FINANCIAL INSTRUMENTS FORRESILIENT INFRASTRUCTURETECHNICAL REPORTOCTOBER 2018

Funded by

FOREWORD
Disasters cause poverty. A recent study by the World Bank estimated that disasters force some 26 million
people into poverty whilst causing $60bn of economic losses annually. More than 200 million people per year
are affected by events such as earthquakes, cyclones and flooding in developing countries. The poorest people
suffer disproportionately due to their higher vulnerability and exposure, and this can have long-term impacts on
their development prospects. Climate change will further increase the intensity of weather-extremes, andincrease pressure on systems, exacerbating these impacts.
Disasters also cause significant fiscal and economic shocks to vulnerable countries. For the highest risk
countries, the costs of disasters can overwhelm the capacity of governments to respond, and this can amplify
the impacts on the lives and livelihoods of people significantly. In Dominica in 2017 for example, more than
200% of GDP was wiped out overnight. For these reasons, building resilience to disasters is prioritised withinseveral of the Sustainable Development Goals, which are at the heart of DFID’s work.
Resilient infrastructure is a key to reducing the impacts of disasters. Infrastructure that can perform duringor shortly after a crisis can not only reduce impacts on people’s lives and livelihoods but can be of substantial
national economic and social benefit. However, there are a number of barriers to building resilient infrastructureor retrofitting existing infrastructure, including upfront costs and local capacity. These challenges can beprohibitive for the world’s poorest and most vulnerable nations, leading to poor quality infrastructure that does
not perform well during crises. The result is that shocks place greater stress on economies and social systems,
and the continued spiral of poverty.
The Centre for Global Disaster Protection draws upon UK and global expertise in risk, finance andinsurance to provide impartial advice, innovation and cutting-edge science. The Centre is DFID’s flagship
Disaster Risk Finance technical assistance programme, aiming to help developing countries strengthen theirpre-disaster planning and financial arrangements so they can respond more rapidly and effectively when adisaster strikes.
As part of its work on innovative risk financing, the Centre ran an innovation lab earlier this year. By bringing
together knowledge and expertise, the lab developed new ways of realising a resilience dividend by balancing
the upfront costs of resilience (e.g. retrofitting) with the associated reductions in insurance premiums (due tolower Annual Average Losses). Although further work is needed, this report presents some initial analysis,
including worked examples, to illustrate the potential of the products.

Rachel Turner
Chair of the Board, Centre for Global Disaster Protection
Director, Economic Development, Department for International Development

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FOREWORD
Almost one and a half million people have died in natural disasters over the past 20 years. This is a waste oflife; a waste of potential.
Natural disasters also have a massive economic impact. Our models suggest natural catastrophes cost theworld’s poorest countries almost $30bn a year on average. Hard-won development gains are regularly wipedout – and it is the poor and the vulnerable who are most impacted.
In case anyone had forgotten the crippling impacts of natural disasters, 2017 served a painful reminder.
Somalia, Ethiopia and Kenya struggled with drought. Floods and landslides wrecked lives and livelihoods in Sri
Lanka and Bangladesh. Several Caribbean islands were devastated by a very active hurricane season.
Whenever and wherever catastrophe strikes, our thoughts are with those so profoundly affected.
We did not, however, need last summer’s tropical cyclones to understand that something is not working. We
did not need hurricanes Irma and Maria to learn that investments in resilience reduce losses from natural
disasters. And we did not need the events of 2017 to know that incentives are too often insufficient to drive
action in the most vulnerable regions.
These truths are at the heart of the Centre for Global Disaster Protection. Innovation is required to solve suchcomplex humanitarian, political and economic problems. The impacts of recent disasters – and the need tofinance reconstruction – have heightened the innovation imperative. They provide an opportunity to deploy
instruments which catalyse investments in resilience; which enable vulnerable communities to recover faster.
RMS too knows that it is possible to stop manufacturing natural disasters. And RMS knows that financial
mechanisms could in theory securitise – and therefore incentivise – the potential ‘resilience dividends’ frominvestments in disaster risk reduction.
Yet equally well understood is the fact that financial structures which incentivise resilience are difficult toimplement in practice – in developed and in developing countries. To move from theory to practice; to redirect
capital at the required scale, ideas need to be fleshed out, structures need to be robustly designed andcashflows need to be tested. Any new financial mechanisms must pass muster with all stakeholders, lest theintended benefits evaporate.
Since 1988, RMS’ mission has remained constant: to make communities and economies more resilient toshocks through a deeper understanding of catastrophes. Now, with the Centre’s help, experts from the finance,
humanitarian and development communities have for the first time come together to refine financial instruments,
address practical challenges and provide the interdisciplinary buy-in which mobilises action.
In this collaborative environment, innovation has happened. This report is a product of that innovation.
The four new financial mechanisms examined in the report can help monetise the resilience dividend, thereby
incentivising both resilient building practices and risk financing. The outcome: less physical damage, fewer lives
lost and faster economic recovery whenever nature proves too much.
More is needed, of course. Policymakers and donors have a crucial role to play, not least in sponsoring pilots,
funding the quantification of resilience, promoting risk-based pricing, supporting risk finance and advocating
duties of care around life, livelihood and shelter.
Thankfully the significant public benefits of resilience justify the investment. And now we have four new financial
instruments for donors and the market to pilot in real-world situations.
Daniel Stander
Global Managing Director, RMS

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EXECUTIVE SUMMARY
The world faces a huge demand for infrastructure investment. Global infrastructure needs are large andgrowing: the 2017 Global Infrastructure Outlook estimates infrastructure investment needs of $94 trillion by
2040. However, financing infrastructure is a difficult task, especially in developing countries, driven bychallenges such as low user purchasing power, high country risk and weak institutional set ups. These
challenges help to explain why, if current trends persist, there is expected to be a 20% infrastructure investment
shortfall by 2040.
Without further intervention, a large proportion of this infrastructure is expected to be non-resilient,particularly in developing countries, increasing the exposure to disasters. This lack of resilience helps to
explain why the impact of disasters are most acutely felt in developing countries. Last year’s hurricane season
left Dominica – a small island state with a GDP per capita 8 times lower than the US – suffering losses of 224%
of GDP. Low-income, high-exposed countries such as Bangladesh can suffer losses of approximately 3-5% of
GDP every 5-10 years from recurring disasters while direct economic losses (as a % of GDP) from disasters
are 14 times higher in low-income countries than high-income countries. These challenges will be exacerbatedby climate change.
Investments in resilience make economic sense but are difficult to realise. Studies suggest that investingin and maintaining infrastructure so that it is resilient can often lead to benefits that are four times higher than
the additional costs. This gives rise to the concept of a ‘resilience dividend’. However, this dividend is often not
sufficient to ensure resilience, particularly in developing countries for a number of reasons. Resilience typicallyrequires additional upfront costs but only delivers long-run economic benefits that can be perceived as uncertainby those taking decisions. Making such decisions is inherently challenging given short-term focused politicalstructures, and can be exacerbated by the lack of fiscal space in many developing countries and difficulties inaccessing private finance. Moral hazard may also deter investment in resilience if there is an expectation forforeign aid disbursements in the event of a disaster. In a similar vein, misaligned political incentives can distortincentives as governments may be politically rewarded for responding to disasters and not for prevention.
Insurance can play an important role in supporting resilience. After a disaster, structured and well governed
payments can flow quickly from insurers to the centres of need, aiding faster recovery. Insurance also has animportant role to play in incentivising preplanning. Finally, and crucially, by providing risk-based pricing
incentives, insurance provides a vehicle through which (some) aspects of the resilience dividend can bemonetised, and hence used to provide stronger financial incentives for resilience.
This project seeks to provide an outline design of a series of financial instruments that, through a
combination of insurance and other means, seek to monetise the resilience dividend so as to provide
stronger incentives for resilient infrastructure construction.
To help support the design of these instruments, an 'Innovation Lab' brought together experts from a
range of sectors. The 'Innovation Lab' convened experts from the finance, insurance, engineering,humanitarian, and development communities to help create initial 'strawman solutions', identify the main
challenges to implementation and discuss ways to overcome these challenges. The Lab built upon a detailed
literature review of the state of infrastructure finance and analysis of existing financial instruments, directly andindirectly related to resilience. Experts worked on specific real-world case studies providing backgroundinformation and modelled examples of the resilience benefits in each case.
The lab emphasised a number of key themes to inform the design of the products. These include theneed to focus on the services provided by infrastructure asset, rather than the physical characteristics of theasset itself; the importance of recognising the wide-range of benefits brought about by resilience investments
and not just the expected reduction in asset damage; and the need for solution to build upon current practices
and leverage the expertise of existing stakeholders and financiers on the ground rather than exist in isolation.

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Four potential financial instruments emerged from the lab discussions, ranging from repurposed
existing structures that can be brought to the market quickly to ones further from current practice butwith great potential. These instruments were:
1. Insurance-linked Loan Package (ILLP) – an infrastructure loan which has a built-in insurancecomponent. Insurance savings through risk reduction offset loan interest repayments.
2. Resilience Impact Bond (RIB) – a pay-for-performance contract in which an investor is remunerated
based on how well they implement resilience measures according to pre-defined performance indices.
3. Resilience Bond – a risk transfer instrument, in which risk reduction is reflected in a reduced premium
paid by the insured across the term of the bond.
4. Resilience Service Company (ReSCo) – a company who bears the initial costs of resilience and isrepaid on an annual basis using savings on insurance premium.
Two were chosen for cash flow modelling – the ILLP and RIB – to help illustrate the viability of promoting
resilience as well as the vital role that insurance has to play.
Resilience Impact Bond•••

Applicable where the outcomes funder (e.g. donor) wishes to transfer some of the operational risk of
implementing the resilience project, and also benefits from a transparent assessment of how well the
project performs against its objectives.
Strongly aligns the incentives of the outcomes funder with the investor – delivery of different elementsof resilience provides substantial upside to the investor but failure to deliver this resilience can result in
low or negative returns
Can be structured to explicitly promote individual elements of resilience, e.g. structural, operational, andfinancial resilience, offering a targeted approach to building resilient systems.

Insurance-linked Loan Package•••

A simple and potentially efficient means of monetising the resilience dividend generated throughinsurance savings within one product structure which is achievable in the near-term.
The repayment term, and the size of the risk reduction, largely determine how much the accrued
insurance savings can contribute to the overall additional cost of resilience.
Flexibility within the product structure allows for the resilience dividend to contribute to the costs ofresilience, loan repayments, or insurance premium payments, as is appropriate to the use case.

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TABLE OF CONTENTS

Executive Summary .................................................................................................................... 3
Table of Contents ........................................................................................................................ 5
Introduction ................................................................................................................................. 5
1.

Literature Review ................................................................................................................. 92.

The Innovation Lab ............................................................................................................ 22

3.

Resilience Dividend ........................................................................................................... 27

4.

Product Solutions .............................................................................................................. 33

5.

Appendix............................................................................................................................. 80

List of Figures ......................................................................................................................... 106
Disclaimer ................................................................................................................................ 109

INTRODUCTIONi.

Project Objectives and Structure

The Centre for Global Disaster Protection brings together partners including DFID, the World Bank, civilsociety and the private sector with the shared goal of enhancing the financial resilience of developing
countries to climate change and disasters. The Centre was launched by UK Prime Minister, Theresa May,in July 2017. It will work with governments to strengthen pre-disaster planning and catalyse innovative financefor resilience to ensure more cost-effective, timely and reliable response to and recovery from disasters.
The purpose of this project – the first of the new Centre for Global Disaster Protection in collaboration
with Lloyd’s of London – is to design financial risk transfer instruments that provide incentives forresilient infrastructure and building back better (BBB) post disasters. In recent years, various financial
structures have been proposed to create positive incentives for investment in resilience. These include multiyear insurance, resilience bonds and resilient reinstatement. In practice, there are several challenges to existingmodels, especially when applied to developing countries. These include high upfront costs, uncertain benefits,competing budgetary priorities, poor data availability, and misaligned incentives between owners of the asset
and those benefitting from the service it provides. This project develops a series of solutions that can overcome
these challenges to encourage socially beneficial resilience building both pre and post disaster. It focuses on
identifying solutions that allow the benefits from resilience investments to be monetised and thus offset theadditional upfront costs of resilience investment.
The project was a collaborative undertaking. An 'Innovation Lab' convened experts from the finance,
insurance, engineering, humanitarian and development communities to help create initial 'strawman solutions',
identify the main challenges to implementation and discuss ways to overcome these challenges. The Lab built
upon a detailed literature review of the state of infrastructure finance and analysis of existing financial

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instruments, directly and indirectly related to resilience. Experts worked on specific real-world case studies
providing background information and modelled examples of the resilience benefits in each case.
The strawmen outputs from the lab were developed into four product solutions with further input fromexperts. The product solutions describe the features, key stakeholders, risks and challenges to implementation.
Two of these solutions have been developed more fully with risk modelling and cashflow analysis. The othertwo solutions are innovative ideas that would benefit from further research and development and can be
implemented over the longer run and for which risk-modelling and cash-flow modelling have not been
undertaken.

ii.

The Building Blocks of a Successful Solution

The innovative financial solutions described in this report aim to support the financing of resilient
infrastructure and/or building back better, while facilitating the efficient transfer of catastrophe risk.
Solutions need to consider the key challenges in infrastructure financing. Infrastructure financing even
without resilience is a difficult task. The infrastructure financing gap that already exists is likely to become
wider in the future as demand increases, placing greater stress on developing countries. The challenge ofaddressing this gap in the developing world is exacerbated by issues such as poor institutional design andlimited data availability.
Enhancing resilience is economically attractive in the long-term but it brings its own complexities
including higher upfront costs and that benefits are often spread across many agents. A range of studies
suggest that, on average, the benefits of resilience (broadly defined) outweigh the costs fourfold (UNISDR 2007;
OECD 2015a; UK Government Office for Science 2012). Resilience investments can generate a ‘resilience
dividend’. However, developing infrastructure which is resilient to climate change and disasters comes with newchallenges. These include high upfront cost, uncertain long-term benefits, and differences between the agents
who are responsible for managing the risk and those who benefit from resilience. In other words, the positive
externalities of resilience may not be appropriately considered, leading to socially inefficient decisions.
This project seeks to incentivise resilience by creating financial instruments that monetise theresilience dividend and provide it upfront or transfer it to agents who have the capacity and willingness
to wait for it. Monetising the dividend helps to ensure that the agent who is responsible for the asset directly
benefits from implementing resilience. One way to capture the resilience dividend, for example, is throughreduced insurance premiums in response to lower risk once a measure is implemented. If it is possible torealise the resilience dividend upfront the proceeds can be used to fund this resilience measure. Alternatively,
rather than bringing the resilience dividend upfront, a product may transfer it to a ‘patient’ counterparty withlonger term objectives.
The solutions also seek to transfer disaster risks effectively. Risk transfer instruments, such as insurance,
can help stakeholders identify, understand, and assess disaster risks. Once assessed, many risks can be
managed more effectively through insurance-linked products and structures. Insurance can provide prompt andeffective finance after a disaster, dealing with issues of commitment, responsibility, and institutional failure.
Given the complicated nature of infrastructure projects and multiple stakeholders involved, insurance schemes
can distribute funds faster and more effectively than alternatives, thus ensuring greater continuity of service inthe wake of a disaster. As discussed further below, in theory at least, insurance can play a role before a disasterstrikes in catalysing resilience though price incentives.
The solutions are also intended to be implementable. They consider the challenges and barriers to building
resilient infrastructure in the developing context. Their design is built on the existing financing and risk transfer
practices available on the ground and are mindful of institutional and financial constraints.

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Building on these ideas, the analysis makes use of eight success criteria to provide a structured way
to address the issue. These comprise of both ex-ante criteria and ex-post criteria. The ex-ante criteria areintended to allow an assessment of existing financial instruments and select their useful features in light of the
key objectives of this project - incentivising resilient infrastructure and efficient risk transfer. These features arethen extracted and used in the design of potential innovative solutions. The proposed solutions can then be
tested against the ex-post criteria to test their practical viability. Figure 1 summarises these criteria:

FIGURE 1 THERE ARE EIGHT SUCCESS CRITERIA IN TOTAL THAT SHOULD BE MET.

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iii.

Structure of the Report

The report is organised into four sections – a detailed literature review of infrastructure financing and risk
transfer instruments, a summary of the outcomes and findings from the Innovation Lab, a section developing
product solutions and a set of recommendations for next steps (Figure 2).

FIGURE 2 THE REPORT HAS FOUR SECTIONS, MOVING FROM A BACKGROUND LITERATURE REVIEW, THROUGH OURINNOVATION LAB AND AN ANALYSIS OF SOLUTIONS, THROUGH TO POTENTIAL NEXT STEPS.

The literature review helped identify potential building blocks from the existing space of financial
instruments. It covers the state of infrastructure investment, the barriers to resilient building, the role ofinsurance in developing resilience and an overview of existing relevant instruments. It was compiled throughdesk review as well as interviews with insurance sector and other experts.
The findings from the literature review supported the discussion in the Innovation Lab to help create
initial ‘strawman’ solutions. A pre-lab session brought experts together to discuss and refine possible casestudies for the main Innovation Lab session. The Lab was interactive. After some context setting presentations,working groups concentrated on designing innovative financial products to address the challenges of each casestudy.
The strawmen from the labs were then developed and tested through further outreach to relevant
experts, economic cash flow analysis and risk modelling simulations. This process helped refine themechanics of the potential products, provide solid economic justification for its use and stress test their usability
with risk model simulations to understand how the instrument may perform under different scenarios.

81. LITERATURE REVIEWThis section provides a brief overview of three critical areas:•

The (resilient) infrastructure investment context, including financing needs, sources and challenges
to building resilience.

•

The role played by the insurance industry, focusing on transferring risks related to infrastructure andsupporting resilience.

•

The financial instruments for (resilient) infrastructure, including a review of the range of existingfunding and risk transfer instruments that can be combined or built upon to address the challenges offunding resilient infrastructure.

This review draws on a broad set of sources spanning academia, press, public and private sector publications,as well as interviews with industry experts.
Key findings:•

Infrastructure investment needs are large and under-funded, particularly in the developing world.

•

Building resiliently, and ensuring effective maintenance so that resilience persists, adds further
complexity, due to the high upfront costs and/or uncertain benefits realized over long time horizons.

•

In theory, insurance against disasters can play a critical role in incentivizing resilience. In practice thisis challenging due to the short-term nature of insurance contracts, low penetration and limited use ofrisk-based pricing in a highly competitive industry.

•

No single existing instrument fulfils the ambitious goals of this project: 1) to incentivise resilience throughmonetising the resilience dividend and allowing it to be captured before or at the time of infrastructure
construction; 2) to involve risk transfer to ensure effective risk management post disaster.

•

There are, a range of potential financial instruments, including risk transfer and pure funding
instruments. These were suggested as useful building blocks of a solution during the Innovation Lab.

1.1. The Infrastructure Investment Context
1.1.1. Infrastructure investment needs are large and growing
The 2017 Global Infrastructure Outlook1 estimates infrastructure investment needs of $94 trillion by
2040. If current trends persist, there is likely to be a 20% investment shortfall (The World Bank 2017c). The
largest needs are expected to be in the transport and power sectors with 60% of this new infrastructure
investment being required in emerging economies, as shown in Figure 3. China alone accounts for nearly 30%,
India and other emerging Asia for 13%, Latin America 6% and Africa 2%.

1

The Global Infrastructure Outlook focuses on the infrastructure needs of 7 sectors: air transport, road transport, ports, rail, energy,
telecommunications and water. It covers 50 countries across 5 regions: https://outlook.gihub.org/. Estimates of future infrastructure needsvary widely by source, depending on sector coverage, geographic coverage and ambition.

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There are further costs associated with making this infrastructure more resilient to extreme weather,other catastrophes and long-term changes in climate. The World Bank estimate that annual climate
adaptation needs for infrastructure in developing countries could be between $13 and $28 billion until 2050,
with a further $43-$48 billion needed in coastal zones and for water supply and flood protection. While thesefigures are small in the context of the trillions needed for infrastructure investment, the costs, relative to GDP,
fall disproportionately on the lowest income countries (The World Bank 2010).

FIGURE 3 GLOBAL INFRASTRUCTURE NEEDS TO 2040 IN BILLION USD BY GEOGRAPHY AND BY SECTOR (SOURCE: GLOBALINFRASTRUCTURE HUB 2017).

