How natural disasters are paid for makes a big difference to the total economic cost. Ministries of finance receive countless financial protection proposals from reinsurers and banks, but often lack the technical expertise and quantitative tools to evaluate their suitability.
Recent research by The World Bank Group has made this a little easier. An integrated framework has been developed and tested for assessing potential financial protection strategies, requiring only basic technical capacity and readily-available data.Its real innovation is its use of actuarial, economic, and financial theory to condense some of the key benefits and weaknesses of each financial instrument into simple numbers. This allows instruments and strategies to be directly compared and can guide governments and their development partners in choosing an appropriate low-cost approach for financial protection against disaster.
For instance, different governments face different risks, different economic and fiscal environments, and different institutional capacities to manage public finance. And, instruments can differ in cost, speed, accuracy, and flexibility. When structuring a disaster risk financing strategy, these elements all matter.
Early comparative financial analysis and planning, the research finds, can save substantial money. Application of the framework to one drought-prone African country suggested that financing disaster-response costs through a combination of budget reallocation, reserves, and insurance could reduce the cost of response by a quarter, as compared to waiting for humanitarian aid to arrive. And analysis in a small island state exposed to tropical cyclones shows insurance to be more than twice as cost-effective as emergency budget reallocations. This research illustrates how the tradeoffs and uncertainties of financial instruments can be evaluated and used to inform decision making.
The Disaster Risk Financing and Insurance Program offers technical assistance to ministries of finances, donors, and stakeholders to understand and complete this type of analysis, to improve the understanding and the capacity of governments to take informed decisions on disaster risk finance based on sound financial analysis.
Financial and Budgetary Instruments |
||
Goal |
Ex ante instrument |
Ex post instrument |
Risk retention |
Contingency fund or budget allocation |
Budget reallocation |
Risk transfer |
Traditional insurance or reinsurance |
Discretionary post-disaster relief |
| Source: Clarke and Dercon (2016) | ||
The Disaster Risk Finance Analytics Project Is Investing in Off-the-Shelf Software
While catastrophe risk data and information provide the foundation for disaster risk finance solutions, they need to be processed in order to inform financial decision-making. The Disaster Risk Finance Analytics Project aims to contribute to bridging the gap between catastrophe risk data and informed disaster risk financing decision making. Implemented by the Disaster Risk Financing and Insurance Program, with funding from the European Union, the goal is to support governments in achieving four outcomes:
- Understand their financial risk related to natural hazard
- Employ efficient financial/actuarial analysis, such as cost-benefit analyses, in the development of DRF strategies
- Effectively leverage private financial markets through market-based risk transfer solutions, when relevant in the DRF strategy
- Monitor and evaluate DRF strategies
