WDR 2014

Catastrophe bonds: The international community can facilitate the development of innovative risk management tools

The following post is a part of a series that discusses 'managing risk for development,' the theme of the World Bank’s upcoming World Development Report 2014.

One thing financial markets are good at is innovating and creating new instruments that meet the ever-evolving needs of investors and economic agents managing their risks (such as national or subnational governments). In the mid-1990s, after hurricane Andrew and the Northridge earthquake in the United States, it became increasingly clear that some risks were too big to insure with existing instruments. This matters most to governments and insurers who have to pick up the pieces after a natural disaster as the frequency and cost of natural hazards have been increasing over the past few decades.

In the aftermath of a natural disaster, governments have to shift budgetary resources away from new investments for development to relief and reconstruction efforts. For insurance companies, catastrophic events can put pressure on their financial viability. One way to relieve the pressure is to transfer such risks to capital markets. That is how catastrophe bonds (cat-bonds) were born, as financial instruments to further disperse the risk of natural disasters more broadly and use the risk-taking capacity of institutional investors worldwide.

Help Us Help You: Sharing the Responsibility for Managing Risk

The following post is a part of a series that discusses 'managing risk for development,' the theme of the World Bank’s upcoming World Development Report 2014.To know more and share your feedback click here.

Who should be responsible for managing risk?
Sometimes those given the responsibility have the least capacity. People are generally capable of dealing with certain small risks. But they are inherently ill equipped to confront large idiosyncratic risks (household head falling ill), systemic risks that affect many people at the same time (natural disasters), or multiple risks occurring either simultaneously or sequentially (low harvest due to droughts followed by food insecurity due to a food price increase). To manage these different types of risks, people need support from other socioeconomic systems.

If the responsibility needs to be shared, who should share it?
Too often the first response to shared responsibility is to turn to the government for support. Government support, however, could require additional resources, possibly through increased taxes to ensure fiscal sustainability. Increased taxes could be burdensome for the economy and leave fewer resources for self-reliance (self-protection and self-insurance), which could be the most effective actions to manage some risks.

Moreover, government support can distort incentives, causing those affected by risk to take less responsibility for managing it (a situation known as moral hazard). For instance, some U.S. homeowners in disaster-prone areas do not buy disaster insurance knowing they can count on government aid if their home is destroyed. Hence approaches to sharing responsibility must ensure that risk takers or those exposed to risk retain some “skin in the game.”

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WDR 2014

Seizing Opportunities under Extreme Risks: Fragile and Conflict-Affected States

Fragile and conflict-affected countries confront some of the most extreme risks and constraints to their management that, if unaddressed, could create a vicious cycle of poverty, fragility, and conflict with far-reaching implications beyond these states. A well-balanced and collective approach to risk and opportunity can build on the progress made toward better development results going forward.

One thing that fragile and conflict-affected states (FCSs) have in abundance is the extreme risks facing their people. In these environments, consequences of risks materializing are often a matter of life and death. People living in such states make up only 15 percent of the world population, but represent nearly one-third of all people in extreme poverty, one-third of the HIV-related deaths in poor countries, one-third of people lacking access to clean water, one-third of children who do not complete primary education, and half of children dying before reaching their fifth birthday. Only eight of the 36 FCSs have so far met the Millennium Development Goal (MDG) of halving extreme poverty, according to a new World Bank analysis, and the upward trend in the number of poor in FCSs (figure) is expected to take their share in the global poor population to 50 percent by 2015, according to an OECD report. The majority of MDGs in fragile states will not be met by 2015.

The incidence of extreme risks in FCSs is matched by the prevalence of severe constraints on the ability of people to manage risk. Characterized typically by high levels of corruption, weak governance and institutional capacity, an unfavourable environment for doing business and low competitiveness (figure), these states offer limited access to functioning market mechanisms, communities, or governments that provide an enabling environment for managing risk. Three quarters of the limited foreign investment in fragile states go to only seven (resource-rich) states.

Danger of a pandemic

The following post is a part of a series that discusses 'managing risk for development,' the theme of the World Bank’s upcoming World Development Report 2014.

On February 15, 2013, an asteroid 45 meters across sailed past the Earth at 4.9 miles a second. This was the closest encounter on record with an asteroid this big. Such rare events trigger fear because people overestimate the risk of unusual events – at least for a while. The odds of other rare events are often underestimated. People have a hard time understanding frequencies that are longer than a human lifetime; politicians discount probabilities of disasters that are unlikely to hit while they are in office and so they underinvest in prevention. In sum, we have trouble assessing low-probability, high-impact risks – the kind of events dubbed as Black Swan by Nassim Taleb.

Responding to concerns about the asteroid, The Economist (Danger of death! Feb. 14, 2013) created a graphic to illustrate how we are unlikely to die from asteroid impact (odds of one in 75,000,000). The chart showed that more prosaic, but still rare, dangers were worse. For instance, 27 people died in 2008 in America from contact with dogs (a one in 11,000,000 chance of death). The ranking also showed the odds of death in any given year from a range of causes, such as heart disease, choking, falling down stairs, cycling, and bee stings.

Risk-taking by the enterprise sector can support people’s resilience

The following post is a part of a series that discusses 'managing risk for development,' the theme of the World Bank’s upcoming World Development Report 2014.

