DISASTER RISK FINANCE INSTRUMENTS: RISK TRANSFER FOR DISASTERS

Risk transfer is the process of formally or informally shifting the financial consequences of particular risks from one party to another. The first party, which may be a household, community, organization, or national or local government, receives a financial payout from the other party after a qualifying event occurs (such as a disaster), in exchange for a fixed and specified payment.

The best-known form of risk transfer is insurance, which involves a company (or the state) providing a guarantee of compensation for specified loss, damage, illness, or death in return for a specified payment, known as the insurance premium. Other forms of risk transfer include reinsurance (insurance for insurance companies) and alternative risk transfer (ART), which includes catastrophe bonds and derivative contracts such as catastrophe swaps. Each of the various types of risk transfer serves a different purpose within a comprehensive financing strategy for all stages of post-disaster response. As indicated in the diagram below, instruments such as parametric insurance and some forms of agricultural insurance provide rapid payouts to support financing requirements for disaster relief and early recovery, whereas indemnity insurance is better suited to providing a greater level of finance needed for longerterm reconstruction.