Evie Calcutt considers the actuarys role in helping developing countries to build decision-making capacity for financial protection against disasters.
The number of extreme natural disaster events is on the rise. In 2017 alone, the economic losses from such events reached $340bn, as is shown in Figure 1. The frequency and severity of such events is only expected to increase as the climate changes, and although we do not know exactly when catastrophes will strike, evidence shows that the most vulnerable in society are disproportionately affected when they do.
If governments, policymakers and other experts are proactive in planning for such events before they occur, however, they can help prevent extreme natural disasters from turning into human and economic disasters.
The UK government works to support countries in the developing world as they seek to increase their resilience to global challenges, including natural disasters. The Centre for Global Disaster Protection (the Centre), announced by prime minister Theresa May in July 2017, brings developing countries together with partners including the government, the World Bank, civil society and the private sector. The Centre's goal is to enhance financial resilience to climate shocks and disasters, enabling sustainable economic development and protecting the lives and livelihoods of vulnerable people.
Actuaries are expected to play an active part in the Centre's business, applying their experience and technical training in insurance and risk management to the growing area of disaster risk finance.
The UK insurance industry's role
Developing countries in Africa, Asia, Latin America and the Caribbean are vulnerable to natural disasters such as earthquakes, hurricanes, typhoons, droughts and floods, which leave lasting devastation. A recent study, funded by the Centre and performed by risk modeller RMS in collaboration with Lloyds of London, revealed that the annual average economic loss from natural disasters for 77 low and low-middle income countries is US$29bn, increasing to US$47bn at the 90th percentile.
When financing for these options, there is a choice: funds can be arranged in advance of the disaster and drawn on as required ('pre-planned or 'ex-ante' financing), or they can be arranged after the event ('post-disaster' or 'ex-post' financing). Figure 2 highlights the types of instruments and tools that can be put in place as either pre-planned or post-disaster financing. One such pre-planned solution is market-based risk transfer - i.e. the use of insurance and reinsurance markets.
Currently, losses from natural disasters in low and low-middle income countries are largely uninsured. In consequence, the recovery of the costs is arranged post-disaster, with a significant dependency on humanitarian aid - which can be slow to materialise, leading to higher overall costs.
There is, however, a substantial opportunity for financing instruments such as insurance to be used to transfer risk from those who cannot bear it to those who can, while protecting development and promoting preparedness and resilience. One of the Centre's objectives is to support further innovation and growth in this market so that appropriate and affordable risk cover can be provided.
It is worth noting that successful risk financing is about much more than just insurance payouts. Any financial solution needs to be considered as part of a comprehensive disaster risk finance strategy that sets out pre-disaster plans, triggers and finance.
The role of actuaries
Actuaries can contribute to the discussion on disaster risk finance using their experience in financial and risk management to help governments and policymakers with complex issues, especially where long-term risk and uncertainty feature most heavily.The Centre plans to provide training to the governments of developing countries to build capacity, and actuaries can help support this effort by educating on complex concepts, such as risk transfer.
Actuaries from the UK Government Actuary's Department (GAD) have already started working with developing countries, building their understanding of the practical and political considerations that need to be considered when providing advice on this topic. GAD currently has actuaries seconded to the Centre, and Colin Wilson, deputy government actuary and past president of the IFoA, is on the Board of the Centre.
The UK government is a world leader on this agenda and a backer of the Sustainable Development Goals (SDGs) as adopted by the UN General Assembly in 2015. Its work to end extreme poverty will need the best from the UK public and private sector to work together.
The IFoA's SDG campaign reflects its desire to harness the expertise of actuaries to further identify and explore opportunities for meeting the SDGs. The IFoA will hold a webinar, and a workshop, later this year where the role for actuaries will be explored. For actuaries who are interested, there will be opportunities to get involved and make a difference. For details about the campaign, click here.
Case study: actuaries working in development
GAD undertook a research project with the World Bank to evaluate various mechanisms for disaster risk financing. The research was aimed at sovereign stakeholders in developing countries as well as international development organisations, including the UK Department for International Development (DFID). The focus was on providing stakeholders with a methodology to evaluate disaster risk financing instruments, along with practical examples. An analytical framework was used to compare the costs of financing a spectrum of potential disasters through various instruments, including contingency funds, contingent credit facilities, budget reallocation, humanitarian assistance and insurance placement.
Figure 3 shows an example of the analysis, comparing three primary hypothetical risk strategies to finance post-drought disaster expenditures for a specified developing country. The initial instrument in all strategies is the federal contingency budget, which must be exhausted before other instruments can be applied. Additionally, unlimited humanitarian assistance is always assumed to be available as a last resort. The base case, Strategy A, includes only these instruments (contingency budget and humanitarian assistance). Strategies B and C consider a layer of insurance and budget reallocation, respectively, between the layers of contingency budget and humanitarian assistance. The research demonstrated that insurance (strategy B) can be a cost-effective financing mechanism, it being the cheapest on average as insurance effectively costs less than humanitarian response. The cost savings of insurance rise for more severe droughts, as the one-in-five-year and one-in-30-year costs clearly demonstrate.
Evie Calcutt is an actuary in the Insurance and Investment team at the UK Government Actuary's Department.