that may be known by
some in the group. In the session, risks that are known unknowns may emerge, and
perhaps even some risks that were previously unknown unknowns may become known.

Facilitating a brainstorming session takes special leadership skills, and, in some

organizations, members of the internal audit and ERM staff have been trained and
certified to conduct risk brainstorming sessions. In addition to well-trained facilitators,
the participants need to understand the ERM framework and how the brainstorming

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session fits into the ERM process. The participants may very well be required to do
some preparation prior to the session.

In using this technique, one company familiar to the authors noted that, because the
objectives were unclear to some of the participants, the process had to back up and
clarify the objectives before proceeding. Using a cross-functional team of employees
greatly increases the value of the process because it sheds light on how risks and
objectives are correlated and how they can impact business units differently.

Often in brainstorming sessions focused on risk identification, a participant may

mention a risk only to have another person say: Come to think of it, my area has that
risk, and I have never thought of it before. With the team sharing experiences, coming
from different backgrounds, and having different perspectives, brainstorming can be
successful in identifying risk. It is also powerful when used at the executive level or
with the audit committee and/or board of directors.

Flowchart Method

The Flowchart Method is used to graphically and sequentially depict the activities of
an operation or process to identify exposures, perils and hazards. There are a variety of
methods that can be used including: product analysis, dependency analysis, site
analysis, decision analysis and critical path analysis. These methods can illustrate
interdependency within your organization; they can easily pinpoint bottlenecks and can
determine a critical path. They do not indicate frequency or severity, but only show
minor processes with major loss potential, they have a limited applicability to liability
exposures and in most situations, they are too process-oriented.

SWOT Analysis

SWOT (Strengths-Weaknesses-Opportunities-Threats) analysis is a technique often

used in the formulation of strategy. The strengths and weaknesses are internal to the
company and include the companys culture, structure, and financial and human
resources. The major strengths of the company combine to form the core competencies
that provide the basis for the company to achieve a competitive advantage. The
opportunities and threats consist of variables outside the company and typically are not
under the control of senior management in the short run, such as the broad spectrum of
political, societal, environmental, and industry risks. For SWOT analysis to be effective

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in risk identification, the appropriate time and effort must be spent on thinking seriously
about the organizations weaknesses and threats. The tendency is to devote more time
to strengths and opportunities and give the discussion of weaknesses and threats short
shrift. Taking the latter discussion further and developing a risk map based on
consensus will ensure that this side of the discussion gets a robust analysis. In a possible
acquisition or merger consideration, a company familiar to the authors uses a SWOT
analysis that includes explicit identification of risks. The written business case
presented to the board for the proposed acquisition includes a discussion of the top risks
together with a risk map.

Risk Questionnaires and Risk Surveys

A risk questionnaire that includes a series of questions on both internal and external
events can also be used effectively to identify risks. For the external area, questions
might be directed at political and social risk, regulatory risk, industry risk, economic
risk, environmental risk, competition risk, and so forth. Questions on the internal
perspective might address risk relating to customers, creditors/investors, suppliers,
operations, products, production processes, facilities, information systems, and so on.
Questionnaires are valuable because they can help a company think through its own
risks by providing a list of questions around certain risks. The disadvantage of
questionnaires is that they usually are not linked to strategy. Rather than a lengthy
questionnaire, a risk survey can be used. In one company, surveys were sent to both
lower- and senior-level management. The survey for lower management asked
respondents to List the five most important risks to achieving your units
goals/objectives. The survey to senior management asked participants to List the five
most important risks to achieving the companys strategic objectives. The survey
instruments included a column for respondents to rank the effectiveness of management
for each of the five risks listed, using a range of one (ineffective) to 10 (highly
effective). Whether using a questionnaire or survey, the consolidated information can
be used in conjunction with a facilitated workshop. In that session, the risks are
discussed and defined further. Then interactive voting software is used to narrow that
risk list to the vital few.

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Risk Transfer Mechanisms

Insurance. Insurance is a contractual transaction that guarantees financial protection

against potentially large loss in return for a premium; if the insured experiences a loss,
then the insurer pay out previously agreed amount. Insurance is common across most
developed countries and covers many types of peril (e.g. fire and theft insurance to
protect property, automobile liability insurance). Reserve fund. Catastrophe reserve
funds are typically set up by governments, or may be donated, to cover the costs of
unexpected losses.

Risk pooling. Risks pools aggregate risks regionally (or nationally) allowing individual
risk holders to spread their risk geographically. Through spreading risks, pooling allows
participants to gain catastrophe insurance on better terms and access collective reserves
in the event of a disaster (e.g. Caribbean Catastrophe Risk Insurance Facility (CCRIF),
which allows Caribbean governments to purchase coverage for earthquake and/or
hurricane, securing US$110 million of reinsurance capacity in addition to its own
reserves).

