Public Disclosure Authorized Public Disclosure Authorized / -~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~------ ~~~~~~~~ ~ ~ ~ ~ ~ ~ ~ ~ ~ Public Disclosure Authorized quup ~~~~~~ ~Q Public Disclosure Authorized Disaster Risk Management Series Managing Disaster Risk in Mexico: Market Incentives for Mitigation Investment Alcira Kreimer Margaret Arnold Christopher Barham Paul Freeman Roy Gilbert Frederick Krimgold Rodney Lester John D. Pollner Tom Vogt The World Bank DisasterManagement Facility 1999 Washington,D.C. Copyright ( 1999 The International Bank for Reconstruction and Development/THEWORLD BANK 1818 H Street, N.W Washington, D.C 20433, U.S.A. All rights reserved Manufactured in the United States of America First printing June 1999 The findings, interpretations, and conclusions expressed in this paper are entirely those of the authors and should not be attributed in any manner to the World Bank, to its affiliated organizations, or to members of its Board of Executive Directors or the countries they represent. The World Bank does not guarantee the accuracy of the data included in this publication and accepts no responsibility for any consequence of their use. The boundaries, colors, denominations, and other information shown on any map in this volume do not imply on the part of the World Bank Group any judgment on the legal status of any territory or the endorsement or accep- tance of such boundaries. The material in this publication is copyrighted. 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Photo credits: Cover, Mexico City earthquake, 1985, photographer, Fred Krimgold; page 5, aerial view of Mexico City after 1985 earthquake, photographer, Fred Krimgold; page 8, damage from Hurricane Gilbert, Mexico, 1985, photographer, Alcira Kreimer; page 16, improved building standards for post-earthquake reconstruction, 1989, photographer, Fred Krimgold; page 24, Mexican family outside a reconstructed home, 1987, photographer, Alcira Kreimer; page 30, direct damage to infrastructure leads to economic and social disruption, 1994, photographer, Fred Krimgold; page 36, Post-1985 earthquake home reconstruction in Mexico, 1987, photographer, Alcira Kreimer. Cover design by Wendy Guyette of Communications Development. Library of Congress Cataloging-in-Publication Data has been applied for. ISBN: 0-8213-4491-9 Contents Acknowledgments v Abbreviations vi Executive Summary 1 Risk Identification 1 Risk Reduction 1 Risk Transfer 2 The Role of FONDEN 3 The Role of the World Bank 4 1. Introduction 6 2. Risk Identification: Assessing Hazards and Vulnerability 9 Hazard and VulnerabilityAssessment 9 What Kind of Disasters Occur in Mexico? 10 How Are Hazards and Vulnerability Assessed in Mexico? 13 How Do Natural Disasters AffectEconomic Development? 13 Recommendations 1 5 3. Mitigating Damage by Reducing the Level of Risk 17 Developing a Risk Reduction Strategy 17 Coordinating Risk Mitigation Efforts throughout the Country 17 What Steps Have Been Taken to Mitigate Risk? 19 Recommendations 2 1 The Role of the Fund for Natural Disasters 23 4. Mitigating Losses by Transferring Risk to the Insurance Industry 25 Insurance and Reinsurance Coverage throughout the World 25 Demand for Property and Casualty Insurance in Mexico 26 Supply of Property and Casualty Insurance in Mexico 27 Mitigation of Risk by Insurance Companies 28 Recommendations 28 iii iv Managing Disaster Risk in Mexico: Market Incentivesfor Mitigation Investmnent 5. Using New Financial Instruments to Transfer and Finance Risk 31 New Financial Instruments for Transferring Risk 31 Risk Transfer and the Fund for Natural Disasters 32 Using Alternative Risk Transfer Mechanisms to Deal with Uninsurable and Uninsured Properties 33 Recommendations 34 6. Summary of Findings and Recommendations 37 Identify Risk 37 Mitigate Risk 37 Transfer Risk 38 ReorganizeFONDEN 39 The Role of the World Bank 39 Annexes 1. Geographic Distribution of Major Hazards in Mexico 41 2. Estimated Cost of Disaster Events in Mexico, 1980-98 42 3. Examples of Catastrophe Funds and Catastrophe Risk Pooling Used in Other Countries 48 4. List of People Interviewed for Study and Participants in Workshop 51 References 56 Tables 2.1 Forest fires in Mexico, 1993-98 13 2.2 Annual deaths and direct economic losses caused by disasters in Mexico, 1980-98 14 3.1 Responsibility for technical support to