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Cutter (2016; p. 742) has recently stated “it is the need for making the business case for investments in risk reduction and resilience which is driving the policy agendas articulated in the Sendai Frameworks for Disaster Loss Reduction.”Footnote 1 There is no doubt that the primary motivation of businesses is to maximize profits. On the surface, only those disaster risk management (DRM) actions, which include both (pre-disaster) mitigation and (post-disaster) resilience, that are viewed as promoting this objective will be undertaken, though not all of these actions are recognized. But there are several broader benefits of DRM to businesses themselves and to the economy as a whole that are typically neglected, and hence businesses underinvest in DRM both from their own perspective and also from the standpoint of society.

We refer to the broader benefits, or spillover effects, of DRM as Co-Benefits. When a business installs a sprinkler system to protect against fire spreading on its premises, it also helps protect adjacent buildings and an entire community. This is also the case for strengthening the foundation of a tall building, lest it collapse on its neighbors, or for instituting better water drainage practices that reduce flooding potential for the community. It also applies to accelerating business recovery, which puts people back to work and provides needed inputs to other businesses in the affected area. More broadly actions by any one business can contribute to overall community well-being in terms of improving the quality of life and promoting economic growth and stability. These Co-Benefits are not all captured by the firm that pays for them, and this leads to underinvestment in DRM.

Overall, private sector DRM strategies have many benefits, including avoided losses and other direct or indirect benefits for the firms implementing them, as well as positive spillover effects (“externalities”) for other firms, the macroeconomy, and society as a whole. However, businesses tend not to engage in DRM sufficiently from a societal perspective, because of internal decision-making limitations and because they cannot capture many of these spillovers benefits. Therefore, greater awareness of Co-Benefits and government and NGO incentives are needed to encourage private firms to increase investment in DRM (see Rose 2016).

Another source of Co-Benefits pertains to broader gains to society apart from disasters. This refers to DRM investments that benefit disadvantaged segments of the population and that contribute to sustainable development itself, such as vaccinating their employees or using more durable materials in their buildings. Many of these gains are external to the firm but feed back positively onto businesses themselves by promoting economic stability, spawning a healthier and more productive workforce, etc.

Still another category of Co-Benefits can be captured primarily by businesses themselves, if they are able to recognize them. These include DRM investments that improve the image of the firm or that otherwise lead to an increase in long-run profits, such as actions that are viewed as being in the public interest or that protect society from catastrophic risk. Ironically, many of these Co-Benefits are more tangible and immediate than most ordinary DRM benefits, which may not appear until a disaster has struck many years after the investment has been made.

Inducements are often needed for businesses to invest in a manner and at a level that captures these Co-Benefits for themselves and/or their host economies. Examples include providing businesses with better information on how they can reap some of the rewards of broader Co-Benefits, developing more versatile financial instruments, or providing them with subsidies that correspond to some portion of the Co-Benefits that contribute to societal goals. Although the subsidies represent a cost to government, it may be less expensive, as well as more effective, to have the private sector undertake these efforts. The appropriate design of incentives, preferably based on strong theoretical foundations and empirical evidence, is critical to cost-effective implementation of DRM.

This chapter analyzes many important facets of private sector investment in DRM, primarily from an economic perspective. It is intended as a first step to greater investment in DRM by identifying potential Co-Benefits, explaining why they are not always pursued, and suggesting ways to integrate them into private sector decision-making.

9.1 Integration into Business Culture and Sustainability Planning

The infrequency and sporadic nature of disasters cause a serious perception problem with respect to DRM. Learning is possible, but limited by institutional memory. Often mitigation and resilience are viewed as areas of concern separate from day-to-day business activity.

Several analysts have suggested, however, that it is prudent for businesses to integrate DRM into their general business strategies and practices. Essentially, this is a general way of capturing some Co-Benefits. For example, Zolli and Healy (2012) have emphasized the importance of organizational and operational flexibility, which makes businesses more capable of coping with drastic change. Sheffi (2005) has provided numerous examples of supply-chain rigidity that led to business failure in the aftermath of a disaster, but is now countered by a broader view of the supply chain as a web that includes back-up sources.

