Caribbean Development Bank / Inter-American Development Bank Joint Initiative on Mainstreaming Disaster Risk Management

Transcription

1 Caribbean Development Bank / Inter-American Development Bank Joint Initiative on Mainstreaming Disaster Risk Management REPORT ON THE TECHNICAL WORKSHOP ON THE MANAGEMENT OF DISASTER RISK THROUGH FISCAL AND BUDGET PLANNING JUNE 26 27, 2006, CARIBBEAN DEVELOPMENT BANK, BARBADOS May 2007 This report was produced by Franklin McDonald, Workshop Facilitator, and benefited from input from the presenters at the workshop. Dougal Martin and Cassandra Rogers (of the IDB) edited the report and prepared the executive summary. Nizamuddeen Ameerally and Karen Cummings managed the production of the report on behalf of the CDB. Maria Suarez and Michael Hennessey (IDB) formatted the report.

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3 TABLE OF CONTENTS I. BACKGROUND AND PURPOSE... 1 II. OPENING SESSION... 1 III. TECHNICAL SESSION 1: SOCIOECONOMIC IMPACT OF NATURAL HAZARDS IN THE CARIBBEAN... 3 IV. TECHNICAL SESSION 2: ELEMENTS OF DISASTER RISK MANAGEMENT... 4 V. TECHNICAL SESSION 3: ELEMENTS OF BUDGET AND FINANCIAL PLANNING AND POLICY RELEVANT FOR DISASTER RISK MANAGEMENT... 7 A. Integrating Natural Disasters into Development Planning... 7 B. Ex-Ante Financial Risk Management... 8 C. Planning and Budgeting for Fiscal Risk... 9 D. Political Economy Obstacles to a Forward-Looking and Prudent DRM E. Advances in Fiscal/Budget Planning and Financial Protection Against Natural Hazards in Colombia F. Overview of CATSIM Model (Preparation for Day 2 Working Sessions) VI. TECHNICAL SESSION 4: GROUP EXERCISE A. Overview of Excercise B. Country X (Grenada) Presentation C. Country Y (The Bahamas) Presentation D. Group Z (Jamaica) Presentation E. Discussion VII. CLOSING SESSION A. Next Steps in the Caribbean B. Donor Presentations C. IDB Next Steps D. CDB Next Steps and Closing Remarks... 20

4 LIST OF ABBREVIATIONS BMC CATSIM CDB CDERA CIDA DDI DRR DRM ECLAC IDB IIASA IMF OECS PAHO UNDP UWI Bank Member Countries Catastrophe Simulation Model Caribbean Development Bank Caribbean Disaster Emergency Response Agency Canadian International Development Agency Disaster Deficit Index Disaster Risk Reduction Disaster Risk Management European Commission for Latin America and the Caribbean Inter-American Development Bank International Institute for Applied Systems Analysis International Monetary Fund Organization of Eastern Caribbean States Pan-American Health Organization United Nations Development Programme University of the West Indies

5 EXECUTIVE SUMMARY The Caribbean Development Bank (CDB) and Inter-American Development Bank (IDB) jointly organised and co-hosted a Technical Workshop on the Management of Disaster Risk through Fiscal and Budget Planning from June 26 to 27, The workshop was held at CDB s Headquarters in Barbados. The Technical Workshop brought together some 73 professionals, including permanent secretaries and directors from ministries of finance and planning and national disaster coordinators from 17 member countries of CDB and IDB, development partners and CDB and IDB staff. Dr. Compton Bourne, President of the CDB, and Luis Alberto Moreno, President of the IDB, delivered opening remarks and restated their institutions commitment to mainstreaming disaster risk management (DRM), in order to address the risk of natural disasters in the region. The workshop provided an opportunity to enhance the understanding of senior public sector personnel in finance, planning and in DRM of the processes involved in the integration of DRM in national development strategies, including through the use of practical tools. Among the topics discussed were the socioeconomic impacts of natural hazards and disasters in the Caribbean; policy elements of a DRM framework; key actors in DRM with special reference to the identification of risk bearers (public and private sectors) and their role in financial management of disaster risk and fiscal contingent liabilities; and the elements of budget and financial planning and policy as it relates to DRM, including incorporating disaster losses into macroeconomic projections and the planning process, ex-ante financial risk management, and frameworks and methods for incorporating risk analysis into financial planning, budgeting and accounting. The special problems of implicit liabilities and moral hazard were addressed. Political economy barriers to prudent DRM and Colombia s experience in fiscal and budget planning and financial protection against natural hazards were also highlighted. Participants had the opportunity to develop integrated risk management and financing strategies and associated action plans for three stylized disaster-prone countries in the Caribbean, using an interactive tool that simulates disaster risks in a specified region and examines the ability of a government to finance relief and recovery. Participants were in general agreement that while emergency preparedness and response had been largely mainstreamed into national development planning, there was a sense of urgency for ex-ante DRM to be similarly mainstreamed, as a prerequisite for sustained disaster risk reduction and social and economic development in member countries. It was noted that this required the involvement of all stakeholders and in particular, the inclusion of DRM in fiscal and budget planning. Strong interest was expressed in applying the Catastrophe Simulation Model (CATSIM) at the national level as a capacity building tool, to illustrate the tradeoffs and choices national authorities may confront in increasing their resilience to the risks of catastrophic disasters. In addition, participants were of the view that, while the workshop provided the opportunity for initial exploration of financial instruments, effectively incorporating DRM in fiscal and budget planning agreement required agreement on the part of political directorates. To this end, it was recommended that the interaction be continued at the sub-regional and national level and that the private sector should be included as an integral partner in the dialogue. i

