Risk Financing Strategy Olga Jonas - Joaquin Toro Bangkok - February 2006

Overview of Concepts

EVENT beforeafter Preparedness Mitigation Awareness Response Relief Reconstruction

FINANCIAL STRATEGIES RISK REDUCTION RISK FINANCING

RISKASSESSMENTRISKASSESSMENT A Comprehensive Risk Management Framework RISK FINANCINGRISK FINANCING RISK MITIGATIONRISK MITIGATION INSTITUTIONBUILDINGINSTITUTIONBUILDING EMERGENCY PREPAREDNESSEMERGENCY PREPAREDNESS

Key Questions for Policy Makers What is country’s risk exposure? Natural hazards Man-made hazards Can risk exposure be reduced through mitigation (reduce vulnerability)? What is the ex-post funding gap? Should gov’t retain this residual risk or should it transfer part of it to international reinsurance/capital markets?

What is country’s risk exposure?

Can vulnerability be reduced? Retrofitting critical public assets Preparedness Hazard mapping and land-use planning Building codes Need incentives, institutions …very high social returns

Ex-post financing needs Wide discrepancy between economic and insured losses  most of the risk is carried by governments and homeowners Lack of liquidity in the aftermath of disasters may severely retard economic recovery Recurrent disasters impair and constrain public finances (excessive borrowing)

Timeliness and Phasing of Financing

Types of Financing to Address Gap Risk retention (reserves) Risk transfer Insurance (e.g., pilot parametric small states pool) Catastrophe bonds Inter-temporal risk spreading Contingent debt

RISK FINANCING Probability of OccurrenceType of Risk Resource Gap Reserve Funds years years years Recurrent Risks All Hazards Catastrophic Risks Parametric Coverage Contingent Facility Budget Capacity Cat Bonds

Probabilistic Catastrophic Risk Modeling HAZARD MODULE EXPOSURE MODULE VULNERABILITY DAMAGE MODULE LOSS MODULE

COLOMBIA Disaster Vulnerability Reduction APL APL1 National Level APL2 Municipal Level APL3 Municipal Level Repeater

COLOMBIA DVRP Emergency Assistance Instrument: ERLs still take time to prepare, disbursement 16 months after the earthquake struck Armenia. APL floating phase requires preparation of an appraisal document, due diligence at the Bank and the signature of the Vice President. The DDO is intended to give middle-income borrowers access to long-term IBRD resources if market borrowing becomes difficult and a financing need materializes. The DDO, however, functions as a Development Policy Loan with all conditions satisfied prior to loan signing, and could not, in this case, be used to finance eligible expenditures needed for investments.

COLOMBIA DVRP

L 100 L 500 L 1000 AAL Total6, , , Government1,470.12,501.62, Strata 1 – Total as % of GDP6.46%11.25%13.37%0.37% Gvt. as % of National Budget 11.03%18.75%22.13%1.03% Str. 1&2 as % of Nat. Budget 2.5%5.51%7.06%0.14% Simulations

COLOMBIA DVRP 3 weeks6 months1 year Government’s post disaster commitment 1. Lifeline infrastructure replacement 2. Provision of safety nets 3. High return and sustainable mitigation investment 4.Other infrastructure Ex post sources of funds Aid Central funds transfer Budget reallocation Tax surcharge Domestic credit Development Banks Other external Credit Ex post funding gap Specific Scenario

COLOMBIA DVRP Time after the catastrophic event One weekOne month Six months Cumulative monetary values Ex post funds available Government budgetary outlays Ex post funding gap

COLOMBIA RISK FINANCING Optimizing coverage of Public Assets Promoting insurance of Private Assets Designing an optimal financial strategy for residual risks –Reserves –Contingent loan –Additional (Parametric) coverage

CARIBBEAN CATASTROPHE RISK INSURANCE INITIATIVE (CCRII)

Stormy Weather

Particularities of CARICOM States High exposure to a variety of adverse natural events Limited resilience to disasters because of small size and limited borrowing capacity Dependence on donor support for post- disaster needs Limited access to insurance

Catastrophe Risk Insurance Facility Payouts triggered by parametric index (e.g., hurricane category, wind speed, etc.) Insurance premium related to individual risk exposure (avoid cross subsidization) Long term financial sustainability –Annual premium paid by participating countries –Small losses covered by a reserve pool (risk capital provided by donor countries) –Reinsurance of excessive losses on the international market

Reducing Premium Cost Commercial Premium = –Expected Loss (Pure Premium) –Reserve (Cost of capital) –Administrative Cost –Return on Equity

Pure vs. Commercial Premiums For illustrative purpose only

Conclusions Risk Management should be an integral part of development planning –Comprehensive long-term approach –Residual risk includes indirect losses –Time dimension of financing needs Need for Public/Private partnerships Premium = EL + Reserve & Cat Load + Admin Cost + ROE