Resilient Finance: Closing the Protection Gap Against Disaster Risk

September 30, 2021

In July 2021, catastrophic flooding inundated parts of Germany and Belgium with damage spreading further into neighboring countries. The flooding took the lives of over 200 people and caused devastating damage to homes and businesses; the insurance industry is expecting losses on the scale of billions of EUR.

Governments will bear much of the cost of this flooding. Germany has announced an immediate aid package of EUR 472 million to support affected people. The European Union Solidarity Fund will likely be instrumental for the recovery. Once again, the floods reminded that we need better systems in place to finance recovery from natural disaster.

Natural disasters are not infrequent in Europe. In the past 40 years, disasters affected almost 7% of the European population costing on average EUR 12 billion losses each year. Given the number of compounding shocks, such as the ongoing pandemic and climate change, financial preparedness is paramount to recovery.

The World Bank and the European Commission recently conducted a study that assessed the status of financial preparedness of Europe to respond and recover from disasters. It found that damage to residential buildings forms over 50 percent of total loss from both flood and earthquake risk. However, only 30 percent of EU member states have more than half the population covered by catastrophe insurance (see Figure 1). This suggests that there is a large protection gap and that many people must rely on government aid to recover.

Figure 1 - Proportion of households covered by catastrophe insurance against earthquakes (left) and floods (right)

Source: AXCO Non-life insurance market reports: Country report 2020s; OECD 2015, 2016, 2018; EU JRC 2012 Note: There are some limitations to the above data, which are in some cases outdated. In addition, when the range of households covered was provided, the upper limit was selected, so the penetration might be overstated.

Insurance instruments could help to close the financing gap posed by natural disasters. Recent research by European Insurance and Occupational Pensions Authority (EIOPA) and the European Central Bank highlighted the role of insurance in mitigating negative macroeconomic and welfare impacts of disasters. If a high share of damage is covered by insurance, the initial fall in economic output following a disaster may be reduced.

The effects from the current flooding in Europe are stark, but expected, according to catastrophe risk models developed for the World Bank and EC. Models estimate damage of major floods and earthquakes in some countries to exceed EUR 50 billion. There is a 1 percent chance of experiencing this loss in any given year.

Figure 2 - Countries with highest estimated average annual loss (AAL) for floods and earthquakes in EUR million

Note: The analysis builds on two regionally consistent probabilistic catastrophe risk models (developed by JBA Risk Management (JBA) for floods and by the Global Earthquake Model Foundation (GEM) for earthquakes). Combining these models with data on disaster risk finance and economic modeling, the analysis reports on the size of costs and potential funding gap EU governments might face. View the full infographic here.

Financial preparedness of European governments to meet such costs differs across the countries, but overall is limited. Large post-disaster costs are shouldered by government budgets. Every year on average, European governments may collectively have to provide more than EUR 16.2 billion through budget reallocations, borrowing and external aid.

Still, there are reasons to be optimistic. With increasing recognition of the need to build financial resilience to climate and disaster risk — as mentioned in the 2021 EU Adaptation Strategy and the EU Green Deal - there are opportunities to strengthen financial resilience of European governments to disasters. Some of these opportunities could be implemented now. For example, developing comprehensive disaster-risk financing strategies to provide finance when needed. Developing such a strategy includes identifying priorities for financial preparedness to disasters and identifying sources of funds to meet post-disaster costs effectively and timely. Other opportunities will take more time and effort. For example, introducing risk-financing instruments, like catastrophe insurance. Building data for financial preparedness is critical for evidence-based decision-making; it is possible to start collecting this data now.

As we recover from COVID-19 and adjust to a changing economy, there is an opportunity to shape this recovery to take a resilient, green and inclusive development path. Strengthening financial resilience to disasters and climate related events will be key to reducing the financial and economic impacts from future crises and make us more resilient.

Photo Credit: M. Volk / Shutterstock

This blog was originally published in the World Bank Group’s Private Sector Development blog.

Financial Resilience Around the World | Blog Series

Jean Pesme

Global Director, Finance, Competitiveness & Innovation (FCI) Global Practice

World Bank Group

As Global Director, Finance in the Finance, Competitiveness & Innovation (FCI) Global Practice, Jean leads the World Bank’s work to promote the development of sound, stable, sustainable, and inclusive financial systems. His global team of experts works with governments and partners to make financial systems more resilient, to open access to finance for poor and vulnerable people, to support economic activity and to develop financial markets. Their strategy and its implementation emphasize development of digital financial services, addressing climate change and sustainable finance and creating opportunities for women by bolstering their financial inclusion. Previously, Jean led the World Bank’s Financial Stability and Integrity global team, which assists countries in building and restoring robust and resilient financial systems operating with integrity, transparency and in compliance with international standards and recommendations. He has extensive experience working on financial sector issues, notably in the Middle East and North Africa.

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CO-AUTHORS

Samantha Cook

Senior Financial Sector Specialist

World Bank Group

Samantha Cook is a Senior Financial Sector Specialist within the Crisis and Disaster Risk Financing team in the FCI. Her role focuses on the development of integrated disaster risk financing and insurance solutions leveraging best practices in public financial management. Ms. Cook was instrumental in the establishment of the Pacific Catastrophe Risk Insurance Company, a risk pool established to help the Pacific Islands meet their post-disaster liquidity needs. Ms. Cook coordinates the crisis and disaster risk management program in South Asia and manages the Trust fund for supporting disaster risk finance solutions in middle-income countries financed by the Swiss State Secretariat for Economic Affairs. Ms. Cook began her career as an economist in investment and then central banking and was a fellow for the Overseas Development Institute.

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Tatiana Skalon

Financial Sector Specialist

World Bank Group

Tatiana Skalon is a Financial Sector Specialist with the World Bank Crisis and Disaster Risk Finance team at the Finance, Competitiveness and Innovations Global Practice. Her key projects are in the regions of Europe and Central Asia, South Asia and East Asia and Pacific. Over the past two years, she increasingly worked on public financial management of disasters. This comprises, for example, the COVID-19 expenditure analysis aimed to understand the cost of ad hoc financial management of the pandemic and Public Expenditure Review on post-disaster spending in the Philippines. Tatiana also works on development of disaster risk finance strategies, public assets data systems and sovereign disaster risk finance. She holds a MSc in Comparative Law, Economics and Finance from IUC of Turin and a PhD in Risk and Emergency Management from IUSS Pavia.

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