Appropriate risk information allows public and private decision makers to assess the underlying price of risk, and clarify costs and benefits of investing in risk reduction or risk financing. A lack of knowledge about a country’s exposure to risk - and about the ‘cost’ of this risk - can lead to sub-optimal investment decisions to protect welfare. Putting a price on risk is also crucial to elevate disaster risk management to the Ministry of Finance and integrate risk considerations in public investments. Moreover, better information on the potential impact of disasters can help overcome behavioral biases, such as the reticence of businesses and households to buy catastrophe risk insurance. Disaster risk financing and insurance can also provide the short term incentives for the large scale investments in risk assessments which enables evidence based decision making in disaster risk management beyond financial protection.

Disaster risk financing helps governments, businesses, and households plan in advance of a disaster and agree ex ante on rules and processes for securing funds through their budget (budget mobilization) and spending this money (budget execution). This creates greater discipline, transparency, and accountability in post-disaster spending. Market based financial mechanisms further contribute to this. For example, a government needs to have reliable and independent rules for payout in order to transfer risk to international financial markets; insured homeowners know precisely what they are eligible for through their contractual agreement with their insurer (insurance policy). Discipline is also important for a government to be able to credibly commit when it will not act and thus facilitate ownership of risk.

Different levels of post-disaster funds need to be available at the appropriate time following a disaster to cover relief, response, and reconstruction efforts. In the aftermath of a major disaster, for example, the government does not require money for the entire reconstruction program at once. The rapid mobilization of funds to support relief efforts is crucial to limit humanitarian costs. This rapid response can also save money; for example, well-targeted early interventions in slow-onset disasters such as drought cost a fraction of emergency aid after a famine develops. While immediate liquidity is crucial to support relief and early recovery operations, the government has more time to mobilize the majority of resources for the reconstruction program. Likewise, businesses and households need to have access to timely financing following a disaster, for example through catastrophe risk insurance and/or post disaster credit.

Access to capital is necessary for effective emergency response and reconstruction as well as for investment in risk reduction and prevention. Yet different sources of money come with different costs. Disaster risk financing policies can secure access to disaster financing for governments, businesses and households before an event strikes and ensure timely and cost-effective financial resources to support post-disaster recovery and reconstruction activities while minimizing the cost of these funds through an optimal use of financial instruments such as reserves, contingent credit, risk transfer solutions, and post-disaster credit.

Clarifying who is responsible for risk – clearly establishing the contingent liability of the national and subnational government, donors, the private sector, and households – overcomes challenges such as Samaritan’s Dilemma. The absence of clear rules regarding the share of costs for response and reconstruction assumed by the national government can turn into a disincentive for the businesses and households to invest in risk reduction or purchase catastrophe risk insurance, and can trigger delays in post-disaster response and recovery. Clearly established rules for the amount and timing of payouts under social protection programs give predictability to vulnerable households, enabling better planning and budgeting.

Definition:

An instrument, such as an insurance contract, that passes on the risks to the government associated with a certain event to another party.
For example, in disaster insurance the financial risks associated with a disaster event are passed from the insured to the insurer.
Governments are increasingly looking to sovereign risk transfer to provide budget protection against disaster and climate shocks. New financial mechanisms for sovereign risk transfer include capital market instruments: any financial contract that can be structured to act in the same way as reinsurance, but with investors, not reinsurers, providing the protection. Examples are catastrophe bonds and catastrophe swaps.

Case Study:

The Caribbean Catastrophe Risk Insurance Facility (CCRIF) will allow CARICOM governments to purchase insurance coverage to finance immediate post-disaster recovery needs. A key feature of the CCRIF is the speed at which it is designed to provide short-term liquidity to a government affected by an earthquake or hurricane.
The CCRIF functions as a mutual insurance company controlled by the participating governments. It was initially capitalised by the participating countries themselves, with support from donor partners.
Considering that on average, a hurricane or an earthquake only affects one to three Caribbean countries in any given year, a pool holding only the reserves for three potential payouts should be sufficient for the entire group of countries participating in the pool. Each year as the pool is depleted, participating countries would replenish it in proportion to their probable use of the funds in the pool.

Definition:

Insurance of public assets, including but not limited to transport infrastructure (roads, bridges, tunnels, ports), schools, hospitals, water and sanitation infrastructure, to help transfer the cost of reconstruction away from the government to dedicated risk carriers. This can also help enforce building codes and quality standards, as well as rapid rehabilitation of damaged assets.

Case Study:

The Colombian government has enabled protection of infrastructure investments worth US$38 billion. The government worked with the World Bank DRFIP to adopt international good practices from private insurance markets to improve requirements for catastrophe risk insurance of PPPs, which helped protect infrastructure investments worth $38 billion. In addition, the government ensures the improvement of quality and coverage of insurance for public assets by (i) issuing insurance guidelines for the central and subnational levels; and (ii) developing internet-based software to improve the management of data on insurance policies and exposure of nationally owned property.

Definition:

A financial tool that provides governments with immediate access to funds following disaster events to enable a more rapid and efficient response. This type of financing is typically used to finance losses caused by recurrent natural disasters. A line of contingent credit is an ex ante instrument that allows borrowers to prepare for a natural disaster by securing access to financing before a disaster strikes.

Case Study:

The Development Policy Loan with a Catastrophe Deferred Drawdown Option (Cat DDO) is a contingent credit line that provides immediate liquidity to IBRD member countries in the aftermath of a natural disaster. It is part of a broad spectrum of risk financing instruments available from the World Bank Group to help borrowers plan efficient responses to natural disasters. For example, Colombia disbursed the full balance of a US$150 million Cat DDO to address a crisis caused by the worst rainy season in the country for decades.

Definition:

Borrowing by the government in the aftermath of a disaster to help address the damages and losses. This could involve domestic or international bonds or loans from international development partners.

Case Study:

Following the 2011 Great East Japan Earthquake, issuance of Japanese Government Bonds (JGBs) financed the majority of the estimated reconstruction costs. In total, slightly more than ¥14.2 trillion of JGBs have been issued. A portion of these bonds are reconstruction supporters bonds that facilitate financial support and solidarity from the Japanese public. These bonds offer the lowest possible interest rate for government bonds (0.05 percent) for three years, before converting to standard JGB rates.

Sato, M., and L. Boudreau. 2012. “Knowledge Note 6-4: The Financial and Fiscal Impacts.” Knowledge Notes, Cluster 6: The economics of disaster risk, risk management, and risk financing. Washington, DC: World Bank.

Definition:

A reserve fund designated for financing disaster losses. Allocations to the contingency fund can be made through budget allocations of the national or local governments, international agencies, communities, or a combination of these. Funds are made available immediately after a disaster and are disbursed using clear and simple rules.
Often governments rely on general contingency budget allocations which may be used for natural disaster expenditure shocks but are not exclusively earmarked for this.

Case Study:

The government of Mexico established FONDEN, a financial vehicle, by which the federal government allocates budget ex ante for post-disaster response and reconstruction. Its objective is to improve the budgetary management of adverse natural events and support the rapid reconstruction of federal and state infrastructure, low-income housing and eligible natural environment assets. FONDEN is the Government of Mexico’s mechanism to face the dual challenge of financing disasters and executing post-disaster resources efficiently and transparently across all levels of government.