Natural disasters remain all too common, and the aftermath of such disasters is full of high-stakes political leadership and debate, media attention, public appeals, and well-intentioned actions. Yet well-intentioned responses by governments and the international community often fall short of their aims. In this book, Clarke and Dercon (2016) argue that the fundamental problem is the funding model, whereby after a disaster, farmers and homeowners, subnational governments, and national governments are required to plead for help to benefactors, such as subnational governments, national governments, and the international community, all of whom retain discretion over how to allocate their budgets until after a disaster strikes. This ad hoc post-disaster funding model does not work well. It is too slow, leads to a fragmented and underfunded response, and encourages underinvestment in risk reduction and preparedness, thereby increasing the economic and human costs of catastrophes.

The Solution? The solution is for governments and their partners to adopt pre-agreed-upon, pre-financed, rules-based preparedness plans that can be implemented after a disaster strikes without the need for further political decisions. Specifically, the responses to disasters can be more business-like and more effective (indeed, duller) if three things are in place beforehand:

• 1. A sound, coordinated plan for post-disaster action agreed upon in advance
• 2. A fast, evidence-based decision-making process
• 3. Financing on standby to ensure that the plan can be implemented.

A Plan—But Not Just Any Plan. Good planning is based on an iterative dialogue among scientists, bureaucrats, implementers, and financiers about what or who is to be protected, how it or they are to be protected, and what the cost will be. Bad planning happens when at least one of these parties is missing from the dialogue. Planning is a political choice; it is not just a technical exercise. Political statements by governments or development partners about how much money would be made available or how many people would be mobilized in the event of a disaster are not conducive to good planning. Useful political statements focus on target outcomes and leave the details on the “how” to be worked out by the implementing agencies and financiers.

Benefactors who want to maximize the development impact of their support should think through different natural disaster scenarios, assess what support they would provide in each scenario, and own up to this contingent liability when in discussions with other partners. A benefactor with either no contingency plan or its own stand-alone contingency plan will fall short in its efforts to help people. Benefactors can channel their financial support into precise sets of plans in which it is clear who exactly is being protected, how, and who is paying.

Behavioral biases against good planning are strongest for the kinds of disasters that have not occurred in the recent past—that is, for nearly all future disasters. To combat these biases, there is a particular need to invest in science-based risk information and clear communication of this information to make sure that all parties know what contingencies they need protection for.

Sound Decision Making—But Based on Good Rules, Good Data. By ensuring that as little as possible must be decided by stakeholders when a disaster strikes, rules can promote decisive, timely action. The data driving these decisions need to be resistant to manipulation and strike the right balance among cost, speed, and accuracy.

Any data that could trigger action will depend on investments before a disaster in design of the data collection system, including an audit function, and in the human and technological capacity to collect data in a timely manner. Three types of data are particularly useful for triggering post-disaster action: ground data on the damage to or losses of people and buildings, area average index data on damage and losses, and parametric indices.

No rule is perfect, and so there should be some discretionary backup system to deal with situations in which the rules fail.

Standby Financing—But Based on Smart Choices of Instruments and Triggers. Financial and budgetary instruments are the glue that hold credible plans together and make them strong enough to withstand the whirlwind of highly charged post-disaster politics (see table).

When designing and implementing disaster risk finance strategies, details matter. Financial experts add value. It is important to pay for financial advice and to build in-house expertise.

The triggers in the financial strategy should match the triggers in the plan. Traditional reinsurance can be particularly useful for locking in plans for reconstruction, and indexed reinsurance can play the same role to finance indexed early actions.

Partially subsidized financial instruments can be used to encourage others to contribute to the cost of well-defined plans.

Leaders should focus on providing protection, not relief, and using financial incentives to encourage others to own up to and finance their share up-front. Ad hoc, post-disaster support is still needed, but it should act as a backup when plans fail. It should not be the first line of defense for droughts, floods, earthquakes, tropical cyclones, or pandemics.