Insurance-linked securities. Insurance-linked securities, most commonly catastrophe

(cat) bonds, offer an avenue to share risk more broadly with the capital markets. Cat
bonds are issued by the risk holder (usually a government or insurance company) and
trigger payments on the occurrence of a specified event. This event may be a specified
loss or may be a parametric trigger, such as the wind speed at a location (e.g. in 2006,
the Government of Mexico issued a cat bond (the Cat-Mex bond) that transfers
earthquake risk to investors by allowing the government to not repay the bond principal
if a major earthquake were to hit Mexico).

Micro-insurance. Micro-insurance is characterized by low premiums or coverage and

is typically targeted at lower income individuals who are unable to afford or access
more traditional insurance. Micro-insurance can cover a broad range of risks; to date,
it has tended to cover health and weather risks (including crop and livestock insurance).
Weather insurance typically takes the form of a parametric (or index-based) transaction,
where payment is made if a chosen weather-index, such as 5-day rainfall amounts,
exceeds some threshold. Such initiatives minimize administrative costs and moral
hazard and allow companies to offer simple, affordable and transparent risk transfer

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solutions (e.g. Weather-based Crop Insurance Scheme established by the Government
of India, protecting more than 700,000 farmers against drought).

The World Bank came up with its own disaster risk-financing and insurance (DRFI)
framework to better categorize the financial protection strategies countries can use
against disasters. The DRFI framework classifies risk financing mechanisms into 2
ways: (1) sovereign disaster risk financing -- which entails identification and
assessment of the governments contingent liabilities associated with natural hazards
and financial strategies to increase their financial response capacity in the aftermath of
a disaster while protecting their long-term fiscal balance, and (2) catastrophe risk
market development -- which increases the transfer of public and private risks to the
insurance sector.

Disaster Risk-Financing and Insurance (DRFI) Framework, World Bank 2012

Current Policy on Risk Transfer Mechanisms

The UN Framework Convention on Climate Change in 2007 formulated the Bali Action
Plan which identified risk transfer mechanisms as risk management and risk reduction
strategies which is part of enhanced adaptation actions for the country. The Hyogo
Framework for Action (HFA) highlighted the importance of (1) promoting the

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development of financial and risk-sharing mechanisms, particularly insurance and
reinsurance against disasters, (2) encouraging the establishment of publicprivate
partnerships to better engage the private sector in disaster risk reduction activities,
encourage the private sector to foster a culture of disaster prevention, putting greater
emphasis on, and allocating resources to pre-disaster activities such as risk assessments
and early warning systems, and (3) developing and promoting alternative and
innovative financial instruments to address disaster risk (Jha and Stanton-Geddes,
2013). IPCC SREX (2012) emphasized that risk sharing and transfer mechanisms at
local, national, regional, and global scales can increase resilience to climate extremes.
Mechanisms such as informal and traditional risk sharing mechanisms, micro-
insurance, insurance, reinsurance, and national, regional, and global risk pools are
linked to disaster risk reduction and climate change adaptation by providing means to
finance relief, recovery of livelihoods, and reconstruction; reducing vulnerability; and
providing knowledge and incentives for reducing risk (IPCC SREX, 2012)

In the Philippines, the Climate Change Act of 2009 and the Philippine Disaster Risk
Reduction and Management Act of 2010 both mandated the appropriate design of risk
transfer mechanisms as part of resiliency measures required to be taken. Indonesias
National Action Plan Addressing Climate Change (NAPACC) states that several
funding mechanism should be immediately tried, including market instruments like
insurance and reinsurance as part of its climate actions.

The Government of Vietnam formulated the National Strategy for Natural Disaster
Prevention, Response and Mitigation 2020 which includes a strategy on the
development of catastrophe risk financing solutions (including insurance) to
complement other disaster risk management measures. The Climate Change Master
Plan of Thailand seeks the creation of a financial mechanism to support the
implementation of adaptation for coping with the negative effects of climate change.

Several international financial institutions such as the World Bank and the Asian
Development Bank have provided assistance to various countries in developing and
establishing their risk transfer strategies towards climate change adaptation and disaster
risk management. The World Bank pioneered and supported the development of the
Turkish Cat Insurance Pool after the devastating Marmara earthquake in Turkey, the
Caribbean Cat Risk Insurance Facility (CCRIF) which insures 16 national governments

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in the Caribbean, drought insurance coverage for the government of Malawi, the
MultiCat bond of Mexico that provides the Mexican government with rapid funding to
finance disaster relief efforts after earthquakes and hurricanes, and many other
countries around the world. The Philippines and Southeast Asia can learn from these
countries and adapt or develop their own risk transfer strategies suited to their
individual context. The World Bank is currently spearheading the development of
national level risk finance instruments in countries with high exposure to disasters and
climate change, including Cambodia, Indonesia, Laos, the Philippines and Vietnam.
Asian Development Bank on the other hand is assisting selected pilot cities to study
and develop risk transfer products and strategies that are suited and cost-effective for
local governments in Asia and the Pacific.

