Financial Strategies for Managing the Economic Impacts of Natural Disasters

Transcription

1 Financial Strategies for Managing the Economic Impacts of Natural Disasters Case Studies The Turkish Catastrophe Insurance Pool This case study describes the development, organization and operation of the Turkish Catastrophe Insurance Pool (TCIP). As the first public-private insurance pool operating in a disaster-prone, developing country and supported by the international donor community, the Turkish experience is of special interest. In reading this case, you should consider whether the Turkish case raises issues relevant for your country. Are the conditions in your country similar to Turkey? If not, what changes might be needed for the design of a viable system? If such a system is not relevant for your country, what might be low-cost alternatives for reducing the financial vulnerability of urban and rural dwellers to catastrophic natural events? Since this any publicprivate insurance pool involves difficult issues of equity and efficiency, should citizens and stakeholders be involved in the decision process for reducing and sharing the losses from disasters? 3.1 Introduction Turkey s history, with more than twelve earthquakes of magnitude 7 or greater in the last century and with firsthand experience with the inadequacy of multi-story residential buildings, underscores the seriousness of earthquake risks in this country. Earthquake vulnerability has increased in Turkey mainly due to increased urbanization, faulty land use and construction, inadequate infrastructure and environmental degradation. Recent estimates suggest an annual probability of 0.02 of a major earthquake in Istanbul, which is estimated to result in 30 to 40 thousand deaths and damage or destroy up to 400,000 buildings (Erdik, 2002). This means that within the next 50 years such an event is very likely. Expected annual losses are estimated at around 1 billion USD (Gurenko, 2000). Although Turkey has stringent building codes for seismic risks, there has been insufficient enforcement resulting in a highly vulnerable building stock. In the past, the government has assumed the main financial responsibility for replacing buildings destroyed in earthquakes. This practice has given homeowners little reason to purchase private insurance, and has also reduced incentives for building or retrofitting the existing building stock to meet standards, especially on the part of absentee property owners. Finally, if property owners expect government assistance after disasters strike, this will encourage further development in disaster-prone areas. Before the TCIP, insurance cover for earthquake exposure was very low in Turkey. Insurers have been reluctant to offer extensive cover because of the high loss potential combined with low capital reserves and too little information on the risks. There is also low demand because of the high premiums relative to the average household income. 3.2 The Turkish Catastrophe Insurance Pool The recently introduced Turkish Catastrophe Insurance Pool (TCIP) is a public legal entity for offering compulsory earthquake insurance for residential properties. The designers of this pool have attempted to solve the fundamental problem of the non-affordability of earthquake insurance in Turkey with a public insurance system that offers limited cover and transfers some of the risk to international financial institutions. The idea of the system is to replace government post-disaster support with mandatory insurance combined with stricter enforcement of building codes. Studies for the creation of this system began over a decade ago after the 1992 Erzincan earthquake, and gained momentum after the Adana-Ceyhan earthquake of The framework 1

2 for the TCIP was established by a legal Decree after the devastating earthquake of 1999, and the first policy was issued nine months later. The objective of the TCIP is to reduce Turkey s vulnerability to the devastation of an earthquake by establishing a long-term reserve for financing post-event reconstruction. In financing this reserve, the TCIP places more responsibility on private house owners and thus reduces the government s post-disaster financial exposure. By decree, the Turkish government will no longer assist private residents in reconstructing their homes after an earthquake unless part of their losses are insured. Besides making earthquake insurance cover available at affordable rates, the idea is to use insurance as an instrument to encourage improved building practices. TCIP organizational structure According to (Yazici, 2002) and as shown in Figure 3.1, some important characteristics of the TCIP s organizational structure are as follows: The accumulated fund is administered independently from the government s budget to eliminate the risk of the fund diverted to other purposes; The TCIP is administered by a Board with representatives from the public and private sectors; The operational manager is a leading reinsurance company in Turkey (Milli Re); Private insurance companies market the compulsory policies on a commission basis of 15 percent; Insurance companies cede all premiums and risk to the TCIP; Reinsurance brokers provide part of the backup for the system; There is an independent manager of the fund s assets; A public relations company will communicate information on the system to the public; Claims are assessed by independent loss adjusters; Voluntary coverage in excess of the TCIP is provided by insurance companies; Figure 3.1: The organizational structure of the TCIP 2