In addition, in many countries a business-continuity industry has been spawned to meet the increasingly needed functions that more companies are realizing are beyond their own expertise or can be applied more cheaply if contracted out (e.g., information technology back-up, massive clean-up, logistical support, relocation). Large companies in industrialized countries can readily form and staff their own emergency management office, but smaller firms and firms in developing countries are less likely to be able to do so. The professionalization of DRM at the operations level in this new service industry fills a much-needed gap.

Resilience is considered to be the response to short-run shocks, while sustainability refers to maintaining a long-run development path in which actions by the current generation do not compromise the well-being of future generations, with an emphasis on maintaining the value of natural capital and human capital, not just physical capital. If a country cannot survive short-run shocks, it clearly will not be sustainable. One other aspect of the relationship is key: transforming the ingenuity that arises from short-run resilience into longer-term practices to promote sustainability. Rose (2014) has specified the following steps that can help achieve this goal:

  • Identify effective resilience tactics at the micro (business), meso (industry/market), and macro (regional/national) levels based on actual experience. For example, ingenuity in conserving and substituting for critical resources under extreme stress should be examined for their more permanent potential under normal conditions.

  • Develop resilience indicators based on evidence of successful practices to monitor progress on resilience capacity. Even though disasters may be sporadic, the need to develop ways to mute their negative impacts should be a continuous process.

  • Disseminate findings on best-practice resilience tactics and community response. Likewise, the continuous dissemination of information about resilience will help make it ingrained in daily life.

  • Evaluate the cost-effectiveness of resilience. This helps ensure resilience will be implemented as efficiently as possible, thereby helping to remain on or return to a sustainable path.

  • Analyze the strategic tradeoffs between mitigation and resilience in terms of cost-effectiveness. Resilience should not be assessed in isolation of other major strategies, and that assessment should be done in terms of their ability to cope with short-run crises and to contribute to long-run sustainability.

  • Identify ways to make resilience in the face of crises enduring, so as not to repeat previous mistakes. A good institutional memory contributes to both resilience and sustainability.

  • Identify ways to transform short-run resilience responses into sustainability strategies. The view of resilience should go beyond consideration of individual tactics and should be evaluated in terms of broader community strategies that capture synergies.

  • Steer the economy and related systems to greater flexibility in terms of resource provision and utilization. A key attribute of resilience is flexibility, and ways need to be found to take advantage of this attribute, as in broadening the array of sustainable future paths.

Overall, the many Co-Benefits of DRM represent a type of “Resilience Dividend.” This concept heightens the potential of DRM to not only reduce disaster losses but also to enhance the prospects for future growth and development, and hence sustainability. It is part of what is now known as the “Triple Dividend of Resilience”, where resilience is defined more broadly than in most of this volume (Tanner et al. 2015; Surminski and Tanner 2016). In addition to contributing directly to reducing vulnerability to disasters, resilience reduces uncertainties that promote entrepreneurship and investment, and also provides tangible joint product benefits other than those related to reducing risk.

9.2 Shortfalls in Private Sector Investment in DRM

9.2.1 Private Sector Investment Decisions

The primary objective of businesses is to maximize profits, and for many firms the focus is only on the short term. Secondary objectives, such as increasing market share, are usually consistent with this primary concern as well, but are more long term. DRM will be undertaken by businesses as long as it is consistent with profit maximization. Most DRM initiatives involve investment, so the objective is often couched in terms of maximizing net present value or the internal rate of return. The latter principle is often used to compare or rank alternatives. Brugmann (2012) emphasizes the importance of factoring mitigation, adaptation and resilience into the picture, as opportunities to improve investment performance. He notes that this can help establish a market basis for DRM.

Investments have two interrelated features that other business activities do not have, or have to a lesser degree. First, the returns to the firm take place over the course of time. Second, because they take place in the future, the returns involve a degree of uncertainty. Interest rates are used to account for both features. Revenues in the future year are not directly comparable to each other, so the market interest rate is used to discount future returns to account for the time value of money. The interest rate is also used to adjust for risk, such that higher than market rates reflect a risk premium. Investments in new or unproven technologies are relatively more uncertain than others; these are characteristic of many of the larger DRM investments, which have to be customized. Another factor that translates into greater uncertainty surrounds the benefits of DRM. These benefits are the avoidance of lost profits, adjusted by the probability of occurrence of the disaster. These probabilities are highly uncertain, so the risk premium may be increased accordingly.

