13 Disaster Linked Financial Strategies

Dr. Lubna Siddiqui

    Objectives

  •  To develop  an  understanding  about  the economic  impacts  of  disasters  and  the rationale   behind   the   necessity   for investment in various stages in  disaster management
  • To  examine  how  the  economics  of Disaster   Management and   funding mechanism  can  be  effective  at  various stages of Disaster Management
  • To acquaint with   the institutional mechanisms of  Disaster Management funding in India
  • To  understand  about  the  global  best practices for financing different stages of disaster management

 

Rationale

 

Mainstreaming Disaster Risk Reduction with Developmental interventions require coherent contextual investment in a strategic way that helps address current and future risk of disasters. Effective coordination between and involvement of the local, state and national government and other donor agencies is significant for ex-ante (prior to disaster event) and ex-post (post disaster event) investment in Disaster Risk Reduction

 

Unit 1 – Economic Impact of Disasters

 

Disasters in any economy, increase scarcity by reducing the inputs necessary for output. Fewer inputs result in lesser output. Thus, disasters usually result in a reduction in the total production of a nation. Production Possibilites Frontier (Figure-1) illustrates the condition in a nation’s economy when it is most efficiently managing its resources to produce goods and services. Points A, B, C on the curve are all efficient allocation of the nations resources to produce two resources; whereas point X respresents an underutilization of resources, while point Y represents a state not practically possible for the nation, given its current set of resources as it is supposedly produce more than what it can actually produce.

 

    Figure 1 – Production Possibility Frontier  Source: (Hayes)

 

An economy operating on PPF is said to be efficient if it is impossible to produce more of one resource, without decreasing the output of another resource. Disaster events shift this balance. For instance, droughts reduce the agricultural output and significantly alter the prices of produce, thereby affecting the resources available for consumption as well as further production. Cyclones, Earthquakes, Floods etc. could cause harm to the manufacturing bases (agriculture farms, manufacturing units, roads and infrastructure) and thereby alter the output. Pandemics like Dengue, Swine Flu, Ebola etc. affect labour intensive production due to its impact on the health of human capital.

 

Thus, disasters expose the dependence of economy on the capital or on labour. Any effect on the labour and or capital would require significant aid and investment into the economy to at least recover to a state it was prior to the disaster. Disaster events generally result in a reduction in productive capacity of the affected nation reducing welfare and consumption. Without significant savings or access to finance options, variations in wealth/ income results in consumption volatility.

    The following figure (Figure-2) shows the total damages due to disaster events in India from 2005 to 2016. A trend line shows the increase in economic damages due to the occurrence of disasters.

 

     Figure 2 Total damages due to disasters from 2005-2016 in INDIA

 

The above economic damages recorded by CRED in EMDAT database measures only direct damage to houses/ infrastructure. The damages do not include the value of lives lost and indirect costs due to social disruption.

 

How does the Local government lose revenue post-disaster?

 

In any post disaster event, the local government faces the following challenges in resumption of functioning (Settle, 1985):

 

1. Loss of Tax Base: Tax is a major income to the local government. The destruction of Tax base due to any disaster event with resultant damage to property renders local government unable to recover without outside support.

 

2. Loss of Business: Livelihoods are affected and the ability of individuals, households and enterprises to consume are affected either due to the impact on supply or on the demand side. Due to decreased consumption, indirect taxes revenue is substantially reduced.

 

3. Changes in Debt Ratio or the amount of Money Government has borrowed in relationship to Taxable Property: Due to overwhelming of local government’s capacity to respond and recover, the local government would need to rely on external borrowings which would increases its debt ratio.

 

A community with flourishing revenue producing industries such as oil refineries & industries generates significant tax revenue and thereby corresponding cash reserves that could be utilized for emergency response/ recovery. But a community with smaller revenue base would find it difficult to raise funds post-disaster and would have to seek State or Central government’s intervention.

    It is also observed that there is a convergence of material (relief materials), aid workers and money (towards relief) in a disaster struck area. Such a convergence of activity would lead to an impression of economic activity post disasters. Broken window fallacy must, therefore be avoided.

 

Broken Window Fallacy

 

A window is broken by a small boy while playing cricket. A repair man comes to repair the window. If the cost of repair is Rs. 300/-, the visible economic activity in this event is that the repairman’s day has been made by the event and associated earning.

