Prepare for the perfect storm

The widespread and devastating impact of the December 26 tsunami on India has, among other things, demonstrated the glaring lack of financial preparedness of the aam aadmi in dealing with such an eventuality. Disaster relief, for Indians, has always been in the form of grants and loans from the government.

This approach has two problems. One, it generates a fiscal risk for the state as public finances have to be reallocated when disasters strike. And second, it forces the already hapless citizens to deal with the government, which is not always efficient in reaching out aid and assistance to those who need it most.

A superior mechanism for effective and efficient transfer of resources is insurance. Catastrophe insurance, however, has not been able to become the mainstay of post-disaster financial support in India, unlike many other parts of the world.

So how is catastrophe insurance organised in other parts of the world? There are many instances of public-private partnerships providing catastrophe insurance. One such example is the California Earthquake Agency. The CEA is a `privately financed, publicly managed' tax exempt state agency that provides earthquake insurance in competition with the private sector. The capital of the California Earthquake Agency comes from insurance companies who chose to contribute towards the same at the time of inception. In addition, some portion of this money is invested while reinsurance cover is brought from the rest. Consumers buy this policy from insurance firms. The Agency policy covers very specific damage. The CEA can handle claims of about $7-10 billion.

A very different model from the California Earthquake Agency is the Florida Hurricane Catastrophe Fund. Insurance companies pay a reimbursement premium to the Fund for each $1000 of insured value for covered policies. They are then eligible for cover on their hurricane losses. The Florida Hurricane Catastrophe Fund funds come from the premiums paid and investment returns on the premiums.

A third model is the Turkish Catastrophe Insurance Pool. The TCIP is a publicly managed insurance pool, started under the aegis of the World Bank in 2000. All citizens in Turkey are mandatorily required to buy cover from the TCIP of up to $30,000. The Turkey Catastrophe Insurance Pool covers all damages directly caused by an earthquake. The pool in turns buys reinsurance from the international reinsurance market.

India would do well to harness some of these models to constitute a more sustainable means of disaster relief. In doing so, we must note that such partnerships are not without some caveats. First, publicly managed schemes tend to dampen the market mechanism of setting premiums and making claim payments efficiently. Sometimes tax laws discriminate against the insurance companies and there ceases to be a fair playing ground between the public and the private sector.

In the case where a common fund pays for reinsurance, questions of moral hazard arise. In the case of California Earthquake Agency, the coverage is often found to be inadequate, thereby defeating the very purpose of insurance.

A workable model for India could be a variant of the Florida Hurricane Catastrophe Fund, whereby insurance companies buy reinsurance from a public limited reinsurance company, which would in turn utilise a variety of domestic and offshore avenues for hedging. This would include the international reinsurance market, the international financial markets by issuance of catastrophe bonds and weather derivatives.

Why does India not have a workable catastrophe insurance model? The primary hurdle in this regard is access to the reinsurance market. Though the GIC is expected to provide reinsurance, the regulatory framework does not allow this to be done in an adequately effective manner. A large number of issues need to be addressed in this area. These should be taken up with utmost urgency.

The writer is a research associate with Invest India Economic Foundation, Delhi. These are her personal views.