Catastrophic Disasters and Risk Management

Just seven months after the catastrophic 7.0 magnitude Haitian earthquake, devastating Pakistani floods and seemingly untamable Russian wildfires have drained financially overburdened international aid agencies, highlighting the need for alternative risk transfer mechanisms to redistribute the financial obligations of disaster relief and reconstruction. A steady increase in natural disasters over the last twenty years has put unrelenting strain on donation- dependent relief agencies – requiring wealthier countries to pony-up more and more cash for at- risk countries with unsophisticated insurance markets. According to a recent World Bank report, less than 3% of the costs of catastrophes are absorbed by any form of insurance in developing nations, compared to 50% in the United States.

As relief agencies struggle to raise upwards of $460 million to manage the ongoing Pakistani floods, serious doubts have emerged as to the sustainability of the current relief model. Many are pushing developing nations to begin hedging risk in capital markets- a fast-growing industry.  John Seo, managing principal at Fermat Capital Management, anticipates that with an increasingly volatile risk landscape, the need for risk management strategies will almost certainly balloon “quadrupling in 10 years”.  Investors are already trading event-linked futures on the Chicago Climate Futures Exchange to hedge against disasters – part of a rapidly growing convergence among the capital and insurance markets.  As novel financial mechanisms are created to supplement the traditional reinsurance market, new opportunities for coverage emerge. As recent experience has shown, however, countries with under-developed insurance markets and the domestic uninsured will place enormous economic burden on national governments unless proper risk mitigation efforts are undertaken and vulnerable sectors begin to distribute risk in capital markets.

Full article here.