1.1.2. Financing infrastructure is no easy task
Past spending in infrastructure has not been enough to meet today’s requirements and if current rates
are maintained, the gap will continue to grow. This highlights the pressing need for innovative financing
solutions and substantial reallocation of capital. However, scaling up infrastructure investment faces a numberof challenges (OECD 2015c):•

Capital intensity: large upfront investments, lack of liquidity and a delayed return period lead to
substantial financing requirements that may exceed the capital available from conventional sources.

•

Economies of scale: the profitability of infrastructure investment assets depends on achieving criticallevels of demand, which is uncertain ex-ante and, for private investors, increases required returns.

•

Externalities: infrastructure assets often produce non-monetizable benefits that do not lead to direct
payoffs for an investor or are difficult to measure for a policymaker.

•

Heterogeneity: complexity, number of stakeholders: different infrastructure assets have different
characteristics and all infrastructure typically affects a wide range of stakeholders. This reduces
information for investors and increases the complexity of legal arrangements to manage risks andincentives between stakeholders.

•

A lack of bankable pipelines: the difficulties and political economy challenges of project preparation(e.g. acquiring permits and consents) means that there are insufficient bankable projects (Ehlers 2014).

•

Financing regulations and policies: Basel III and Solvency II regulations could reduce the capital thatmight be allocated to infrastructure at the global level (Bielenberg et al. 2016).

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Many of these challenges are exacerbated in developing countries, widening the infrastructure
financing gap that already exists:•

Lower users purchasing power: reduced ability of users to pay for infrastructure asset services
exacerbates the financing gap. Foster & Yepes (2006) estimate that roughly a third of developing
countries in the two lowest per capita income groups did not attempt cost recovery for electricity assets.
The challenge is even more severe in the water sector, where only around 10% of the poorest countries
attempt to recover any operating or capital costs.

•

Country risk: existing studies suggest infrastructure investment, especially that financed by the private
sector is highly sensitive to sovereign risks. Araya et al. (2013) show that a difference of one standard
deviation in a country's sovereign risk score decreases the probability of having private participation in
infrastructure by nearly a third and reduces private investment in dollar terms by around 40%. Similarly,
Moszoro et al. (2015) show that higher levels of corruption (measured by the Corruption Perceptions
Index) correspond to lower levels of private investment participation in infrastructure. The perceptionthat these risks are higher in lower-income countries may unfairly stigmatize investment in infrastructure
generally, without due consideration for the characteristics of a specific project (The World Bank 2017b;
OECD and World Bank 2015).

•

Institutional and regulatory set up: weak institutions, regulatory frameworks and enforcement issues
have negative impacts on infrastructure investment (OECD and World Bank 2015). 40% of surveyed
investors in developing countries mentioned that they experienced financial losses through adverse
regulatory changes, and 34% through breach of contract (MIGA 2013).

•

Data availability: the lack of adequate data on the volume and performance of private capital mobilized
for infrastructure investments in developing countries reduces the appeal of such projects for investors.

•

Public communication and engagement issues: in several low income countries, private sector
infrastructure projects have failed due to strong end-user opposition (OECD and World Bank 2015),
highlighting the need for effective communication with regards to critical infrastructure.

Finally, the need to ensure that infrastructure is resilient to climate change and disasters brings its own
challenges:•

Additional cost, uncertain benefits: building resiliently often requires higher upfront costs, whilebringing potentially uncertain, heavily-discounted long-term economic benefits. This is particularly
challenging in developing countries often dealing with lack of fiscal space and difficulties in accessing
private finance. Furthermore, there is significant uncertainty over the cost of future technology. Future
resilient infrastructures could be enhanced and cheaper, creating a temptation to wait rather than invest
now (Fay et al. 2010).

•

Externalities - the broader resilience dividends: typical cost-benefit analysis may adopt a limiting
view of the benefits of resilience, making such investments appear unattractive. Cost-benefit analysis
may focus only on the lens of avoided physical asset damages. However, investing in resilient
infrastructure can yield a ‘triple dividend’: in addition to 1) avoiding losses when disasters strike, it can2) unlock development potential by stimulating innovation and bolstering economic growth; and 3)
generate social, environment and economic co-benefits of resilient investments even if a disaster does
not happen for many years (Kryspin-Watson 2017). These broader benefits may be difficult to estimate
and incorporate for public asset owners. They may be irrelevant to private ones.

•

Information Asymmetries: even when there is a desire to capture the broader benefits of resiliencemeasures, this may not be possible as they are not well known by all parties involved. Lack ofawareness of the benefits of resilience or the associated risks among policy makers, investors and the11general public is due to a number of reasons: 1) there is no effective or common way to measure
resilience or its wide-reaching benefits (ClimateWise 2016); 2) infrastructure owners rarely share
information on vulnerabilities due to security concerns (Kunreuther et al., 2016b); 3) most infrastructure
managers have sparse experience with disasters (Chang et al. 2014); 4) the broader risks to a highlyinterdependent system are complex and may be unknown.
•

Commitment and ownership of risk issues: identifying key stakeholders and interests in resilient
infrastructure on the ground is difficult. Given the wide-ranging benefits and interdependencies ofresilient infrastructure, the stakeholders responsible for limiting physical asset damages may not be thesame as the beneficiaries of a continuous service.

•

Moral Hazard: post event public support may discourage investment in resilience (Kunreuther et al.,2016b). Aid and government recovery programs can deter private investment in resilience as there isan expectation of being bailed out in the case of disaster (Neumayer et al. 2014). This is further
exacerbated by the low perceived urgency to act due to the infrequency of catastrophic events(Kunreuther et al. 2016).

•

Misaligned political incentives: Similarly, governments are politically rewarded for responding todisasters, not for preventing them. This can deter investment in resilient infrastructure and incentivise
spending on recovery and emergency response measures (Neumayer et al. 2014). Moreover, making
complex, long-term policy commitments to resilience is inherently challenging given short-term focusedpolitical structures (UK government 2011).

•

Institutional, technical and enforcement capacity: resilience requires additional technical capacity
and an enabling environment to enforce resilience measures, which may be lacking in some of thecountries most exposed to catastrophe risks. For example, building hurricane-resilient housing requires
technical capacity, adequate building codes as well as the ability to enforce building to code via theappropriate institutional set up.

•

Maintenance: related to the previous point, resilience is not just delivered at the point of construction.
It requires ongoing maintenance. This brings a host of further funding and misalignment of incentives
issues. Despite high economic rates of return, maintenance of infrastructure is generally neglected inboth developed and developing countries. This may be due to differences in funding sources,
particularly in developing countries: international institutions and donors may be more willing to provide
loans (potentially at concessional low rates) or grants for the construction of new infrastructure than formaintenance. This means that, once the infrastructure is built, the government must raise themaintenance cost from its general revenue sources. Given competing spending priorities and low
visibility, this often results in maintenance being deprioritised (Rioja 2013).

1.1.3. Sources of infrastructure finance are diverse
Traditionally, especially in developing countries, infrastructure investments have been financed withpublic funds. While public funding finances around 40% of infrastructure spending in developed countries, thisincreases to 60-65% in developing countries (OECD 2017b). Indeed, data from the World Bank suggests thatprivate participation in infrastructure financing in developing economies has seen minimal growth since 2007
and has actually fallen in the latest data (The World Bank 2016a). Developing countries can struggle to attract
the required levels of private financing given the economic, political and institutional issues discussed above.
There are, however, significant differences between countries – for instance, in India the share of private
investment has been steadily increasing to nearly 40% in 2013 and is even higher today, while in China almost
all infrastructure financing is from the public sector (Chong & Poole 2014).

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Where the private sector is involved in infrastructure finance, it is normally through corporate actors.
Globally, 65-75% of private finance in infrastructure comes from corporate actors, with the rest from institutional
investors (Bielenberg et al. 2016). Public-Private Partnerships (PPPs) are growing as a source of infrastructure
financing, but typically make up only about 5 to 10% of overall infrastructure investment, even in leading PPP
use countries (Woetzel et al. 2016).
Support from development partners to infrastructure in 2013 was estimated at around $60 billion peryear and represented a small but significant share of infrastructure financing in developing countries(6-7%) (OECD 2015d). The basic split of financing in developing countries in 2013 for four key infrastructure
sectors is shown in Figure 4. In these countries, development partner funding accounts for, on average, around
6-7% of infrastructure investment, although it is markedly lower in the communications sector where strong
demand has made the sector ripe for private investment. Development partner funding 2 is concentrated in low
income and low middle-income countries due to reduced capacity to mobilize domestic and external private
finance (see Figure 5). From 2007-2016, almost 77% of official development assistance (ODA) for infrastructure
sectors was directed towards low income countries 3, while the total volume of ODA funding for infrastructure
increased at 8% per annum.

FIGURE 4 DEVELOPMENT FINANCING PLAYS A SMALL BUT SIGNIFICANT ROLE IN INFRASTRUCTURE FINANCING. SOURCE(OECD & WORLD BANK, 2015).

2

The following figures are based on the data from the OECD-DAC database which collates ODF from around 50 major development
partners – this is not a complete representation of all the support available but offers a reasonable sub-sample.
3
Defined as those with incomes per capita under $3,955 (OECD and World Bank 2015).

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FIGURE 5 ODA FOR INFRASTRUCTURE SECTORS IS MORE CONCENTRATED IN LOWER INCOME AND LOWER-MIDDLE INCOME
COUNTRIES4. SOURCE (OECD, 2017C).

The recent rise in ODA for infrastructure financing has been driven by greater contributions frommultilateral agencies, increasing at a rate of 5.7% per annum from 2007-2016 (OECD 2017c). This trend
is evident in Figure 6. DAC country donor funding make up 53% of the total ODA financing that was reported to
the OECD in 2016, with multilateral agencies accounting for 42% 5. However, the role of multilateral agencies
has been growing in recent years with their share of total ODA rising from 31% in 2007 to a peak of 45% in
2014. This has been associated with an increased role for loans rather than grants: indeed, of the increase in
ODA from multilateral agencies since 2007, 85% was due to a rise in lending (see Figure 7).
Multilaterals are particularly prominent in financing infrastructure in low-income countries. Multilateralagencies account for between 50 and 70% of the infrastructure ODA in low-income countries. This makes
multilateral agencies particularly important in these countries; by contrast multilaterals only account for around30-40% of infrastructure ODA in middle income countries.

FIGURE 6 THERE HAVE BEEN STRONG INCREASES IN ODA FROM MULTILATERAL AGENCIES IN RECENT YEARS6. SOURCE(OECD, 2017C).

4

ODA data comes from the OECD's DAC database which collates ODF data from major development partners but is not complete –hence the total value of ODA aid in Figure 5 is lower than the level of development partner infrastructure finance implied in Figure 4.
5
The following figures are based on the data from the OECD-DAC database which collates ODF from around 50 major development
partners – this is not a complete representation of all the support available but offers a reasonable sub-sample.
6
ODA data comes from the OECD's aid flow database which collates data from a large number of aid agencies but is not complete – itrepresents an underestimate of true aid flows

14

FIGURE 7 GREATER ISSUANCE OF LOANS RATHER THAN GRANTS APPEARS TO HAVE THE DRIVER OF RECENT GROWTH INODA FROM MULTILATERAL AGENCIES7. SOURCE (OECD, 2017C).

Development partners can also support the private sector in mobilizing financial resources forinfrastructure projects. (OECD 2015d) (OECD and World Bank 2015). This support tends to be provided by
Development Finance Institutions (DFIs) and International Finance Institutions (IFIs), who have experience inworking with the private sector, rather than bilateral donors. Total disbursements for infrastructure from DFIs
and IFIs to the private sector amounted to $5.9 billion in 2013, of which IFIs contributed around 71%. Beyond
financing, there is also a key role played by a range of development partners to promote best practices in thedesign and implementation of infrastructure projects, which can lead to efficiency gains of to 40% of project
costs (Global Green Growth Institute & G-24 2015).
Beyond these aggregate-level trends, comprehensive data and analysis on infrastructure financing
remains elusive. The OECD is currently undertaking an important study - ‘Breaking Silos: Actions to develop
infrastructure as an asset class and address the information gap’ - to map the gaps in data on infrastructure
financing spend and how they might be filled (OECD 2017a).

1.2. The Risk Transfer Context
Investment in infrastructure involves large capital outlays and is exposed to a range of concentrated
risks including legal, political and environmental ones. Insurance and insurance-related instruments canbe used as a means of transferring these risks to agents better equipped to manage and hold them. These can
include (re)insurance companies, risk pools, public agents and the capital market. This section summarises thecurrent role insurance plays in transferring disaster risks related to critical infrastructure projects and explores
the role of insurance in building resiliently.

1.2.1. In the context of infrastructure, insurance practices vary
The decision on whether to use risk transfer mechanisms largely depends on the sponsorship of theinfrastructure project. Privately financed infrastructure projects tend to make use of insurance, predominantly
during the construction phase. Experience is more mixed for public projects.
Where the project involves private investors, insurance is typically taken out during the construction
phase, and more rarely, during the operational phase, to protect investor’s cashflows. Project insurance,
typically held by engineering companies, serves to protect investors’ cashflows against a range of possible
perils. During the construction phase, these include business interruption, property damage, late delivery, public
liability, third party liability, political risk (depending on location), environmental risk and contract works (Baarts
7

ODA data comes from the OECD's aid flow database which collates data from a large number of aid agencies but is not complete – itrepresents an underestimate of true aid flows.

15

& Longley 2003). Contracts can provide cover over multiple years, given the long-term nature of the construction
phase, and tend to extend for one to two years after completion to cover potential defects. The £15.9bn Crossrail
project broke new ground in terms of insurance contract duration with the first nine-year policy without a breakclause in the UK (Lloyd’s of London 2014). Upon completion, a smaller subset of operational risks can also becovered by insurance, typically on an annual contract basis. These can include business interruption, third party
liability, terrorism and property damage among others.
Catastrophe risk can be insured separately, bundled with other traditional types of insurance, or
covered under “all hazards” policy. The contracts differ on the extent of cover offered, indemnity limits, andwhether the policies are compulsory, bundled or voluntary (IPCC, 2012). Depending on the exposure, insurancecompanies might impose higher deductibles or limits for catastrophe risk. In many instances, insurancecompanies have been reluctant to offer country-wide policies for hazards because of the systemic nature ofthese risks, as well as problems of moral hazard and adverse selection.
Where extreme catastrophe risks cannot be insured efficiently by the insurance market, the government
can step in as an insurer of last resort. In some highly exposed countries, such as the Netherlands, insurance
for flood doesn’t exist and government relief is provided instead (IPCC, 2012). For London’s £4.2bn Thames
Tideway Tunnel project, which is largely financed by private investors and lenders, the infrastructure firm incharge, Bazalgette, procured a set of standard commercial insurance policies (Tideway 2017). The residual risk
was covered by the UK government through a contingent financial support package, which mitigated certain
extreme risks beyond the commercial insurance limits, in order to ensure the project was attractive to private
investors. (National Audit Office 2017).
In the case of publicly owned assets, policy and practice on insurance varies significantly between
countries. In Sweden, disaster risk insurance for public assets is illegal (IPCC, 2012). At the other extreme,disaster risk insurance of public assets is compulsory by law in four APEC economies and Colombia (The WorldBank 2017b). In some cases, the law requires public asset owners to evaluate available disaster risk
management options to determine the most appropriate one. This is the practiced in Australia and New Zealand,
where states and government agencies must assess available insurance options on a cost-benefit basis. Finally,some economies leave financial risk management of public assets to the respective managers, who decide
whether to protect them with disaster insurance. This approach is taken in Canada, Taiwan, and the UnitedStates (U.S.) (The World Bank 2017b). In the U.S alone, there is considerable variation: transit organizations
generally seek private insurance for catastrophe risks (Kunreuther et al. 2016), while the New York’s
Metropolitan Transit Authority (MTA) has its own captive insurance company. Both New York’s Metropolitan
Transit Authority (MTA) and Amtrak now use catastrophe bonds to offer protection from disasters (Kunreuther
et al. 2016), providing diversification of capital and rapid pay-outs in complement to their traditional (re)insurance
programs. The majority of states, however, often carry cover of catastrophe for their public assets (IPCC, 2012).
Despite varying practices, catastrophe perils, including for infrastructure assets, remain largely
uninsured even in developed countries. Coverage is low globally. On average, only approximately 30-40%
of catastrophe losses have been covered by insurance over the past 10 years (Czajkowski et al. 2017). While
there is no systematic data indicating the degree to which critical infrastructure is insured against catastrophic
risk, there appears to be low insurance of assets even in mature insurance markets such as the U.S (Czajkowski
et al. 2017). Lloyd’s (Edwards & David 2012) estimates that although the U.S. has a relatively high insurance
penetration rate from a global perspective, 57%of losses from disasters during 2004 to 2011 were uninsured.
Our research suggests that, while typical project-specific insurance packages are common during theconstruction phase of UK-based projects, catastrophe insurance is uncommon thereafter.
In many developing countries, with a few exceptions, there is little insurance for disaster risks in thecase of both public and private infrastructure projects. The market is underdeveloped, particularly because
there is often limited risk assessment information, limited scope for risk pooling and little or no supply of
insurance instruments (IPCC, 2012). Data issues are a critical barrier: data on exposure is often poor and model
coverage is limited. Even when infrastructure is financed by development bank loans, this insurance typically
only covers catastrophe risks during the construction phase and potentially the first couple of years after
completion. A key example where catastrophe insurance is linked to infrastructure is FONDEN, Mexico’s natural
disaster fund, which has been transferring catastrophe risk to the (re)insurance and capital markets since 2004,
targeting the funding of both emergency relief costs and infrastructure reconstruction. The Caribbean
Catastrophe Risk Insurance Facility and the Pacific Catastrophe Risk Insurance Pilot both supply insurance

16

against emergency losses to member sovereign nations. Underinsurance is still common in the developingworld. RMS analysis shows that average annual asset losses from catastrophe events in these countries isaround $29.1 billion, of which only 3% are insured. While there is no equivalent data specifically for infrastructure
assets in developing countries, stakeholder discussions suggest that insurance penetration for these assets islikely to be similar or lower.

1.2.2. Insurance can play a key role
Where insurance is in place for infrastructure assets, it can be a fast and cost-effective solution in theevent of disaster. Insurance can provide prompt and effective immediate response, dealing with issues ofcommitment, responsibility and institutional failure. Given the complicated nature of infrastructure projects andmultiple stakeholders involved, insurance schemes can distribute funds quickly and effectively, thus ensuring
greater continuity of service in the wake of a disaster. Supporting infrastructure systems to become functional
again as soon as possible can save lives, prevent ‘cascading failures’ of other urban systems, and minimize
potentially devastating social and economic outcomes (Lloyd’s, 2017). Edwards & David (2012) examine fivelarge catastrophes to show that an increase in insurance penetration of 1% would reduce proportion of the total
damage borne by the taxpayer by approximately 22% of the total estimated damage.
As well as directly providing cover, insurance practitioners often play a valuable role ex ante in helping
government and other stakeholders understand and “price” the risk exposure of their criticalinfrastructure. Disasters are a tail risk that represents a significant contingent liability for the government. It is
often associated with large fiscal costs and the contingent liability of the government is generally implicit andnot clearly defined by law. The government thus acts as a (re) insurer of last resort, in some cases without
knowing with precision its disaster risk exposure (The World Bank & Swiss Confederation 2011). By exploring
insurance solutions, governments can better assess, understand, and manage these risks.