6 Technical Workshop: Executive Summary Improving management of natural disaster risk through fiscal and budget planning: Fiscal and Budget Planning Challenges Growing risk Natural hazards are becoming more frequent and severe in the Caribbean. Disaster losses are growing by 20% per annum, while GNI is growing by only 3-4%. Disasters have negatively impacted the economic performance of Caribbean states and their ability to improve the quality of life on a sustained basis. Existing processes are inadequate Existing planning and budgeting processes are inadequate for preparing for natural disasters or coping with the economic and fiscal upheavals that ensue from them. Governmental decisional making processes generally assume favourable future conditions. Much of government disaster risk liabilities are contingent and implicit. Disasters destabilize the economies and public finances of developing countries to a much greater degree than developed countries. Political economy unfavorable Political incentives act against proactive DRM because activities are invisible and occur in the future while costs are visible and up front. Moral hazard is present both at the national and international levels. Psychological obstacles to rational assessment of probabilities and risk Recent research in psychology and behavioural economics suggests that people have trouble assessing probabilities and risks. This leads to disaster myopia. Managing the Challenges Using a broad framework for DRM A useful framework for DRM considers five policy areas: risk evaluation; mitigation and prevention; financial risk transfer; emergency preparedness and response; rehabilitation; and reconstruction. Earlier emphasis on reactive programmes focused on post-disaster relief has been replaced by proactive activities focusing on risk reduction and management. Clarifying roles and responsibilities Wide range of national and sub-national actors, regional organizations and donors in DRM can be a strength but may also inhibit effective action. Clear definition of who assumes what parts of the risk is needed for effective DRM and to avoid moral hazard problems. Private sector can contribute to DRM through prevention, employee protection, and business continuity systems. Changing the conceptual approach Mainstreaming DRM requires using a probabilistic approach to appropriately represent natural disaster risk. Probability distributions should be derived and integrated with development planning. As disasters are extreme events, average risk metrics, such as the mean or expected value, do not suffice for comprehensive analysis. Volatility (variance) should be accounted for as well. Improving the incorporation of risk into budgeting Economic planning should assess both direct risks (to assets) and indirect risks (to macroeconomic flows). Fiscal risk can be viewed in four categories: (i) direct and explicit; (ii) direct and implicit; (iii) contingent and explicit; and (iv) contingent and implicit. Key needs are to limit the government s fiscal risk, improve budgeting for disaster risk, insure government against disaster risk, and deal with moral hazard. Strengthening financial risk management There are two categories of risk financing instruments available to the Follow Up CATSIM dissemination and use Action 1: Countries should take up IIASA s offer to share the CATSIM software to interested governments and provide technical assistance. Action 2: Data collection, particularly as an input to CATSIM, should be improved. Action 3: CATSIM should be extended to deal with multiple hazards. Utilize available lines of assistance Action 1: Countries should take full advantage of the technical and financial support available from the CDB, IDB and other entities. public sector: temporal risk spreading (reserve funds, contingent credit)and spatial risk spreading (insurance, reinsurance, catastrophe bonds, weather derivatives). The most common form of risk transfer is insurance or reinsurance. Pre-requisites for effective risk transfer and a functioning insurance market are: (i) acceptable quality of risks (building standards, zoning and regional physical planning); and (ii) reduced quantity of risk (incorporation of prevention and mitigation measures). Risk financing instruments have substantial costs (often a multiple of the average losses incurred over a number of years). Careful analysis of the costs and benefits is needed. Risk financing should be explicitly integrated with DRM and risk reduction measures. Overcoming political economy problems Rigorous risk evaluations can assess probabilities and risk in a scientific manner and help to inform decision making. Awareness campaigns and advertising the risks and effects of natural disasters can increase knowledge among societies and affected sectors. International institutions need to be creative in devising measures of national investment in prevention in order to make countries and sectors pre-event efforts more widely known and change political incentives. Noting the example of the Government of Colombia Colombia, which suffers from a variety of natural hazards, is at the forefront of DRM. The Ministry of Finance (MOF) has a Risk Management Unit and systematically analyzes various categories of contingent liability, of which natural disasters are one category. The MOF has estimated the government s total exposure and probable maximum losses for 100, 500, and 1,000 year events. The MOF has a clearly thought-out and explicit financing strategy Action 2: Countries should take full advantage of the technical and financial support available from the CDB, IDB and other entities. Multilateral cooperation Action 1: CDB, IDB and other similar entities should continue to collaborate in the promotion of DRM. Action 2: Teamwork and cooperation are required to address the magnitude of the tasks and challenges. ii

