# **Explanation 3: Demand for catastrophe insurance is "low" because people are not rational**

Given the low frequency risk of natural disasters and their complexity, individuals are less susceptible to be rational: they under-invest in mitigation and under-insure. Moreover, collective memory might not be a reliable basis on which to gauge the risk of a natural disaster. A case in point: the Dominican Republic was hit by Hurricane Georges in 1998 but had not been affected by a significant catastrophe since 1979. In fact, many hurricanes have made landfall on the island since the late 1970s but none had a significantly negative impact on the economy. The Dominican Republic also straddles five tectonic plates which make it very vulnerable to seismic activities; however, the last earthquake occurred some two generations ago in 1946. Hurricane Gilbert in 1988 was Jamaica's first major catastrophic shock since the earthquake of 1907. In the current collective memory of the Dominican Republic and Jamaica, therefore, the probability of serious damage from an earthquake is extremely remote.

Public interventions may help correct this market failure. The public sector may engage in information campaigns to provide accurate information on catastrophic risk. However, experience shows that even if the benefits of insuring are identified and disseminated, people will continue to under-invest in mitigation and to under-insure. Public interventions to rectify this market failure could be in the form of providing incentives to those who invest in risk-reduction measures. Individuals and firms who purchase insurance could also be granted tax credits or deductions, for example. Although this might be difficult to enforce in poor and marginal areas that are most at risk, consideration could be given to legislating mandatory catastrophe insurance coverage.

**Explanation 4: Prices of catastrophe insurance are "high" and supply of catastrophe insurance is "low" because land-use regulations and building codes are inexistent or not enforced**

In many Caribbean countries, the lack of enforcement of existing land-use regulations and of building codes limits access to catastrophe insurance or makes catastrophe insurance unaffordable. The presence of properties in high-risk areas eitfier prevents insurance companies from offering comprehensive coverage to those who most need insurance protection or places the cost of insurance out of reach of those who cannot afford high premiums. Dwellings are constructed in hazard-prone, low-lying coastal areas, deep river basins or valleys and along steep slopes. In Santo Domingo, the Dominican capital, about 300,000 people live in the high-risk, flood-prone and highly polluted Ozama River Basin. "Chattel" houses in Barbados, Jamaica and Trinidad and Tobago are another example of vulnerable, uninsurable properties (lacking dug-in foundations, secured frames or bolted roofs) which could be easily dislodged in the event of flooding or strong winds. Compliance with building codes ensures minimal damage and some structural survival in the event of a catastrophe. It also lowers the costs of catastrophe insurance. In the Caribbean region, however, houses are not built in compliance with engineering requirements or location restrictions.'<sup>6</sup> Even if they exist, legal codes and provisions in the region tend to be outdated or inadequate. Jamaica adopted building codes and earthquake hazard mitigation policies after its last earthquake in 1907. There are currently no official building codes or standards in Trinidad and Tobago, although substantial work has been done in the field. Barbados's first building code was drafted in 1992 but is yet to pass into law. The Dominican Republic has a uniform building code (UBC), similar to the California building code, but only a

> **16** For an in-depth review of this issue see World Bank, 2002 (b) and (c).

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