1.2.3. Insurance can incentivise resilience, at least in theory
Several recent papers have argued that insurance and insurance-linked instruments can catalyse
resilience through price incentives. Resilience measures should lead to lower future premium payments in
response to risk reduction for the insurer (Lloyd’s, 2017). Thus, insurers can help improve construction
standards or developing prevention policies (The Geneva Association & The World Bank 2018). For example,
conversations with insurance industry specialists suggest that, although installing sprinklers for schools in the
UK was not a legal requirement, many local authorities opted for this measure, incentivised by the large
reduction in insurance premium that resulted. Similarly, United Insurance, an insurance company active in the
Caribbean, promoted structural mitigation, offering premium discounts of up to 40% for retrofitted commercial
properties and 25% for retrofitted domestic properties in the late 1990s. When Hurricane Jose subsequently
struck Antigua in 1999, losses were 10% of the total sum insured, but only 4.75% of the sum insured in the caseof retrofitted projects (Benson & Clay 2004). Other insurers have offered discounts for clients who implement
resilience measures such as hurricane shutters, relocation away from coastlines and retrofits to make structures
more hazard-proof (Benson & Clay 2004). In designing such schemes, a number of important factors need tobe considered – such as the treatment of assets that already benefit from more resilient measures and thebenchmark from which improvements in resilience are recognised – in order to make sure that the mechanism
is robust and does not undermine insurance penetration (Risk Management Solutions 2010).
In general, however, the ability of insurance to provide sufficient economic incentives to build resiliently
has been questioned due to the short-term nature of typical contracts and because premiums are notalways fully risk-based. Typical insurance premiums are renegotiated annually and subject to frequent priceand cover changes, particularly in the wake of a disaster. The resulting lack of visibility reduces the incentive
for the insured to invest in resilience measures. While multi-year contracts could incentivise resilience by offering
a long term fixed price for insurance, their implementation in the real world has been limited (Maynard & Ranger2011) due to the high costs associated with tying up capital for long periods. In addition, premiums rarely reflect
the true level of risk. Other supply and demand factors are often more important in price formation. Additional
premiums reflecting data or model uncertainty in expected losses also dilutes the impact on premiums of
mitigation measures as reflected in the modelled risk. This is particularly true in developing countries exposed17

to frequent disasters, where the vast majority of risks are transferred to the reinsurance industry. For example,
more widespread discriminatory pricing in the Caribbean is discouraged by low retention of risk and blanketpricing policy practiced by reinsurers who tend to lead pricing (Benson & Clay 2004).
The industry might also incentivise resilience through reduced cover, pre-conditions for cover or
technical assistance and information with regards to existing risks. Incentivizing resilience through preconditions for cover can be very effective. In the late 1990s, catastrophe insurance penetration in Fiji was
unusually high for a small island state. This reflected a set of institutional arrangements and aligned incentives
between the finance industry, insurance sector and the regulator. Securing a mortgage in Fiji was madeconditional on the acquisition of cyclone insurance, which itself could only be obtained on the presentation of acertificate confirming compliance with the 1985 National Building Code (Benson & Clay 2004). Requesting
information and limiting insurance cover could also lead to improving resilience. A recent example of followed
the tragic events at London’s Grenfell Tower in 2017. Matters related to cladding and to fire safety moregenerally became a concern for Professional Indemnity Insurers in the case of high-rise buildings. The insurance
industry is thus envisaging a number of measures incentivizing risk reduction, such as requesting disclosure,providing further due diligence on the ground, restricting cover where risk is deemed high or applying a higher
level of self-insured excess (Willis Towers Watson 2018).

1.3. The Financial Instruments Context
The previous sections illustrated the various financing needs – and challenges – associated withresilient infrastructure, especially in developing countries, and the potential role for insurance.
Infrastructure financing is a difficult task; the financing gap that already exists is likely to become wider in the
future, placing greater stress on developing countries where the challenge of addressing this gap is made moredifficult by issues such as poor institutional design and limited data availability. While developing infrastructure
which is more resilient to climate change and disasters is societally beneficial, it comes with additional
challenges, particularly around ownership of risk and the uncertain realization of benefits that resilience building
provides. The insurance industry can also play a potentially important role in managing the catastrophe risks
faced by infrastructure, supporting recovery and, in the right circumstances, enhancing resilience.
The purpose of this section is to explore a range of existing infrastructure financing and risk transfer
instruments and the role they can play in relation to the objectives of this work. The overarching aim of
the project is to identify a financing instrument that can meet eight success criteria. These comprise 1) ex-ante
criteria – preconditions for success, which allow us to reduce the universe of existing instruments to a set of
relevant ones to this project; and 2) ex-post criteria which test a viable path to implementation once a potential
solution has been identified:•

Motivate the development of resilient infrastructure. Solutions should promote increased andmaintained resilience to catastrophes.

•

Monetize resilience benefits through effective insurance and funding mechanisms. Solutions
should allow resilience benefits to be captured and monetized, thus creating a ‘resilience dividend’.

•

Deliver resilience benefit upfront. The resilience dividend should be realized in a lump sum upfront
to reduce the financing needs for resilient infrastructure. This reflects that the high upfront costs ofresilient infrastructure are one of the biggest barriers to its provision.

•

Involve risk transfer. Solutions should help transfer risks to parties better able to bear catastropherisk through effective and efficient insurance coverage.

The review considers the features of existing instruments across two major categories: risk transfer
instruments and pure funding instruments. The risk transfer instruments can be further grouped into (i)traditional insurance instruments, such as catastrophe insurance and reinsurance, multi-year insurance, (ii)alternative risk transfer instruments and carriers such as sovereign risk pools, catastrophe bonds, resiliencebonds. The universe of traditional funding instruments is long, but we have chosen to focus on more recent

18

structures, such as green bonds and impact bonds. Some of these instruments are directly related to disasterrisk and resilience while others have been developed for use in other contexts (such as climate mitigation or
health) but could conceivably be used to support resilience building. Although this list of instruments considered
may not be exhaustive, it provides a broad overview of some of the most important instruments of relevance tothis work (see Figure 8).

FIGURE 8 EXISTING INSTRUMENTS EITHER FOCUS ON PROVIDING RISK TRANSFER OR FINANCING. SOURCE (VIVIDECONOMICS).

1.3.1. The resilience dividend is yet to be monetised by risk transfer instruments
Our review of existing risk transfer instruments suggests that there is no single instrument in the market
that satisfies the first four ex-ante criteria simultaneously. Figure 9 summarises the findings: while
insurance and insurance-related instruments involve risk transfer, their ability to incentivise resilience throughmonetizing the associated benefit is questionable. The property most clearly absent from the existing suite ofrisk transfer instruments is that they do not allow the resilience dividend to be captured and delivered upfront.
The Appendix provides more detail about each of the instruments in relation to each of the criteria.

FIGURE 9 SUMMARY OF FINDINGS ACCORDING TO OUR SUCCESS CRITERIA. SOURCE (VIVID ECONOMICS).

While there is no one risk transfer instrument providing all that is intended for the purposes of this project, anumber of ideas may help identify some of the building blocks for a solution:•

Multi-year insurance contracts capture the resilience benefit through lower insurance
premiums. They demonstrate the significance of long-term relationships in helping to create incentives
for resilience building, especially given the long asset lives of many resilience improving investments.

19

Their implementation however relies on the assumption that 1) insurers are willing to offer multi-year
cover for catastrophes and 2) the price of this cover is reflective of actual risks. In practice, these
conditions may not be consistently observed in the market, as discussed in section 1.2.3 above.
•

The resilience bond mechanism has a number of attractive features in the context of this work.
In theory, the concept allows the resilience dividend to be monetised through lower insurance
premiums. It also brings these savings forward through the rebate mechanism, although they only
become available after completion of resilience measures. To date, work is ongoing in converting theconcept into a marketable product (re:focus partners 2017).

1.3.2. Traditional and innovative funding mechanisms can provide capital
upfront
Given the limitations of existing insurance-related products in the context of the objectives of thisproject, a range of funding instrument were also reviewed; these may allow the provision of upfront
financing/ dividend delivery. These financing-focused instruments span both the public and private sector,
ranging from basic grants and concessional lending from development agencies, bond-based capital market
instruments and more innovative, donor-supported bond issuances such as the IFF's Vaccine Bond program.
The Appendix provides more details and some of the key insights from this review include:•

Multilateral lending for infrastructure by international development institutions can be extended
either on concessional or commercial terms. Concessional loans are loans that are extended on
more generous terms than market loans. The concessionality is achieved either through interest rates
below those available on the market or by grace periods, or a combination of these. For example, theWorld Bank’s IDA extends concessional lending to the poorest developing countries – it provides credits
at little or no interest rate and repayments are stretched over 25 to 40 years, including 5-to 10-year
grace period. Multilateral lenders can also provide loans on commercial terms, often offering long-termsource of finance (20/30-year loans) critical for infrastructure projects.

•

Green bonds demonstrate the growing investor appetite for financial instruments with strong
environmental, social and governance (ESG) credentials. An established and vibrant market, they
provide upfront funding for projects with positive environmental benefits, but do not generate resilience
dividend or involve risk transfer.

•

Impact bonds, also known as pay-for-performance contracts, transfer the risk of implementing
a project to private investors who receive principal repayment plus a financial return according
to the extent to which independently verified performance targets have been achieved. They are
therefore not ‘bonds’ in the conventional sense as investors stand to lose part or all of their investment
if unsuccessful. Impact bonds are typically issued by a government or a donor, funded upfront by private
sector investors and executed by private sector service providers. Thus, they are an attractive option intheory as they promote private sector involvement and risk sharing. However, modifying them toresilient infrastructure investment needs careful consideration of outcomes and measurement issues.

•

The International Finance Facility for Immunization's vaccine bonds convert long-term donor
pledges into upfront capital for immediate project finance. IFFIm sells 'vaccine bonds' in capital
markets that are effectively backed by the pledges from donors – this secures favorable pricing andprovides immediate resources to support immunization programs (Gargasson & Salomé 2010). Though20not directly relevant to infrastructure or disaster risk management, the IFFIm concept helps to illustrate
how public donor funds can bring forward upfront benefits.
•

The World Bank’s Catastrophe Deferred Drawdown Option (CAT DDO) shows the importantcomplementary role that various instrument layers play. Such layering ensures quick recovery postdisaster without jeopardising the long-term resilience goals of a structure (GFDRR 2011). With the CAT
DDO, funds of up to $500 million are available immediately once a state of emergency is declared due
to a disaster. Countries must have disaster risk management programs in place to be eligible for the
CAT DDO, encouraging disaster resilience.

21

2. THE INNOVATION LAB
2.1. Overview
The Innovation Lab brought together experts from finance, insurance, development, engineering andhumanitarian sectors to design creative yet realistic financing options to incentivise resilience. Cofinanced by Lloyd's of London and the Centre for Global Disaster Protection, the Lab convened a diverse rangeof over 50 attendees who contributed to the discussion on the day. A detailed attendee list is available in the
appendix of this report.
The Lab consisted of three sections: context setting, product development on pre-worked case studies,and a discussion on primary challenges. The first part of the day set the context around the challenges ofbuilding resiliently in developing countries and the intense needs that many of them face, with a focus on the
Caribbean. Experts gave short presentations and shared knowledge around eight diverse tables to build acomprehensive picture. In the second part of the day, working groups applied their expertise on a specific casestudies to design innovative financing solutions that encourage resilience. In the final part of the day, attendees
identified the key challenges and lessons learned from the Lab.
Five representative case studies were developed before the main lab session, describing the country
and peril context (see Appendix iii. for a more detailed description of each and further details on the exact
process of the innovation lab):

1. A small, low income country, highly exposed to earthquake risk (e.g. Nepal) – designing innovative financing
solutions to support building or retrofitting of schools to ‘code+’ following the Gorkha earthquake in April
2015.

2. A small island state, highly exposed to hurricane risk (e.g. Dominica) – encouraging resilient and sustainable
low-income replacement housing following the hurricane season in 2017.

3. South-East Asia, highly exposed to earthquake and other hazards (e.g. Indonesia or Philippines) –developing a financial product that concentrates on funding protection, effective maintenance, or quick
recovery for road network infrastructure after earthquakes.

4. A small island state, large-scale coastal defence – financing coastal defences and preparedness for ports
and cruise terminals, which are critical for the continuity of jobs and income following the hurricane season
in 2017, incorporating risk transfer product to facilitate rapid recovery of services for future events.

5. Resilience of critical infrastructure services across several small island states – risk transfer product tofinance rapid recovery of critical services, such as health, sanitation, power, education, across several
states in the immediate aftermath of events.
The literature review (Section 1) informed the eight success criteria that would define a successful solution andidentify potential building blocks that could be used from the existing space of financial instruments. The eight
criteria that lab participants were asked to contemplate in designing solutions are outlined in Figure 10:

22

FIGURE 10 THERE ARE EIGHT SUCCESS CRITERIA IN TOTAL THAT SHOULD BE MET. SOURCE (VIVID ECONOMICS).

The lab was a collaborative and interactive process. Attendees rotated around different groups throughout
the day so there was the opportunity for everyone to be involved in discussions on 2-3 case studies. The Lab
facilitated a wide range of rich discussion. Critically, it helped catalyse four ideas for products solutions, as set
out in Section 4. In addition, it provided extra context and emphasis on some of the key barriers to greater
resilience. It also helped identify several critical issues and contextual factors that need to be taken in designingsolutions to enhance resilience.

232.2. Key challenges on the groundExpert presentations highlighted several practical challenges that are preventing effective resiliencemeasures from being adopted. These issues create market failures that prevent the socially efficient level ofresilience from being implemented (see Figure 11).

FIGURE 11 SUMMARY OF PRACTICAL CHALLENGES TO RESILIENT INFRASTRUCTURE AND POST DISASTER RECOVERY.
SOURCE (VIVID ECONOMICS).

1. Scale: disasters can have large economic and societal impacts, which exacerbate existing financing
difficulties. Hurricane Maria, for example, resulted in damages and losses equivalent to 226% of Dominica’s
GDP in 2016, and large parts of the country remained without power several months on (Government of
the Commonwealth of Dominica 2017). This aggravates restricted budgets in many of the Caribbean islands
and on-going difficulties raising low cost capital to fund resilience measures.

2. Institutional, technical capacity and enforcement issues: application and enforcement of construction
standards and building codes is key. However, even when technical know-how of how to build resiliently
exists, there is often limited institutional capacity to deliver it on the ground.

3. Commitment and ownership of risk issues: identifying key stakeholders on the ground can bechallenging: those who benefit from the continuity of a resilient service often differ from those who service
the asset financially.

24

4. Misalignment between short political cycle and long-term impacts of investment in resilience:different time scales should be considered in proposed product solutions to ensure a viable path to
implementation.

5. The limitations of simple cost-benefit analysis: typical cost-benefit analysis may be limited to thebenefits of resilience on a physical asset damage only basis. These are not sufficient in a high discount rateenvironment and a solution must be mindful of the broader “triple dividend” of resilience.

6. Operation and maintenance along with the required knowledge and resources to facilitate this will play alarge part in determining the success of any resilience building scheme.

7. Political economy: addressing resilience building can often be overlooked due to poor allocation of
responsibilities in government agencies and weak political will.

2.3. Lessons learned from the Innovation Lab
Several underlying themes emerged from the discussions around the tables that should be understoodand considered when designing and implementing a financial solution. These themes are summarised in
Figure 12 and elaborated on below.

FIGURE 12 THREE KEY THEMES SHOULD BE CONSIDERED WHEN DESIGNING A SOLUTION. SOURCE (VIVID ECONOMICS).

25

1) Understanding the role and importance of resilience•••

Resilient infrastructure is not just about the asset, it is predominantly about the resilient service thisasset provides. Rather than thinking about what the infrastructure is, one should think about what it does
(e.g. protection, provision of essential services, connection).
The resilience dividend contains a range of benefits, not only reduction in asset damage. One
example of this broader range is the “triple resilience dividend” which considers benefits that accrue evenin the absence of disaster. This include the reduction of future losses from disaster, increased economic
potential in lower risk environments, and the co-benefits of resilience investments (such as schools used ascommunity shelters, roads used as coastal defences, resilient buildings used for solar power generation).
As well as building resilience at an individual asset level, resilience solutions should consider
systems-based approaches. Incorporating interconnectedness and interdependency of different types ofinfrastructure is essential in understanding and valuating its resilience dividend.

2) A robust solution is not simple to devise•••

A financial instrument is only a part of the solution. While an important vehicle to channel funds andincentivise stakeholders, it cannot succeed without important structures and political will in place. Broader
policy enabling environment and institutional set up to enforce building to code is therefore key.
Many of the benefits from resilience measures are hard to monetise (and sometimes quantify). A
range of public policy interventions may be needed to encourage behaviour that supports the delivery ofthese benefits.
Bringing the resilience dividend forward is difficult. Instead, transferring this dividend to parties more
willing to wait for it may be a more realistic and easier to implement approach.

3) Some common prudent steps should be acknowledged in designing a solution•

Where possible, build upon what already exists. Solutions should build upon current practices andleverage the expertise of existing stakeholders and financiers on the ground rather than exist in isolation.
Solutions should utilise local skills and build local technical expertise.

•

Future resilience dividend needs to be tied to current immediate needs. It is easier to talk about future
benefits when they are aligned with current problems•

Insurance and insurance related mechanisms are critical in allowing to monetise the resilience
benefit. An enabling environment for increasing insurance penetration and greater risk-based pricing is
key.

26

3. RESILIENCE DIVIDEND
3.1. Quantifying and Capturing the Resilience Dividend
The motivation for development of resilience-linked financial instruments is based on two principles:••

There are benefits associated with the development of more resilient buildings and infrastructure.
The benefits can be quantified, captured, and monetised using innovative financial structures.

The captured benefit described within these principles is defined as the ‘resilience dividend’. Quantification of
the resilience dividend is fundamental to the development of effective product options. In some cases, oncemeasured, the resilience dividend can be transferrable into up-front capital. This capital can financially motivate
resilience building activities offsetting the initial additional costs of developing resilient infrastructure.

The Benefits of Resilience
Total disaster costs are a function of both the direct and longer-term downstream impacts of a disaster event:
1. Direct impact (physical) - damage and loss that occurs during a disaster event as a direct result of
the severity of hazard that is experienced, including:
Structural asset damage
Injury and loss of life
The financial impact of these components of disaster losses can be covered using standard insurance
policies. Catastrophe models are ideally placed to quantify the risk of direct losses.
2. Downstream impact (operational, societal, environmental, and economic) – contingent losses that
result from direct damages, including:Disaster response costs
Service disruption
Impact on health and livelihood
Impact on economic and developmental potential
The magnitude of downstream impacts can be multiples of the direct losses. The systemic nature ofcontingent impacts means that they are more difficult to quantify and may not be as comprehensively
captured under standard insurance coverages, although certain contingent losses such as service
disruption are strongly correlated to direct damage and hence can be explicitly quantified using
catastrophe models. With reasonable assumptions it is also possible to quantify other downstream
impacts, though the model uncertainty increases as the complexity of the system increases.
The benefits of increasing the resilience of physical infrastructure therefore extend well beyond the reduction in
direct damage and loss. The objective of this process is to develop innovative financing products that capture
and monetise the benefits of risk reduction into a realized resilience dividend. Effectively, the product aims tocapitalize on the future event savings that are expected to result from more resilient infrastructure.

The Role for Insurance
Insurance exists to transfer the unmanageable volatile risk of large future losses into manageable annual
insurance premium payments. Premium payments are a function of the underlying risk: if the risk of loss is
reduced using resilience measures, then it is expected that the annual insurance premium payments will also
fall. Insurance may therefore be a useful means of monetising the benefits of risk reduction measures.

27

All elements of disaster losses, direct and downstream, are technically insurable, though those responsible forthe losses range from asset owners, to government, to the international development community. Despite thereality that all parties benefit from more resilient infrastructure, typically only one will be responsible for the riskof structural asset damage and loss, and therefore for insurance premium payment.
The simplest approach to capturing a resilience dividend to use towards resilient infrastructure is therefore to
use the saving on asset insurance premium, for which ownership is less ambiguous than for other types ofdisaster losses associated with the infrastructure.

Risk Reduction
A hypothetical example is used to demonstrate how retrofit measures can reduce the risk of direct damage andloss to a portfolio of school buildings in Dominica 8, and how this benefit might be captured as a resilience
dividend through savings on insurance premiums. Sensitivity analyses are also included to demonstrate how
risk-reduction can be represented in insurance premium, and how discount rates influence the total resilience
dividend that can be accrued over time.
The example compares how the vulnerability of a standard (‘base’) school construction compares against a
retrofitted (‘resilient’) alternative at an additional cost of 5.5% of building value. As expected, the structuralvulnerability of the school buildings decreases following installation of wind retrofit measures, though themagnitude of reduction varies across a range of wind speeds. Figure 13 displays this difference between thevulnerability of the base and resilient examples.
100%
Base

90%

Retrofit
Damage Reduction (percentage)

80%

Damage Reduction (absolute)

Mean Damage Ratio

70%
60%
50%
40%
30%
20%
10%
0%
50

60

70

80

90

100

110

120

130

140

150

160

170

180

190

200

Wind Speed (60-second Sustained, mph)
FIGURE 13 VULNERABILITY CURVES FOR BASE SCHOOL CONSTRUCTION AND SCHOOLS WITH RETROFIT MEASURES. BLACK
CURVES SHOW DAMAGE REDUCTION AS A PERCENTAGE, AND IN ABSOLUTE TERMS.

