concentration of people and assets in highly disaster prone urban areas.<sup>26</sup> The potential for higher losses will continue to rise with further urban development.<sup>27</sup>

# **Limitations of Ex Post Financing Responses**

In most developing countries insurance markets are not well developed and coverage for natural disasters is very limited. In practice, hazard risk coverage tends to be limited to major industrial and commercial properties. Hazard insurance for homeowners (other than terrorism) is sometimes present where property rights have been established, but is usually restricted to upper-income households.

As a consequence of limited fiscal resources, cognitive and related political economy issues (see Box 1), and very low insurance penetration, governments have generally responded to natural disasters after the fact. Typically this means relying on domestic budgets, including diversion of resources from other projects, and on extensive financing from international donors. Mobilizing emergency funding from external donors has become the linchpin of some governments’ strategies for funding disaster reconstruction and has become a major component of lending programs for the World Bank and other multilateral development banks.

## **<mark>Box 1: Cognitive and Political Economy Issues</mark>**

<mark>Research has demonstrated that most people are not rational when dealing with low probability events and often make poor decisions in dealing with them. The nature of a risk can be important in determining a response. For example a dread factor has been found with certain risks such as the possibility of cancer or nuclear accident which tends to increase their subjective probability. Natural disasters on the other hand tend to be discounted. The U.S. Insurance Research Council found in a 1996 study that while 95% of U.S. houses are insured for common perils like fire, only 20% of homes exposed to flooding are insured against floods (see Box 2.). Reasons given for this include certainty equivalents which are less than the insurance premiums required to remove them (i.e. people underestimate the probability and severity of a loss, unless an event has occurred relatively recently), overestimation of the response of their fellow citizens and government and lack of awareness of the availability of insurance (which is sometimes heavily subsidized for those most at risk). In the US people exposed to flood clearly overestimate the amount of ex post federal aid available, much of which is in the form of loans from the Small Business Administration. Flood insurance coverage, which is subsidized, normally provides much better ex post indemnities. In countries with disaster laws that ostensibly make housing good after a disaster (usually earthquake), people are often still living in tents many years after the hazard event.</mark> <mark>Even where insurance is available, politicians are often caught between conflicting forces. Not only do they have an imperative to be seen to be dispensing money to victims after a disaster, but often the construction industry has a strong lobby, not least because of the importance of this industry to economic activity. When housing shortages exist the political discount rate becomes even higher. Thus while the statistical and physical measures underlying insurance pricing can demonstrate the level of risk in certain locations they can also be seen as a threat to development within the electoral cycle. Some cities, even in industrial countries, have been known to suppress flood maps for this reason. One of the authors was publicly chastised in parliament in his home country for sponsoring a study of cyclone risk in a state subject to such hazards, but also with a burgeoning tourist and retirement sector.</mark>

> 26 IFRC, World Disaster Report, 2001

> 27 Swiss Re, _Sigma._ No. 2 (2003). pg. 13.

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