Clarke and Wren-Lewis (2016) examine the ways in which risk transfer instruments—insurance, reinsurance, derivatives, and capital market instruments—can act as commitment devices, helping governments and development partners to commit ahead of the disaster to restrict their post-disaster discretion for the good of the country.

They identify three distinct problems that can arise from an inability of benefactors to commit:

1. Disaster relief may be prone to a moral hazard problem and the classical “Samaritan’s dilemma” in particular. Those at risk deliberately underprotect themselves because they know governments or donors will come to their rescue.
2. Benefactors do not undertake the steps needed to avoid the misallocation of disaster relief. Many who should receive relief do not, and sometimes funds are diverted to those who suffered no losses at all. Before a potential disaster, benefactors would like to reduce misallocation, but if they cannot commit to doing this, recipients will self-insure. This serves to diminish the incentive to pay to reduce misallocation.
3. Finally, disaster relief frequently arrives too late. Besides practical reasons for relief not arriving in a timely fashion, benefactors may wait to see what others give before giving. This strategy may be motivated by the wish to gain clarity on burden sharing among donors before making payouts.

Especially in countries with poor governance, solving commitment problems by improving the functionality and credibility of the respective relief institutions is not feasible. Instead, investing in a system of risk transfer to third parties could be a more effective solution and has become part of countries’ disaster risk finance strategies.

Clarke and Wren-Lewis consider four properties of schemes to transfer risk to third parties, each having different implications for the commitment problems (see table).

• Recipient insurance subsidies. Benefactors purchase or mandate the purchase of insurance for the poor and vulnerable. Or benefactors subsidize a fixed or proportional part of the premium payment.
• Benefactor (re)insurance. Benefactors, prior to disaster, coordinate insurance coverage with donors and purchase insurance.
• Common payout triggers. Benefactors ensure uniform relief triggers for public monies and private insurance.
• Disaster indices. Benefactors gather and publish statistics on disaster-loss proxies (such as satellite data on wind speed, rainfall) and construct disaster-loss indices to trigger payout.

The events surrounding natural disasters are often highly political events that are closely followed by the public—especially the government’s response. Evidence from around the world suggests that voters’ responses to these events may give governments incentives to prepare for and respond to natural disasters in ways that are suboptimal, or costly, for society.

In light of this dynamic, one possible benefit of disaster risk finance instruments may be to discipline governments and other benefactors to abide by rules and commitments determined before disasters occur. Specifically, disaster risk finance instruments may help governments credibly commit to cover certain risks and help to hold governments accountable to voters. The role of disaster risk finance instruments as commitment and accountability devices, however, is largely unexplored.

Boudreau (2016) provides preliminary empirical evidence that risk financing instruments can serve as a commitment device based on the experience of Mexico’s Fund for National Disasters, FONDEN. The author’s findings support the claim that Mexico’s disaster risk finance program has disciplined politicians in light of the incentives provided by voters.

Mexican voters punish politicians for the occurrence of natural disasters in the run-up to elections but reward them for the allocation of post-disaster relief. Voters also respond to delays in post-disaster reconstruction by punishing the incumbent political party in the upcoming election.

Governors and the federal government respond to the incentives set by voters—requests and approvals for funds from FONDEN increase in presidential election years. Moreover, post-disaster relief increases in the run-up to these elections. These results do not imply that the FONDEN system is ineffective at disciplining politicians during election cycles—the behavior in the absence of FONDEN is unknown. However, FONDEN may be helping to address a commitment problem resulting from elections that would otherwise be more severe.

In fact, the evidence is consistent with FONDEN helping to discipline benefactors. In the early years of FONDEN, almost all applications for funds were granted by the federal government. Over time, the ratio of approvals-to-applications has fallen significantly, particularly for events when parametric thresholds are used to determine municipalities’ eligibility. Furthermore, FONDEN’s efforts to increase the insurance coverage of assets appear to be successful. In 2011 FONDEN implemented rule changes that promote the take-up of insurance and increase the overall coverage of assets. Since that time, the proportion of loss events with insurance relative to those without insurance has increased markedly. At the municipality level, events after the 2011 policy change are about 15–25 percent more likely to be covered by insurance .