3 TCIP Cover The system in this early stage is rather limited in its cover. Some of the important characteristics are as follows: The TCIP covers only residential building that fall within the borders of a municipality, ie no commercial or rural coverage; Earthquake insurance is a stand-alone product, which means it is sold separately from standard fire and homeowner s insurance; The policies also cover the additional risks of earthquakes, including fire, explosion and landslides; There are strict limits on the cover, currently at about USD 25,000 per dwelling. There is no coverage for contents of buildings; The deductible is 2% of the insured sum, meaning that the property owner will pay the first 2 percent of losses. Enforcement Through this program, the government fully intends to reduce its obligations for supporting apartment and homeowners in rebuilding their buildings after an earthquake. According to law, there will be no government compensation in the form of housing credits or reconstruction of damaged buildings. The obligatory policies will be enforced by requiring homeowners to present their insurance documents for any real estate transactions and also when opening an account for water, natural gas, electricity and telecom services. Pricing and Backup The pricing of the premiums takes account of the balance necessary to ensure the affordability of the policies and also promote incentives for mitigation measures. For the latter purpose the premiums are set according to the risk of the dwelling. Housing with steel frames located in low seismic-hazard zones pay the lowest premiums, whereas masonry structures in high seismichazard zones pay the highest. The average premium is now US$ 22 per annum. However, these risk-based premiums do not entirely reflect actuarial risk. Those in low-risk areas pay more than the actuarial risk value, and the opposite is the case for residents in high-risk areas. These cross subsidies make insurance more affordable to poor homeowners in high-risk zones. The payment of premium does not, however, ensure the viability of the system. An event can occur before premiums have accumulated to cover claims, or an event can occur that is more damaging than expected. In either case, catastrophe funds must have a backup system to provide the necessary capital. This can take several forms, including: traditional reinsurance, usually covering some excess of loss structure, where certain loss layers are absorbed by insurers; swaps, where funds or insurers operating in independent geographical locations exchange their policies, contingent credit arrangements, where funds are guaranteed loans at a pre-arranged interest rate, or catastrophe bond, which is an instrument whereby the investor receives an abovemarket return when a specific catastrophe does not occur, but shares the insurer s or government s losses by sacrificing interest or principal following the event. These arrangements for post-event capital have associated costs, sometimes substantial, which will be passed on in higher premiums to policyholders. This is one of the reasons that insurance systems may not be affordable in low-income countries. 3

4 The unique role of the international community The TCIP has to an important extent circumvented commercial reinsurance by ceding part of its risk to an international entity. In this case, the World Bank will absorb or partially absorb three layers of the risks through a contingent loan facility offering favorable conditions. These layers are shown on Figure 2 (Andersen, 2001). At the lowest layer, the World Bank has provided US$ 15 million as a startup for the fund. In each of the three layers up to USD75 million, the World Bank will absorb a fixed percentage of losses, above which the TCIP will be responsible. Figure 3.2: Financing structure of the TCIP Current status of the TCIP To date, the penetration of earthquake insurance is about 17% of dwellings. This is up from 5% and 7% before and after the 1999 earthquake, respectively. This means about 2 million policies, insuring a sum of around US$ 27 billion. The goal of the TCIP is to increase cover to 60% by The fund, however, has been criticized in that it makes no allowance for directly financing loss-reduction measures (Balamir, 2002). The system is not, however, without problems. It is necessary for the Turkish parliament to pass follow up legislation in order to the conditions of the TCIP, including mandatory insurance. To date, the parliament has not passed this legislation. Without the long-term perspective of obligatory insurance, many homeowners are canceling their policies. The system will depend on political will for its implementation. 3.3 Democratic process: A need for a stakeholder approach? The complexities and technical details of financing catastrophic risk can easily conceal that any insurance arrangement is embedded in a social/political system and entails value judgments about who bears the risks and benefits, and who decides. In contrast to the expert-designed 4

