Management of Weather and Ecosystem Risks in Latin America: the New Financial Instruments of Transfer

In the past few years, the number and intensity of natural disasters has increased significantly. In particular, the Latin American countries have been seriously affected given their high degree of vulnerability. Such natural events cause not only human losses, but also put in risk the sustainability of efforts being implemented for the economic development of emerging countries, destabilizing countries' public finances and debt management. This is why it is necessary to have effective natural disaster risk management strategies and financing mechanisms. Within these financial strategies we can find: fiscal resources, contingent credit lines, catastrophe bonds and insurance/derivatives. The weather derivative market at the global level has been growing in the past decade, achieving a total of US$ 19.2 billions in 2007. However, such market in Latin America is still nascent. Even with significant evidence showing that the impacts of natural disasters on public finances is greatly reduced in countries with a higher level of development of insurance and financial systems, many countries in Latin America continue to absorb most of these risks. This is mainly explained by the short political cycles (4 to 6 presidential years), which provides a disincentive to undertake investments in prevention that would yield benefits beyond their political term, while in the short term they can invest in responding to natural disaster (ex-post) that it is anyway seen as an exogenous event not under the control of politicians. Furthermore, the role of the public sector in using financial risk transfer instruments is not only relevant for its impact in the risk adaptation and response, but also for the natural disaster risk and climate change agenda. Insurance Premium prices send signals to the market about the changes in risk provides of activities and/or geographic regions, putting pressure in various market agents to invest (or not) in disaster prevention/mitigation. To summarize, the implementation of a financial system that includes financial weather hedges is necessary to: (i) cover the urgent needs right after a natural disaster; and (ii) as a mechanism to deepen (and attract) the financial weather derivative/insurance market to be used by private sector, national and subnational governments, etc. Finally, in order to put in place such a system, the following are some necessary conditions: (i) have access to capital markets and financial instruments, such as derivatives and insurance; (ii) have access to information and probabilistic analysis about weather events; and (iii) have national and/or subnational governments with the capacity to use these instruments.