Challenges

Proactive risk financing initiatives are being promoted at several levels. Reaching
the poor remains a challenge.

For decades, the financing of disasters in developing countries has relied on a reactive
approach, consisting of the diversion of funds from domestic budgets and extensive
financing from international donors. Such ex post funding approaches are inefficient,
often poorly targeted, and insufficient. Moreover, they provide no incentives for
proactive risk reduction measures such as improved urban planning, higher
construction standards, etc. Reactive approaches to risk financing are becoming
increasingly unsustainable due to a number of factors. Vulnerability is increasing as
emerging economies grow and accumulate more assets. Poorly planned urbanization,
continued environmental degradation, and population growth contribute to further
increases in vulnerability and growing disaster losses. The IPCCs Fourth Assessment
Report confirms that climate change will bring more frequent and more intense extreme
weather events. The increase in hazard exposure and in vulnerability point to a
continuing trend of increasing losses due to natural disasters. With the capacity and
willingness of donors to fund disaster relief and reconstruction ultimately constrained,
the funding gaps between available donor resources and post-disaster funding will grow
if disaster prone countries do not engage in risk reduction and pre-disaster risk
financing.

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Insurance markets in the majority of developing countries are undeveloped, and
coverage for natural disasters is extremely limited. Where hazard coverage exists, it is
usually limited to major industrial and commercial properties, and some wealthier
households. The demand for risk transfer instruments in emerging markets is often
constrained by market gaps, lack of regulatory frameworks, lacking data on disaster
risk, a lack of a culture of risk financing, and the reluctance of large reinsurance market
players to invest in the development of small risk markets. For a number of years, efforts
have been undertaken to promote a more proactive approach among to risk financing
in developing countries. A number of examples come from World Bank-led efforts,
including the provision of technical support to Mexico in issuing a cat bond,2
contingency financing arrangements in Colombia, the Caribbean Catastrophe Risk
Insurance Facility (CCRIF, the first regional institution which allows the eighteen
participating countries to pool their risk and save on individual premium payments),
and the Turkish Catastrophe Insurance Pool (TCIP, a mandatory earthquake insurance
pool for homeowners). These initiatives provide much needed, immediate liquidity
after a disaster for more effective government response, and some relief of the fiscal
burden placed on governments due to disaster impacts. They constitute critical steps in
promoting more proactive risk management strategy that includes preparing for disaster
impacts and planning for the response. These formal mechanisms, however, do not
address the issue of reaching the poor, who are consistently the most affected by
disasters.

A limited number of micro insurance schemes for disaster risk are available in
developing countries.

A wide range of microfinance services have been offered to low-income households for
several decades. Overtime, these have included micro insurance products, mainly for
independent risks such as funeral expenses, health and loss of life. With little to no
access to formal insurance mechanisms for disasters, the poor are forced to self insure,
depleting their savings when disaster strikes. Other consumption-smoothing strategies
include taking emergency loans from microcredit institutions or money lenders and
relying on family or community support. Community support measures may break
down in times of disaster, as entire communities are affected at once. Without adequate
coping strategies, poor households are locked into the poverty cycle, taking out high-
interest loans or defaulting on existing loans, selling assets and livestock, or engaging

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in low-risk, low-yield farming to lessen their exposure to extreme events. Reliance on
government or donor assistance is often inadequate, as this support can be ad hoc,
poorly targeted, and slow in disbursing. Moreover, disaster assistance can discourage
governments and individuals from taking advantage of the high returns of preventive
action. Micro insurance can help to break this cycle by providing low-income
households, farmers, and businesses with rapid access to post-disaster liquidity, thus
protecting their livelihoods and providing for reconstruction. As insured households
and farms are more creditworthy, insurance can also promote investments in productive
assets and higher-risk/higher-yield crops. In addition, insurance has the potential to
encourage investment in disaster prevention if insurers offer lower premiums to reward
risk-reducing behavior.