 

But the person who spent that Rs. 300/- cannot spend it on anything else. The boy’s father who spent the money might have thought about purchasing a new pair of shoes for the boy. Thereby a positive to the Glass industry ends up as a loss to the shoe industry.

 

Thus during disasters, society loses value of object unnecessarily destroyed. Post disasters, when there is a flurry of relief material and labour for the repair and rebuilding activities, an impression of a booming economy is created. A careful study into the necessity of this activity would add validity to this belief. Destroying certain things and recreating does not necessarily mean productive employment or utilization of resources.

 

The occurrence (location, scale, distribution) of disasters are uncertain, but the government and individuals presume certain expectations of disastrous loss events and act on those expectations. (Phaup & Kirschner, 2010) Due to the resource crunch post disasters and the corresponding national losses, it becomes imperative for the nation to focus on financial strategies at various stages of disaster management. Better focus on development pre-disaster events generally reduces the necessity and extent for response/ relief resources. Better resource management during the relief and rehabilitation phases of disaster management supports long term development.(Fan, 2013) The Rio+20 Conference renewed mandate to nations by stressing on the importance of stronger inter-linkages between DRR, Recovery and long term development planning, calling for coordinated strategies that comprehensively integrate Disaster Risk Reduction, Climate change Adaptation into public and private investment. (Vorhies, 2012)

 

Individual’s response to disasters

 

Each individual has his/her own way of managing situations during adverse situations and maintaining their living standards even during disastrous events.

   These decisions include their choice of housing materials, location of residence, choice of occupation (formal or informal etc.), It could also include social support institutions like family, friends etc. or availing loans/ advances from financial lending institutions during tough times. Others could simply save for bad times or rely on insurance. These steps are taken during the good times rather than during or after disaster events. Post disasters opportunities for such measures might be severely restricted. Loss of human and non-human capital reduces potential future income and ability of survivors to obtain credit (Phaup & Kirschner, 2010). It has been observed that household savings are higher in countries with greater disaster risk exposure, and higher frequency of disaster events.

 

Public policy for disaster management

 

A successful disaster policy is the one taken prior (ex-ante) rather than post materialization of the disaster risk (ex-post). During post disaster events, government may be in a position to redistribute amongst the affected by borrowing. Due to its taxation power, government is in a better position to allocate resources than relying on private aid/ credit post disasters.

 

In developing nations, an effective disaster policy is essential. Economic growth is observed to have increased disaster risk due to the changing micro-behavior by changing the aggregate exposure to disaster risk (Kellenberg & Mobarak, 2008). It is significant to note that the economic growth and environmental quality are also related to each other. For example, the increased level of exposure in the Indonesian coast to the 2004 tsunami could be due to the trade-off between growth and environmental protection. Mangrove forests were converted to shrimp farms and tourist resorts which raised standard of living and commerce but the natural protection of mangroves from Tsunami threats was hampered. The conversion of forest land to agricultural land has also increased the risk of exposure to landslides and floods. Therefore, disaster financing and development plans must be complementary to each other.

 

Local governments have the following ways to fund for disaster response and recovery (Settle, 1985):

 

1. Funds Transfer management. e.g management. (General or Specific)- from a different portfolio to disaster a transfer of irrigation funds towards integrated water resource

 

2. Contingency Funds/ Disaster Reserves– about 3-7% of jurisdiction’s total revenue creation of such budgetary allocations to fund during contingencies.

 

3. Increase in Tax-rate to replace long-term reserves (as Recovery investment depletes reserves)

 

4. Specialized funds like Library funds, State Gas Tax funds, Motor Vehicles Registration Funds

 

5. Mutual Aid Agreements with other local governments to aid during and post disaster events.

 

6. Tax Anticipation Notes used to fund for current investment in anticipation of tax received in a future date.

 

7. Municipal Bonds: or debt security issued by local administration to finance certain planned investment.

 

8. Insurance Program: for example in the US, the National Floods Insurance Programs, 1968 which identifies Flood prone Areas, subsidize flood insurance to property owners in these areas, while flood plain regulations were a responsibility of the local government.

 

9. Assessment Districts– (example Los Angeles County Flood Control District) where re-development agencies are formed that acquire property in hazardous areas or damaged property and sell it to private developers to reconstruct entire area. This is best suited for city business districts. Lease-Purchase Agreement could be formulated where private development on public demand is promoted with some public use of private facility which would return to Government ownership after a specific period of time.

