Economic impact of natural disasters

Economic impact of natural disasters

Risk analysis may be falling short with regard to natural disasters. While the management of political challenges has charged ahead in both the private and public sectors, comparable services regarding earthquakes and other hazards often leave investments with an uncomfortable level of risk exposure.

Natural disasters in perspective

In recent weeks, a 7.8 magnitude earthquake in the Ecuadorian city of Manabí took the lives of over 600 people. Unfortunately, seismic events of this scale are not uncommon, with over 140 quakes recorded at a 6.0 magnitude or higher in 2015 alone. Add in floods, tsunamis, and other naturally occurring events, and it starts to put into perspective the risk that these incidents pose.

According to the the World Bank, natural disasters between 1990 and 2012 were responsible for damages valued in excess of 10% of 2010’s world GDP. The brunt of these damages are shown to have been born by emerging economies that were undergoing swift increases in national assets, infrastructure, and investment, and thus were ill prepared to manage the fallout of these incidents.

With regard to geographic distribution, Asia seems to be facing the greatest level of exposure– with damages valued at over 12 percent of 2010 GDP. The combination of fast growth, low development, and high levels of seismic activity leave even the most developed nations at risk. Japan’s ominous experience in Fukushima provides a clear example of this.

Risk management options

Although natural disaster is a salient risk factor for companies as they invest abroad, the magnitude of losses associated with these events creates a substantial barrier to entry for many insurance providers. As a result, emergent geographic locations such as Asia find losses covered by insurance accounting for just 111 Billion out of 1.2 trillion dollars worth of damage attributed to natural disasters between 1990 and 2012.

Traditionally, as seen with political risk insurance through organizations such as the Overseas Private Investment Corporation (OPIC), major risks have been insured by the public sector. However, as they are often managing a fast growing economy and the many challenges it brings, disaster risk insurance can often find itself on the back burner.

A secondary challenge for governments is limited access to risk mitigating finance options. With the average sovereign credit rating of emerging markets leaving room for improvement, mustering the requisite credibility to find buyers for government issued catastrophe bonds (CAT bonds) and other risk linked securities can be a challenge. Without these instruments, government-backed insurance programs are likely to receive little confidence from the private sector.

Fortunately, if prioritized effectively, CAT bond issuance can be met with success and provide sovereigns with a level of support in times of crisis. In 2008, Mexico successful issued disaster bonds amounting to 100m under its MultiCat program. Not only was this an unprecedented success in terms of issuance, but the impacts of Hurricane Katrina were mitigated with funds triggered under this agreement.  

Analyzing risk

From the point of view of investment, natural disaster risk can be assessed on three levels: direct operational exposure, indirect exposure, and long term market stability. The assessment of these operational and political risks naturally would be undertaken in conjunction with analysis on up-to-date geological information from the country in question.

Operational exposure assesses the risk factors associated with current assets owned within the country. Successful analysis would provide a look at the susceptibility of these assets to seismic activity, flooding, or other risks, as well as the availability – both domestically and internationally – of insurance and other risk mitigating instruments.

Even in the event that operations can be adequately insured, the need to utilize transportation networks, utilities infrastructure, or even tap into local demand will often leave companies substantially exposed to the efficacy of government disaster response risks. Analysis of the government programs, access to financing, as well as an understanding of the infrastructure likely to be impacted by disasters is of critical importance at this stage.

Following a natural disaster, recovery may see infrastructure restored quickly – ensuring the continuation of operations – but a failure to provide adequate service to citizens throughout the country. Depending on the prevailing socio-political conditions of the country in question, political change, instability, or other political risks may arise as a result of an otherwise non-political event. Thus, it is of critical importance to work environmental factors into existing political risk analysis in the event that disasters are shown to be likely within a given jurisdiction.

Categories: Economics, International

About Author

Maxfield Brown

Maxfield Brown is an international investment specialist focused on ASEAN+3. With previous roles in extractives and education, he currently works for a subsidiary of the investment facilitation practice Dezan Shira and Associates. He holds an MA in International Political Economy from the University of Kent’s Brussels School of International Studies and a BA in International Studies from Ohio Wesleyan University. You can follow him on Twitter @MaxfieldVandel