Saturday, December 8, 2012

Unmitigated disasters? New evidence on the macroeconomic cost of natural catastrophes

Unmitigated disasters? New evidence on the macroeconomic cost of natural catastrophes. By Goetz von Peter, Sebastian von Dahlen and Sweta C Saxena
BIS Working Papers No 394
December 2012
http://www.bis.org/publ/work394.htm
 
Abstract: This paper presents a large panel study on the macroeconomic consequences of natural catastrophes and analyzes the extent to which risk transfer to insurance markets facilitates economic recovery. Our main results are that major natural catastrophes have large and signi cant negative e ects on economic activity, both on impact and over the longer run. However, it is mainly the uninsured losses that drive the subsequent macroeconomic cost, whereas sufficiently insured events are inconsequential in terms of foregone output. This result helps to disentangle conicting ndings in the literature, and puts the focus on risk transfer mechanisms to help mitigate the macroeconomic costs of natural catastrophes.

JEL classification: G22, O11, O44, Q54.

Keywords: Natural catastrophes, disasters, economic growth, insurance, risk transfer, reinsurance, recovery, development

Excerpts:

By using a novel and unique dataset, this paper measures the dynamic response of growth to major natural catastrophes, and examines the extent to which risk transfer to insurance markets facilitates economic recovery for a large cross-section of countries. With this aim, the paper makes three contributions to the literature. First, our analysis has a broader scope than other studies.  We construct a large panel with 8,252 country-year observations, covering 203 countries and jurisdictions between 1960 and 2011, matched with 2476 major natural catastrophes of four different physical types. Importantly, we make use of the most detailed statistics available on total and insured losses, obtained from industry sources. These unique data are better suited for the analysis than the public CRED database used in the existing literature.1 On the methodological side, we estimate the full time profile of economic growth in response to natural disasters in a dynamic specification. This allows us to present a more complete picture of growth dynamics than studies that focus on a particular time segment only.

Third, and most importantly, this is the first paper to make the link between natural catastrophes and economic growth conditional on risk transfer. This nuances the transmission channels, thereby helping to resolve the conflicting findings on catastrophe-related growth e ects in the literature.  In particular, we show that the uninsured part of disaster-related losses drives the subsequent macroeconomic cost in terms of foregone output. In focusing on economic activity, we recognize that disasters invariably diminish the wellbeing of affected populations even if growth rebounds.2 That said, there is little evidence that countries rebound from natural catastrophes when uninsured.  We nd that a typical (median) catastrophe causes a drop in growth of 0.6-1.0% on impact and results in a cumulative output loss of two to three times this magnitude, with higher estimates for larger (mean) catastrophes. Well insured catastrophes, by contrast, can be inconsequential or positive for growth over the medium term as insurance payouts help fund reconstruction efforts.

These fidings suggest that risk transfer to insurance markets has a macroeconomic value. This value may be particularly high for smaller nations that lack the capacity to (re)insure themselves against major natural disasters. The analysis thus contributes to the policy debate on different forms of post-disaster spending, as well as the balance between prevention ex ante and compensation ex post. Our finding that catastrophes have permanent output effects is also relevant for a growing literature that explains asset pricing puzzles through rare disasters. The extent to which risk transfer mitigates the macroeconomic cost of disasters is pertinent to the literature on finance and growth, which focuses on banks and stock markets but not on insurance. Considering the macroeconomic value of risk transfer could also enrich the macroprudential approach to the regulation and supervision of insurance companies.

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