 

10. Other Administrative suggestions for the Local Government include:

    a. Listing of all property & facilities under jurisdiction, with estimated values and a depreciation schedule

 

b. Fee Structure (Water Tax, Service Tax) must include component of replacement cost, as well as operation & maintenance funding and must have a fixed asset system amortize. This would enable the government to better appropriate replacement cost.

 

Developing nations needs to be proactive in controlling rate/ form of urbanization, thereby having plans in place for disaster and development. Goal of poverty elimination and DRR are complementary. Development investment may lower disaster risk exposure due to the quality of institutions, education, healthcare access and quality. The capacity of less developed nations to respond to any disaster risk and to deliver essential services may be overwhelmed due to inadequate housing, congestion and thereby the exposure might actually increase. Thus an inverted U-relationship between development and disaster risk exists for disaster events (Figure-3) like floods, landslides, windstorms disaster deaths increase with increase in income and then decrease (Kellenberg & Mobarak, 2008).

 

Figure 3 Turning points for Landslides, Windstorms, Floods- Deaths vs GDP/capita Source: (Kellenberg & Mobarak, 2008)

   

Challenges for government on ex-ante disaster budgeting

 

If individuals/ households do not save enough, or take on too much risk of exposure to disasters, or invest little on mitigating disaster effects, government could increase investment ex-ante by increasing taxes and reducing public consumption expenses before the occurrence of events to help funding the cost of relief and recovery.

 

Major obstacles to ex ante investment are (Phaup & Kirschner, 2010) are as under-

 

1. Political incentives to postpone spending till the occurrence of disaster event: Urgent unmet needs are always posing threats especially in developing nations. It would thus appear wasteful on the part of decision makers to spend on mitigation/ preparedness/ response for a potential threat rather than on issues that require urgent attention like housing, sanitation, drinking water supply, electricity etc. Further, there are political rewards for quick relief.

 

2. Moral hazard: Availability of insurance or other financial assistance post disasters weaken incentives to invest in the avoidance of losses. National policy for assisting victims post disasters increases the risk of building structures in areas of increased exposure to disaster risk and diminishing motivation for individuals to invest on insurance. Thus disaster linked financial strategies must include the buy-in from the at-risk individuals to invest in and have financial interest in investing on disaster risk reduction.

 

Some measures to counter moral hazard are the assignment of first losses to insured and later to the non-insured, capping benefits per claim, levying risk-based premiums, specifying eligibility conditions for assistance- based on location, type of construction, owner provided mitigation measures, lending for recovery visavis grants

 

3. Dynamic inconsistencies (change in preference over time) of policy makers: Taxpayers might believe that policy makers will enact ex ante budgeting, raise taxes currently to pay for probable losses in future only to reverse the policy later and spend the revenues for other purposes. Mechanisms must ensure funds for relief/ preparedness or mitigation are used for their specified purposes only and not on opportunistic spending by policy makers. There are examples worldwide that have made possible such mechanisms:

 

i.     Belgium standing fund

 

ii.     Carribean catastrophic risk insurance fund

 

iii.     EU solidarity fund

 

iv.     New Zealand Earthquake commission fund

 

v.     Japanese earthquake reinsurance company

 

4. Ostensible impossiblity of saving for disasters by government: Savings for disaster events are most efficient if they are incorporated in the budget and not independent of the national budget. Ex ante budgeting for disaster events must be a complement to fiscal policy, rather than function as a substitute.

    Current trends in Disaster linked financial strategies

 

It is observed that most of disaster spending occurs in the Emergeny response phase (roughly 66%) followed by Reconstruction/ Rehabilitation in the recovery phase (22%) and the least in mitigation efforts towards reduction of disaster risk prior to the disaster event.

 

                                                         Figure-4 Spending on Disaster Management

  Source: (Tanner, Lovell, Wilkinson, Ghesquiere, Reid, & Rajput)

 

If flood risk reduction measures are undertaken in a property and if the flood risk does not manifest during the lifetime of that building, then would the investment on mitigation of flood risk be considered worthwhile? Recent studies suggest that investment on disaster risk mitigation builds resilience that leads to triple dividend of resilience that yield gains irrespective of hazard manifestation.(Surminski & Tanner, 2016) The triple dividends are:

 

(1)  Preventing loss of life and property

(2)  Attracting investment by lowering the looming threat of losses from disasters

(3)  Capturing additional development benefits that are often unnoticed

 

Sources of Funding:

 

The above mentioned fig.-4 shows a detailed description of various sources of funding. The sources are mapped on a linear scale between the resource mobilization and the donor’s understanding of the local needs. The funding sources include international funding, national allocation to local governments and individual contribution towards disaster management.