7 Management of Disaster Risk through Fiscal and Budget Planning I. BACKGROUND AND PURPOSE 1.1 As a means of addressing increasing disaster risk in the Caribbean and the potential threat that disaster impacts pose to Caribbean economies and societies, in 2005 the Caribbean Development Bank (CDB) and Inter-American Development Bank (IDB) established a Joint Initiative on Mainstreaming Disaster Risk Management (DRM). This initiative seeks to encourage and support countries in the Region to integrate DRM in their strategic and operational planning, management decisions and processes. 1.2 The first phase of the process consisted of a planning meeting of permanent secretaries in finance and planning and heads of specialised agencies, held at CDB s Headquarters in Barbados in October At that meeting, countries strongly supported the need for DRM mainstreaming and endorsed the CDB/IDB Initiative. 1.3 From June 26 to 27, 2006, the Presidents of the two organizations co-hosted a Technical Workshop on the Management of Disaster Risk through Fiscal and Budget Planning, which was held at CDB s Headquarters in Barbados. The Agenda of the workshop is presented as Appendix 1. Over 70 participants involved in disaster risk reduction and management in the Caribbean attended, including 39 national representatives comprising permanent secretaries and directors responsible for the budget and planning functions in ministries of finance and planning and national disaster coordinators; CDB and IDB staff; and development partners (Appendix 2). 1.4 The purpose of the workshop was: (i) (ii) To enhance the understanding of permanent secretaries of the ministries of finance and of planning, as well as national disaster coordinators, of the processes involved in the integration of disaster risk management in their national budgetary processes and fiscal strategies; and To provide practical tools for their use. 1.5 It was anticipated that at the end of the workshop, participants would possess the knowledge and the practical tools required to facilitate the mainstreaming of natural hazard risk reduction into the annual work plans and policy documents of the public sector. II. OPENING SESSION 2.1 In their opening remarks, both Dr. Compton Bourne, President of the CDB, and Mr. Luis Alberto Moreno, President of the IDB, assigned a high priority to the mainstreaming of disaster risk management and restated the commitment of their respective institutions to the Joint Initiative on Mainstreaming DRM. Both presidents also referred to the need for increased attention to be placed on engaging both the public and private sectors in mainstreaming efforts and urged participants to make strengthening DRM a high priority for individual countries as well as the Region. 2.2 In his Welcome and Opening Remarks Dr. Bourne, issued a special welcome to his IDB counterpart, and noted the high importance being placed on the subject. He alluded to the vulnerability of the CDB Member States and drew attention to the linkage between poverty, environmental degradation and the increasing impact of disasters on the Region. He also noted

8 CDB/IDB Technical Workshop the shift in the Region from reactive measures related to relief towards more strategic proactive interventions related to risk reduction (mitigation and prevention) and risk transfer mechanisms. It was noted that this shift was taking place at both the national and the regional levels with dialogue on a Catastrophe Fund being reinvigorated after Hurricane Ivan in The CDB President noted several common Caribbean issues including poorly planned and under-regulated settlements, squatting, the occupation of vulnerable sites, non-observation of building codes or standards, and under resourced/ineffective physical planning agencies were cited as contributing to the repetitive cycle of economic loss, damage to productive capacity, destruction of housing stock and physical infrastructure too regularly experienced by Caribbean States. Dr. Bourne also pointed out that the states had not made adequate financial provision for hazard mitigation, relief or rehabilitation as few states had paid explicit attention in their budgeting and planning processes to natural hazard risk reduction, or risk management. He concluded by pointing out that these issues had impacted negatively the economic performance of Caribbean states, and reduced their ability to improve the quality of life and achieve economic growth on a sustained basis. 2.4 The workshop, it was pointed out, was a part of a cluster of activities of CDB in association with its regional partners in response to the impacts and lessons of recent events. It drew specific attention to the plight of the smaller Bank member countries (BMC) whose economies were particularly fragile and emphasised the need for greater attention to be paid to loss reduction efforts and the building of resilience in the Region. The important contribution being made by CDB s Disaster Mitigation Facility for the Caribbean since its inception was referred to, as was the need for mainstreaming risk reduction activities in both the public and private sectors. He noted that the workshop was focussing on sharing experiences and practical tools to facilitate the mainstreaming Natural Hazard Risk Reduction into the annual work plans and policy documents of the public sector, through the efforts of the ministry responsible for finance and planning. 2.5 Mr. Luis Alberto Moreno in his remarks also emphasised that the presence of both presidents indicated the extreme seriousness of the subject, and urged that mainstreaming at all levels be taken very seriously. He reiterated that the immediate aim of the workshop was to showcase and demonstrate practical measures (tools and methods) of value in core government systems, and to share lessons learnt. The need for proactive approaches and direction as the basis for sound and effective budget decision-making in disaster situations was emphasized as a lesson emerging from the many disaster and crisis situations encountered by nations in the hemisphere. It was pointed out that strengthening DRM had to be a top priority for the entire region, and that the IDB was committed to strengthening the capacity of Caribbean governments to managing disaster risk, and protect and expand hard-won development gains. 2.6 The IDB President reinforced the link between poverty and disasters, pointing out that the poor are more likely to live in disaster prone areas, and less likely to have the means - such as savings and insurance to deal with disaster impacts. The experience of the IDB in assisting its members in responding to the direct and indirect costs of natural disaster was cited, and the specific challenges (compared to a balancing act) to the national budget management and planning apparatus referred to. It was pointed out that over the past 25 years, natural hazards in the Caribbean alone have cost over US$8 billion in direct damages and possibly the same amount in indirect losses. 2.7 President Moreno pointed out that the IDB had many relevant initiatives that would be discussed throughout the meeting. Most recently he highlighted the launch of a disaster prevention fund for strategic interventions for disaster prevention, and that he was also launching an innovative 2