8

This example also supports the applied use case analysis for the Resilience Impact Bond contained in the following section, whichcontains further information on the specific details of this use case.

28

There are several key observations for this example, which affect the cost-benefit of retrofit for events of different
magnitudes:
•
•
•

•
•

At lower wind speeds, the percentage reduction in damage is at least 25%, but the absolute savings
may be small since the events do not cause extensive damage.
Retrofitting creates the greatest proportional savings, up to 60% reduction, at a wind speed of 120 mph.
The greatest absolute damage reduction occurs at wind speeds of 150 mph and the absolute damage
reduction equals or exceed the additional cost of the retrofit for a portion of the curve. At wind speeds
greater than 150mph the relative value of retrofitting decreases – this occurs as the vulnerability curves
for the base and retrofit cases converge at higher wind speeds.
For extremely severe events (200 mph) the damage ratios are approximately 100% for both the baseand resilient cases. However, the probability of these types of event occurring is very low.
The loss you would expect to experience on average in one year, the average annual loss (AAL), is
reduced by 46%, reflecting the complete distribution of event severity and frequency.

This example demonstrates that the benefit of investment in retrofit for an individual event depends on its windseverity. For low loss causing events, the total saving may not be as great as the cost of resilience, the sameis true at very high wind speeds. Figure 14 displays the wind hazard profile of the ten school locations acrossDominica. The hazard occurrence exceedance probability (OEP) curves show the probabilities of exceeding a
range of wind speed thresholds at the locations of the schools (including minimum, maximum, and mean ranges
to show the variability in wind hazard across the island).
20%
19%

Mean

18%

Maximum

17%

Minimum

Occurrence Exceedance Probability

16%
15%
14%
13%
12%
11%
10%
9%
8%
7%
6%

5%
4%
3%
2%
1%
0%
50

60

70

80

90

100

110

120

130

140

150

160

170

180

190

200

Wind Speed (60-second Sustained, mph)
FIGURE 14 DOMINICA WIND SPEED HAZARD OCCURRENCE EXCEEDANCE PROBABILITY CURVE.

It is the combination of vulnerability, and hazard frequency and severity that determines the AAL. AAL, or purepremium, is a measure of the annual expected loss that can be expected to occur within a year, on a long-term
average. Among other factors, this forms the basis for calculation of insurance premiums – a reduction in AAL
should generally yield a reduction in insurance premium. The magnitude of AAL reduction as a portion of the29

additional cost of resilience is a good indicator of whether a resilience investment yields a good cost-benefit
ratio (‘Resilience Ratio’).
𝑅𝑒𝑠𝑖𝑙𝑖𝑒𝑛𝑐𝑒 𝑅𝑎𝑡𝑖𝑜 =𝐶𝑜𝑠𝑡 𝑜𝑓 𝑅𝑒𝑠𝑖𝑙𝑖𝑒𝑛𝑐𝑒 ($)∆𝐴𝐴𝐿 ($)

As would be expected, the resilience dividend (ΔAAL in this case) should be large in relation to the cost ofresilience in order to produce good benefit-cost ratios. Note that ΔAAL is a metric that describes the averageannual risk reduction, some years may experience no losses (and no Δloss) and the resilience dividend may be
accrued over many years. As a general guide:-

Average annual losses vary significantly based on vulnerability, combined with the frequency andseverity distribution of the hazard (as described above). Loss cost is a measure of the AAL as aproportion of the value of the asset under consideration9. When combined with reasonable risk
reduction measures, high loss costs represent scenarios where there is a good potential resilience
dividend. A loss cost of 10 would imply that AAL is 1% of the total value of the asset, this is a very highloss cost (in the context of catastrophe risk), which could represent a worst case for residential orcommercial type exposures. For additional context:-

In general, the major influence of loss costs is the frequency of the peril at any given location.
▪ Climate perils (e.g. hurricane, flood) typically have higher loss costs than earthquakes.
This is largely due to the difference in frequency (climate impacts are much more
frequent than earthquake impacts).
▪ Extreme loss costs (10-50) are possible where high frequency is combined with low
vulnerability. For example, slab-on-grade single family dwellings in some low-lying
areas of lower Mississippi basin can have loss costs exceeding 30 for flood risk. This
would be considered extremely high risk.

-

Additional costs of resilience can be very small compared to the total value of the base structure. For
example, smaller retrofit measures, such as roof anchors or opening protection may cost as little as 1%of the total cost of base construction.

-

More substantial resilience measures, such as seismic damping or heavy protection measures, canincur high costs.

-

For certain resilience measures, risk reduction can be of the order of 90% of AAL. The schools example
demonstrates a case where the risk reduction in terms of AAL is 46%.

-

The resilience ratios can therefore vary significantly between use cases. However, it is likely that theresilience dividend will need to be accrued across several years for it to contribute meaningfully to theadditional cost of resilience.

The resilience ratio is indicative of the number of years it would take for the annual reduction in insurance
premiums to pay entirely for the additional cost of resilience (its ‘payback period’), if changes in insurance
premiums are assumed to fully mirror changes in AAL. In reality, insurance costs are likely to be influenced byadditional factors, and the true payback period is a function of the actual cost of insurance premium which canbe achieved, and the discount rate which is used to calculate the present value of future annual savings. These
factors are explored further in the following sensitivity analysis and in Section 1.5.

9 𝐿𝑜𝑠𝑠 𝐶𝑜𝑠𝑡 =𝐴𝐴𝐿∗1000
𝑇𝑜𝑡𝑎𝑙 𝑉𝑎𝑙𝑢𝑒

30

Scale
The costs and values of insurance and resilience investments vary according to the scale of the underlying
infrastructure or resilience project. Scale refers here to the number, value, and spatial distribution of theunderlying exposure10. Scale is important for a number of reasons:
•
•
•

•
•

The relative frictional costs of setting up innovative financing mechanisms decrease with increasing
scale.
Larger portfolios of assets are more attractive to insurers. Administrative costs and volatility in loss
decrease with increasing scale.
The modelling uncertainty in the benefit of resilience measures decreases as the number of assets
increases. Risk reduction measures deployed at scale are therefore more likely to be recognised in
reduced insurance premiums.
The total magnitude of risk, and potential risk reduction benefits, is a key factor in determining whether
there is a great enough resilience dividend available to be worth capturing.
Building resilience at scale, across many pieces of infrastructure, has inherent benefits to the overall
resilience of the system over targeting individual assets. The operational resilience of services isdependent on how well the system as a whole is able to manage disasters.

The types of innovative financing mechanisms developed in the following section may therefore yield greatest
benefit if they are deployed at scale (e.g. investments of the order of $1-10 million), ideally with risk transfer
mechanisms that cover high value individual assets, and/ or larger numbers of lower value assets. Ultimately,use cases in high risk areas are more likely to generate high resilience dividends – risk modelling can therefore
greatly help to isolate appropriate use cases, and to support prioritisation.
However, in addition to the economies of scale that result from applying this structure to larger projects, there
are also obviously additional costs, both in the cost of investment in resilience, and the cost of risk transfer.

Cost-Benefit Sensitivity
The resilience ratio describes the number of years of AAL-based savings that would have to be accrued before
the initial cost of the resilience measure is paid for. In reality, the payback period (time after which premiumsavings pay for additional cost of resilience) is strongly dependent on:--

The actual cost of the insurance premium, which is influenced by the risk, but also other factors including
the uncertainty, magnitude of coverage, number of covered assets, and administrative costs. For
simplicity, the cost of insurance premiums for a portfolio of assets is assumed to be 2x its AAL in thisexample- this would reduce the payback period (resilience ratio) by 50%.
Discount rates – which affect the net present value of spending on resilience and insurance premia 11.

An illustrative range of sensitivity analyses, using the hypothetical schools analysis already discussed, havebeen completed to demonstrate how insurance premium and discount rate assumptions influence therelationship between total cost and annually accrued benefit (Figure 15).
Note that these sensitivity results are presented to demonstrate the potential impact of higher discount rates on
the ability to accrue resilience dividends over time. Results are expected to vary significantly between use cases,
and under different product structures.

10
11

Exposure refers to the underlying ‘assets at risk’. Assets can constitute buildings, infrastructure, people, livelihoods, services, etc.
Discount rate refers to the rate at which future cashflows are adjusted to calculate their present day equivalent value.

31

150.00%
Pure Premium (AAL), Discount Rate = 0%, Resilience Cost = 5.9%
Pure Premium (AAL), Discount Rate = 10%, Resilience Cost = 5.9%
Pure Premium (AAL), Discount Rate = 3%, Resilience Cost = 5.9%

Net Present Value Benefit-Cost Ratio

100.00%Technical Premium (2x AAL), Discount Rate = 0%, Resilience Cost = 5.9%
Technical Premium (2x AAL), Discount Rate = 10%, Resilience Cost = 5.9%
Technical Premium (2x AAL), Discount Rate = 3%, Resilience Cost = 5.9%
Technical Premium (2x AAL), Discount Rate = 10%, Resilience Cost = 2.42%

50.00%

0.00%

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30-50.00%-100.00%

Year (since inception, t=0)

FIGURE 15 TIME SERIES OF NET PRESENT VALUE BENEFIT-COST RATIO FOR A RANGE OF PREMIUM AND DISCOUNT RATEASSUMPTIONSKey Sensitivity Results-

Since the resilience dividend is typically realised on an annual basis, as savings on insurance premiums
are paid, high discount rates (of 10%) significantly reduce the ability of the dividend to totally pay for the
additional cost of resilience. In the worked example, where the additional cost of resilience is 5.9% and the
reduction in AAL is 46%, the following results are seen:
A discount rate of 0% and a pure risk-based premium (i.e. insurance premium = Average AnnualLoss) yield a payback period of 29.3 years.
If a discount rate of 10% is applied in the NPV calculation – the maximum benefit-cost ratio that canbe attained is -67.6%. i.e. the resilience dividend never pays totally for the additional cost ofresilience.
A discount rate of 10% significantly limits the potential for the accrued savings on insurance
premium to contribute totally for the additional cost of resilience. If the discount rate is reduced to
3% in the same example, the payback period is of the order of ~20 years.

-

To achieve a NPV benefit-cost ratio of 0% after 10 years, assuming a discount rate of 10% (i.e. 10-year
payback period):
Pure Premium (AAL): additional cost of resilience can be no more than 1.21% on top of base costTechnical Premium (2x AAL): additional cost of resilience can be no more than 2.42% on top ofbase cost.

The product solutions contained in the following section aim to demonstrate how some of the potential benefits
and challenges of capturing the resilience dividend can be addressed using innovative methods.

32

4. PRODUCT SOLUTIONS
4.1. Overview of Product Solutions
Four main product concepts emerged from the Innovation Lab. These range from ideas that have alreadybeen developed but which can be re-purposed for these challenges which could be brought to market relatively
quickly, through to ideas that, although further from current practice, hold significant potential. The four productconcepts are:
1. Resilience Bond – a risk transfer instrument, in which risk reduction is reflected in a reduced premium
paid by the insured across the term of the bond.
2. Resilience Service Company (ReSCo) – a company who bears the initial costs of resilience and isrepaid on an annual basis using savings on insurance premium.
3. Resilience Impact Bond (RIB) – a pay-for-performance contract in which an investor is remunerated
based on how well they implement resilience measures according to pre-defined performance indices.
4. Insurance-linked Loan Package (ILLP) – an infrastructure loan which has a built-in insurancecomponent. Insurance savings through risk reduction offset loan interest repayments.
All four product concepts are described in the following section. Of the four concepts, the Resilience Impact
Bond (RIB) and Insurance-linked Loan Package (ILLP) were determined to have greatest potential for further
development. Further structuring and in-depth analysis, including risk and cash flow modelling has therefore
been carried out for these two products.

Incremental Innovation
FIGURE 16 OVERVIEW OF PRODUCT SOLUTIONS

The format for the product solutions section is as follows:
1. Executive summary of results
2. Preliminary analyses of:
Resilience Bond
Resilience Service Company
3. Detailed analyses of:
Resilience Impact Bond
Insurance-linked Loan Package
4. Discussion of key findings and next steps

33

4.1.1. Executive Summary of Results
The process of product development and use case analysis has provided good insight into the potential
applicability of the proposed product solutions, and more generally around the challenge of monetizing theresilience dividend. Some key findings, and repeated themes, include:•

Resilience measures can result in realized cash savings through reductions in insurance premium. In
other words, where insurance would already be in place, insurance provides a vehicle for monetising
the resilience dividend. The products largely focus on the portion of the resilience dividend associatedwith the reduction in direct physical damage.

•

Resilience also leads to benefits resulting from development co-benefits or increased economic activity
in a lower risk environment. The RIB structure offers a targeted means of promoting and financially
incentivising the non-direct resilience benefits, by assigning a return on investment to desired resilience
outcomes.

•

It can be challenging to bring the savings up-front; insurance premium can only fall as risks changeover time, while there is a risk of misaligned incentives if donor funds are provided in advance of
resilience measures being introduced.

•

The ILLP, ReSCo, and RIB address this challenge by, instead, transferring the additional upfront costsof resilience to a structure or party who is able and willing to wait to see the benefits of resilience overa longer timeframe.

•

The primary factors which influence the ability of the resilience dividend to contribute significantly to thecost of resilience are:-Realised resilience dividend: the magnitude of risk reduction, as reflected by the savings on
insurance premium.

-

Resilience cost: the additional costs of the resilience measure.

-

Timescale: the timescale over which insurance premiums are paid and savings accrued,
strongly influences the size of the monetisable resilience dividend.

-

Discount Rate: the potential total resilience dividend is suppressed in a high discount rateenvironment, if it only possible to realise that dividend over time.

•

The resilience dividend to resilience cost ratio is higher for vulnerable exposure which is exposed tohigh frequency impacts, typically from climate perils. Investment in retrofit for low frequency perils suchas earthquakes, where significant absolute reductions in average annual loss may be relatively moredifficult (and costly) to achieve, may require consideration of a broader definition of resilience benefits
to inform investment decisions than direct damage alone. The additional benefits of seismic resilience
could be captured to some extent within a RIB, which offers a structure where the wider benefits ofresilience can also be used to motive the outcome funder to pay a dividend commensurate with thebroader benefits.

•

Public (donor) funding can support investment in resilience where the size of the resilience dividend or
the degree to which it can be brought up-front and monetised is insufficient to incentivise resilient
building alone. Donors or international financial institutions, as parties more likely to be able to wait to
see the benefits of resilience, can also play a structural part in product design.

34•A hypothetical portfolio of schools in a hurricane prone region has been used as the basis for the primaryrisk analysis in each of the RIB and ILLP. The analyses differ slightly in that the resilience benefit ofretrofit for existing infrastructure has been analysed for the RIB, whereas the benefit of complete‘resilient construction’ versus a standard alternative is used for the ILLP.

•

Increased resilience has broader societal and economic benefits, which extend beyond the reduction
in expected direct damage and loss. The cashflows associated with these types of downstream
resilience benefit are commensurately more complex and varied, it is therefore more challenging toefficiently create monetised resilience dividends from these sources. While not explicitly used in the
cash flow analyses for the RIB and ILLP, it is expected that a quantitative assessment of broader
benefits can support the direct benefit-cost assessment.

Key Product Analysis Results
Resilience Impact Bond•

Applicable where the outcomes funder (e.g. donor) wishes to transfer some of the operational risk of
implementing the resilience project, and also benefits from a transparent assessment of how well the
project performs against its objectives.
Strongly aligns the incentives of the outcomes funder with the investor – delivery of different elementsof resilience provides substantial upside to the investor but failure to deliver this resilience can result in
low or negative returns
Can be structured to explicitly promote individual elements of resilience, e.g. structural, operational, andfinancial resilience, offering a targeted approach to building resilient systems.

••

Insurance-linked Loan Package•

A simple and potentially efficient means of monetising the resilience dividend generated throughinsurance savings within one product structure which is achievable in the near-term.
The repayment term, and the size of the risk reduction, largely determine how much the accrued
insurance savings can contribute to the overall additional cost of resilience.
Flexibility within the product structure allows for the resilience dividend to contribute to the costs ofresilience, loan repayments, or insurance premium payments, as is appropriate to the use case.

••Interpretation of Analysis Results
In reviewing the product solutions and in-depth analyses there are a few points to note:•

The results are presented for select applied examples – therefore it should be recognisedthat the results are expected to vary between use cases, and for the range of structural
options that exist within each product. Additional commentary is contained in thediscussion which addresses the sensitivity and applicability of the products under abroader range of conditions (e.g. peril type, resilience measure cost and benefit, insurance
premia).

•There is inherent uncertainty in the results of catastrophe risk models. Uncertainty is
explicitly accounted for in the models, and incorporated in the results, however this should
be recognised when model results are used in decision making. In addition, reasonableassumptions, such as marginal construction cost estimates, were selected to assess
realistic hypothetical examples, however these assumptions will likely vary in practice.

35

4.2. Resilience Bond
4.2.1. Overview
A Resilience Bond is an innovative risk-linked financing mechanism that takes the existing model of acatastrophe bond (cat bond), in common usage within the Insurance Linked Securities market, but also accounts
for the impact of resilience measures.
Like cat bonds, sponsors pay premiums on an insurance contract, and these premiums are used to makeinterest payments to bond investors. In the event of an eligible disaster, investors lose all or a portion of theirinvestment and the bond principle is transferred to the bond sponsors as an insurance payout.
Unlike cat bonds, Resilience Bonds explicitly account for the impact of resilience measures by reducing bondinterest payments as the measures are implemented and reduce the financial risk born by bond investors. The
difference in interest payment is credited to the resilience measures and can be securitized to provide upfront
project capital through project revenue bonds or various types of project loans.
In a development application, resilience bonds could be sponsored by a consortium of stakeholders that havean interest in implementing the resilience measures or in minimizing future disaster recovery costs. Consortia
members might include local asset owners and homeowners, local business and industry interests, regional
economic development authorities, international development banks, aid agencies, and national governments.

How could this work?
The application of a Resilience Bond structure could be suited to upgrading roads in Southeast
Asian countries, for example, by focusing on roads not only as a physical asset, but also as
potential sources of protection (coastal roads built as dual-purpose berms/barriers) and as a meansof delivering transportation services to support both regional economic activity and essential
services (access to airports, ports, hospitals, etc.).
Road networks could be categorized by types of users, such as primary beneficiaries who directly
lose money if a road is out of service and secondary beneficiaries who experience other disruption.
For example, each of the following categories of road types could be associated with different
Resilience Bond sponsoring interests:
Coastal roads that can be reinforced/upgraded or rebuilt to provide dual purpose coastal
protection (Sponsor: MDBs / aid agencies / national gov’t)
Major commercial roads that support commercial/industrial operations where long-term
disruption would have broad general impacts on the local/regional economy (Sponsor: private
sector consortium of beneficiaries)
Essential service roads that support airports, seaports, hospitals and major construction supply
lines if/when materials are needed for reconstruction (Sponsor: MDBs / aid agencies / national
government)36

4.2.2. Stakeholders-

Core Stakeholders: owners of assets protected by dual purpose coastal protections, business and industrial
interests that rely on major commercial roads, and essential service providers.

-

Optional Stakeholders: development banks, aid agencies, economic development authorities, and national
governments.

4.2.3. Product components
Funding mechanism: Upfront resilience costs financed by securitizing future Resilience Bond “rebates”
Risk transfer mechanism: Catastrophe coverage provided by cat bond features of the Resilience Bond
Resilience benefit mechanism: Upfront capital for resilience measures is provided according to projectgenerated risk reductions that are specified and modelled in advance.

FIGURE 17 CASHFLOWS UNDERPINNING THE RESILIENCE BOND

4.2.4. Cash Flows
𝑷: Sponsor premiums paid on an insurance contract to the Resilience Bond facility.
𝑰: Insurance payouts issued by the Resilience Bond facility in the event of a qualifying natural disaster.
𝑹: “Rebates” paid by the Resilience Bond facility to the source of project capital, which mirrors the reduction
in interest payments made to investors as the resilience measures reduce the risk to investor principle.

$: Upfront capital provided to the resilience project based on projected “rebates” attributable to the project.

