Natural disasters are increasing in frequency, intensity and associated costs. For governments, they represent an important fiscal risk. The unexpected use of public funds and associated budget volatility can damage sovereign bond ratings and impact access to finance at a time when it is most needed.
Developing countries are being hit the hardest. Between 2000-19, 29% of all natural disasters occurred in low- to middle-income economies. There is also growing evidence of the relationship between poverty and disasters.
For financial regulators, these so called ‘physical risks’ can develop into systemic financial stability risks. They can disrupt trade and economic activity and destroy infrastructure and real estate assets in investors’ portfolios.
Disaster aid and relief programmes can form part of the solution but are not adequate to meet this growing challenge or always reliable. In response, institutions are developing more sophisticated strategies for the financial management of disaster risks.
Unlike traditional assets, disaster risk finance cannot and does not offer steady ‘returns’ on investment. They function more like insurance. Catastrophe bonds are one such example of insurance-linked securities, transferring risks to investors with attractive rates of return. Having emerged in the mid-1990s, they are still a small but fast-growing market. In 2020, cat bond issuance reached $16.4bn.
Targeted frameworks are being developed all over the world, from the Arab countries to Asia and the South Pacific. Developments in data availability and solutions are also helping with the assessment and quantification of risks.
Such initiatives are welcome and much needed. But they should be seen as complementary to, not substitutes for, the efforts to manage factors contributing to the increased frequency of disasters and other physical risks. This includes rethinking our economic models and setting on the path to sustainable growth before we face irreversible tipping points.