Atanu Dey On India's Development

Global Disasters, Insurance, and Moral Hazard

Suhit Anantula reports that globally an astonishing US$4 billion has been pledged for tsunami relief till date. That is an incredible amount. Assuming that about 4 million people are directly affected (certainly an upper bound), $4 billion implies a lower bound of $1000 per person. My guess is that the aggregate promised aid exceeds the aggregate annual income of the affected population. The actual aid delivered will probably be much lower than the pledged amount, if one were to extrapolate from the past performance.

Some have advocated the creation of a single world disaster relief fund. The Aid Charade by Jody Beihl suggests:

how about creating a single world disaster relief fund. Rather than one-upping each other with bids every time a disaster strikes and competing “beauty-contest-like” for top marks, each country could simply pitch in a yearly amount — say a percentage of their gross national product. The funds could then be drawn on when disaster strikes. That would rid us of what is starting to look like a charade of bidding and perhaps insure that real help comes on time, both when and where it is needed.

The idea is not new, of course. There is nothing is new under the sun. Adam Smith’s Inquiry into the Nature and Causes of the Wealth of Nations (published in 1776) informs us of one such scheme carried out in on a smaller scale. Galbraith is my guide to Adam Smith and he writes:

… were it not for Smith, we might not know that after a bad storm, or “inundation,” the citizens of the Swiss canton of Underwald (Unterwalden) came together in an assembly where each publicly confessed his wealth to the multitude and was then accessed,pro rata, for the repair of the damage.

{Source: The Essential Galbraith (pg 157) Houton Mifflin Company 2001.}

The idea is that of spreading the cost of recovery across the entire population of the globe. A sort of insurance payment where the premium is paid according to the ability to pay of various parties. There are two problems. First, how do you ensure that people pay. Second, what about moral hazard? It is a well-known problem that if one is insured against loss, then one may not exercise due caution and take unnecessary risks. If, for example, the government insures people against flood damage, then people will build on flood-prone areas knowing that they will be bailed out in case of disaster. This is normal human behavior. Moral hazard examples abound. Drivers take more risks in cars which are fitted with air-bags and seat-belts.

I have worked out an ingenious way around the problem of moral hazard. It will have to wait, however. I want at least a few people to buy the book. ***insert appropriate emoticon here***

  • Aditi

    It is all very well to profess about a world disaster relief fund, where each nation(or individual) contributes “according to his capacity and to each according to his need”, but isn’t that something we have been asking of the rich since ages, yet to no avail? Let us look at global poverty for instance, we all want the rich to contribute more so that the poor come out of their plight, but has anything been done? Or rather, has anything been “worked out”?
    My question regarding a global disaster relief is not “how to make every one pay” or “what each should pay”, but WHY should everyone pay for a disaster in one specific country?

  • http://ipatrix.com Patrix

    The moral hazard aspect makes a difference. A primary case being homes along the Florida coast. In spite of being hit by numerous hurricanes (4 last season), people especially the higher income group keep rebuilding because basically the State of Florida is the largest underwriter for insurance there and has significantly lower premiums than as market would suggest. In addition, they are credited with relief aid too in case of damage.