In the past week, the volatility in financial markets was not the only storm to hit the region: Hurricane Dean, a category 5 wind-storm (the strongest in the scale) wiped through the Caribbean region leaving a trail of human and economic losses across Haití, Dominica, Santa Lucía, República Dominicana, Jamaica and Mexico’s Yucatan peninsula. And a terrible earthquake (it had a magnitude of 7.9 on the Richter scale) devastated coastal areas of Peru.
Unfortunately, this is not the first time…and it won’t be last…Though these natural catastrophes are to a large extent unavoidable, the vulnerable countries in the region are by-and-large not well prepared to deal with the consequences. On the one hand few countries have well-thought and tested disaster preparedness policies: how to evacuate people before a storm, how to get medical supplies to the affected areas, how to deal with the casualties, etc. On the other hand, while the extent of the damage is directly proportional to the size of the population leaving in the most vulnerable areas, few countries have building codes or enforce zoning laws that could help mitigate the damage. Elevated risk exposure and lack of preparation are a serious threat to development and require urgent attention at the national level as well as in donor countries. Unfortunately, there is too much complacency.
At the same time, despite its vulnerability to natural disasters, insurance coverage in the Latin American and Caribbean region is the lowest in the world. Why are catastrophic insurance markets so underdeveloped in the region? Perhaps it is because internal markets don’t have the scale needed to develop such insurance mechanisms. Everyone assumes that when push comes to shove, the government will cover the costs. Why don’t governments buy insurance to minimize the fiscal impact of natural disasters? Perhaps the biggest obstacles are the lack of available instruments at reasonable prices and a resistance to spending money on something so intangible that might not even provide a future benefit. Politicians don’t have many incentives for investing today, when the benefits tomorrow may be enjoyed by another administration.
In a recent joint paper with Eduardo Borensztein and Patricio Valenzuela we discuss the potential benefits of catastrophic risk insurance in the context of the case of Belize, a particularly vulnerable country in the region that was devastated by two hurricanes in the early 2000’s and had to restructure its debt in 2006. But let us not be disingenuous: catastrophic risk insurance isn’t a panacea. Countries that adopt it have to ensure that their regulatory mechanisms allow the government to purchase the insurance without creating disincentives for private agents and sub-national entities. This is key, since the less private insurance that is available, the larger the state’s liabilities and the less effective any level of public insurance.
Quick development of capital markets in this region will create opportunities to diversify financial instruments, including insurance. Nevertheless, governments have to be proactive and understand that a hurricane or earthquake can wipe out decades of investments and push millions of people into poverty. Sitting to wait until the next storm, and hoping for aid to help pay for recovery and reconstruction won’t do any good.