37

4.2.5. Challenges and Path to Implementation
Further research, modelling and application to a particular use case is needed to develop this option to a productsolution:
Structural complexity: This mechanism involves multiple stakeholders with complicated incentives
structures and may require integrating multiple financial instruments. These complexities may increase thefrictional cost of set-up.
Governance: There are likely to be significant political and administrative challenges associated withaligning and managing large consortia of Resilience Bond beneficiaries and stakeholders.
Insurance coverage: Resilience Bonds are insurance products that require sponsors who will pay insurance
premiums in order to access the rebate. This may be a challenge in markets with low insurance penetration.
• Clearer opportunities for this approach exist where there is an existing insurance market.
• Absent existing insurance, co-sponsors need to be incentivised to pay insurance premiums andgive up their ‘rebate’ to contribute to project finance. Is the gain of insurance cover plus reduced
disruption and damage from future events sufficient?
• Insurance cover must align with the proposed resilience project and subsequent resilience
dividends. This can be more challenging where indirect losses need to be covered and modelled(e.g. losses to a commercial business due to an impaired road network). Risk reductions for suchindirect losses may prove difficult to monetise in a rebate.
Scale issues: Like cat bonds, resilience bonds generally require large aggregate amounts of insurance
coverage. At the same time, the size of rebates may be small compared to project capital requirements.
This may be a particular challenge in high discount rate development environments.

4.2.6. Does it meet the product objectives?
Encourages resilient infrastructure
Monetises resilience dividend
Makes resilience dividend available upfront
Involves risk transfer

3 Has a viable path to implementation
3 Offers flexibility
3 Has a sound economic justification
3 Causes ‘no harm’

?
3
3
3

38

4.3. Resilience Service Company
4.3.1. Overview
The idea of the ReSCo was inspired by the innovative financing mechanisms employed by Energy service
companies (ESCOs). ESCOs develop, build, and fund projects that create energy savings. They pay for the
project upfront and rely on receiving some proportion of the savings that are realised due to the reduced energy
usage to make a return on their initial investment.
A similar innovative mechanism could be used in conjunction with insurance policies to generate resiliencesavings in the context of assets. Retrofitting a house, for example, reduces risks and results in lower insurance
premium (assuming these are risk-based).
The high up-front cost of the retrofit could be borne by a ReSCo (Resilience Service Company), on the basis
that;
The asset insurer recognises the upgraded resilience with a reduced insurance premium.
The asset owner uses some of the insurance savings to pay back the ReSCo over time. This solution
minimizes the up-front cost of resilience and motivates action through reducing annual insurance costs.

The ReSCo is independent from the insurance company, though bilateral agreements are required to ensurethat:
The insurer guarantees a reduction in insurance premium for implementation of a range of retrofit options.
The ReSCo can guarantee that resilience measures are well implemented.

How could this work?
The ReSCo structure could be suited to disaggregated retrofit solutions with small scale yet'easy win' resilience options, ideally where insurance is already in place. These would likely
need to be resilience options which were effective at reducing losses from short return period
events. For example, roof anchors and opening protection to increase resilience to hurricane
wind damage.

4.3.2. Stakeholders
Core Stakeholders: asset owner (house owner); insurance provider, ReSCo
Optional Stakeholders: donor, non-insured asset owner39

4.3.3. Product components
Funding mechanism: upfront resilience costs financed by the ReSCo; it may be possible to provide aconcessional loan to support the ReSCo
Risk transfer mechanism: catastrophe insurance either exists already or is initially funded by a donor
Resilience benefit mechanism: Rather than deliver the resilience dividend upfront explicitly, this model
would transfer it to stakeholders who are more willing to wait for it (the ReSCo). Resilience measures are
implemented upfront with no funding from the asset owner.

FIGURE 18 ILLUSTRATIVE CASHFLOWS IN THE RESCO MODEL.

4.3.4. Cash Flows$𝒀: The cost of the resilience measure, funded by the ReSCo.
𝑨𝑨𝑳𝒏𝒐𝒏 𝒓𝒆𝒔𝒊𝒍𝒊𝒆𝒏𝒕 , 𝑨𝑨𝑳𝒓𝒆𝒔𝒊𝒍𝒊𝒆𝒏𝒕 : The annual average loss for non-resilient and resilient assets.
∆𝑨𝑨𝑳 = 𝑨𝑨𝑳𝒏𝒐𝒏 𝒓𝒆𝒔𝒊𝒍𝒊𝒆𝒏𝒕 − 𝑨𝑨𝑳𝒓𝒆𝒔𝒊𝒍𝒊𝒆𝒏𝒕 : The Insurer reduces the premium that the house owner pays, toaccount for the reduction in risk: the resilience dividend is equal to the reduction in Average Annual Loss.
The house owner now pays a fraction, 𝝆, of the resilience dividend to the ReSCo each year, to payback the
initial cost of the resilience $𝑌.
𝑪𝒂𝒕𝒊𝒏𝒔𝒖𝒓𝒂𝒏𝒄𝒆 : The payment by the insurers in the event that a catastrophe occurs.
𝑪𝒂𝒔𝒉𝑭𝒍𝒐𝒘𝒊𝒏𝒔𝒖𝒓𝒂𝒏𝒄𝒆 : The cost of insurance taken out by the ReSCo to cover their cash flow to cover asituation whereby the ReSCo does not receive the agreed payment from the Asset Owner.

40

4.3.5. Challenges and Path to Implementation
Further research, modelling and application to a particular use case is needed to develop this option to a productsolution:
Developed insurance market: a functioning insurance market would likely need to exist locally andpremiums need to reflect actual levels of risk (risk-based premiums). In addition, typical insurance contracts
are much shorter than the repayment terms of retrofit options – a development of long term agreements iskey. If insurance doesn't exist, donor or state involvement is required to make this viable.
Set-up of ReSCo: Resilience Service Companies need to be developed. This requires legal and technicalassistance, provision of initial capital, insurance against the risk of no repayment, cashflow modelling for
viability studies. This would likely require development partner support, who may need to explicitly seek tocatalyse an early example of a ReSCo.
Economically viable use cases: some assets may not be appropriate for retrofit (practically and/ or
economically). Where retrofit is appropriate, available options should be low cost and high impact to ensurethat the reduction in premium payments pays for the cost of the resilience measure (in a reasonable
timeframe). Sourcing use cases and modelling cashflows is a critical step to ensure sound economic
justification. Care should be taken in calculation of the benefit-cost ratios to ensure that the societal benefitof an intervention is recognised, donor support may be appropriate in cases where the societal benefits of
the intervention are high.

4.3.6. Does it meet the product objectives?
Encourages resilient infrastructure
Monetises resilience dividend
Makes resilience dividend available upfront
Involves risk transfer

3 Has a viable path to implementation
3 Offers flexibility
3 Has a sound economic justification
3 Causes ‘no harm’

?
3
?
3

41

4.4. Detailed Analysis – Resilience Impact Bond
Primary Objective: To finance measures that increase the physical, operational, and financial resilience ofessential services (e.g. schools, social care, hospitals).

Impact Bonds: Impact Bonds are pay-for-performance type contracts in which the return on investment is afunction of both the original principal amount and the success of the project.
The desired project outcomes are defined at inception – performance is ultimately measured against thesedefined outcomes. Once terms are agreed, an impact investor supplies project capital and carries out the projectthrough an implementation agent in order to deliver the desired outcome. The success of the project is assessedagainst pre-defined criteria by an outcomes funder, who makes repayments which are based on the original
principal amount and measured performance of the project. Performance criteria take the form of outputs(action-based criteria) and outcomes (results-based criteria), which are independently measured at definedintervals during the term of the bond.
In the context of physical, operational, and financial resilience of essential services, impact bonds can be auseful instrument to combine multiple objectives via a set of performance criteria. The performance criteria canbe based on both outputs and outcomes, going beyond the physical asset and considering the services that theasset provides (e.g. continuity of service after disaster, and during retrofit). An impact bond is appropriate where(i) an outcome funder wishes to transfer some of the operational risk of implementing a project, and (ii) outcomesare clear and measurable, and can provide clear evidence as to the effectiveness of the program. Most
importantly, the product structure can result in profitable returns on investment for the investor and value formoney for the project sponsor.

4.4.1. Objectives
The impact bond for resilience aims to promote the physical, operational, and financial resilience of essential
services. These components can be broadly defined as follows:•

Physical resilience – ability of buildings to withstand impacts of natural disasters. The physicalresilience of a structure can be increased through:▪ Installation of retrofit measures (e.g. bolt and braces, roof anchors, opening protection)▪ Construction of green or grey infrastructure to reduce the hazard (e.g. coastal defences)•

Operational resilience – ability of service provider to ensure delivery of quality services. Operational
resilience can be increased through a range of risk management practices, including:▪ Design and implementation of pre-arranged disaster response and contingency plans▪ Use of early warning systems•

Financial resilience – rapid and reliable access to sufficient funds to support costs of response,
recovery, and reconstruction following disaster. Financial resilience can be addressed using a range of
mechanisms, including:▪ Separately held and managed capital reserves▪ Traditional indemnity-based insurance▪ Parametrically triggered funds, sourced through (re)insurance or capital markets

Clearly defined performance indices are assigned to each of these components of resilience. The investor isfinancially incentivised to deliver a successful project – this aligns with the outcome funder’s objectives ofincreasing the resilience of essential services, and objectively quantifying the impact of their investments.

42

4.4.2. Motivation
Impact bonds offer a number of distinct potential advantages over more traditional financing mechanisms.
•

•

•
•

•
•

The structure explicitly creates aligned incentives across its stakeholders. All stakeholders are
motivated for the DIB to result in the overall outcome of increased resilience, be this for financial gain,or to mitigate the severity of future shocks, thereby reducing the impact on services and the financing
required for recovery.
Outcome-led project design offers a targeted approach to building resilience. Projects managed under
this structure have clear definitions of success from the start and have pre-defined mechanisms forassessing project performance.
The additional initial costs of building resiliently are transferred to a party who is willing and able to bearthese costs (the impact investor), and to realise a return on investment on a rolling annual basis.
The impact bond acts to partially transfer the operational risk of implementing a resilience project awayfrom the project sponsor. This is a useful feature for donors, who are motivated to invest efficiently inprojects that achieve their desired outcomes.
Well designed performance indices are valuable in their own right, as a means of demonstrating thatinvestments have been impactful.
The payments made by an outcomes funder can offer an attractive return for an investor, while still
being considered good value for the sponsor, when the costs are compared to the magnitude of
immediate impact and future savings.

4.4.3. Structure
A generic structure for an impact bond for resilience is described within this section, including the roles andresponsibilities of involved parties, project phases, example performance indices, and the role of insurance
within the structure. An applied example of the impact bond in a defined use case is presented afterwards – thisincludes definition of the use case, the results of risk, resilience, and cash-flow analyses, and a commentary on
the applicability of the product in this instance.

Roles and Responsibilities
The generalised roles and responsibilities of the parties involved in the product are as follows:•

Outcomes funder (e.g. donor12) – designs structure of the impact bond and repays the bond at definedintervals. They structure the return on investment is a function of; (1) the initial loan amount, and; (2)performance indices which reflect the ‘success’ of the project.

•

Impact investor (e.g. UBS Optimus Foundation 13) – provides capital and carries out project using animplementation agent. The impact investor is financially incentivised to carry out a project that performs wellagainst its defined objectives. The investor stands to make a loss if the project performs poorly against thedefined performance indices.

•

Implementation agent (e.g. Build Change 14) – acts on behalf of the impact investor to implement project
locally. Responsible for ensuring that outputs are carried out effectively, and that outcomes are maximised.

•

Insurance provider – structures and supports insurance products that provide coverage for the physicalassets, operational costs of disaster, and investor cash flows as required.

12 https://assets.publishing.service.gov.uk/media/57a0896b40f0b64974000092/DIB_Study_Final_Report.pdf
13 https://www.ubs.com/microsites/optimus-foundation/en/stories/development-impact-bond-in-education.html
14 http://www.buildchange.org/programs/safeschools/

43Phases
There are a number of analogous pilot projects that have been completed to test the impact bond concept in arange of use cases. The actual content and sequence of tasks is likely to be variable between projects, but
might include the following:
1. Outcome funder agrees impact bond structure with impact investor, including defining; (i) project
objectives; (ii) outputs and outcomes with associated performance indices and ROI credits, and; (iii)task and repayment schedule.
2. Impact investor engages with implementation agent to design project plan.
3. Impact investor purchases appropriate insurance coverages.
4. Implementation agent coordinates across local service providers, construction and planning firms,
insurance providers, disaster planning agencies etc. to implement the project and deliver against thedefined outputs and outcomes.
5. Outcomes funder independently audits the outputs and outcomes at defined intervals during the termof the bond.
6. Repayments are made based on the work completed, and the success of the project according to theperformance indices.
Upon completion of the bond term, final payments are made, and responsibility for the asset insurance,
maintenance, disaster response and contingency plans pass to the authorities responsible for the assets andservice provision.

44

Performance Indices
The physical, operational, and financial components of the project each have their own performance criteria,with associated outcomes/outputs. Performance is measured against the target outputs and outcomes – theperformance across multiple criteria determines the return on investment for the impact investor. The applied
use case helps to shape what elements of physical, operational, and financial resilience are appropriate to the
product structure. Criteria and performance indices can be deigned to support project needs (Table 1).
Component

Criteria

Construction
and/or Retrofit
PhysicalResilience

MaintenanceDisaster/Contingency
Planning

Operational
Resilience

Continuity ofServices

Description
Building physicalresilience to hazard canbe achieved though; (i)designing andconstructing disaster
resistant structures, and/or; (ii) retrofitting existing
structures to become
more resistant todamage.
Maintenance involves theongoing monitoring andrepair of structuraldegradation through time,
this is required to ensure
physical resilience ismaintained to initiallevels.
The resilience of services
is strongly dependent on
the strength of plans thatare made prior to disasteroccurring. Contingency
plans will include
preparing for provision ofservices assuming
structures have beendamaged, and usual
resources arecompromised.
In addition to increasing
the resilience of services
in the face of external
shocks, high quality
services must remain
available for the durationof the construction or
retrofit phases - resilience
projects should not
disrupt service provision.

Asset
Insurance

The underlying physicalassets should be insured,
so that financing isavailable for complete
repairs following damage.

Pre-arranged
Financing

Appropriate financing
mechanisms should be inplace to support
immediate disaster
response needs andcontingency plans.

Financial
Resilience

Options(situation
dependent)

Output Example(action-based)

OutcomeExample(result-based)

Completeconstruction, or
retrofit, depending on
situation.

Increase the wind
resistance of thestructure by X % at awind speed of Y mph(equivalent to anannual return periodof Z years). Assessedusing engineeringand modellingassessments.

Engineering audit
to assess
implementation
duringconstruction, andupon completion.

Carry out site
monitoring andmaintenance
exercises on a 6month recurring
schedule across theterm of the bond.

Disaster responseplans can beassessed according toexpert review, and/ or
through scenariobased exercises.

Demonstrate thatsuitable plans andresources are inplace to ensure
continuity ofservice provision
following disaster.

Qualitative and/ or
quantitative
assessment ofcontinuity of service.

No deterioration in
educational
outcomes whencompared with theprevious 3 years
while construction
or retrofit phase isin progress.

Insurance can be paid
for by asset owner/service provider/government/ donor/
investor. Insurance
can be arranged
separately to theimpact bond or
included within it.
Reserved funds, orparametricallytriggered relief funds.
Funds can be sourced
privately, or from theinsurance,
reinsurance, or capital
markets.

Demonstrate thatappropriate levels of
insurance are inplace for theunderlying asset.

Demonstrate thatsuitable financing will
be available tosupport disaster
response plans.

TABLE 1 OVERVIEW OF POTENTIAL PERFORMANCE CRITERIA FOR IMPACT BOND

45

Insurance
There are a number of roles for insurance within the impact bond structure, both in increasing the financial
resilience of the essential services and protecting the investors potential returns. The insurable elements within
an impact bond for resilience include:•

Physical assets – even structures which have been retrofitted are at risk of damage – it is important that
there are sufficient funds to cover costs of repair and reconstruction following impact from a disaster. If an
event occurs during the term of the bond and there are no funds available for repair and reconstruction,then the impact bond is subject to significant risk of failure. The service provider, impact investor, andoutcomes funder are therefore all incentivised to ensure that asset insurance is in place. Depending on thesituational context, there are multiple options for insurance of the underlying assets, including:Insurance premium paid by the service provider or outcomes funder as a pre-condition to theimpact bond. From a sustainability and efficiency perspective, it may be most efficient for theasset owner to purchase insurance coverage.
Insurance sourced through local insurance markets, or international reinsurance/ capital
markets
If no insurance is in place for the asset initially, then insurance purchase by the impact investor
can be included as an output of the impact bond. This insurance is taken out on the behalf of
the asset owner – the investor is compensated using a return applied on the cost of insurance.

•

Operational costs – capital is required to implement disaster response and contingency plans, both
immediately following disaster, and over the longer term following more severe events. Risk transfer andinsurance mechanisms are ideally placed to supply this short-term, rapid, reliable liquidity and long-term
capital if an event does happen. Funds for operational costs must be reliable, and rapidly accessible
following disaster. There are a range of options for this type of fund, the appropriateness of each depends
on the magnitude of the capital required, and the local situational context. These options include:
A disaster fund, managed and held by any of the involved parties – the most sustainable option
over the long term would likely be for the fund to be managed locally by the service provider
Parametric risk transfer, using the reinsurance or capital markets. When designed well,parametrically triggered funds can be efficient in delivering capital rapidly.
The impact bond can include cover of operational costs as an output•

Future cashflows – when included as outputs, the impact investor is incentivised to provide coverage forthe physical assets and operational costs. However, even when these measures are taken, if an event
occurs during the term of the bond then performance indices are likely to be negatively impacted, and thefuture returns on investment reduced. It may be possible for the impact investor to take out insurance
against their invested capital and future potential cashflows.

The impact bond for resilience presents an opportunity to create an insurance product that provides coverage
across each of these needs, where all insurable elements would be packaged under the same product. The
specific needs will vary distinctly between individual projects, so a flexible modular insurance product would be
required if it were to be easily replicated across different impact bonds.

46

Product Schema
Figure 19 presents a product schema, which highlights the relationships between involved parties, and the
direction of cash-flows between them.
In this example, the project timeline runs for 5 years, the vertical arrows show the direction and timing of
payments between parties, including two hypothetical events which occur within the term of the bond, and theassociated insurance payments.

FIGURE 19 PRELIMINARY SCHEMA FOR RESILIENCE IMPACT BOND (RIB)

4.4.4. Applied Example: School Retrofit Program
The resilience impact bond is applied to a theoretical use case, highlighting how it might be used to increase
the resilience of education services in Dominica though a program of school retrofit, and disaster response andcontingency planning.

Situational Context
The following use case has been designed to interrogate the applicability of resilience impact bonds in ahypothetical, but real-world setting. The costs and risk information contained in this analysis are reasonable forthe defined use case, however, results are likely to vary significantly between use cases.
The uncertainty in results with respect to this use case have been presented (e.g. mean, standard deviation
metrics) – to give a sense of the uncertainty within this modelling, but it should be assumed that results will vary
for different combinations of exposure, peril-region, assumptions, or risk models. Modelling should therefore be
updated if the product is to be applied in a different context.

47

Summary of Use Case
•
•

•

•
•

For ten existing schools located across the island of Dominica, the outcomes funder wishes to increase theresilience of school infrastructure and education services to hurricane risk.
The resilience program has multiple components, which are intended to address the physical, operational,
and financial components of resilient systems:
1. Wind retrofit program to upgrade the structural resistance to wind damage
2. Implementation of disaster response and contingency plans to ensure continuity of service following
disaster
3. Establishing suitable funding mechanisms for transfer of excess wind risk, and to support disaster
response and recovery costs
The term of the bond is 5 years, resilience measures will be implemented across the portfolio of schools
throughout this period, and the performance indices will be measured at defined intervals (e.g. yearly)
throughout the project, as appropriate.
The existing school infrastructure is uninsured.
No retrofit measures or contingency plans are in place, and there is no existing funding to support the costsof deploying contingency plans following disaster.

Analysis
Component

Assumption

Notes

SourceRegionDominica - schools distributed islands
districts.

RMS

Peril

Hurricane - wind only

RMS

Base school construction

Construction Type: Masonry,
Occupancy Type: Education, Year built:
1995, Number of Stories: 2

RMS

Base value of school buildings$10 million total, $1 million per. unit.
Construction costs are expected to vary,
though the additional costs of retrofit
and the risk are assumed to scalelinearly with base value, so all metrics
scale linearly and cost benefit ratios areconserved with changes in basestructure value.

