Pacific Catastrophe Risk Financing InitiativeOptions for Regional Risk Financing

AUSAID WorkshopCanberra, AustraliaMarch 4, 2009

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Pacific Catastrophe Risk Financing Initiative

A World Bank Initiative at the request

of the Pacific Island Countries

In collaboration with the Global Facility for Disaster Reduction and Recovery (GFDRR), Asian Development Bank (ADB), Pacific Islands Applied Geoscience Commission (SOPAC), and the Pacific Island Forum Secretariat

Technical risk modeling work conducted by AIR Worldwide

South Pacific Island Countries are highly exposed to natural disasters

Samoa100% of GDP and

42% of population affected

Tonga30% of GDP and

42% of population affected

Vanuatu86% of GDP and

16% of population affected

Fiji12% of GDP and

11% of population affected

Actual reported losses in worst year, 1960-2007

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Disaster Risk Management Framework

Risk Assessment

Institutional Capacity Building• Decentralized Emergency Management System•Community Participation•Legislative Framework•Training, Education and Knowledge Sharing

Emergency Preparedness•Emergency Response Planning•Exercises•Public Awareness•Communication and Management Information Systems•Technical Emergency Response Capacity

Risk Mitigation Investments•Warning and Monitoring Systems•Hazard Mapping and Land use mapping•Code Refinement and Enforcement•Hazard Specific Risk Mitigation

Catastrophe Risk Financing•Reserve Funds•Contingent Debt Facility•Insurance•Catastrophe Bonds•Catastrophe Insurance Pools

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Country-specific catastrophe risk assessment models have been developed for the first time for the South Pacific Island Countries

HAZARD

VULNERABILITY

LOSSES

Intensity Calculation

Exposure Information

Damage Estimation

Policy Conditions

Event Generation

Loss Calculations

LifelineInformation

EXPOSURE

HAZARD

VULNERABILITY

LOSSES

Intensity Calculation

Exposure Information

Damage Estimation

Policy Conditions

Event Generation

Loss Calculations

LifelineInformation

LifelineInformation

EXPOSURE

Selected Pacific Island States– Fiji– Tonga– Samoa– Papua New Guinea– Solomon Islands– Vanuatu– Cook Islands– Tuvalu

Specific perils– Earthquake (including ground-

shaking hazard and earthquake-generated tsunami hazard)

– Tropical cyclone (including wind, storm surge and precipitation).

Catastrophe risk model

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Country catastrophe risk profile brochures

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0 100 200 300 400 500 600 700 800

Fiji

Samoa

PNG

Solomon

Tonga

Vanuatu

Vanuatu

Cook Islands

Tuvalu

US$ millionTC EQ Combined peri l s

Pacific Island Countries have a large contingent liability due to natural disasters

Direct loss estimates, PML (250 years), by country

EQ: earthquake-generated ground shaking hazard and earthquake generated tsunami hazard; TC: tropical cyclone.

0% 5% 10% 15% 20% 25% 30% 35% 40% 45%

Fi ji

Samoa

PNG

Solomon

Tonga

Vanuatu

Cook Is lands

Tuvalu

% of Tota l Government ExpendituresTC EQ Combined peri l s

Emergency loss estimates, PML (250 years), by country

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Post-disaster financing creates large contingent liability for Donors

Catastrophe Risk Profile of the Portfolio of 8 Pacific Island Countries –

Estimated Direct Economic Losses by Return Period

0

200

400

600

800

1000

0 25 50 75 100 125 150 175 200 225 250

Return period (years)

US

$ m

illio

n

EQ TC Combined EQ+TC

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Countries have access to various financial instruments to finance natural disasters

Relief phase (1-3 months)

Recovery phase (3 to 9 months)

Reconstruction phase (over 9 months)

Ex-post financing Budget contingencies Donor assistance (relief) Budget reallocation Domestic credit External credit Donor ass. (reconstruction) Tax increase Ex-ante financing Reserve fund Contingent debt Parametric insurance Traditional insurance

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Sovereign catastrophe risk financing framework

Reserves

Insurance/Reinsurance

Insurance Linked Securities

Contingent credit

International Donor Assistance

Risk Retention

Risk Transfer

Low frequency High frequency

High severity

Low severity

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Sovereign Catastrophe Risk FinancingThe Case of Vanuatu

For information only

Hypothetical National Financial Strategy for Earthquakes and Tropical CyclonesRP (years) Exhaust. Point Coverage Est. annual cost

US$ million US$ million US$ million526 years

13 Catastrophe Risk Insurance

7.5 0.5

9 years5

Contingent credit2.5 0.8

3 years3

National reserves2.5 1.8

1 year

Pacific Catastrophe Risk Fund

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Providing Insurance Coverage Against Short Term Government Budget Shortfalls After a Disaster

• Problem– After a catastrophe event governments need money quickly to

provide emergency relief and early rehabilitation and keep services running

– Aid may arrive slowly– Aid is usually earmarked to specific projects

• Proposed Solutions– An instrument to provide immediate post-disaster budget support – Coverage against major perils: Earthquake and Tropical Cyclone– Parametric insurance allowing for rapid payment– Pacific wide to allow benefits of diversification– Protected by international reinsurance and capital markets to give

stability– Backed by donor contribution to guarantee sustainability

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Country-specific risk assessment allows for individual risk-based premiums