Recent years has brought growing interest from private sector insurance firms in micro
insurance. Primary insurers at the country level play a key role in most micro insurance
schemes, by channeling the risk to commercial markets and allowing the intermediary
agency to focus on client relations and support. Regulatory changes implemented in
India over the last several years have increased the incentives for insurance companies
to participate in such schemes. Internationally there is also increasing interest from
reinsurance companies like Swiss Re, which has recently developed a partnership with
Millennium Promise for a Climate Adaptation Development Program to develop risk
transfer tools for Millennium Villages against the effects of adverse weather. Micro
disaster insurance can cover sudden-onset events, such as earthquakes, floods, and
cyclones, as well as slow-onset events, such as droughts. Traditional micro insurance
programs have consisted of indemnity insurance, which pays claims based on actual
losses and requires an extensive network of claims adjusters who assess individual
losses following an event. Indemnity schemes include those in India offered by NGOs
in conjunction with insurance companies in two states. These schemes build on micro
insurance arrangements for independent risks, such as unemployment, fire and
accidents, by extending cover to loss of life, property or livestock due to natural disaster
events. Coverage for property losses due to floods, earthquakes, cyclone and other
natural calamities is offered to groups such as women with a minimum group size of
250, or to community groups for managing the impacts of disasters post-event. Clients
can also engage in risk reduction training for a small fee.

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More recently, index-based schemes have emerged, which feature contracts written
against a physical trigger (parametric insurance). In the case of weather derivatives for
crop risks, farmers collect insurance compensation if the index reaches a certain
measure or trigger, regardless of actual losses. Index-based weather derivative
schemes have been undertaken in India, Ethiopia,

Malawi, Nicaragua, Peru and Ukraine. Contracts are written against a physical trigger,
for example, severe rainfall measured at a regional weather station. Contracts are
designed by insurance companies and sold by rural development banks, farm
cooperatives or microfinance organizations. Since payouts are not coupled with
individual loss experience, farmers have an incentive to engage in loss reduction
measures, for example, switching to a more robust crop variant. These schemes may
offer a viable alternative to traditional crop insurance, which has failed in many
countries due to the high costs associated with settling claims on a case-by-case basis.
The major advantages of index-based insurance are the reduction of moral hazard and
of transaction costs. Index-based mechanisms are also more transparent, as they are
based on a physical trigger and the payout is fixed in advance. The major downside of
index insurance is the basis risk: if the trigger is insufficiently correlated with the losses
experienced then no payout may occur, even if the losses are substantial. To date index
schemes have relied on the existence of networks of rainfall meters and have been
primarily focused on crop insurance. The World Bank is currently testing the use of
triggers based on remote sensing for flood schemes in Thailand and Vietnam that would
allow wider application of index schemes and include inundation and not just
precipitation with the coverage.

The World Bank has also worked with the Government of Mongolia to develop a
livestock insurance program based on measures of animal mortality rates, which raises
the hope of extending index schemes to other types of non-agricultural livelihoods and
small and medium size enterprises. Another promising initiative is the Global Index
Reinsurance Facility, which is being developed by the World Bank and the International
Finance Corporation with a private sector reinsurer and donors. The GIRF will
underwrite index able weather and other index able natural catastrophe risks in
developing countries and also includes a technical assistance pool funded by donors to
develop the technical parameters of the business.

18
Recommendations

For micro disaster insurance to serve as a sustainable and effective risk management
mechanism for the poor, the current pilot and fledgling programs will need to be scaled
up to cover the large number of low-income households and farms facing risks from
natural disasters. While there is great potential, there is insufficient experience with
current programs to judge their future viability.

Academics and other partners should be engaged to collect further evidence and elicit
lessons from operating experiences related to the value of micro insurance as a pro-
poor instrument. Existing programs demonstrate some innovative ideas and creative
alliances to deal with market failures and other issues. Safety nets for high-risk poor
communities will not work without public-private partnerships, as no one partner can
operate without the assistance of the others: highly exposed and fiscally unstable
developing country governments cannot fully absorb the risks; informal community
solidarity and family systems are overtaxed by large covariant losses; and private
insurers cannot offer low-cost policies, given the need for expensive reinsurance and
large uncertainties in the projected loss estimates.

A multi-stakeholder approach should be promoted in pioneering micro insurance

programs to develop a sustainable model for reaching the poor, including
NGO/community groups, microfinance organizations, government regulators,
entrepreneurs, donors, IFIs, and private insurers. While there is a lot of hope that
insurance can become an important adaptation and risk management tool, climate
change will present new challenges, as disaster impacts continue to grow, affecting the
insurability of assets.

A concerted effort among climate change specialists, micro insurance and risk-
transfer experts, the research community, and representatives from civil society,
governments, and bilateral and multilateral donor institutions is needed to consider the
implications of future climate scenarios on micro insurance programs.

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Conclusions
Its extremely important to identify all the risks early on. The better the job done at
identifying the risks at the planning stage, the more comprehensive the risk response
plan will be. Risk identification is not an area that should be skipped, being one of the
most important processes in risk management. Risk identification and risk transfer
together can improve the overall stability in the current chaotic situation. A global
contemporary approach with emphasis in small scale sectors all over the globe will
ensure a successful implementation of the strategies. Collective effort is a must in this
condition and era for the ultimate survival of human species in planet earth which is
currently ravaged by natural calamities every now and then.

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