Catastrophe Risk Financing in Developing Countries

Cummins and Mahul wrote this for the World Bank as an analysis of how developing countries can finance the cost of natural disasters. The reference has not verified the detailed contents.

The problem the volume addresses is specific. Developing countries face disproportionate exposure to natural catastrophe, have limited fiscal capacity to absorb the cost, have thin or absent domestic insurance markets, and typically finance disasters after the event through budget reallocation, borrowing and donor assistance, all of which arrive slowly and at uncertain amounts.

The analytical framework distinguishes risk layers by frequency and severity. High-frequency low-severity losses are best retained and financed from reserves or contingent budget lines. Medium layers can be transferred to insurance and reinsurance markets. The highest-severity lowest-frequency layer, where the cost exceeds what insurance markets will absorb at acceptable prices, may require capital market instruments or sovereign arrangements.

The instruments covered include contingent credit lines drawn on when a defined event occurs; sovereign catastrophe insurance and regional risk pools, of which the Caribbean Catastrophe Risk Insurance Facility was the first and is the standard example; parametric insurance triggering on measured physical parameters, which pays quickly but carries basis risk; catastrophe bonds; and the development of domestic property insurance markets, which requires legal, regulatory and actuarial infrastructure that frequently does not exist.

Since 2009 the field has expanded, with the Pacific and African regional pools established, with parametric agricultural insurance programmes at scale in several countries, and with substantial evidence accumulated on take-up rates and basis risk. Readers should verify current programme design and evidence.