Return period

1-in-150 years

1-in-10 years)

Parametric Insurance Coverage

Prototype insurance coverage

Estimated Pure Premium Rates

0.0%0.5%1.0%1.5%2.0%2.5%3.0%3.5%4.0%

Cook Fiji PNG Samoa Solomon Tonga Tuvalu Vanuatu

Tropical Cyclone EarthquakeFor Information only

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By acting collectively, Pacific countries can take advantage of the regional risk diversification benefits

0200400600800

1,0001,2001,4001,6001,8002,0002,200

Tropical cyclone Earthquake Combined perils

US$ m

illion

Aggregate individual reserve requirements Regional reserve requirements

By pooling their catastrophe risks, South Pacific countries can reduce their capital requirements by

50%

The regional risk diversification benefits can reduce the estimated technical premium rates by 45% on average

Note 1. Technical premium rates estimated for a hypothetical insurance portfolio, which offers parametric coverage for combined perils (earthquakes and topical cyclones) with return periods between 10 yrs and 150 yrs.Note 2. Estimated technical premium rates may differ from commercial premium rates due to market conditions.

0%

2%

4%

6%

8%

10%

12%

Fiji Samoa PNG Solomon Tonga Vanuatu Cook Tuvalu

Estimated pure pure premium rate

Estimated technical premium rate with regional diversification

Estimated technical premium rate without regional diversification

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Options for Catastrophe Risk Financing

• Donor Catastrophe Risk Fund– Financed and managed by donors– Limits ownership of the Pacific Island Countries– Perpetuates post-disaster financial assistance

• Regional catastrophe insurance portfolio– Placed on the private cat reinsurance markets– Takes advantage of regional risk diversification– Over-relies on catastrophe reinsurance

• Pacific Catastrophe Risk Fund– Public-private partnership for the financing of natural disasters

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• Regional joint reserve mechanism

• Participating countries build up collective reserves

• Risk fund owned and managed by the participating countries

• Countries can retain some risks and pass excess risks to the reinsurance market when it is most efficient

• Lower and more stable premium rates over time

• Initial reserves are needed to start up

Pacific Catastrophe Risk Fund

Reserves

Reinsurance/ART(Purchased on international

financial markets)

Country 2

Country 3

Country 1

Country 4

Country 5

Country 6

Country 7

Premium Payout

Insurance Payout

Insurance Premium

Initial donor contribution

Initial donor contribution

Initial donor contribution

Growth

Estimated technical premium rate for different levels of initial reserves

3.0%

3.5%

4.0%

4.5%

5.0%

5.5%

6.0%

Fiji Samoa PNG Solomon Tonga Vanuatu Cook Tuvalu

US$10 million reserve US$25 million reserve US$40 million reserve

Hypothetical scenario based on an insurance portfolio of 8 countries16

Hypothetical Catastrophe Insurance Portfolio Risk Profile

Catastrophe Insurance Portfolio profile – Probability Density Function

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0%

10%

20%

30%

40%

50%

60%

- 5 10 15 20 25 30 35 40

US$ million

Retention LOL=46%

Reinsurance LOL=12%

Reinsurance LOL=2%

Caribbean Catastrophe Risk Insurance Facility

16 Caribbean countries covered against hurricane and earthquake risks

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• Provides tools to assess donors’ contingent liability related to natural disasters

• Communicates the price of risk to the countries• Sensitizes countries about the economic and fiscal

impact of natural disasters as part of their DRM dialogue with donors

• Provides financial incentives for countries to engage in DRM (e.g., compliance with building codes)

• Promote alternative financing solutions through market-based instruments

• Enhance the recovery and reconstruction efforts• Complements other DRM activities

Benefits of Catastrophe Risk Financing for Donors

Potential Roles for Donors in Catastrophe Risk Financing

• Convening power– Knowledge of countries– Long term dialogue

• Provider of public goods – Catastrophe risk models– National and regional database

• Provider of technical assistance– Design of cat risk financing strategy

• Financier– Funding for project preparation/implementation– Start-up reserves– Premium subsidies

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Next Steps

• Stakeholder consultation for selected 8 countries– Country visits to discuss catastrophe risk financing strategies– Regional meeting

• TA for regional catastrophe risk financing options– Assist countries in quantifying post-disaster short term budget

gaps – Develop customized country catastrophe risk financing

strategies– Facilitate institutional capacity building– Assist countries in implementing selected financial options

• Completion and refinement of Pacific catastrophe risk assessment– Refine existing models– Expand models to other Pacific Islands– Creation of a regional GIS exposure database (financed and led

by ADB) 21

Nigel RobertsCountry Director, Pacific Islands, PNG and Timor Leste

Olivier MahulEmail: omahul@worldbank.org

Iain ShukerEmail: ishuker@worldbank.org

Contacts

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