A major debate revolves around whether uncertainty reduces or merely postpones business investment. Doh and Pearce (2004) suggest that a context of continuous vs. discontinuous uncertainty makes a difference, with disasters clearly being in the latter category. A great deal of literature relates to regulatory uncertainty, which is also very applicable to disaster mitigation (e.g., building codes, zoning ordinances). Findings are mixed, however, on whether uncertainty inhibits forward movement (cf. Yang et al. 2004; Aragón-Correa and Sharma 2003). Carrera et al. (2003) and others note ways of capitalizing on uncertainty, such as the advantages of being a “first-mover” (another type of Co-Benefit). Hoffmann et al. (2009) provide an example of three factors in a case study of German electric utilities facing climate change regulation as influencing forward progress on investment: (1) securing competitive resources, (2) leveraging complementary resources, and (3) alleviating institutional pressure.

9.2.2 Private Sector Investment and the Public Sector

Although businesses continuously voice their support of free markets and opposition to government interference, most firms will work in a cooperative spirit if it is in their best interest. For enlightened business managers, best interest means not just short-run maximization of profits, but also maintenance of the business’s image. Both of these factors augur well for businesses cooperating in sustainable development efforts.

Governments have led the charge to “mainstream” DRM into development planning, as exemplified by a case study of Jamaica (ODI 2014). That country has included a broad range of sectors and vulnerabilities into the plan, including transportation infrastructure, food security, ordinary flood protection, landslide risk reduction, and climate change. A Senegal case study (ODI 2014) indicates a very broad approach in which the country’s National Platform brings together all ministries. At the same time, this study notes shortcomings, including a lack of coherence among levels of government and an absence of the requirement of environmental impact assessments prior to the undertaking of major projects.

Public sector investment decisions are not dissimilar to the private sector at the core. Benefit-cost analysis (BCA) is typically applied with the objective of maximizing the net present value of future returns. Given the uncertain nature of disasters, the benefit side of the ledger is often weighted by the probability of occurrence. In such an expected value setting, Co-Benefits for extreme events can readily exceed Direct Benefits of DRM because the weights are so low (the events are so infrequent). It should be kept in mind, however, that with regard to other decision criteria, such as minimizing regret, the probabilities do not come into play, and the avoidance of disaster is the key factor.

Two major differences between public and private sector decision criteria should be noted, however. First, public sector evaluations are usually required to consider all benefits to society, not just narrow benefits to a private enterprise, which are often confined to market values translated into revenues. In other words, at least in theory, government investment decisions should incorporate all Co-Benefits. Second, the government discount rate is usually considered to be lower than the private one for several reasons, including government’s much greater resources that do not necessitate borrowing in capital markets and government’s relative greater ability to absorb adverse shocks from uncertainty.

9.2.3 Private Sector Co-benefits

The major benefits to a firm from a DRM investment are the revenue losses avoided and any ancillary revenues it may receive. The latter would be exemplified by Co-Benefits in the form of salable by-products or joint products, such as a decision to install solar panels to insulate the firm against disruptions from central power stations, where excess solar electricity can be sold back to the grid. This is still a relatively short-sighted perspective, and its limitations are discussed both from the vantage point of the firm and society as a whole in the following sub-sections.

A more enlightened view of the firm’s objectives incorporates longer-run considerations relating to its good name or its survival. DRM often provides broader social benefits that might be considered by the firm, as pressures from shareholders, incentive systems, etc., tend to focus private companies on the bottom line. Examples would be voluntary reductions in pollution that improve the firm’s image and implementation of flood control practices that benefit the entire flood plain.

