Thursday, January 21, 2010

Give Well, don't Guide Star, and how to respond to Haiti

In this post, I propose hedging catastrophe risk in emerging markets via reinsurance transactions.  I argue it's cheap because most emerging market catastrophes are uncorrelated with developed market catastrophes, and they are small risks, relatively speaking.  I argue it's more efficient because it prevents crowding out of more effective, higher success rate development aid programs. (Let's be realistic: Search and rescue teams in Haiti are not "free" in any sense of the word.  Their cost per lives saved, unfortunately, is very high.  We'd save many more lives buying mosquito nets.)

This brings me to the Red Cross, and my suggestion to them.  Millions of people of generously texted their $10 to the Red Cross, a genuinely generous act.  However, they should know there is no guarantee most of these contributions go to Haiti.  I for one don't think that matters.  However, I'd imagine many of these contributors want their money to be for disaster relief.

What, in theory, could the Red Cross do?  They could take these contributions and buy catastrophe insurance on other potential emerging markets disasters.  They will very likely occur.  They will stretch the resources of the Red Cross and others.  They will crowd out longer term projects that may be substantially more cost effective.

[Side note: Don't think the Red Cross isn't financially savvy enough to pull this off.  You may not believe this, but the Red Cross securitizes the cash they know they will receive from hospitals for the blood in your arm before they even collect it.]

So, why don't they do this?  I doubt I'm original in my thinking.  I know there's at least one major stumbling block: Guide Star.  Guide Star has a near lock on the market for evaluating charitable foundation performance.  But, unfortunately, one size does not fit all.  The oversimplification (on my part) says they look at dollars spent on programs versus dollar collected.  A high number is good.  A low number is bad.  If the Red Cross spent a material fraction of their contributions on catastrophe insurance, this would look like "administrative overhead" which would not be particularly good for their rating.  It would make their ratio very volatile. 

(For those paying attention, it would look like the opposite of a combined ratio of a catastrophe reinsurer...maybe in a later post I'll discuss the notion that Guide Star encourages charities to have too much stability in their payouts, which means they are unable to respond to disasters...oh, and there's also a beautiful legal construct called UPMIFA and UMIFA that contribute to this problem....)

What's the alternative?  One of my friends introduced me to some nice guys at GiveWell a couple of years ago.  (Please do not confuse them with!)  These guys approach charities like investors.  They want to know how to evaluate if the charity delivers on its mission.  You can argue all day long about exactly what they do, (as they would attest, I think I argued with them all day long!)  But, I can comfortably assume that if a charity wanted to be in the insurance business, the team at GiveWell would figure it out, and evaluate the charity's ability to operate like an insurance company.

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