RMS

Additional retrofit measures

Roof Sheathing, Roof Covering,
Opening Protection

RMS

Additional cost of retrofit+5.9% on top of base structural value
assumption - equivalent to $590k for aschool portfolio of $10 million

RMS, National Institute of Building
Sciences15

Model version

RMS North America Hurricane Models
v17.0, wind model (vintage 2017). Longterm Rate (LTR) perspective.

RMS

Bond term

5 years

Low interest rate

1.5% (near risk-free, below market rate)

High Interest Rate

15%

Discount rate

3.5%

Insurance load factor

2x Pure Premium for indemnity-based
insurance; 1.5x Pure Premium forparametric insurance

Sensitivity Assumptions

Maintenance cost per. year

2% of base value

Kaiser, Harvey H., Capital Renewal andDeferred Maintenance Programs, The
Association of Higher Education
Facilities Officers (APPA), 2009, p9.

Modelling

Economics

Typical duration for impact bond pilot
projects
5-year UK treasury rate (1.10%) + a
small premium (40bps)
Similar to high return rate on existing
pilot stage development impact bonds
Green Book Long Term Discount rate,
0-30 years

TABLE 2 MODELLING AND ECONOMIC ASSUMPTIONS USED FOR ANLAYSIS
15 https://www.nibs.org/general/custom.asp?page=mitigationsaves48

Risk Analysis Results
RMS has carried out a risk analysis to quantify the hurricane wind risk to the hypothetical portfolio of schoolbuildings in Dominica. The base view quantifies the risk as if no retrofit measures have been installed, theresilient view quantifies the reduced risk that would occur if the range of resilience measures were installed.
The retrofit options that have been assessed for this analysis are upgrades to the roof sheathing and covering 16,
and additional opening protection17. These are retrofit measures that can be applied to existing school
infrastructure. The costs of implementation are typically related to the overall base value of the asset – thebuilding and retrofit cost assumptions have been derived from internal RMS expertise and additional research.
Costs are expected to vary by region, although relative costs and risk reductions will be largely conserved, so
results from this section can help to inform expected results in other regions.

Costs (% of Building Value)

Value

Construction

Roof
Sheathing

Roof Covering

Opening
Protection

Total

Base

-

-

-

-

Retrofit

0.40%

1.50%

4.00%

Total Insurable
Value($ million)

Additional Cost ($million)
10

5.90%

-

10.59

0.59

TABLE 3 CONSTRUCTION AND RETROFIT COST ASSUMPTIONS

The following ‘retrofit’ risk results assume that all retrofit options described in Table 3 have been implemented
to the ‘base’ school construction. The risk and resilience metrics presented in Table 4 show that on average,
annual losses are expected to reduce by 46% as a result of retrofitting. It is theoretically possible to monetise
this risk reduction through savings on insurance premium.
Average Annual Loss

Loss Cost

Absolute ($)

Standard
Deviation ($)

Reduction(%)(AAL*1k/Value)Base

43,633308,764-4.36

Retrofit

23,502

187,55346%

2.35

Construction

Resilience Metrics
Resilience
Ratio

Premium

Benefit-Cost
Ratio(2x Technical
Loading Factor)--

87,265

29.31

0.03

47,004

TABLE 4 RISK REDUCTION AND RESILIENCE DIVIDEND METRICS

A combination of the high base risk (loss cost of 4.36) and the large risk reduction (46%) contribute to a highpotential resilience dividend in this example.

16 https://www.fema.gov/media-library-data/20130726-1706-25045-9347/chapter8.pdf
17 https://www.fema.gov/media-library-data/20130726-1707-25045-9020/chapter10.pdf

49

Hurricane Wind Risk Model Results
Figure 20 presents loss-based exceedance probability (EP) curves. The EP curves incorporate secondary
uncertainty, which is a model estimate of the uncertainty that exists within the risk analysis. Note that the model
also incorporates an estimate of post-loss amplification (PLA), which can result in total event losses that exceed
the total value of the school portfolio.
4.0%
Base School Construction
3.5%

School Retrofit
Event Saving
5x Savings Sensitivity

3.0%

Occurrence Exceedance Probability

Additional Cost of Resilience
2.5%

2.0%

1.5%

1.0%

0.5%

0.0%
0.0

2.0

4.0

6.0

8.0

Event Loss (USD)

10.0

12.0

14.0

Millions

FIGURE 20 LOSS OCCURRENCE EXCEEDANCE PROBABILITY CURVES FOR BASE AND RETROFIT CASES, AND FOR EVENTSAVINGS (INLCUDING 5X SAVING SENSITIVITY TO REPRESENT NON-DIRECT BENEFITS)18 .

As is expected from the convergence of the base and resilient vulnerability curves at high wind speeds, theabsolute event savings decrease for more severe events (the ‘tail’ of the distribution). However, given the scaleof these losses, the absolute event savings are still greater than the additional cost of resilience for all eventswith an annual probability in excess of the 1 in 100-year return probability (RP100, 1% EP).
A sensitivity is included to demonstrate how the event savings EP curve would look if additional non-direct event
savings are included. The 5x sensitivity represents an assumption that for every dollar saved in direct damage,18

Note that the event savings, and sensitivity curves are not strictly exceedance probability curves, but rather represent the difference inloss between the base and resilient EP curves across the range of probabilities. They demonstrate that there the event savings are
relatively reduced in the tail of the distribution.

50

$4 are saved in additional costs19. The result of this sensitivity shows that the point at which the event savingsare equal to the additional cost of retrofit changes from approximately RP100 to RP50.
Additional benefits of resilient infrastructure include reduction in injury and loss of life, reduced impact toessential services and livelihoods, reduced impact on quality of education and the long-term societal andeconomic benefits that result. The financial benefits of these elements have not been captured explicitly in thisanalysis since they are less well able to be monetised. However, it is fair to assume that the savings on direct
damage and loss represent the lower bound of the total event savings that are expected as a result of increasing
structural resilience.

Summary of Risk Analysis Results
•
•
•
•
•

•

•

Retrofit generates significant risk reduction on an annual average perspective (46% reduction in AAL).
This risk reduction can be monetised through reduction in insurance premiums, benefit-cost ratios are
expected to increase after application of technical pricing formulae.
The relative benefit of retrofitting decreases in the extreme tail (in excess of RP1000), though large
magnitude of loss for these tail events still yields event savings that are large relative to the cost of retrofit.
From a direct loss perspective, there is approximately a 1% annual probability of an event occurring in which
the saving as a result of retrofit is greater than the cost of retrofit.
However, on average, the annual reduction in risk as a result of retrofit is significant, and from a pure riskbased perspective, the annual average risk reduction would cover the additional costs of resilience after~30 years.
When the pure premium is transformed into a technical insurance premium, the absolute annual savings
increase, and the effective payback period is expected to reduce. For example, if there is a straight premium
loading of 2x on average annual loss, the higher premium results in a greater saving, so the effective
payback period would reduce from 30 to ~15 years. The amount spent on insurance premium is alsocommensurately higher.]
The results support the need for a range of measures to manage the wind risk – including retrofit to reduce
the overall severity of impacts, and risk transfer to help manage the excess risk.

Cash Flow Analysis
Vivid Economics has carried out a cash flow analysis to illustrate how the impact bond structure would operate
in the applied example. The performance of the bond is quantified for a range of scenarios. The scenarios
describe a range of possible situations, in which the impact investor either completes, or fails to deliver, against
the determined performance criteria (outcomes and outputs). The scenarios also describe the investor andoutcome funders net present value adjusted return on investment (ROI), assuming that events of varying
magnitudes occur within the term of the bond.
The cash flow analysis is carried out from perspectives of the impact investor and outcome. Returns are afunction of work completed, performance against criteria, expected operational costs of disaster, and whether
the bond runs to completion.
Note that the additional costs of implementing the resilience impact bond have not been quantified and are notincluded within the cash flow analysis, neither are any additional costs to the outcome funder.

19

Natural Hazard Mitigation Saves: 2017 Interim Report51

Overview of Cash Flow Analysis
•
•
•
•
•

•
•
•

•
•
•
•

•
•

•

Impact investor funds 100% of the investment and is remunerated by the outcome funder over a period of
5 years (bond term).
The resilience program is carried out simultaneously across all 10 schools, phasing is at the discretion of
the investor, though they are incentivised to carry out work efficiently.
The criteria for success are a mix of outputs (low risk) and outcomes (high risk). Performance criteria
outlined in Table 5.
Criteria are binary in this example, i.e. the investor receives nothing if they fail to meet the required standard,
100% of invested capital + return if they successfully fulfil the pre-agreed criteria.
Low rate of return applied to low risk physical tranche, which is an output almost exclusively dependent on
the investor’s ability to design, implement and maintain pre-agreed measures to the required resiliencelevel.
Operational resilience tranches are riskier in terms of investor’s ability to meet the required outcomes. They
are therefore remunerated at the high rate of return (15%).
Financial resilience (asset insurance and relief funds) are critical elements of the structure and are therefore
also remunerated at a high rate of return (15%).
Asset insurance is a pre-condition for the bond in this example. The impact investor therefore benefits
directly from any insurance savings.
The alternatives would be (i) for the schools to pay for asset insurance coverage, or (ii) for theoutcome funder to purchase asset insurance.
The most sustainable and efficient arrangement may be for the asset owner to hold the insurance.
If this was the case, then the impact investor would still receive a return on resilience through thepayments made by the outcome funder, but the asset owner would benefit from reduced insurance
costs.
A 30% share of physical resilience capital is retained for maturity (5 years) if all operational resilience
conditions are jointly satisfied by the investor;
Cashflows are modelled by estimating the annual cost of various resilience measures and applying a return(high or low) on this cost.
Discounted cashflow model applied over the term of the impact bond to compute the net present value of
future return (capital + interest) with the net present value of cost.
11 scenarios are modelled. These are non-exhaustive: given the complexity of the structure, they aim tocapture the key scenarios from the perspectives of the outcomes funder and investor and demonstrate therange of potential returns.
The scenarios are ordered to illustrate the sensitivity of the structure to; (i) extreme event risk, and; (ii) failure
to complete some or all of the criteria.
For any event above 175mph, the bond is reimbursed immediately – it “converts”. Given the extent ofdamages and the investor’s capital at risk (value of retrofit), it is unrealistic to expect investors to continue
services or deploy a sufficient disaster relief plan. From this perspective, the structure is a mix between an
impact bond and a Resilience Bond. Tail risk events are therefore borne by the outcome funder. The
outcomes funder can choose to insure against this event in order to protect their capital outlays and theschool services in an extreme event.
The speed of retrofit is at the discretion of the investor and has to be completed over 5 years. They are
incentivised to complete it quickly since; (i) a large share of their initial investment (70%) is returned as
retrofit measures are completed, and; (ii) the price of insurance decreases as risks are reduced, which
generates further savings for the investor (insurance rebate).

52

Resilience
Type

Criteria

Retrofit

CreditObjective

Disaster
Planning

Asset
Insurance

Reduce expected MDR at
140 mph by 50%.
Damage reduction
independently assessedat design stage, and after
installation. Potential to'outperform' against
criteria.

The resilience metric is dependent
on the specific measures
implemented. A combination ofengineering assessments and risk
modelling should support definitionof this metric on a case by casebasis.

1.5%

Sustain resilience benefitsof retrofit.

Demonstrate that the installed
retrofit measures have beeninspected and are fully
operations at defined intervals
across the term of the bond(annually and following major
wind events).

-

Option to establish a maintenancefunction, which would support
maintenance over the long-term
following completion of the 5-year
program.

15%

Ensure there are
adequate disaster
response andcontingency plans forprovisions of service
following an event.

-

Demonstrate thatcomprehensive plans
have been designed –use scenario-based drills
to test that defineddisaster response plans
are adequate for a rangeof event severities.

If maintenance function isestablished, option to include
responsibility for disaster andcontinuity planning under the samefunction.

15%(i) Decrease the potential
impact of shocks onservice provision, and (ii)ensure that the retrofit
program does notnegatively affecteducation services.

-

No deterioration in
educational outcomesversus the previous three
years prior to the start of
the retrofit program orfollowing a hurricane.

Pre-requisite(return made on
premium savings)

Ensure that there issufficient insurance
coverage to support costsof school reconstruction
following damage.

A pre-condition for beginning
the retrofit program.
Demonstrate that the schools
are covered by adequate
insurance policies, whichreflect the risk assuming noresilience measures.

-15%(only achieved if both
asset insurance and relief
funds are in place)

Ensure that there aresufficient funds to cover
the operational costs ofimplementing disasterplans.

Demonstrate that there isaccess to funds that are
sufficient to cover 'worst-case'scenario (defined as 175 mph
event). Options include a
separately held and managed
fund, or parametricallytriggered insurance.

-

Financial
Resilience
Disaster Relief
Funds

Options and Notes-

Operational
Resilience
Continuity ofServices

Outcome Criteria(result-based)

Implement retrofit
measure that increases
the wind resistance of theschool building.

1.5%

PhysicalResilience

MaintenanceOutput Criteria(action-based)

Depending on the data that isavailable to establish a baseline
metric for prior quality of service
provision, a range of qualitative andquantitative assessments can
support measurement of thisoutcome.
Options: (i) Indemnity asset
insurance is a pre-condition for thebond, remunerated at a high rate of
return - investor retains any
insurance savings. (ii) It would be
more efficient, and therefore lessexpensive for the outcomes funderor to purchase this insurance.
Options: (i) Investor holds sufficient
capital in a special purpose vehicle(SPV). (ii) Wind stations are
installed, and parametric insurance
is structured to provide variablepayouts for a range of event
severities, this may be moresustainable over the long-term, after
the bond has terminated.

TABLE 5 APPLIED IMPACT BOND PERFORMANCE CRITERIA

53

Positive Investor Return on Investment
Scenario 1

Scenario 2

Scenario 3

Scenario 4

Scenario 5

Criteria

Best case (no majordisaster during term of
the bond), investor fulfils
all criteria

90mph event occurs inyear 3, causing 3.3%
damage to non-resilient
schools, and 1.7%
damage to resilient
schools

140mph event occurs inyear 3; causing 31%
damage to non-resilient
schools and 14.6%
damage to resilient
schools. Investor deploys
disaster relief plan for 1yr
period, after which thebond matures.

160mph event occurs inyear 3 causing 52% mean
damage to non-resilient
schools and 36% damage
to resilient schools.
Investor deploys disaster
relief plan for 1yr period,
after which the bondmatures.

Scenario - Disasterstrikes in year 3 (180mph) causing 73% mean
damage to non-resilient
schools and 64.2%
damage to resilient
schools. Bond matures
immediately - nocontinuation of services
is required or realistic.

Retrofit

Y

Y

Y

Y

Y

Maintenance

Y

Y

Y

Y

Y

Disaster
Planning

Y

Y

Y

Y

Y

Continuity ofServices

Y

Y

Y

Y

Y

Asset Insurance

Y

Y

Y

Y

Y

Disaster Relief
Funds

Y

Y

Y

Y

Y

Investor’s ROI (%)

18.3%

12.3%

7.5%

6.9%

7.0%

Payments by Outcomes Funder(NPV)$1,196,91220$1,196,912$596,252$596,252$492,954

Insurance Payments (NPV)--$173,579$230,888-

ResilienceType

PhysicalResilience

Operational
Resilience

Financial
Resilience

TABLE 6 CASH FLOW SCENARIOS WHICH YEILD A POSITIVE INVESTOR ROI.

20 Note that in this example the bond is designed to pay for the cost of retrofit, which are to be applied to existing school infrastructure (the notional value of the 10 schools is$10 million total).
54

Negative Investor Return on Investment
Scenario 6

Scenario 7

Scenario 8

Scenario 9

Scenario 10

Scenario 11

Criteria

Scenario - nomajor disaster
until maturity,
investor puts
together disaster
relief plan, but it
is judged
insufficient; fails
at education
criteria, losses
retained initialinvestment of
30%

Scenario - no majordisaster until
maturity, investor
fails at financial
resilience (both asset
insurance andparametric coveragefor disaster relief),
losses retained initialinvestment of 30%

Scenario - no majordisaster until
maturity, investor
fails at part offinancial resilience asset insurance,
losses retained initialinvestment of 30%

Scenario - no majordisaster until
maturity, investor
fails at part offinancial resilience disaster relief-related
financial resilience (inthis case parametricinsurance), losses
retained initialinvestment of 30%

Scenario - no majordisaster until
maturity, investor
fails against all
operational resilience
criteria, foregoes allof the high return
tranche, losses
retained initialinvestment of 30%

Scenario - investor
fails at physicalresilience in year 1,
steps out of the
project to avoid
further cumulative
losses and losses all
costs incurred in year
1

Retrofit

Y

Y

Y

Y

Y

N

Maintenance

Y

Y

Y

Y

Y

N

Disaster
Planning

N

Y

Y

Y

N

N

Continuity ofServices

N

Y

Y

Y

N

N

Asset Insurance

Y

N

N

Y

N

N

Disaster Relief
Funds

Y

N

Y

N

N

N

Investor’s ROI (%)-11.6%-19.0%-17.7%-4.8%-27.8%-43.9%

Payments by Outcomes Funder(NPV)$846,268$519,253$566,178$919,170$399,424$137,305

Insurance Payments (NPV)

-

-

-

-

-

-

Resilience Type

PhysicalResilience

Operational
Resilience

Financial
Resilience

TABLE 7 CASH FLOW SCENARIOS WHICH DEMONSTRATE THE RETURN ON INVESTMENT, AND COST INCURRED TO THE OUTCOME FUNDER, BASED ON SITUTATIONS IN WHICH
THE PROJECT FAILS TO DELIVER AGAINST THE DEFINED PERFORMANCE CRITERIA.

55

Results of Cash Flow Analysis
The investor stands to make significant positive returns on their investment when they fulfil all criteria
and no or very minor disaster events occur. The cash flow outcomes should the investor meet all criteria
under a range of disaster scenarios is presented in Table 6. Scenario 1 presents the easily interpretable 'base
case' – here all criteria have been met and no disaster occurs over the course of the bond, in which case theinvestor stands to make a return of 18.3% on their invested capital. Under scenario 2, a minor event occurs
which does not trigger the insurance payout and is not damaging enough to trigger early maturity of the bond.
The investor will need to pay for the damages to the school from their own funds, which will reduce their overall
ROI to 12.3%. They will be financially incentivised to carry out these repairs as, by contrast, failing to meet the'asset insurance' criteria of the project will lead to them earning a negative ROI.
When all criteria are met but tail-end events occur, insurance covers the damage to the asset and thebond matures early – the ROI to the investor in these cases is lower due to early maturation but still
positive. Scenarios 3 and 4 detail cases where high-intensity disaster events occur but which are still within therange where insurance will cover the damages that arise due to the event. The insurer covers the cost ofdamages to the asset rather than the investor and the bond ends prematurely as repairs will need to be carriedout on the asset. The investor implements their disaster plan but overall earns a slightly lower ROI (around 7%)
as a result of this early maturation.
Insurance transfer risk away from the outcomes funder. Scenarios 3 and 4 also illustrate the benefits for
insurance in this type of instrument: if instead of taking out insurance the investor is expected to repair damages
to the asset, it would require a substantial payout from the outcomes funder to correctly incentivise the investor
to carry out those repairs, potentially an order of magnitude larger than the investor's original investment. For
example, in scenario 3 - where a 140mph event strikes in year 3 when 40% of schools have been made resilient– the investor receives a total of $378,322 from the outcomes funder for having taken out insurance. By contrast,
the event causes damages to the resilient schools of $582,400 and the non-resilient schools suffer damages of$1,865,400, a cost that would need to be made by the outcomes funder to the investor in order to ensure thatthe investor would not rather exit the structure.
Should the investor fail to meet all criteria they will earn a negative ROI – a range of scenarios where
various criteria are not met is are presented in Table 7. These scenarios help to illustrate that an investor
would be financially incentivised to perform well on the project and meet the criteria as the result of any criteria
not being met is a negative ROI for the investor. In other words, the payment structure monetises the resilience
dividend for the investor. Of particular interest is scenario 8 which shows the case where asset insurance is notprovided by the investor. When insurance is a criteria, there is clear incentive for the investor to procure
insurance and protect the asset from disaster risk. As discussed previously, if the defined criteria was to carryout repairs should an event occur the investor may either choose to fail the project and not repair the asset or
the outcome funder could be burdened with an extremely large payout to correctly incentivise repairs.