5 Turkish Catastrophe Insurance Pool (TCIP), which is encountering difficulties in the Turkish parliament, a study carried out to advice Hungarian policy makers on a nationwide insurance program took account of the contending views of the flood insurance problem and its solution held by the Hungarian stakeholders(linnerooth-bayer, et al., 2002). The stakeholders include the public, the local authorities, the government ministries and private insurers. Renn et al. (1995) define public participation as the forums of exchange that are organized for the purpose of facilitating communication between government, citizens, stakeholders and interest groups, and businesses regarding a specific issue or problem (p.2). The Hungarian participatory approach to recommend a design of a flood insurance program included extensive interviews with the stakeholders, a public survey to 400 persons in the risk and non-risk community and a stakeholder workshop, where consensus was reached on the role of the government, insurers and local area residents. The process was aided by a simulation, catastrophe model that demonstrated how future flood losses would be distributed among the victims, the government and the insurers depending on the design of the pool. The consensus reached by the Hungarian stakeholders was similar, and at the same time importantly different, to that reached by World Bank experts and Turkish policy makers on the design of the TCIP. The Hungarian stakeholders agreed to a radical change in current practices. Like the TCIP, only insured flood victims would be eligible for additional public financial support in the aftermath of a catastrophe. In contrast to Turkey, however, disaster insurance in Hungary would be private, voluntary and not risk based. The stakeholders, including the insurance and government representatives, agreed on a public-private flood insurance system that would provide support for vulnerable regions, including subsidized premiums for low-income households and nation-wide cross-subsidized premiums. Many Hungarians showed a strong preference for social solidarity, even if this meant reduced incentives for loss reduction on the part of individuals and municipalities, balanced with a view that the government play a large role in loss reduction (similar to the French insurance system). While the results of the Hungarian study cannot be transplanted to Turkey, it raises the question whether the Turkish policy makers and parliamentarians might have benefited from early involvement of the stakeholders in discussions on the design of the TCIP. Discussion questions Does your country have a program for transferring the risks of disasters to private households, farms and other businesses? If not, are there insights from Turkey that would be relevant for your country? In light of the political and social context in your country, what changes, in your opinion, might be needed for the design of a public-private insurance system? If such a system is not relevant for your country, what might be low-cost alternatives for reducing the financial vulnerability of urban and rural dwellers to catastrophic natural events? How might citizens and stakeholders be involved in the decision process for reducing and sharing the losses from disasters? References Andersen, Torben J. (2001). Applications of New Risk Transfer Instruments, Paper presented at workshop on Innovative Financial Instruments for Natural Disaster Risk Management, IDB, Erdik, Mustafa (2002). Earthquake Risk Assessment for Istanbul Metropolitan Area, Proceedings, Second Annual IIASA-DPRI Meeting on INTEGRATED DISASTER RISK MANAGEMENT: Megacity Vulnerability and Resilience, IIASA, A-2361 Laxenburg, Austria, July Gurenko, Eugene (2000). The Role of World Bank in Supporting Turkish Catastrophe Insurance Pool. World Bank Conference "Innovations in Managing Catastrophic Risks." Washington DC, January 8-10,

6 Linnerooth-Bayer, Joanne, Anna Vári and Zoltan Ferencz (2001). Stakeholder Views on Flood Risk Management in Hungary s Upper Tisza Basin, In Linnerooth-Bayer J. and A. Amendola, Special Edition on Flood Risks in Europe, Risk Analysis, 23: Renn, Ortwin and Thomas Webler (1995), A Brief primer on Participation. Philosophy and Practice in Ortwin Renn, Thomas Webler, and Peter Wiedemann (1995), Fairness and Competence in Citizen Participation: Evaluating Models for Environmental Discourse, Dordrecht, Kluwer. Yazici, Selamet (2002). The Turkish Catastrophe Insurance Pool, Presentation, Istanbul. 6