 

Figure 5 Sources of funding for disaster management (Smith, 2011)

 

 

The variety of funding sources and donors understanding of local needs thus require sound financial strategies for disaster management to effectively utilize the funds and bring about disaster risk reduction.

 

Media coverage is a key factor that directs inflow of funds. In the aftermaths of Indian Ocean Tsunami, 2004 it was observed that the event generated extensive media coverage, which resulted in the substantial level of short-term international assistance. About 92 nations pledged financial assistance with the 3 largest donors – US, Australia, Germany- providing nearly 1/6th (16.5%) of $13.5 Billion pledged. A World Bank report records that during cold war period, every article in New York Times covering a disaster correlated roughly with $1.76 Million increase in aid. However following Indian Ocean Tsunami- this correlation was roughly $3.1 Million per article. (Letukas & Barnshaw, 2008)

 

Insurance as a tool for Disaster Risk Funding

 

Funding for disasters face one major hurdle in the realization of outlays towards humanitarian assistance. Disaster aid is usually about 10% of the total disaster losses. (Linnerooth-Bayer, Mechler, & Pflug, 2005) Two years post the 2001 Bhuj Earthquake, assistance from central reserve fund and international sources had only reached 20% of the total fund committed.

 

Donor communities including Financial institutions, international agencies, non-governmental organizations and donor governments are recognizing the need to focus more on prevention of disaster losses. Government bodies, households and enterprises (especially SME) in poor countries/ developing nations cannot easily afford commercial insurance to cover disaster risks. Low-cost micro-insurance for independent risks like funeral expenses- are widely available in India, Bangladesh etc. but not the case with dependent risks that affect many communities at the same time. Cost of catastrophic insurance (for low-probability high cost events) is higher than pure risk premium (as the former involves the insurers cost of back-up capital to cover dependent claims). This explains the reason why households in low-and middle income countries stay away from insuring – especially for catastrophic insurance. Thus, the donor community could focus on disaster assistance to risk management programs that leverage aid through public and private contributions and that promotes loss mitigation. Following examples illustrate the utilization of insurance as an effective tool for disaster risk financing.

 

(1)  Turkish Catastrophe Insurance Pool– It tackles insurance affordability in a middle-income developing nation. Istanbul faces a 0.41 probability of severe earthquake in 2004-2034 period. In response to the earthquake risk, earthquake insurance policy is mandated as per law for all property owners. The owners pay a risk-based fee to a privately administered public fund. In order to reduce the premium, World Bank produces back-up capital for two layers of risk- as a loan and in the form of a contingent fund.

 

(2)  Ethiopia Index based weather derivative– Drought in Ethiopia was severe in the year 1984. To manage increasing occurrences of weather based disaster risks, an index based weather derivative was set up. The derivative is a contingent contract with a pay-off determined by future weather events such as a specified lack of precipitation measured at weather station. Thus farmers could reduce their losses by diversification and yet get benefits due to the physicality of the hazard. The affordability of the scheme was ensured by World Food Program by convincing donors to subsidize premiums or by providing back-up capital to reduce the risk of drought.

 

Challenges in insurance as a tool for Disaster Risk Reduction

 

The science associated with insurance models must be transparent, independent, and viewed as reliable by insurers, investors and donors. There still exist large uncertainties especially with longer term risks and the reluctance of private sector to enter the risk-transfer market. Promotion of good governance and sound regulatory policies would help in more investors for insuring on catastrophes. Refocusing of disaster aid is not to replace with unaffordable private insurance but to act as a complement to post disaster humanitarian aid with pre-disaster support of risk management

 

Sources of Disaster Risk Funding in India

 

The following funds are set up for Disaster Risk Financing in India:

 

(i) National Disaster Response Fund (NDRF): The section 46 of the Disaster Management Act 2005 says that NDRF is to be utilized for meeting the requirement for emergency response, relief and rehabilitation due to any threatening disaster situation or disaster. The NDRF shall be used for severe nature of the following nationally notified disasters: cyclones, drought, earthquake, fire, flood, tsunami, hailstorm, landslide, avalanches, cloud burst, pest attack and cold wave/ frost. The NDRF was previously called the National Calamity Contingency Fund (NCCF). The National executive committee of the National Disaster Management Authority is entrusted with the responsibility of taking decision on expenses from NDRF as per guidelines issued on 8th April, 2015. The NDRF is financed through levy of cess on items approved through the finance bill passed every year. Any requirement over and above the NDRF is met through general budgetary allocation.

