Traditionally, the role of finance in disaster has focused on ensuring the availability of funds for relief, recovery and reconstruction. However, finance already plays an important role ex-ante. Infrastructure is largely publicly owned in many countries. Therefore, figuring out the extent of resilience a country can afford is a public finance problem; the goal is to maximise benefits (i.e. loss of assets, or economic losses down the line) while minimising costs (since resources are limited). If the design and materials take resilience components into account, it is estimated that upfront costs of construction rise by 5% to 15%, which may discourage their incorporation.
However, since the infrastructure is publicly owned the cost-benefit analyses have to consider the cost over the full lifecycle of an infrastructure project. The design standards, then, have to be based on such a life-cycle cost-benefit analysis. One challenge in this regard, especially in countries with low capacity for enforcement, is that compliance with standards is low.
Another is that designing finance-based incentives requires a thorough understanding of risks. The session explores if and how finance can play a role in monitoring and incentivizing compliance with standards for location, design and materials for disaster resilient infrastructure. For e.g. If insurance premiums are risk reflective then premium reduction can incentivize resilience. Banks may can charge lower interest rates for more resilient infrastructure (“DRR loans”) as the risk is lower. For large infrastructure projects where there is a small market, premiums may not be risk reflective. “DRR bonds” similar to green bonds that invest only in resilient infrastructure could have similar characteristics. But for this they need the capacity to measure, monitor and incentivize risks.
As countries step up their investment in infrastructure, they need to consider different mechanisms of ensuring their resilience. Governments need to improve standards and specifications for public financing based on risk assessment. The nature and frequency of hazards should guide the inclusion of hazard-resistant features in the design and implementation of infrastructure projects. Based on risk assessment, the governments can allocate resources for mitigating infrastructure risks. For example, investments in storm water drainage can improve the resilience of urban infrastructure. Introduction of risk pools and insurance can also improve the resilience of infrastructure. In this session, different financial mechanisms of infrastructure risk management will be discussed, achieving a good balance of public and private sector resources to address the funding gap in resilience of infrastructure systems and ways to mainstream this effectively.
- How are we addressing the funding gap in developing resilient infrastructure: in terms of quantum of funding and allocation for resilience?
- What are the issues hampering long-term investments in resilient infrastructure in changing socio-economic environments? Why are traditional tools (such as deterministic cost benefit analysis) no longer suitable?
- How can the role of financial institutions at various levels (national, sub-national, global) be harmonized for better factoring in of resilience in infrastructure investments?
- What mechanisms can be adopted to enable creation of effective risk pools?
- What mechanisms may be adopted to enable better understanding of the acceptable or optimal level of risk, and how much could be retained, before transferring their risk to markets through insurance.
- What is the current imbalance in ownership of risk? How can the role of various stakeholders be re-evaluated to enable risk-sharing in a more efficient manner (private sectors, insurance, etc)?
Recommendations from IWDRI 2018
The role of finance in incentivizing resilience
Infrastructure is largely publicly owned. Therefore, determining the extent of resilience a country can afford is a public finance issue with the goal being to maximize benefits (i.e. loss of assets, or economic losses down the line) while minimizing costs. Financial instruments play the key role in incentivising uptake of good practices towards building DRI. However, effective financial planning requires a sound underpinning of data on hazards, risks and climate dynamics. E.g. taking resilience into account while developing infrastructure may raise upfront construction costs by 5 to 15%. This can be justified only by a comprehensive cost benefit analysis over the lifecycle of a project.
Understanding contingent liabilities
Governments are advised to set up institutional and operational frameworks to understand “contingent liabilities” to identify how and to what extent a budget is impacted after a disaster. E.g. In Japan, pre-disaster contracts are made with private sector developers to be prepared for post-disaster reconstruction.
Acceptable level of risk
Mitigation funding and residual risk financing is beneficial for recognition of risk at various levels. Governments need to better understand the acceptable or optimal level of risk, and how much could be retained and/or transferred, before transferring their risk to markets through insurance.
Looking beyond insurance
While insurance is able to create incentives for governments and private institutions by making premium risk reflective, it is unable to address the root cause of risk. Hence, using insurance in the absence of other systemic measures cannot be the answer to creating incentives for building resilient infrastructure. Risk financing strategies for sovereign nations will depend on their varying capacities, risk appetite, resources and willingness to manage risk. Ownership of risk is a critical issue in this regard. No matter who owns the infrastructure, the government of any country still has to plan for the risk.
A layered approach to risk management can be facilitated through a range of financial instruments that are now available to address financing development (or redevelopment) of resilient infrastructure. Disaster risk screening of infrastructure is one such method.
Mainstreaming the role of the private sector
Banks and infrastructure financing institutions are a key source of finance for infrastructure projects and have a role in improving compliance to standards for risk assessment and building. Institutional risks are critical, which is why a study of contingent liabilities becomes important.