9 Management of Disaster Risk through Fiscal and Budget Planning partnership with the Caribbean Disaster Emergency Response Agency (CDERA) for DRM related to sustainable tourism in the region. 2.8 The opening session was followed by three technical sessions on Day 1. III. TECHNICAL SESSION 1: SOCIOECONOMIC IMPACT OF NATURAL HAZARDS IN THE CARIBBEAN 3.1 Mr. Ricardo Zapata, of the Economic Commission for Latin America and the Caribbean (ECLAC), had been invited to review the direct and indirect impacts of natural hazards and their implications for macroeconomic performance in the Caribbean. He presented a comprehensive overview of ECLAC's experiences in responding to the impacts of the wide range of hazards that threaten life, limb, property, infrastructure, livelihoods and sustainability in the Region. He confirmed that there was an urgent need to fully develop emergency management capacities and the appropriate capacities and systems for timely assessment of the direct and indirect costs of natural hazard impacts. 3.2 He pointed out the linkages with macroeconomic and sectoral performance, and the implications for revenue projections, economic performance, inflation, balance of payments and public sector financing. He drew many examples from the recent events in the Region and from the lessons learned from using ECLAC's methodology for post-disaster impact assessment, and their efforts at capacity building. 3.3 The increases in population in Latin America and the Caribbean, he noted, had in general coincided with a reduction in the number of disaster related casualties. This reflected improvements in the early warning system, particularly those related to meteorological events. At the same time economic impact of disasters over the last 25 years had significantly increased. He indicated that the annual average direct and indirect damages due to extreme events in the hemisphere was almost US$6.5 billion, and that in 2005 the cost to the Mexican economy of three hurricanes was estimated to be US$4.6 billion. 3.4 Mr. Zapata pointed out that these data suggest an urgent need for more attention to be focussed on risk reduction, and that the responsibility was not confined to the state sector. The important role of community action, genuine engagement of the private sector and the role of social and cultural mechanisms were strongly emphasized. 3.5 He explored risk transfer issues and pointed out that local, national and international levels of risk transfer were all required. He reinforced the point made by others regarding the strong correlation between exposure to risk and persistent poverty, citing the direct linkage between vulnerability and poverty, marginalization, and gender/ethnicity. 3.6 Mr. Zapata ended by noting that the data being cited was from Latin America, with very little data and information from the Caribbean islands. He encouraged the meeting to examine means of improving the collection of such data for future assessments. 3.7 Dr. Len Ishmael, Director General of the Organisation of Eastern Caribbean States (OECS), had been invited to present highlights of the socioeconomic impacts caused by recent disaster events in the OECS. Unfortunately, due to a conflicting engagement, she was unable to attend the workshop. 3

10 CDB/IDB Technical Workshop IV. TECHNICAL SESSION 2: ELEMENTS OF DISASTER RISK MANAGEMENT 4.1 This technical session provided an overview on the fundamental elements of DRM in order to acquaint fiscal and planning policymakers with the subject and to allow them to understand where their role would fit in. 4.2 Dr. Cassandra Rogers of the CDB reviewed five primary policy elements of a risk management framework: risk evaluation; mitigation and prevention; financial risk transfer; emergency preparedness and response; rehabilitation and reconstruction. She traced the evolution and progress of efforts in Caribbean societies over the years to manage their vulnerability and the exposure of the Region to multiple hazards and noted that earlier reactive programmes focused on post-disaster relief had been replaced by proactive strategic initiatives and activities focussing on risk reduction and management. 4.3 She emphasised the clear linkage between disasters, development and poverty, citing studies done by multilateral agencies, including the United Nations Development Programme (UNDP), which indicated that disasters placed at risk natural and human capital, as well as the region s social and economic development targets. She indicated that among risk transfer, mechanisms and options available to Caribbean states were: i. Insurance/re-insurance of public infrastructure and private assets. ii. iii. iv. Financial market instruments e.g. catastrophe bonds. Privatization of selected public services [with safety regulations]. Calamity funds. 4.4 Dr. Rogers provided a brief but comprehensive description of CDB s policy and strategic initiatives in proactive DRM, being implemented under the CDB/USAID Disaster Mitigation Facility for the Caribbean. These included the mainstreaming of DRM into national development planning, the development of a model Disaster Risk Reduction (DRR) policy for the Caribbean, national DRR policies (in five of the BMCs); hazard mitigation plans; national digital databases for hazard mapping/vulnerability assessments; production of hazard maps and vulnerability assessments; legislative reviews and capability assessments for disaster mitigation; capacity building in hazard mapping and vulnerability assessment; and training courses in DRM. Other related activities included the completion of a Sourcebook on Integrating Natural Hazards into the Environmental Impact Assessment Process (the NHIA-EIA Sourcebook) and regional training in its use; facilitating regional fora on mainstreaming DRM in national development planning (targeting Physical Planners, National Disaster Coordinators); and mainstreaming DRM in fiscal and budget planning (the current activity). 4.5 Future planned activities cited by Dr. Rogers included for 2006: the proposed establishment of a permanent focal point for DRR and in 2007, revision of CDB s Natural Disaster Management Strategy. 4.6 Dr. Keipi, of the IDB, addressed the issue of Disaster Risk Reduction and Financial Protection and he sought to pose and respond to the question of ''who bears the risk and who pays?''. 4