56

Product Evaluation
Encourages resilient infrastructure
Monetises resilience dividend
Makes resilience dividend available upfront
Involves risk transfer

3 Has a viable path to implementation
3 Offers flexibility~ Has a sound economic justification
3 Causes ‘no harm’

3
3
3
3

A. Encourages resilient infrastructure• The product promotes resilient infrastructure as one component of building resilient services. The
performance criteria are explicitly linked to resilience outcomes, and the overall structure createsalignment between the outcomes funder (project sponsor) and the investor, who is financially
incentivised to deliver a project that increases the resilience of the underlying infrastructure, and theservices it supports.
B. Monetises resilience dividend• The resilience dividend is monetised twofold:• The investors return on investment is linked to the resilience benefit that the retrofit generates. For
example, the investor makes an RoI of 18.3% in cases where the resilience measures are fully
implemented but makes negative returns in cases where some or all of the resilience measures are
not met.
• the resilience dividend is captured again through reduced asset insurance costs – depending on
who purchases the insurance, the savings can pass through to any of the impact investor, outcomesfunder, or service provider. This is realised on a rolling basis, as resilience is implemented.
C. Makes resilience dividend available upfront• The resilience dividend is monetised as described above. The structure relies on the credible
commitment by the outcomes funder to the investor being sufficient to incentivise the investor toundertake the upfront and other measures that promote resilience. In other words, rather than resilience
dividend being provided upfront, it is transferred to an investor who, as a result of contractual
commitments with the outcomes-funder, is patient enough to receive the monetised resilience dividend
over time. The product therefore does not satisfy the criteria, though this does not restrict the upfront
spend on resilience.
D. Involves risk transfer• There are multiple roles for insurance within the resilience impact bond, including; (i) asset insurance
for the underlying infrastructure; (ii) parametrically triggered funds to cover the operational costs ofdisaster, and; (iii) insurance that is intended to provide coverage for the impact investor, so that they
can protect future cashflows and expenditures against the risk of disasters impacting the project.
E. Viable path to implementation• Impact bonds and pay-for-performance contracts more broadly, are already being implemented. There
are donor funded development impact bond pilots which have tested the structure in a range of
scenarios. This paves the way for a resilience impact bond focused on resilience in terms of built
experience, further work would need to be carried out to identify a suitable use case for the resilience
impact bond.
F. Offers flexibility• The performance criteria can be fully tailored to reflect the desired project outcomes, for a range of use
cases. The structure is also fully flexible in terms of the rate of return that is offered for each of theperformance criteria, such that outcomes that are more important to the sponsor can be remunerated
more highly if desired.

57

G. Has sound economic justification• From the perspective of the impact investor, the bonds are remunerated at a rate that is consistent withthe risk of non-delivery, impact bonds can therefore offer attractive returns.
• From the perspective of the outcomes funder, further work would need to be undertaken to assess thevalue for money of this instrument compared to alternative grant-based structure. In particular, thisadditional research would need to generate an evidence-based assessment of the probability of thedifferent resilience measures being undertaken through a more convention grant-based funding
instruments.
• It is inefficient to incentivise insurance through this structure, since the remuneration will have to begreater than the total premium cost for it to become an attractive option for the investor. This is why
asset insurance is a pre-requisite within the applied example.
H. Causes ‘no harm’• There are in built performance criteria which aim to minimise disruption to services. There is a risk thatthe resilience measures fail to deliver the desired risk reduction, but appropriate engineering andmodelling exercises can help to manage this risk.

Challenges to Implementation•

Complexity. The impact bond for resilience has a significant number of complex and interconnected
elements. These include the performance indices themselves, which require a range of bespoke qualitativeand quantitative methods for both their design and measurement. If the product is well structured, then there
will be little flexibility in determining how well the impact investor has performed against the performance
criteria. However, due to the uncertain nature of quantifying resilience benefits, some of the performance
criteria are necessarily objective – which introduces the risk that there are disputes over assessment of
performance. This risk increases as the number of subjective performance criteria within the productincreases. Risky structures become unattractive to investors who are solely interested in financial gain. The
scale of the management task also increases with the complexity and scale of the project.

•

Efficiency. The outcomes funder is motivated to use an impact bond structure for two main reasons (i) the
link between investment in resilience and the ultimate event savings can be quantified, and the returns thatare offered are understood to be good value for money in this context, and: (ii) impact bonds are a useful
tool for monitoring and demonstrating the positive impact of their investment. Within this context, impact
bonds can be efficient delivery mechanisms from the perspective of the outcomes funder. However, it isinefficient to use impact bonds to incentivise the purchase of insurance, because the outcomes funder will
have to ultimately pay more than they would spend if they paid for the insurance directly. Insurance cantherefore be motivated by making it mandatory within the structure (as is the case in the applied example),or, a more efficient option may be for the service provider or outcomes funder to purchase the asset
insurance directly.

•

Sustainability. There is a risk that the responsibility for the resilience of the infrastructure and services falls
too heavily on the impact investor and outcomes funder during the term of the bond. Retrofit measures,
disaster plans, contingency funds, and asset insurance all need to be ultimately maintained by the service
provider and asset owner. The long-term resilience of the infrastructure and services depends on how well
the responsibility for the risk is transferred upon completion of the bond.

58

4.5. Detailed Analysis – Insurance-Linked Loan Package (ILLP)
Primary Objective: To incentivise resilient infrastructure and financial resilience through insurance
savings within an integrated loan and insurance product.

4.5.1. Overview
This approach, requiring only small modifications from current practice, proposes a solution that explicitly
integrates risk transfer solutions into the (concessional) loans provided by international financial institutions
intended to either (i) finance new infrastructure where a resilient design alternative exists or (ii) fund retrofit orinfrastructure upgrade programs.
Resilience can be incentivised by reduced upfront costs of insurance and/or by offering more favourable lending
terms (implemented by use of a conditional grant element delivered by a donor) upon demonstration that
identified resilience measures have been delivered. The flexibility of the structure also allows for the provisionand funding of maintenance.
Resilience Incentive: Saving on insurance premiums can be made available for reinvestment in resilience,either upfront by allowing expected future savings to be repurposed or withdrawn or over time as savings are
realised.
Insurance Element: A portion of the loan is earmarked for the provision of insurance. In order to allow disbursalof funds within the early years of the loan, this capital is held and managed in a separate resilience fund for the
lifetime of the loan in order to meet future premium payments. This fund could take one of a number of forms,
depending in part on the level of donor involvement, including a returnable grant from a donor placed into a trust
fund or a Special Purpose Vehicle (SPV). Pricing assumes that resilience measures provided for in the loan are
successfully implemented, subject to pre-agreed checks. With resilience measures in place, the premium islower for the duration of the loan, providing a ‘dividend’ to the asset owner that can at least partially offset any
cost of implementing resilience. Dependent on scale, insurance cover could be sought through multi-year
contracts or capital markets placements, with the ability to reset contracts and re-assess the underlying risk andsubsequent premium at regular intervals.
Use Case: Suitable for financing build from scratch or upgrade/retrofit of critical infrastructure where ongoing
resilience to disaster is crucial.

4.5.2. Motivation
Potential exists for the successful development and implementation of standalone multi-year insurance
contracts or alternative risk transfer mechanisms, designed to reflect future expected risk reductions frominvestment in resilience in premium reductions. Wrapping such a product into an infrastructure financing loan
from an international financial institution provides the flexibility to monetise the resilience dividend upfront
through either reducing the initial loan amount, or more practically allowing the resilience ‘dividend’ attributed tofuture insurance payments to be withdrawn from the insurance fund.
It also recognizes the important role already played by these types of loans in infrastructure financing and theopportunity available to further incentivise resilient building and the uptake of insurance. Furthermore, therecipient should be able to benefit from improved access to a range of potential product, technical assistanceas well as due diligence and scrutiny by sourcing insurance in conjunction with the loan provider.

59

Development Bank Loans and Infrastructure Financing
Patterns in infrastructure financing sources mean that instruments linked to development bank loans may
present one of the biggest and most practical near-term opportunities for innovation.
The contribution of multilateral agencies to ODA for infrastructure financing has been growing in recent
years with share of total ODA rising at a rate of 5.7% per annum over 2007-2016, peaking at 45% in 2014
(OECD, 2017c). This has been associated with an increased role for loans rather than grants: 85% of theincrease in ODA from multilateral agencies since 2007 was due to a rise in lending.
Development bank financed infrastructure projects typically include insurance during the construction
phase, and in some cases during the first couple of years after completion, but no further. Similarly,
maintenance is not usually considered beyond the completion of a project. Typical project length is 3 to 5
years and funds need to be fully disbursed during this time. In contrast, loan repayments may be made overa 20-year period or longer.
Projects are scrutinised for viability and conformation with bank standards and aims, including vetting ofprocurement processes and service providers. Additional site inspections to confirm structures are built tocode are not typically included within this process.
Concessionality on bank interest rates beyond established pre-agreed lending terms can be achieved
through donor funding channelled via a trust fund, which pays the difference between concessional andnon-concessional rates.
Case Study: Global Concessional Financing Facility (GCFF)
The GCFF provides development support on concessional terms to middle-income countries impacted byrefugee crises across the world (https://globalcff.org/). The GCFF routes donor funds from supporting
countries to unlock concessional lending at rates at or closer to those available to IDA eligible countries.
Donors fund the concessionality spread - the difference between the IBRD interest rate, used in lending to
middle-income countries, and the IDA rate, recalculated on a quarterly basis. The concessionality amountfor a given loan is calculated as the net present value of the concessionality spread during the life of theloan, given the financial characteristics of each loan. Donor contributions are allocated to qualifying projects
by the GCFF. The Facility allows benefitting countries to access affordable and more sustainable financing.
21

21 Information sourced through communications with the World Bank.

60

4.5.3. Structure
A generic structure for an ILLP is described within this section, including roles and responsibilities of
stakeholders, product components and principal cash flows and the form of insurance. In its simplest form, theinsurance-linked loan package is an infrastructure financing loan that; (i) includes the additional cost of resiliencein the initial notional; (ii) embeds the cost of insurance premium; (iii) monetises the resilience dividend as aresult of insurance premium reductions arising from investments in resilience and (iv) holds capital for futurepremium payments in a separate vehicle.
The product could be targeted at new infrastructure, either large high value single assets or more likely, a
portfolio of a larger number of assets representing either a significant construction or retrofit/upgrade program
across a country or region.
Key features
The initial loan amount equals the total cost of resilient construction plus an amount targeted to cover the future
cost of insurance and/or maintenance. The portion of the loan attributable to construction and resilient building
costs is disbursed over a time horizon of 3 to 5 years, through standardized procurement and contracting
processes with service providers. A separate vehicle such as a trust fund or SPV is required to manage theportion of the loan allocated to insurance, allowing premium payments to be made across the lifetime of theloan whilst permitting full disbursal by the lending entity within the 3 to 5-year disbursement period. This vehicle
needs to accommodate variable cashflows through time, i.e. the risk is expected to change across the term of
the loan, as are the insurance premium costs. Depending on the level of donor involvement other grant
structuring options such as returnable grants may be feasible. This analysis does not extend to a comparisonof the cost-benefit of different fund models including associated opportunity costs.
The net present value of future expected premium payments is paid into the resilience fund. The recipient
country repays the loan through regular interest payments at pre-agreed lending rates, which may besupplemented to varying degrees by donor funds to achieve the equivalent of concessional lending rates. The
roles and incentives of the various stakeholders are outlined in Table 8.

Stakeholder

Role

Development Bank

ExampleIncentive

Challenges

Provide initial capital International Bankfor Reconstruction
and Development,
Caribbean
Development Bank
etc.

Realize a return on
investment andachievedevelopment goals

Risk of default on
payment and notachievingdevelopment goals

Donor

Funding increased
resilience throughsupport ofconcessional
interest repayments

NGO, StateTo increase
community
resilience and theresilience of nations
so as to achieve
development goals

Managing effective
implementation of
funds

Recipient

Funds construction
and a component of
the additional costsof resilience.
Benefits fromresilientinfrastructure andfinancial resilience
provided byinsurance

National/Local
Government

Increased resilienceand accompanying
socio-economic
benefits of resilience

Justifying additional
spend on insurance
and resilient
infrastructure

TABLE 8 PRODUCT STAKEHOLDERS

61

A detailed breakdown of the constituent product components to be considered within a cash flow analysis areincluded in Table 9, accompanied by a product schema in Figure 21.

FIGURE 21 GENERIC EXAMPLE PRODUCT STRUCTURE FOR INSURANCE-LINKED LOAN PACKAGE

Component

Funding Mechanism

Timing/ Delivery

Infrastructure Financing
Base cost of infrastructure

C

Loan – recipient country
bears cost

Project outset, disbursed over
3-5 years through procurement
process

Base interest repayments

I

Paid by recipient country

Over 15-25 years

P

Financed by developmentbank through loan andultimately borne by recipient
country

NPV of future expected
insurance premiums managed
in an SPV or trust fund for
future disbursement andtransferred to insurer in aseries of multi-year contracts.

Additional cost of resilient
building

ΔC

Project outset, disbursement
dependent on funding
mechanism

Additional interest
repayments due to additional
cost of resilience
Rebate on insurance
premiums

ΔIR

Financed by developmentbank through loan andultimately borne by recipient
country. Potential for donor
contribution.
Financed by recipient
country

Reduced future insurance
premiums or reduced upfront
cost of insurance

Optional concessionality
spread to reward resilience

ΔID

Either reduced cost of
insurance upfront or used topart-fund interest
repayments
Financed by donor throughtrust fundInsurance
Annual insurance premiums

Resilience Features

ΔP

Over 15-25 years

NPV of concessionality spread
funded by donors at outset

TABLE 9 ILLP COMPONENTS

62

Insurance Component and Monetisation of the Resilience Dividend
The product is predicated on the assumption that risk reductions achieved through investment in resilient
infrastructure design or adaptation, can be quantified and captured in associated future premium reductions.
This in turn relies on these three statements being true:
1. The underlying risk can be quantified using commercially available catastrophe models
2. The impact of investment in resilience can likewise be quantified
3. Insurance providers will fully recognise this reduction in risk and pass on the benefit in the form of
reductions in premium
4. An insurance product can be structured so that premium reductions are understood and defined at
project outset
The Applied Example to follow demonstrates the first two statements to be true at least for the chosen casestudy. Note that potential risk reductions for some types of resilience measure such as green infrastructure (e.g.
mangroves, storm water storage systems) and some types of heavy infrastructure (e.g. roads and power) are
more challenging to quantify using commercially available models and may require bespoke solutions.
The third and fourth statements are discussed in the following two sections.
Risk-Based Pricing
Industry feedback from the Innovation Lab suggests there are challenges to achieving adequate risk-based
pricing in practice. These challenges are case specific and include:•

Market dynamics and pressures. Primary insurance underwriters may be unable to pass on benefits
from reductions in the underlying risk to the policy holder if this is not recognised during their reinsurance
purchasing, for example due to data resolution. Impact on profitability and local pricing dynamics may
also lead to risk reductions not being fully recognized.

•

Model and data uncertainty. Underwriters load the model derived expected losses during pricing toaccount for model and data uncertainty amongst other factors. Depending on the methodology used
this may dilute the impact of modelled risk reductions. Data quality and completeness can also be an
important factor for pricing risks in developing insurance markets.

•

Uncertainty in performance of resilience measures. Some common resilience measures such as roof
ties protecting against wind risk are well understood and modelled and have been tested in recent
events. Newer more innovative resilience measures may be less well understood, and underwriters
may be unwilling to recognise the modelled risk reductions in premium reductions.

These challenges can be mitigated by piloting the product in regions where the risk is robustly modelled andusing accepted resilience measures. The full collection and disclosure of asset characteristics will also reduce
data uncertainty. As the uncertainty in the benefit of resilience measures decreases as the number of assets
increases. Risk reduction measures deployed at scale are more likely to be recognized in reduced insurance
premiums.
In the U.S. mandatory wind mitigation credits have been used in many southern hurricane exposed states toaddress these challenges and pass on benefits to homeowners. For example, Wind Mitigation Credits available
in the State of Florida can offers discounts of more than 50% dependent upon an inspection of wind mitigation
measures in place (RMS, 2010).

63Form of Insurance ProductThis product assumes the following basic form for the embedded insurance component. Further development
is required to lock down policy details.
•

Insurance contracts are multi-year up to a maximum of three years with built in resets/renewals at theend of each three-year period. Three years is the maximum period that was deemed to be feasible byindustry participants of the Innovation Lab. Long duration multi-year contracts face a number ofchallenges including the higher cost of capital requirements (Maynard, T., Ranger, N., 2012).

•

Any individual insurance provider is not locked in for the duration of the loan (15-25 years). A pool ofparticipating insurers may be required.

•Future pricing can be adjusted in a pre-determined way (using a defined relationship between themodelled expected loss on the policy and the premium payment). This feature is commonly seen incatastrophe bonds which typically have a duration of three to five years and reset annually toaccommodate changes in underlying exposure or modelled risk.
- This exposes the insurance provider to potential opportunity cost in the case that (re)insurance
pricing hardens during the interim.
- Flexibility of pricing at each 3-year reset needs to be carefully considered against possible
market dynamics in the intervening period. It may be required for the insurance provider to takethe potential downside and accept that that they are being compensated for the risk they aretaking on.
- Resets/renewals will take into account changing views of risk by using the latest commerciallyavailable models.

•Uncertainty in future prices could be accommodated by adjusting the cover provided to keep premiums
stable. For example, if the risk is believed to have increased, either the limit offered to the recipient canbe lowered or the recipient can ‘top-up’ the insurance payments. The stability offered by the coverage
flexing allows the funding requirements to be determined at outset.

•

Alternative risk transfer methods may provide access to risk-based pricing for large portfolios of assets
where the investor is less exposed to model uncertainty on an individual asset and economies of scale
can be realized.

644.5.4. Applied Example: Reconstruction of Schools in a Hurricane-Prone Middle
Income Small Island Developing State (SIDS).
The following use case has been designed to assess the benefits of one possible realization of the ILLP in ahypothetical real-world setting. Reasonable assumptions have been selected and are presented below but could
be expected to both vary significantly in practical implementation and between different perils, regions, asset
types and resilience measures. The potential net benefit of the proposed structure should therefore be assessedon a case by case basis.

Summary of Use Case
Ten schools distributed across a hurricane-prone middle-income SIDS are to be reconstructed following adamaging hurricane using a loan from an international development bank. Schools can be rebuilt according tocurrent practices, the ‘Base Case’, or at additional cost, further strengthened to increase their wind resilience,the ‘Resilient Case’.
The costs of implementation are typically related to the overall base value of the asset – the building andmarginal cost assumptions have been derived from internal RMS expertise and research underlying thedevelopment of the RMS North Atlantic Hurricane Models. Costs are expected to vary by region, althoughrelative costs and risk reductions will be largely conserved
Estimated costs and modelling assumptions are contained in Table 10.
Analysis
Component

Assumption

Description

SourceRegionMiddle Income Small Island Developing State (Dominica)

-

Peril

Hurricane - wind only-

Model version

RMS North Atlantic Hurricane Models v17.0, wind model(vintage 2017)

RMS

Exposure

10 Schools, located 1 per district-

Base Case
Base Construction Type
Modelling

Base Construction Cost (perunit)

Total Base Construction Cost

Construction Type: Masonry, Occupancy Type: Education,
Number of Stories: 2
US$1 million per unit.
Construction costs are expected to vary in practice, though theadditional costs of wind mitigation features are expected toscale linearly with base value.