SINAPROC 18 3.2 Actions taken during various states of emergency 18 3.3 Emergency actions and technical coordinators 19 4.1 Estimate of insurance density 25 4.2 Insurance penetration and macroeconomic indicators in selected countries, 1996 26 4.3 Insurance penetration in selected developing countries, 1996 26 4.4 Reinsurance pricing of catastrophic risks in Mexico, 1994-98 27 4.5 Underwriting profit earned by offshore reinsurers, 1995-97 28 Maps 2.1 Path of Pacific Ocean hurricanes, August-November 1997 11 Al Active volcano risks and hurricane paths 41 Acknowledgments This report summarizes the findings of a World Bank insurers, reinsurers, banks and bank associations, and mission on disaster management, mitigation, transfer, regulators. It also met with experts in natural disaster and financing conducted in Mexico, October 19-28, management, including researchers working at the 1998. It incorporates the insights generated at a work- National Autonomous Universityof Mexicoand at inter- shop on the preliminary findings of the mission held national agencies represented in Mexico City.The active in Mexico City, February 23-24, 1999. interest and support from the team's many interlocu- The report was prepared by a team led by Alcira tors is deeply appreciated. (A list of agencies and indi- Kreimer. Team members included Margaret Arnold, viduals met is provided in annex 4.) Christopher Barham, Rodney Lester, and John Pollner The staff of the World Bank's local office in Mexico (World Bank); Tom Vogt (International Finance Corpo- City provided tremendous support and assistance to ration); and Paul Freeman, Roy Gilbert, and Fred Krim- the team during the October mission and the Febru- gold (consultants).TomDavid and FranciscoJavierPerez, ary workshop. Special thanks are owed to Country from Impact Forecasting,L.L.C. (a subsidiaryof the Aon Director Olivier Lafourcade; .Agricultureand Environ- Group), participated in the missionas private sectorpart- ment Sector LeaderAdolfo Brizzi;and to Mission Coor- ners in the Market Incentives for MitigationInvestment dinator Dora Posada, for their cooperation and support. (MIMI)initiative; we acknowledge their helpful inputs Cooperation and partial funding for the study were to the study. Natural disastermanagement experts Daniel provided by the govemment of the Netherlands, as part BitrTnBitran, Ricardo Toledo, and Luis Enrique Gutier- of the World Bank/Netherlands Environment Program. rez Alcarazalso made valuablecontributions to the study The study team thanks them for their generous support. The report was edited by Barbara Karni and laid out by The team also thanks the private sector partners of Suzanne Luft of Communications Development. the MIMI initiative-the Aon Group, Gerling Global The mission benefited from the close collaboration Reinsurance, Munich Reinsurance, and Renaissance of the MexicanPresident's Office; the Ministry of Finance Reinsurance, Ltd.-for their support of and collabora- and Public Credit; the Ministry of Environment, Natural tion on the MIMIinitiative. Responsibilityfor the report's Resourcesand Fisheries; the Ministry ofthe Interior;and conclusionsand recommendations(as well as any remain- the Federal District Government of Mexico City The ing errors) rests solely with the authors and should not study team would like to express its gratitude for their be attributed to any of the interviewees or supporters cooperation and support. The mission met with private of the initiative. -V Abbreviations CATEX Catastrophe Exchange CENAPRED National Center for DisasterPrevention (Centro Nacional de Prevenci6n de Desastres) CNA National Water Commission(Comisi6n Nacional del Agua) FONDEN Fund for Natural Disasters (Fondo para Desastres Naturales) LIBOR London interbank offer rate MIMI Market Incentivesfor MitigationInvestment NGO Nongovernmental organization PAHO Pan American Health Organization PEMEX Petroleos Mexicanos SEMARNAP Ministry of Environment, Natural Resources,and Fisheries (Secretariade Medio Ambiente, Recursos Naturalesy Pesca) SINAPROC National CivilProtection System(Sistema Nacional de ProteccionCivil) v,i ExecutiveSummary Natural disasters have had a formidableimpact on devel- identify the principal hazards it faces and assess the vul- opment in Mexico.Disasters have destroyedhuman, social, nerability of principal settled areas, infrastructure, and