Protection funds in times of crisis
In the 16th century Italian story ‘La Spiritata’, Formosus secretly weds Rosimunda but needs a considerable sum of dowry to make it official. With the help of mock astrologers, his miserly father Amadeus is tricked into releasing 3,000 crowns from a treasured hoard. Lexicographers have traced the origin for the maxim “saving for a rainy day” to this comedy play. As it turns out, this saying is no laughing matter. Having been passed down through centuries, its wisdom holds true for our present day circumstances.
The concept of building protection funds for the public and society is neither uncommon nor new. This works by pooling industry resources together and safeguarding it during good times. When crisis hits and unfortunate events occur – natural disasters, financial crises, corporate bankruptcies, losses of employment – the accumulated funds are released to support affected consumers or workers in that sector. This has come to be known as safety net protection against an otherwise hard fall. Such measures also prevent knock-on effects or a contagion of trouble in other firms, and provide the breathing space for industries to reorganise and recover. In the end, with such schemes, there is greater institutional resilience to weather storms.
The resource blessing – protection funds in times of crisis
Across the globe, we have already seen how protection funds have served, or can serve, consumers, employees, and producers in the areas of finance, agriculture, social security and air travel.
The 1930s offer us a glimpse of unprecedented crises that led to pivotal responses in the form of new protection schemes. In those years, the US was engulfed by both the Great Depression and the Dust Bowl, a phenomenon where severe dust storms wiped out livestock and crops across the drought-stricken southern plains. These events led to the creation of the Federal Deposit Insurance Corporation (FDIC) to protect depositors against bank failures, and the Federal Crop Insurance Corporation (FCIC), which insures farmers for crop losses arising from natural disasters or adverse weather.
In 2019, the FDIC’s Deposit Insurance Fund stood at $110 billion. Contributions are sourced from insured banks based on respective levels of deposit holdings, with higher rates applied to institutions that pose greater risk to the system. The less-known FCIC operates on the basis of combined premiums from farm producers and government subsidies. Although the scheme got off to a slow start, the FCIC has evolved into a public-private program covering total liabilities of $109 billion on 372 million acres for crop year 2019. Crucially, both protection schemes are designed to improve the risk management practices of banks and farmers. This promotes financial system stability as well as the economic stability of agricultural producers and rural communities.
Turning to our more immediate circumstances, we expect to continue to feel the reverberations of COVID-19’s dire impact for a while. In March 2020, the International Labour Organisation predicted a global income loss of $3.4 trillion from as many as 25 million unemployed workers. We have seen these numbers being progressively surpassed. The social safety net of many countries, particularly Unemployment Insurance (UI) schemes, proved to be a critical lifeline for retrenched workers to stay afloat through income replacement, reskilling and upskilling. UI programs are typically funded by compulsory employer and employee contributions up to limits that cover claims within a time-bound period.
A final example is an air travel consumer protection scheme in the UK, requiring licence holders in the travel business to pay a fee of £2.50 per traveller into an Air Travel Trust Fund. Since 1973, the UK has been protecting consumers from losses when travel businesses fail. At first sight trivial, but when the bankruptcy of Thomas Cook struck in September 2019, many of us obtained a new perspective of this fee. When an estimated 150,000 travellers were left stranded across the world, £152 million was spent for what became the largest repatriation in the UK’s peacetime history. In the end, the trust fund absorbed £481 million or 85% of the total cost of £564 million for Thomas Cook’s collapse.
Prior to this high-profile bankruptcy, the UK government had commissioned a national airline insolvency review. In 2019, its study had proposed for a flight protection scheme to cover the failure of airlines, to be funded by a 50 pence levy on individual air passengers. In hindsight, such a scheme would have been timely had it been established, as the airline industry now struggles to tide over the COVID-19 economic fallout.
Low probability, high-impact events are a fact of life....Humanity reveals instead a preference to ignore them until forced to react – even when foresight’s price-tag is small The Economist, 26 June 2020
Behavioural science shows that people have a natural tendency to avoid insuring against low likelihood, high impact events. The trends from past experience are clear. Typically, it would seem that it is only after struggling through the difficulties of a deep crisis or the failure of large institutions without adequate funding that protection schemes are established.
Yet all of the earlier examples go to show that protection funds can be of great value in times of crisis. How, then, should emergency funds be developed and administered for tough times? What has and has not worked so far?
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