 

(ii) State Disaster Response Fund (SDRF): Under section 48 of the Disaster Management Act 2005, the SDRF is to be utilized for meeting the requirement of emergency response, relief and rehabilitation for the 12 nationally notified disasters as well as towards relief for victims of state-specific disasters. States shall utilize SDRF as the primary source of funding for response and rehabilitation in emergencies of severe nature and if the funds are found to be short of requirement, the states could seek assistance from NDRF. The SRDF/ NDRF is provisioned for relief and not towards compensation of losses/ damages. The source of SDRF funds for the states is grant recommended by erstwhile Finance Commission under article 275 (1) of the Constitution. Government of India contributes 75% of SDRF to general category states and 90% of SDRF to special category states (eleven states- the 7 north-eastern states- Arunachal Pradesh, Assam, Meghalaya, Manipur, Tripura, Mizoram, Nagaland, Sikkim, Jammu and Kashmir, Himachal Pradesh and Uttarakhand) as non-plan grant in two instalments every year.

 

(iii) National Cyclone Risk Mitigation Project: About 75% of the Indian coastlines are highly vulnerable to the impacts of tropical cyclones and related hydro-meteorological hazards. Government of India has initiated NCRMP with a view to address the vulnerability to cyclones. The objective of the project is to undertake contextual and suitable structural and non-structural measures to mitigate the effects of Cyclones in the coastal states and UT’s of India. The project identified thirteen cyclone prone states and UT’s and categorized into:

 

a. Category 1: Higher vulnerability states/ UT’s: Andhra Pradesh, Gujarat, Odisha, Tamil Nadu and West Bengal

 

b. Category  2:  Lower  vulnerability  states/  UT’s:  Maharashtra,  Karnataka, Kerala, Goa, Puducherry, Lakshwadeep, Daman and Diu, Andaman and Nicobar Islands

 

The focus of the project is towards improving early warning dissemination systems, enhancing the adaptive capacity and response capacity of local communities, improving access to emergency shelters, evacuation and protection from wind storms, floods and storm surges and strengthening Disaster Risk Management at central, state and local levels in order to mainstream Disaster Risk Mitigation into development agenda. Financing for the project is through Department of Economic Affairs (GoI), World Bank and the state governments. Funding is through Centrally Sponsored Scheme, supported by World Bank’s Adaptable Programme Loan(NCRMP).

The National Disaster Mitigation Fund was directed to be set up under the directive of the Disaster Management Act 2005. The objective of this fund is to provide financial support aimed at mitigation/ disaster risk reduction which is being served by existing centrally sponsored schemes/ central sectoral schemes such as the Pradhan Mantri Krishi Sinchai Yojana, Krishnajyoti Yojana, National Mission on Sustainable Agriculture, MGNREGA, Major Irrigation projects, Namami Gange- National Ganga plan, River Basin Management, National River Conservation Plan and Water Resource Management. Additionally, the Ministry of Finance has made provision of 10% of total outlay for all CSS schemes as flexi fund.(Ministry of Home Affairs, 2016). Insurance under the Pradhan Mantri Fasal Bima Yojana (PMFBY) provides insurance coverage and financial support to farmers in the event of failure to notified crops as a result of natural calamities, pests and diseases and ensures flow of credit to agriculture sector.(Ministry of Agriculture and Farmers Welfare)

 

India’s Companies Act 2013 mandated enterprises with a net worth of INR 500 Crore or more or turnover of INR 1000 Crore or Net Profit of INR 5 Crore or more in India to assess and take responsibility for the company’s effect on the environment and the impact on social welfare. Such organizations were mandated to invest 2% of the amount of net profit for the last 3 financial years in development functions/ addressing vulnerabilities or building capacity for responding to stress including disasters.

 

Summary

 

Financial strategies for disaster risk reduction requires comprehensive and coherent strategies in both ex-ante and ex-post investment. The government is in a better position to invest on disaster management than private investment. The investment in DRR ex-ante must be parallel to development agenda with greater collaboration between multiple actors. Ex-post investment must be channelized towards greater resilience and capacity building and must be utilized to address the gaps. Contextual strategies suiting the countries’ specific needs addressing vulnerabilities and local requirements would help reduce fiscal impacts of disaster events.

 

References

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