An in-depth discussion of Co-Benefits is presented elsewhere in this volume, so we confine ourselves to a brief summary list here without any detailed description. There are four major categories of Co-Benefits for which we provide some examples:

  • Benefits to the business undertaking the investments

    • improved business image (from being a “good citizen”)

    • improved credit rating (from increased stability)

    • improved ability to deal with multiple hazards (from business continuity planning)

  • Benefits to other businesses in the supply chain or geographic vicinity

    • increased supply-chain stability (from business continuity)

    • reduction in contagion effects (from lower likelihood of fire spreading or falling debris)

  • Benefits to the general business climate

    • reduced uncertainty (through lowering the likelihood- of disaster losses)

    • increased economic stability (from business continuity)

    • increased economic growth (from business continuity)

    • contributions to technological progress (from embodied technological improvements)

  • Benefits to society

    • improved health and education (from employee-related measures)

    • improved environment (from more prudent use of resources)

9.2.4 Bounded Rationality

Economics has long been criticized for invoking simplifying assumptions about behavior, such as the profit maximization motive of businesses. A broader perspective has evolved that incorporates behavioral considerations. The main body of this approach is known as bounded rationality, and it focuses on various limitations to decision-making (see, e.g., Gigerenzer and Selten 2002). A classic example is myopia, which refers to the use of unduly short time horizons. The manager may only be interested in near-term gains, as opposed to long-term ownership considerations. Kuneuther et al. (2013) found that analogous myopia was the major deterrent in undertaking DRM by households in hazard-prone areas. Even major information campaigns to raise awareness have been relatively unsuccessful (Kunreuther 2006). A related phenomenon that also leads to market failure is that of asymmetric information. One key example is the “principal-agent” problem, best exemplified at the business level when the manager is not the owner. The manager’s incentives may be end-of-year bonuses, often based on maximizing sales, rather than maximizing profits, which is more in line with the efficient allocation of resources.

These instances are pertinent to DRM decisions. A manager may see a mitigation measure as reducing profits in the year in which they are made, without considering the longer-term view that it will reduce disaster losses in the future. Myopia and split incentives are likely to lead to even less attention to broader societal benefits of DRM, such as poverty alleviation, economic stability, and sustainable growth. Thus, just demonstrating the existence of these broader Co-Benefits is not necessarily enough to achieve the desired action. Some remedies that would help promote the pursuit of Co-Benefits, but not necessarily in capturing them all, include working with owners rather than managers, appealing to the reputation of the firm, and giving priority for disaster assistance to those firms that cooperate in DRM.

Another limitation of decision-making is lack of information and the inability to process the information available. This concept extends to expertise as well. Yoshida and Deyle (2005) found access to expertise (primarily from engineers, insurance managers and consultants) to be the major determinant of small business investment in hazard mitigation. The emergence of the business continuity industry should help in this regard, especially for smaller firms who lack in-house expertise. This is even truer for home-owners, but programs like the Institute for Business and Home Safety (IBHS 2015) FORTIFIED Program in the U.S., which links expertise with higher standards, offers a promising approach.

The concept of moral hazard refers to engaging in negligent actions because the entity need not bear their full cost. The very nature of large businesses lends itself to this problem, as decisions by one person in the firm are not immediately, or even eventually, penalized. Many corporations are so large that accountability loses transparency or else is dissipated. All but the top officials are insulated from the other operations. It is the mid-level management that must voice concerns about disasters, but may be hesitant to do so, lest DRM expenditures come out of their own budgets. Moral hazard also arises for large firms when their negligent actions are forgiven by governments who lack influence over them.

9.3 Co-benefits of Public Sector Investment

9.3.1 Co-benefits to Society

Not adequately considering co-benefits of DRM is a major reason for underinvestment (Vorhies 2012). Public officials in general need to be better informed of these co-benefits and need to do a better job of communicating them to their finance ministries and to the business community.

To expand on the discussion in the previous section, there are several reasons why even the knowledge of Co-Benefits may not be sufficient for adequate public sector action. Such reasons come under the heading of “government failure”, the counterpart to “market failure”. One of them is the short time-horizon of elected officials, who often cannot see beyond the next election. A counterpart is the insulation of appointed officials. Further exacerbating the problem is the opportunity cost of DRM investment in relation to other goods and services that public officials may prefer to provide, as they view the public interest or their own political self-interest (Vorhies 2012). There are several ways of overcoming this problem. For example greater public participation in the decision process injects a two-way flow of information that promotes DRM. Flores and Smith (2010) have noted that democratic societies tend to do a better job in terms of DRM.