11 Management of Disaster Risk through Fiscal and Budget Planning 4.7 He emphasised that the participants were drawn from agencies with an ''imperative of reducing risk'' since the region was facing increasing fiscal and budgetary ''gaps'' to finance the disaster losses being experienced. These recurring ''gaps'' were demonstrating that the Region s traditional focus on a ''reactive'' mode (emphasizing emergency response and reconstruction) was in fact unsustainable. He indicated that disaster losses had had annual growth rates of 20% since 1980, while GNP growth has been [averaging] only 3-4% per year for the same period. The solution proposed by the IDB is to improve integrated risk financing, combining the reduction of risk with the ex-ante financing of residual risk. Appropriate and strategic investments in prevention were therefore needed to break the vicious cycle of disasters and their impact on the vulnerable economies and societies of the Caribbean. 4.8 He described in detail work done in developing methods and tools for assessing the resource gap to finance reconstruction - the Disaster Deficit Index (DDI). Using the methodology he indicated results of case studies of Jamaica and Trinidad and Tobago. These indicated that the DDI for Jamaica is >1, i.e. there are not enough resources to cover a 100 year event (with a gap of 70%); Trinidad and Tobago, he showed, was better off. 4.9 Despite rising awareness and some progress, Caribbean countries are not adequately addressing the risk disasters pose to development. Some of the challenges to risk management include: i. Disaster prevention is considered a cost, not an investment. ii. iii. iv. Incentives that shape both government and private behaviour, do not favour vulnerability reduction; in the case of governments, the short political cycle (4 to 5 years) is a disincentive. Governments seldom have a well-established financing plan for contingent disaster liability. Risk is not adequately transferred through insurance in most Caribbean states The unusually wide range of national and sub-national actors, regional organisations and donors in DRM was also indicated as a factor that may inhibit effective action. These actors include: (i) ministries of central/national government (finance and planning, interior/defence/national security, health, education, environment, tourism, industry, energy, agriculture, public works, local government); (ii) municipalities/townships; (iii) civil society (community organisations, the general public); (iv) the commercial private sector; (v) financial sector; (vi) media; (vii) academia; (viii) humanitarian organisations; (ix) bilateral donors; (x) multilateral entities; and (xi) regional organisations (CDERA, OECS, Caribbean Community Climate Change Centre, universities, etc) With regard to the matter of ''moral hazard'' and its avoidance, it was indicated that an imperative in risk reduction and ex-ante risk financing is a clear definition of who assumes what parts of the risk and that if no such definitions exist, every one will have an incentive to try to pass on the reconstruction bill. In addition, the inherent moral hazard problem of relying on ex-post help by others was alluded to, as in such cases there is no incentive to undertake activities to mitigate future events It was suggested that progressive modern governments, their state machinery and agencies should avoid policies that create or contribute to the moral hazard problem. Hence, the state should seek 5

12 CDB/IDB Technical Workshop to define what part of any risks it will NOT cover for the private sector, as part of an integrated risk financing strategy Along the same lines, the potential role of corporate social responsibility of the private business sector was explored, and it was suggested that where the risk bearer is clearly identified, private businesses will have an incentive to contribute to risk reduction and management through prevention, employee protection, business continuity systems, etc Several potential areas for the private sector contribution were cited as the response phase, employee rescue (and welfare), philanthropy with humanitarian entities, support to emergency action by the state, participation in reconstruction finance. Such private sector contributions were capable of being influenced by Government providing incentives to private risk reduction measures. It was pointed out that these could provide an increased safety net for the poor, reduce the burden on government resources, and increase the states abilities to finance reconstruction of their own assets Two main prerequisites for effective risk transfer and a functioning insurance market were pointed out: (i) acceptable quality of risks (building standards, zoning regional physical planning, awareness, regulations and control); and (ii) reduced quantity of risk (incorporation of prevention and mitigation measures). It was suggested that the insurance market may abstain from covering risks perceived to be too high, if basic risk management is not in place. The still poorly quantified exposure data in much of the Caribbean, especially data related to flood and storm surge exposure, and suitable hazard models and credible scenarios were referred to as needs to be addressed. The case of Jamaica was paraphrased and factors such as majority of housing is not covered either because they are not insurable due to inadequate quality or quantity of risk or not insured because of lack of agreement among the insurers and the clients on the price of the coverage Dr. Keipi gave several suggestions to be followed if the current vicious cycle was to be broken including: i. The imperative of reducing risk through prevention - choosing right instruments. ii. iii. iv. The governments defining their own liability and risks the state will NOT cover. Mainstreaming management of contingent liabilities of government in fiscal and budget planning. Businesses must practice corporate social responsibility. v. Strengthening risk transfer through local insurance industry and making use of opportunities in international insurance and capital markets Several IDB initiatives, including its policies, programmes, regional dialogue processes, and national engagement with governments and non-state stakeholders within countries were briefly indicated. The current regional programming paper, which includes DRM as an important action item for the region, was highlighted as being available to facilitate DRM initiatives in the IDB and CDB member countries. Examples of country risk evaluation actions currently underway were given, including the Jamaica pilot, and an indicators programme for Trinidad and Tobago. Proposals under discussion, including efforts to prioritise countries at high risk from impacts, adjusting country strategies to ensure that the development agenda in high risk countries 6

