Abstract
Financial intermediaries [FIs] in developing and emerging economies are poorly equipped to manage natural disasters. These events create losses for FIs, eroding capital reserves and compromising their ability to lend. Portfolio-level insurance against disasters can improve FI management of these events. We model microfinance intermediaries [MFIs] exposed to severe El Niño in Peru that can now insure against this disaster risk. Our analyses suggest that insurance allows these lenders to manage this risk more efficiently and effectively. These risk management improvements can translate into better financial performance, expansion of banking service outreach, lower interest rates, and reduced volatility in access to credit. Based on these analyses, a large MFI in Peru with which we collaborated is now managing its disaster risk using El Niño insurance.
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Notes
Collier et al. estimate that recovery from the 1998 El Niño took four to five years.
Inclusions of these payments would embed additional assumption in the model and potentially obscure the results. Dividend payments during a crisis further undermine the capital base of a troubled FI making it more vulnerable. FI managers anticipating that shareholders will demand a payment during the next severe disaster have an increased incentive to manage their financial risk with insurance. Capital infusions can save an ailing FI; however, relying on recapitalization is problematic for several reasons, as described above. In this context, portfolio-level insurance may represent an attractive alternative for FI managers as it reduces uncertainty associated with attracting capital and for equity holders as it reduces the probability that the FI will require a capital infusion during a crisis.
With a premium rate of 7 % of the sum insured, insuring at 6 % of the portfolio results in 42 basis points on the portfolio, 7 % * 6 % = 0.42 %.
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Benjamin Collier is a doctoral candidate and Jerry Skees is the H.B. Price Professor of Policy and Risk in the Department of Agricultural Economics at the University of Kentucky. Skees also is President of GlobalAgRisk, Inc. This research was supported by the University of Kentucky Agricultural Experiment Station and is published by permission of the Director as station number 12-04-050. We also acknowledge the support of the Bill & Melinda Gates Foundation for research and for field work in Peru that has enhanced this article. The findings and conclusions contained within are those of the authors and do not necessarily reflect positions or policies of the Bill & Melinda Gates Foundation
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Collier, B., Skees, J. Increasing the resilience of financial intermediaries through portfolio-level insurance against natural disasters. Nat Hazards 64, 55–72 (2012). https://doi.org/10.1007/s11069-012-0227-0
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DOI: https://doi.org/10.1007/s11069-012-0227-0