Government agencies are likely to improve access to funds through better communication. Templates for information-sharing, such as those developed by the U.S. Federal Emergency Management Agency (FEMA 2013), are one valuable model. Still, just a listing of the relevant co-benefits is only an easy first step. The next and much more difficult step is actually measuring them. Kousky (2012) and Vorhies (2012) provide examples relating to the evaluation of mitigation measures for housing in the form of retrofits, but note difficulties in implementation such as whether to value buildings according to market prices or replacement costs.

Some of the co-benefits are especially difficult to measure, as in assessing potential improvements to the business environment or to more general economic stability. It has not even been demonstrated yet that foreign direct investment (FDI) is driven in any major way by DRM. Many of the indirect standard effects of DRM, such as multipliers stemming from economic interdependence, can be measured by conventional models, such as input-output (I-O) and computable general equilibrium (CGE) models (see, e.g., Hallegatte 2008; Rose 2015). Externalities, or spillover effects, can be measured as well. For example, Rose et al. (2014) measured the side-effects of anti-terrorism measures such as traffic stops, bag and parcel checks, and closed-circuit television monitors. While the latter generated some loss of privacy, it also increased the feeling of security, which translates into increased commercial activity and more broadly an improved business climate to attract investment.

Another difficulty is in catering to various stakeholders. Not all of them are equally impacted, so distributional information is especially important. In addition, one must overcome the apparent bias of DRM with respect to higher income groups. Since they have much more at stake, they are likely to reap the greater share of absolute gains, though the relative position of lower income classes is relevant here, and DRM has the ability to prevent further deterioration of their material status.

9.3.2 Co-benefits to the Private Sector

Despite exponentially increasing financial losses from disasters, business spending on DRM has not kept pace. The issue is how to engage the private sector in DRM from a finance and implementation standpoint. Also important is how this engagement would influence government development planning.

One more direct and apparent benefit to the private sector relates to risk-taking. Analysts have long noted its important role in entrepreneurship, and it should not be stifled but rather enhanced. Investors work in the context of background risk not under their control, but disasters exacerbate this and can lead to greater risk aversion, which has a dampening effect on the entrepreneurial spirit. Reducing this background risk and providing better information on residual risk can help promote DRM. It leads to a context of “risk-conscious decision-making” (Hallegatte 2016, Ch. 2)

There is an important role for insurance in DRM. Insurance is provided by the private sector throughout most of the industrialized world, and its expansion into the developing world would be valuable for this purpose. However, these initiatives are likely to require backing through re-insurance, government subsidies, or government regulation (e.g., ceilings on liability/payouts). One of the especially beneficial aspects of insurance, when structured properly, is the inducement for mitigation. This harkens back to fire loss coverage, where the insured were given reductions in premiums if they undertook sounder fire prevention practices. Lower insurance rates represent an additional co-benefit of DRM, in that it makes insurance more affordable to a larger number of people.

One of the key issues is being able to communicate effectively with businesses, taxpayers, and political supporters of these Co-Benefits. The main challenges are interrelated:

  • Absence of controlled experiments that are the standard in the science fields but not possible in the disaster field, hence rendering analyses relatively more tenuous.

  • Measuring and tracking investment effects is difficult, because first a baseline must be established and then the effects of investing ascertained (again difficult where controlled experiments are not possible, or impossible if the disaster does not strike)

  • Having to do the measurement and communication in the context of uncertainty makes them relatively more difficult to come across as convincing and more difficult to understand by non-scientists.

9.4 Resilience Dividend as a Sustainable Development Theme

Awareness of Co-Benefits of DRM must be raised. Because so many of them are not part of individual business enterprise calculations, they are likely to be ignored. Also, because many of them are especially difficult to measure, their full contributions might not be fully appreciated. Knowledge transfer can be especially valuable in making the business case for DRM. Best-practice methods of evaluation, instruments for finance, and techniques for implementation can be very valuable in this regard. This should also be extended to what is referred to as “Next Practices,” which are more forward looking and help developing countries overcome some of the mistakes and limitations of the past by learning from industrialized country experiences.

This study is only a first step in the process of improving the perceptions of the broad range of benefits of DRM. Below, we discuss some of the broader contributions of DRM in terms of a resilience “dividend.”