13 Management of Disaster Risk through Fiscal and Budget Planning adequately incorporates risk management, and evaluation of institutional capacity were mentioned It was pointed out that the IDB had also taken note of some specific challenges, including: i. The weak demand for disaster prevention by countries (notable exceptions to this have included The Bahamas, Haiti and the Dominican Republic). ii. iii. iv. The need to improve coordination (between countries and donors) of regional programs to address disaster risk in an inter-related world. Use of disaster indicators and country risk assessments for country strategies and programming. Provision of financing for prevention and response Several financial instruments available through the IDB were described as being suitable for utilisation before, during and after emergencies, and information on IDB Disaster Prevention Fund with grant financing up to US$1 million was provided. It was reiterated that the IDB is willing to work with all the regional and national players to tackle and meet the significant challenge of mainstreaming DRM. V. TECHNICAL SESSION 3: ELEMENTS OF BUDGET AND FINANCIAL PLANNING AND POLICY RELEVANT FOR DISASTER RISK MANAGEMENT 5.1 Session 3 represented the core of the workshop and was designed to facilitate participants efforts at integrating disaster risk into budget and financial planning. It also set the stage for the working group exercises in Session 4. A. Integrating Natural Disasters into Development Planning 5.2 Dr. Reinhard Mechler of the International Institute for Applied Systems Analysis (IIASA) gave a presentation on the subject of Integrating Natural Disasters into Development Planning. He first outlined the need for mainstreaming disaster risk into development planning in hazard-prone countries. Concrete insights into how to mainstream risk into national development planning was provided, via a discussion of the IIASA CATSIM model. By probabilistically incorporating direct disaster risk into macroeconomic projections (as losses of assets or capital stock), economic consequences can be analyzed on variables such as economic growth, the fiscal position, the distribution of income and the prevalence of poverty in the aftermath of a disaster as well as assessing potential financing gaps for funding disaster-induced losses. 5.3 The presentation ended with emphasizing three important issues to consider when mainstreaming disaster risks: i. First, there is a need to use a probabilistic approach to appropriately represent natural disaster risk. Probability distributions should be derived and integrated with development planning. 7

14 CDB/IDB Technical Workshop ii. iii. Second, for economic planning it is crucial to assess both direct risks to assets (stock impacts) and indirect and macroeconomic risks on economic flows. Finally, as disasters are extreme events, average risk metrics such as the mean or expected value, do not suffice for a comprehensive analysis, but the volatility (for example, represented by the variance) should be accounted for as well. 5.4 In the discussion following the presentation, one question focused on the role of climate change and its representation in CATSIM. In CATSIM, climate change impacts on the intensity and frequency of weather-related extreme events can be accounted for by altering the probability distributions for the direct risks. Another question was on model availability. IIASA will make CATSIM available free of charge to participants of the workshop and others interested. B. Ex-Ante Financial Risk Management 5.5 Dr. Mechler s presentation on Ex-ante Financial Risk Management focused on ex-ante financial risk management options for the public sector. First, the rationale and need for risk financing for the public sector was presented. In contrast to wealthy countries, developing country governments often face post-disaster deficits for their contingent liabilities of financing relief and reconstruction, which can have serious effects on their long-term development, and their ability to finance needed social and economic programs. 5.6 Historically, developing countries governments have had to resort to ex-post financing by diverting from the budget, or already disbursed development loans, as well as by relying on new loans and donations from the international community. Furthermore, those resources have often been insufficient, are associated with a time lag and do not provide incentives for risk reduction. As a consequence, in recent years, in line with a general paradigm shift from ex-post disaster management to ex-ante risk management, the pro-active financing of disaster risks has become an important cornerstone for tackling the substantial and increasing effects of natural disasters. 5.7 Different risk financing instruments are available for public sector risk hedging, falling into two categories: spatial risk spreading (insurance, reinsurance, catastrophe bonds, weather derivatives) and temporal risk spreading (reserve funds, contingent credit). One instrument popular among the public sector in a substantial number of countries is a reserve fund, that holds liquid capital to be used in the event of a disaster. Normally, such a fund is financed on an annual basis, so that capital can accumulate in years without catastrophes and then can be used in the case of an event to finance the losses. 5.8 For example, in Mexico a catastrophe reserve fund filled with the remaining funds from an annual budget for disaster management has been set up to pay for Mexico s post-disaster liabilities of providing relief to the poor and to undertake reconstruction of affected or lost public assets in the case of more extreme disaster events, where annual budgeted amounts would not suffice. 5.9 A contingent credit arrangement also spreads risk temporarily rather than transfer it. In exchange for an annual fee, the right is obtained to take out a specific loan amount post-event that has to be repaid at contractually fixed conditions. Recently, Colombia has arranged such a transaction with the World Bank The most common form of risk transfer is insurance or reinsurance, (the latter is used when large risk portfolios are to be pooled internationally), which provide cover against losses in exchange for a premium payment. 8