Live in a poor country in Africa but get an ultrasound analysis by one of the top medical experts in the world? Sound like a dream? A tech firm, iMedcare Technologies Co., showcased a process at the 13th Infopoverty World Conference held in New York on March 25–26 by which using data transmitted like a mobile phone call, doctors thousands of miles away can analyze ultrasound results at low cost and prescribe treatment in real time.

Is this innovation good? Clearly, yes. Long-distance medical treatments in India and several countries have shown the great potential that technology has in helping people manage risks, starting with day-to-day health issues. Are all these innovations bound to succeed? Clearly, no. Taking risks to innovate is an integral part of pursuing opportunities. For an individual enterprise, the results are seldom guaranteed; in fact, a large share of innovative firms fail. But for the enterprise sector as a whole, innovation is a risk worth taking. The small share of innovative firms that survive often push the frontier of productivity in the economy and produce great gains and improvements in well-being.

Going through the hoops with the support of the financial system: The Story of Jan Sarkis

The following post is a part of a series that discusses 'managing risk for development,' the theme of the World Bank’s upcoming World Development Report 2014.

A composite story based on prevailing business practices

In January 1990 after the Velvet Revolution, Jan Sarkis, the son of a Greek immigrant in rural Czech Republic, decides to start a business to produce bottled juices. To obtain needed machinery and funds for working capital (fruits, containers, bottles, etc.), Jan takes credit from a local bank. He had heard from the locals that the region used to experience periodic floods. Although Jan hasn’t experienced any himself, he still buys flood insurance from a reputable insurance company. In the 90s, rural Czech Republic was prone to thefts and burglary. So, Jan decides to protect his savings by depositing them in a bank. Good times settle in Czekia, and Jan’s business and the country begin to boom.

Protecting the vulnerable during crisis and disaster: Part II Ethiopia’s Productive Safety Net Program

The following post is a part of a series that discusses 'managing risk for development,' the theme of the World Bank’s upcoming World Development Report 2014.

Despite more than 19 episodes of severe food shortage in Ethiopia since 1895, it was the dramatic images of famines in 1972 and 1984 which came to the world’s attention and (wrongly) made Ethiopia synonymous with drought and famine. Despite consistent food shortages in Ethiopia for decades, it only became clear in the run-up to the 2002/3 drought that, while the humanitarian system appeared to be saving lives, it was proving to be ineffective in saving livelihoods and managing risks effectively. In essence, rural Ethiopians had faced chronic food insecurity for decades, but were receiving ‘treatment’ for transitory food insecurity. In part as a result of this misdiagnosis, rural Ethiopians were becoming increasingly less resilient to drought and were unable to manage risks effectively. This realization prompted the birth of the Productive Safety Net Programme (PSNP).

Protecting the vulnerable during crisis and disaster: Part I

The following post is a part of a series that discusses 'managing risk for development,' the theme of the World Bank’s upcoming World Development Report 2014.

Income support is an essential part of crisis and disaster response. Time after time, governments, donors, and humanitarian agencies step in with support to people affected disasters and economic crisis. They often do this on an ad hoc basis, improvising how and what support to provide. Why not build systems that could respond quickly wherever and whenever crisis or disaster strikes?

Disasters wipe out homes and livelihoods in an instant. Millions of workers lose their jobs in economic crises. Food price spikes put basic staple foods out of the reach of the poor. Governments often feel compelled to act in such situations. To be effective, support to crisis and disaster-affected people needs to be provided rapidly.

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WDR 2014

How does risk affect your life? – Join us for a Live Chat on the World Development Report 2014

Adverse events coming from systemic or idiosyncratic risks may destroy lives, assets, trust, and social stability. While risks in some areas have diminished in recent years (notably health, and economic crises in developing countries), risk has become more pronounced in other areas, including natural hazards, crime, the environment, and food prices. Especially when risk is mismanaged, the consequences can be severe, turning into crises with often unpredictable consequences.

We need to move from arbitrary crisis response to systematic risk management: A perspective from WDR 2014

An old proverb cautions that “an ounce of prevention is worth a pound of cure.” There is a lot of truth to this: interventions to prevent infectious disease and infant malnutrition have repeatedly been estimated to have very high returns, with benefit-cost ratios as high as 15 to 1.

The proverb also applies outside health. Time and again, failure to prevent and prepare has tragic and costly consequences—economic and financial crises, natural disasters, ruinous health outcomes, social unrest—that often could have been avoided at moderate cost. In 2010, an earthquake in Haiti cost more than 220,000 lives, while one of much larger magnitude in Chile produced about 500 fatalities. Chile’s enforcement of building codes appears to account for much of the difference.

Managing Risk for Development

Suppose a political leader implements a policy that results in an economic crisis in the sense that, had he not implemented the policy in this instance, the crisis would not have occurred. In such a situation we are inclined to come down heavily on the leader’s policy and castigate the decision. This would however be a mistake.

To see the mistake—as to see so many things in life—it is worth converting this to a more abstract problem. A (fair) dice is about to be rolled; but before that you have to choose between A and B. If you choose A and the dice outcome is 1 or 2, or you choose B and the dice outcome is 3, 4, 5 or 6, all will be well. Otherwise, there is a major food crisis. What should you do? A little thought makes it clear that you should choose B. If after that the dice shows up on 1, there will of course be a crisis, but that disastrous outcome would not render your decision wrong. Indeed, if you had to play the game again, you should make the same choice.

WDR 2014

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