9.4.1 No Regrets Strategy

One of the major features of the Co-Benefits approach to evaluating DRM investments is that many are not dependent on actually experiencing the disasters that they seek to prevent. Sometimes, such investments would be viewed as wasteful, but this is an unfair characterization, since from a probabilistic standpoint they are prudent. Thus, while the expected value of benefits (losses averted) are positive, the actual direct benefits may be viewed as zero. However, the Co-Benefits often take place irrespective of the occurrence of any disasters. It has been popular to refer to such instances as a “no-regrets” strategy, in that it reaps benefits irrespective of future outcomes. This terminology has come into widespread use in the climate change area, where tactics such as energy efficiency (reductions in energy use that more than pay for themselves) are considered meritorious on their own even if predictions about climate change are not accurate (IPCC 2014).

Clearly, pure no-regrets strategies are just a subset of DRM investments where Co-Benefits themselves outpace the costs. As such, they relieve the pressure on some highly visible projects that do not otherwise appear to have been needed. We should, however, not let the perfect be the enemy of the good, in that investments with partial offsets of costs through Co-Benefits are worth seeking on a probabilistic basis.

9.4.2 Shared Growth and Social Benefits

Prudent DRM investments will increase not only the profit margins of firms but also benefit the entire economy directly and indirectly. Direct benefits stem from the increased capital stock and production (contributions to a higher GDP) of the firm itself. Indirect effects, or Co-Benefits, stem from the many categories discussed in this chapter, including multiplier effects, employment opportunities and tax revenues in all cases, and environmental and broader social benefits in some cases. Moreover, the reduction of uncertainty can have a stimulating effect on both the firm and the overall economy through many conduits including attracting more foreign direct investment.

Most of the population can share the gains of economic growth. Increased employment helps reduce poverty and provides improved health care for those employed (again directly and indirectly). Increased tax revenues can be used to help others, not only in terms of health care, but also education and other social services. Reduced uncertainty provides broader social benefits as well in terms of locational choices, personal investment planning, and human resilience.

There is some controversy about which socioeconomic groups benefit most from DRM. The well-to-do benefit because they have the most assets. On the other hand, the poor often live in areas with greater hazard exposure and vulnerability. Moreover, because they live on the edge of subsistence, even relatively smaller losses can be relatively more injurious to them. Economic and social equity implications of DRM need to be examined and refinements made where they violate a society’s principles of fairness. This is not an easy matter, in part because of the diverse set of relevant equity principles are espoused and sometimes conflict, as for example, comparing the benefits principle with ability to pay a the local level and the many alternative burden-sharing principles for mitigating GHGs (see, e.g., Rose 2009).

9.4.3 Environmental Benefits

Climate change has placed a much stronger focus on the role of the environment in disasters than ever before. Previously only a very small portion of DRM had been oriented toward the environment. For example, a major study of the benefits of 10 years of U.S. FEMA hazard mitigation grants (MMC 2005; Rose et al. 2007) indicated that, while significant portion of the grants yielded environmental benefits, especially those associated with flood mitigation, less than 1 % of the total dollar benefits were environmental. The small fraction resulted despite the broad range of benefits, which included improved water quality (for recreational and commercial fishing, drinking water), reduction of hazardous wastes, and enhancement of wetlands, aesthetic, and health and safety benefits. In hardly any of the cases were environmental benefits cited as a major concern, but they were factored into the FEMA grant applications as Co-Benefits. At the same time, it should be mentioned that environmental benefits in the MMC study and others could very well be significantly under-estimated because of measurement difficulties in this realm.

In case of climate change, the environment is not only the medium through which the disaster is transmitted, but aspects of it are also among the major receptors of damage. Threatened on a much broader scale than ever before are delicate eco-systems, biodiversity, and soils, among others. Projected economic losses from climate change are in the hundreds of billions of dollars per year, with the sizable portion being environmental (IPCC 2014). Abatement of greenhouse gas emissions is being justified on the basis of all of these losses, and adaptation to climate change manifestations can further reduce losses. Most of the improved environmental areas are public goods or common property resources, but even still many of them are utilized by the private sector (e.g., river water for cooling nuclear power plants, pristine areas for recreation). Many environmental goods and services have private goods characteristics as well and are of course directly related to private sector interests. These include timber, soils, and biodiversity, which are threatened more than ever by surface temperature warming, drought, and increased wind and flood damage. In these cases, environmental services are direct benefits rather than Co-Benefits.