15 Management of Disaster Risk through Fiscal and Budget Planning 5.11 The objective of the proposed Caribbean Catastrophe Insurance Facility is to provide coverage to Government treasuries for extreme events. In the form currently proposed, the facility will pool risks over Caribbean countries, develop a reserve fund to pay for more frequent losses, and purchase reinsurance or alternative reinsurance instruments in the market for extreme events. Initially, donor contributions would assist with setting up a viable reserve fund. Whereas traditionally, insurance and reinsurance have been indemnity-based (i.e. related to the actual losses incurred), in recent years derivatives have been offered in the market, where the claim payment is associated with a physical trigger of an index of losses. One interesting application of a contract based on a physical trigger, was the purchase in 2005 of cover for possible relief spending for drought-exposed smallholders in Ethiopia, by the World Food Programme Another novel instrument is a catastrophe bond, that pays high yields, but interest and/or principal may default if a specified catastrophe event occurs during the lifetime of the bond. Catastrophe bonds are rather new and have until recently been issued only by insurance companies. Recently, Mexico as a sovereign entity has transferred part of its public sector catastrophe risk (beyond the capability of the reserve fund), via a mix of catastrophe bond and reinsurance The talk ended with flagging key challenges for government risk financing. One is the substantial cost of risk financing instruments. Often the costs can amount to a multiple of the average losses incurred over a number of years, creating important opportunity cost, as these funds are not available for social programs or infrastructure. Careful analysis of the costs and benefits is needed when considering implementing risk-financing instruments. Another important issue is the current lack of and need for explicit integration of risk financing, with a disaster risk management framework and risk reduction measures. C. Planning and Budgeting for Fiscal Risk 5.14 Prof. Allen Schick of the University of Maryland, one of the leading academics in the field, made a provocative presentation on Planning, Budgeting and Accounting for Fiscal Risks: Framework and Methods for Incorporating Risk Analysis into Financial Planning, Budgeting and Accounting for Government, in which he also explored the issues of implicit liabilities and the moral hazard challenges. He elaborated four categories of fiscal risk: (i) direct and explicit; (ii) direct and implicit; (iii) contingent and explicit; and (iv) contingent and implicit Prof. Schick pointed out that current planning and budgeting processes are generally inadequate for preparing for natural disasters, or coping with the economic and fiscal upheavals that ensue from them. Government decisional processes generally assume that future conditions will be favorable. In general, they do not plan for economic downturns, adverse changes in interest or exchange rates, or shocks such as natural disasters. In addition, governments tended to favor allocation of financial resources to pay for direct liabilities, such as the salaries of teachers and the expenses of operating health clinics, not for contingent liabilities, such as those that might emerge after disaster strikes. A third, related problem explored by Prof. Schick was that many of the costs of responding to disasters are implicit rather than explicit liabilities of government. That is, government has no explicit statutory or contractual obligation to aid firms or households injured by disasters, but it often is impelled to do so. Planning and budgeting for implicit liabilities expose governments to moral hazard by giving businesses and households incentives to take greater risks, such as locating in flood-prone areas Such problems have the potential according to Prof. Schick to destabilize the economies and public finances of developing countries to a much greater degree than those of the developed countries. In contrast to developed countries, which finance recovery from natural disasters by 9

16 CDB/IDB Technical Workshop borrowing at low interest rates, less developed countries often have to redo their budgets during the fiscal year to free up resources to rebuild infrastructure or assist victims of disasters. Often they must curtail planned social or investment expenditure, in order to cover the unbudgeted costs of disasters Prof. Schick concluded that the sensitizing of participants to their countries exposure to the ravages of hurricanes and floods, could lead to the eventual devising and acceptance of new planning and budgeting instruments, to deal with these recurrent events. Key needs are to: (i) limit the government s fiscal risk; (ii) improve budgeting for disaster risk; (iii) insure government against disaster risk; and (iv) deal with moral hazard. D. Political Economy Obstacles to a Forward-Looking and Prudent DRM 5.18 Ms. Marcela Tarazona-Gómez of the University of Toulouse explored the political economy obstacles to implementing a forward looking and prudent DRM. A central issue is the contradiction between the growing evidence that disaster prevention is economically and socially superior to responding after a disaster on the one hand, and the reality that most DRM measures are taken ex-post on the other hand. This is generally assumed to stem from a lack of awareness on the part of policymakers and the public. However, Ms. Tarazona-Gómez suggested that there might be deeper explanations for this contradiction. Specifically, political incentives and problems with behavioral decision-making may be the root problems Political incentive problems are threefold. First, disaster prevention activities are largely invisible whereas ex-post disaster response and alternative projects are visible. Consequently, voters are unlikely to reward politicians for good management. Second, the timing of costs and benefits is politically unattractive. The costs of prevention are immediate and certain whereas benefits come in an uncertain future. Moreover, if the future event does not occur, the value of the money spent to protect against the event looks lost. Politically unstable countries where policy-makers use high implicit discount rates are especially likely to prioritize short-term projects rather than prevention. Third, the presence of international aid creates a moral hazard and reduces the incentive for countries to invest in prevention because they know they have the possibility to receive financial aid for reconstruction and rehabilitation from international donors and lending agencies In addition, a growing quantity of research (largely in the fields of psychology and behavioural economics) suggests that individuals are not fully rational and have trouble assessing probabilities and risks. People tend to over-estimate low probability risks, under-estimate high probability risks, anticipate correlation where there is none, and extrapolate from the recent past. People also tend to be systematically over-optimistic. All of these factors lead to disaster myopia. Furthermore, because individuals use similar heuristics in the face of risky situations, these heuristics may generate systematic biases in populations Based on the comments made during and after the session, many participants in the workshop indicated that they found it difficult to overcome the political economy problems presented on their own. Both political and behavioural explanations work to reduce the incentives of policy - makers to invest in prevention. Some solutions to these problems were mentioned. They all have in common the fact that awareness of the population needs to be increased, as well as the quality and amount of information provided to policy makers and the international community. Countries therefore need to elaborate risk-evaluations and related strategies, adapt their policies to these newly understood risk based needs, and also actively create appropriate incentives, for example a national measure of investment in prevention, to reward countries and sectors for pre-event efforts to reduce post event dislocations. 10

17 Management of Disaster Risk through Fiscal and Budget Planning 5.22 Ms. Tarazona-Gómez threw out the challenge of How to break the vicious cycle to the participants. She presented ideas and approaches aimed at tackling and overcoming the political economy and behavioral obstacles, and incorporating forward looking and prudent DRM measures into governmental budget processes. The growing devastating effects of natural disasters have raised awareness of governments and exposed populations. However, much more attention should be paid to awareness raising campaigns, explaining and advertising the risk and effects of natural disasters, in order to increase knowledge among societies and affected sectors. This is essential to change the perception and behavior that appears to be internalized by policymakers and populations. She quoted the IDB (2006), when the important and clear links to development are recognized, incentives opposing ex-ante prevention and competing investment priorities can be overcome. E. Advances in Fiscal/Budget Planning and Financial Protection Against Natural Hazards in Colombia 5.23 Mr. Jaime Holguín, Risk Manager of the Ministry of Finance and Public Credit of Columbia, explained how his ministry had approached risk related matters and shared many practical experiences with his counterparts from the Caribbean ministries of finance. He showed that his ministry systematically analyzed various categories of contingent liability, of which natural disasters are one category. Colombia has suffered from different types and different intensity events since 1970 with cumulative deaths between 1970 and 2000 estimated at 38,212 and cumulative damage estimated at US$4,576 million The ministry has estimated its total exposure and the probable maximum losses for 100, 500 and 1,000-year events. Using the IDB s Disaster Deficit Index, he concluded that the Government of Colombia would not be able to replace the assets for which it is responsible for anything larger than a 100-year event The ministry has a clearly thought out and explicit financing strategy. This is divided into retained risk (reserves in a calamity fund and a contingent loan), transferred risk (insurance and reinsurance), long-term initiatives (such as catastrophe bonds, new taxes, long-term bonds), and no protection for the highest level of risk. However, the Calamity Fund has insufficient resources (only US$5 million) and the institutional and legal framework needs to be modernized. The contingent loan is for US$150 million and is provided by the World Bank. Long-term initiatives include studying how to best handle higher-level risks. Nevertheless, there will always be some residual risk that cannot be retained or transferred because it is too expensive. Fortunately, such events have a very low probability of occurrence. F. Overview of CATSIM Model (Preparation for Day 2 Working Sessions) 5.26 At the end of the first day, Dr. Mechler introduced the group exercise that participants would undertake on the second day of the workshop. The main objective of the group exercise was to put into practice the workshop concepts and approaches to incorporate DRM into fiscal and development planning. Working groups were formed to evaluate stylized country risk information, fiscal position and institutional capacity and programs, in order to develop an integrated risk management and financing strategy for the country, as well as a multi-year public investment program that would support the strategy As background and preparation for the group exercise, Dr. Mechler introduced the CATSIM model, developed by IIASA. CATSIM, a PC-based tool, is designed to provide insights into how policy-makers in disaster-prone countries can reduce public sector financial vulnerability. The 11