RMS

RMS

US$10 million

RMS

Additional Structural Features

Roof Sheathing, Roof Covering, Opening Protection, Roof
Anchor, Roof Geometry

RMS

Marginal Cost
Constructionof+6.95% on top of Base Construction Cost assumption equivalent to $695k for a school portfolio of $10 million

RMS

Total
Cost

Construction

US$10.695 million

RMS

Resilient Case

Resilient

Resilient

TABLE 10 MODELLING ASSUMPTIONS USED IN THE RMS ANALYSIS FOR BASE AND RESILIENT CASE

65

Risk Analysis and Assessment of Physical Resilience Benefit
RMS has carried out a risk analysis to quantify the hurricane wind risk to the hypothetical portfolio of schoolbuildings for the Base and Resilient Case under the assumptions detailed in the previous section. The modelled
structural vulnerability of the school buildings is lower in the Resilient Case leading to a 47% reduction in the
Average Annual Loss (AAL), the average financial loss incurred from physical damage in an average year. Notethat the AAL represents an average across thousands of simulated years, in which some will experience noloss and others will experience more extreme losses. The standard deviation around the AAL is also shown
indicating the level of volatility and uncertainty in the losses experienced in any one year. This can also be seen
to reduce in the Resilient Case.
OptionCost ($)

AAL ($)σAAL ($)

Base Case

10,000,000

35,955

266,603

Resilient Case

10,695,000

18,958

154,775

Marginal Impact of Resilience+6.95%-47.3%-41.9%TABLE 11 COSTS, AVERAGE ANNUAL LOSSES AND ASSOCIATED STANDARD DEVIATIONS FOR BASE CASE AND RESILIENTCASE

The likelihood of incurring a financial loss greater than a certain value in any one year, the occurrence
exceedance probability, is shown in Figure 22.
3.0%

Base

Occurence Exceedance Probabiltiy

2.5%

Resilient

2.0%

1.5%

1.0%

0.5%

0.0%
0

1

2

3

4

5

6

Event Loss (USD)

7

8

9

10
11
Millions

FIGURE 22 LOSS OCCURRENCE EXCEEDANCE PROBABILITY CURVES FOR BASE AND RESILIENT CASES

66

Cash Flow Analysis
This applied example works through one implementation of the generalized product for this use case and sets
the following product features:•

The asset owner (recipient country) has the choice between a) a loan covering the cost of a non-resilient
asset (Base Cost of Construction, C) and the cost of insurance; or b) the Resilient Cost of Construction (C+ΔC) and the cost of insurance.

•

In both cases, the lender earmarks an amount equivalent to the cost of insurance for a non-resilient asset
and sets it aside in an SPV.
▪ An SPV is chosen for simplicity and as a flexible structure that is agnostic as to the degree, if any,of donor involvement.
▪ As the resilient case and non-resilient counterfactual both set aside an equivalent portion of theloan within an SPV structure, the opportunity cost of the SPV is not considered.
▪ If the borrower opts for resilience measures, the resulting insurance savings are used to offset theadditional cost of resilience through lower annual repayment or upfront savings that can bereinvested. In the modelled example, the insurance rebate is used to lower the annual repaymentsof the loan.

•

The insurance premium is assumed to be constant throughout the lifetime of the loan and paid annually.
The cash flow analysis is agnostic to the precise policy details, but the policy could be assumed to be amulti-year contract renewing every 3 years, with the premium payments held constant under changing risk
by adjusting the coverage level.

•

A donor steps in to reduce the overall interest repayments by providing an upfront amount equivalent to theadditional interest paid on the cost of resilience measures (ΔID). This is a modelling choice requiring a
relatively small donor support; other structures may include a more important donor involvement dependingon the economic viability of the product.

•Insurance is a pre-condition, built into the loan package. Resilience is a choice of the recipient country.

•

The development institution loan consists of 1) a disbursement phase and 2) a repayment phase. During
the disbursement phase, amounts are disbursed uniformly in each year.

•

The loan is amortizing. The notional amount is progressively paid back after an initial disbursement period
and interest is due on the outstanding amount in every given year.

•

Several simplifying assumptions are made:▪ SPV set-up costs are assumed to be zero, as are other frictional costs and there is no fee forrenewal of insurance policies. Includes a one-off commencement fee at the start of the loan period.
▪ The underlying asset value of the school portfolio is assumed to remain constant over the lifetimeof the loan following construction. Inflation in value is assumed to offset expected deterioration.

•

A discounted cashflow model is applied over the term of the loan to compute the net present value of futureloan repayments (capital and interest) with the net present value of the cost of infrastructure.

•

The analysis uses a discount rate of 5% based on a social time preference perspective 22. However, asensitivity is provided at 10% reflecting the opportunity cost of capital.

22 For instance, under the simplest derivation of the social time preference rate, 5% would be consistent with a utility discount rate of

3.2% (compared to the 1.5% value in the Green Book, reflecting the likely higher pure rate of time preference in the region), the elasticityof the marginal utility of consumption being 1.5, and a per capita growth rate in consumption of 1.5% (consistent with the simple averagefor this parameter over the last 10 years in Latin America and the Caribbean, excluding high-income countries).

67

•

Key input assumptions are detailed in Table 12.
Product Component

Loan

Insurance

Assumption

Notes
Base cost of infrastructure+ NPV(Annual Insurance Premiums)
Base cost of infrastructure + additional cost of resilience+ NPV(Annual Insurance Premiums)

Base Loan Value

US$10,876,685

Resilient Loan Value

US$11,571,685

Loan Term

25

Typical loan duration, can vary.

Loan Disbursement Period

5

Typical disbursement period, can vary.

Loan Interest Rate

4.00%

http://www.worldbank.org/en/about/unit/treasury/financialproducts/ibrd/ibrd-lending-rates-and-fees#2

Discount Rate

5%

Social time preference perspective13

Asset Building Time (Years)

5

To conform with disbursement period.

Base Case Annual Premium

US$71,910

Proportional loading factor of 2x. See Sensitivity Tests forfurther information.

Resilient Case Annual Premium

US$37,916

Proportional loading factor of 2x. See Sensitivity Tests forfurther information.

Base Replacement Cost

US$10 million

Equals Total Base Construction Cost, assumed toincrease linearly from 0 to 100% of total value during 5year construction period

Resilient Replacement Cost

US$10.695
millionEquals Total Resilient Construction Cost, assumed toincrease linearly from 0 to 100% of total value during 5year construction period

TABLE 12 PRODUCT LOAN AND INSURANCE ASSUMPTIONSResults of Cash Flow Analysis
Two options are studied: 1) a non-resilient infrastructure loan; 2) a resilient infrastructure loan. The additional
cost of resilience is compared to the net present value of resilience-related future savings.
Cost

Resilient Construction Cost(t=0) [C+∆C]
10,695,000

10.0Interest + Capital
Repayment (Base)

Interest + Capital Repaymentswith Resilience & Donor
Contribution on extra interest

8.0-9,034,344-9,013,644

Asset/Loan NPV ratio

Asset/Loan NPV ratio

1.11

1.19

(a)

Insurance Savings (NPV)

6.0
US$ millions

Base Construction(t=0) [C]10,000,000

9.0

6.1

9.0

6.5

4.0
2.0

2.9

3.1

414,435(b)

Additional resilience loan
(NPV)

-0.2

0.0

-0.4

-393,736(c)(d)

Interest payment & service
cost for additional resilienceloan, - NPV [∆I]

Base

Resilient-188,003

Insurance rebate

Capital repayment

Donor Contribution, NPV [∆I]

Interest and fees

Donor contribution

188,003
Net resilience benefit(e) = (a)+(b) + (c) + (d)-2.0

20,700Total NPV (Loan)
FIGURE 23 CASH FLOW ANALYSIS, ALL AMOUNTS IN
US$ UNLESS SPECIFIED

68

The additional cost of resilience is defined as the net present value of additional lending required and associatedfees and charges (capital repayment, additional interest, additional service fee). Resilience-related savings
consist of the net present value of resilience-induced insurance savings and donor contribution. The results ofthe cash flow analysis are presented in Figure 23, with a summary in Table 13.

Net
Resilience
Benefit% Risk Reduction(AAL)% Insurance Savings(relative to Base Case
insurance costs)

Insurance Savings as % of
Marginal Cost of Resilient
Building% Loan Taken Up by
Insurance Funds

20,700

47.3%

47.3%

71.2%

4.0%

TABLE 13 KEY METRICS

Given that the recipient has taken out risk-priced insurance, they are financially incentivised to build
resiliently as long as the insurance savings from building resiliently outweigh the additional capitalcosts. The costs and benefits of building resiliently for our base case are shown above in Table 13: theinsurance savings (a) plus donor contribution for resilience (d) are larger than the additional costs of resilience[(b) + (c)], which makes it financially beneficial to build resiliently. The net benefit is $20,700 with insurance
savings of 47.3% of the net present value of future expected premiums, which are equivalent to 71.2% of themarginal cost of resilient building. Hence in this example, an investor would prefer to incur the initial extra costto build resiliently as it would reduce the total NPV of loan repayments. However, this positive net benefit
disappears in the absence of the donor contribution to the interest repayments on additional cost of resilience,
as demonstrated by the insurance saving being less than 100% of the NPV of the marginal cost of resilience.
Whilst the insurance premium savings accumulate over the duration of the loan, the loan recipientsthemselves effectively aggregate those savings and choose to build resiliently today. By creating
insurance savings from resilience, the instrument monetises the resilience dividend. This guarantee of savingsin the medium term might be enough, in theory, to promote resilience building today. There is also the option ofallowing the loan recipient to withdraw additional funds from the SPV equal to the NPV of future insurance
premium savings if they commit to building resiliently. This option brings the resilience dividend upfront in puremonetary terms but may have lower efficiency due to the potential moral hazard from the loan recipient.
Building resiliently becomes more attractive and provides larger savings as the repayment period of
the loan increases. A longer loan repayment period creates more years where insurance is needed andtherefore more years where the resilience rebate exists. Keeping all other assumptions constant, the total loan
repayment with resilience building is lower for a loan term of 24 years or longer. For loan terms of 23 years or
less, it would be more difficult to financially incentivise the additional resilience measures. Note that the positive
net resilience benefit assumes a counterfactual where insurance cover is in place; against a counterfactual
where no insurance is in place, an additional cost of insurance remains (Figure 24).

Total Loan Savings for
Building Resiliently ($)

200,000
100,000
0-100,000-200,000-300,000-400,000
10

11

12

13

14

15

16

17 18 19 20 21
Loan Duration (Years)

22

23

24

25

26

27

28

29

30

FIGURE 24 TIME SERIES OF LOAN SAVINGS THAT RESULT FROM BUILDING RESILIENTLY

The instrument relies entirely on reduced insurance premiums as the vehicle to create the 'resilience
dividend'. As such, insurance is an indispensable aspect for this instrument and the cost-benefit of insurance
to the loan recipient versus other forms of disaster risk financing should be assessed on a case by case basis.

69

Sensitivity Testing
The economic benefit of the proposed structure is highly sensitive to the interplay between the additional costof resilience, the absolute value of the AAL, the percentage risk reduction achieved and the insurance pricing
assumptions. The combination of these factors will vary case by case depending on the geographic location,
type of infrastructure, peril and resilient measure chosen. In general, sensitivities show that optimal conditions
include low additional cost of resilience, high insurance loading factors and high absolute risk reduction in termsof the reduction in AAL, but that the relativities of these factors will also determine the net resilience benefit. It
is not meaningful to select a single point at which the structure becomes viable in a multi-variate problem.
1. Cost of Resilience Assumptions
Key output metrics from the cashflow analysis are shown for differing assumptions on the marginal cost of more
resilient construction. Results show as the cost of resilience increases above the base case whilst the absoluteinsurance savings remain more or less constant, the structure becomes uneconomic.
Additional Cost of
Resilience

Net Resilience
Benefit% RiskReduction (AAL)% Insurance
Savings (relative to
Base Case
Insurance Costs)

Insurance Savings as %of Marginal Cost of
Resilient Building% Loan Taken Up
by Insurance Costs

5.0%

139,600

48.2%

48.2%

101.0%

4.0%

6.95%

20,700

47.3%

47.3%

71.2%

4.0%

10.0%

-165,273

45.8%

45.8%

47.9%

4.0%

20.0%

-775,020

40.8%

40.8%

21.4%

4.0%

TABLE 14 KEY CASHFLOW METRICS

2. Insurance Assumptions

Insurance Assumptions

Net
Resilience
Benefit% RiskReduction(AAL)% Insurance
Savings(relative to Base
Case insurance
costs)

Insurance
Savings as % of
Marginal Cost of
Resilient
Building% Loan Taken Up by
Insurance Costs

P=m.AAL + c.σ, where m is theexpense loading factor and is set
equal to 1.15 and c is the risk loading
factor and is set equal to 0.3

253,568

47.3%

43.8%

111.3%

6.8%

Proportional loading factor of 1.5-82,909

47.3%

47.3%

53.4%

3.1%

Proportional loading factor of 2

20,700

47.3%

47.3%

71.2%

4.0%

Proportional loading factor of 3

227,917

47.3%

47.3%

106.9%

5.8%

TABLE 15 INSURANCE PREMIUM SENSITIVITY TESTING

Table 15 shows key output metrics for differing insurance pricing models. The analysis presented so far
assumes a simplistic proportional loading factor where the annual insurance premium equals 2 times themodelled AAL (show here for comparison, highlighted in grey). This loading factor is assumed to contain both
expense and uncertainty loading factors. Premium loading will vary by region, by provider and by underlying
asset and data quality. Additional sensitivities are shown for proportional premium loading factors of 1.5 and 3,
and for premiums estimated using the technical pricing formula, P=m.AAL + c.σ, where P is the annual premium,m is the expense loading factor, c is the risk loading factor and σ is the standard deviation of the AAL. The
technical pricing formula considers the impact of the uncertainty in the AAL. The magnitude of the standard
deviation reflects the volatility in annual losses and the value of c reflects the risk tolerance of the underwriter.
Typical values are chosen for soft market conditions.

70

As both the AAL and the standard deviation in AAL reduce in the Resilient Case (Table 15), the benefit of risk
reduction is preserved in both the proportional loading factor and technical pricing (including uncertainty)
sensitivities. In fact, premium loading actually increases the potential for insurance savings between the Baseand Resilient insurance premiums.
Millions

2.0

1.5

Net Present Value ($)

1.0

0.5

0.0
0%

5%

10%

15%

20%

25%

-0.5

-1.0

-1.5

Additional Cost of Resilience (% of Base Cost)
2x Pure Premium Load
Technical Premium (1.15 Expense Factor, 0.3 Uncertainty Factor)
Additional Loan ($)

FIGURE 25 SUMMARY OF SENSITIVITY RESULTS. SHOWING THE POINTS AT WHICH THE NPV OF THE STRUCTURE REACHESA BREAKEVEN POINT FOR A SELECTION OF ASSUMPTIONS ON THE COST OF RESILIENCE AND INSURANCE PREMIUM
CALCULATION.

3. Risk Level and Risk Reduction
The following tables show summary results for (i) a range of absolute values of the non-resilient AAL, holding
the % risk reduction constant for the resilient case; (ii) a range of percentage risk reductions holding the nonresilient AAL constant. These ranges are chosen to be physically realistic in terms of the hazard environment
and potential risk reductions seen across different mitigation measures and infrastructure types.
Non-Resilient
AAL

Net Resilience
Benefit% RiskReduction (AAL)% Insurance
Savings (relative
to Base Case
Insurance Costs)

Insurance Savings as %of Marginal Cost of
Resilient Building% Loan Taken Up
by Insurance
Costs

10,000-278,471

47.3%

47.3%

19.8%

1.2%

20,000-163,206

47.3%

47.3%

39.6%

2.3%

35,95520,700

47.3%

47.3%

71.2%

4.0%

40,00067,324

47.3%

47.3%

79.3%

4.4%

50,000

182,589

47.3%

47.3%

99.1%

5.4%

TABLE 16 AAL SENSITIVITY ANALYSIS

71

% Risk Reduction(AAL)

Net Resilience
Benefit% Insurance Savings(relative to Base Case
Insurance Costs)

Insurance Savings as % of
Marginal Cost of Resilient
Building% Loan Taken Up by
Insurance Costs

10%-306,067

10.0%

15.1%

6.8%

25%

-174,564

25.0%

37.7%

5.7%

47.3%

20,700

47.3%

71.2%

4.0%

75%

263,77875.0%

113.0%

1.9%

90%

395,28190.0%

135.6%

0.8%

TABLE 17 RISK REDUCTION (AAL) SENSITIVITY ANALYSIS

4. Alternative Applied Example: Water Infrastructure in an Earthquake Prone South-East Asian Country
A hypothetical counter-example is included for a water plant situated in a high hazard region within an
earthquake prone South-East Asian country (the Philippines for the purposes of modelling). A hypothetical asset
value of US$3m is chosen alongside a conservatively low marginal cost of resilience (and an additional 5%),and the asset is modelled under the assumption of poor construction quality and good construction andmaintenance.
OptionCost ($)

AAL ($)

Base Case

3,000,000

3,480

Resilient Case

3,150,000

2,924

Marginal Impact of Resilience

+5%

16.0%

TABLE 18 EARTHQUAKE RISK SENSITIVITY ANALYSIS

In this case, despite the low marginal cost of resilience assumed, the lower value of AAL relative to the asset
cost, even in a high hazard earthquake region, and the low percentage reduction in AAL, mean that a negative
net resilience benefit is seen overall. This example is included to be illustrative of the variation that can be seenin the ability to achieve significant risk reductions and that cost-benefit analyses can vary significantly for low
frequency perils such as earthquake.
Net
Resilience
Benefit% Risk Reduction(AAL)% Insurance Savings(relative to Base Case
insurance costs)

Insurance Savings as % of
Marginal Cost of Resilient
Building% Loan Taken Up by
Insurance Costs-71,407

16.0%

16.0%

10.8%

2.2%

TABLE 19 EARTHQUAKE RISK SENSITIVITY RISK RESULTS

5. Discount Rate
Key output metrics from the cashflow analysis are shown for a high discount rate environment with the discountrate set to 10%. Results show that the net resilience benefit remains positive at the high discount rate of 10%
but that the absolute value of that benefit significantly decreases compared to the base assumption of 5%.

Discount rate

Net
Resilience
Benefit% Risk Reduction(AAL)% Insurance
Savings (relative to
Base Case
Insurance Costs)

Insurance Savings as % of
Marginal Cost of Resilient
Building% Loan Taken Up
by Insurance Costs

5.0%

20,700

47.3%

47.3%

71.2%

4.0%

10.0%

304

47.3%

47.3%

64.8%

2.5%

TABLE 20 DISCOUNT RATE SENSITIVITY ANALYSIS

72

Evaluation
Encourages resilient infrastructure
Monetises resilience dividend
Makes resilience dividend available upfront
Involves risk transfer

3 Has a viable path to implementation
3 Offers flexibility
3 Has a sound economic justification
3 Causes ‘no harm’

3
3
3
3

A. Encourages resilient infrastructure• Rebates resulting from reduced insurance premiums significantly offsets additional cost of resilient
infrastructure, further incentivisation can be provided by donor support.
• Product can be structured to enable ongoing maintenance of infrastructure
B. Monetises resilience dividend• The rebate arising from the reduction in insurance premia can be monetised either by (1) reducing theinitial loan amount in recognition of lower expected future costs, (2) in offsetting interest payments or(3) making insurance savings available for withdrawal through the resilience fund, either gradually overtime or upfront and used for specified resilience purposes.
C.

Makes resilience dividend available upfront• Whether the funds are made available upfront or over time (see B), a key feature of the product is preagreed reductions in insurance premia rather than waiting for uncertain future benefits.

D. Involves risk transfer• Risk-based insurance contracts are key to monetising the resilient dividend by recognition of the risk
reduction achieved through resilient building in premium reductions.
• Uptake of insurance and use of local insurance providers can both increase financial resilience and aid
with the development of the insurance market.
E. Viable path to implementation• International development bank loans are a significant source of infrastructure financing and thisproduct represents incremental development to pre-existing products. The most significant challenges
remain in accessing risk-based insurance pricing and developing appropriate multi-year policies which
also meet the needs of the insurance provider.
F. Offers flexibility• The product has simple defining characteristics, namely the set-up of a resilience fund to manage theinsurance funds provided by the loan, and the monetisation of risk reductions in the form of reductionsin premium payments. The precise structuring and loan amounts can be tailored to consider individual
case insurance requirements. The product structure may also be able to support ringfencing of a portionof the loan for regular maintenance, additionally placed into the resilience fund. Provisioning foradequate maintenance may in turn also have a beneficial impact on risk and premium levels.
G. Has a sound economic justification• The applied example indicates that there is a positive net resilience benefit to the proposed structure
when set against a counterfactual that presupposes the take-up of insurance. This will vary depending
upon different marginal costs of resilience set again the risk reduction and associated premium
reduction and should be assessed on a case by case basis.
• In addition, the cost-benefit of different structuring solutions for managing the insurance portion of theloan should be consider. Both the proposed structure and counterfactual presuppose an SPV set-up
and so the opportunity costs of the SPV are not considered.

73

H. Causes ‘no harm’• Inclusion of insurance within the loan will lead to an overall larger loan amount and ultimately highrepayments. Options exist for donor involvement in funding interest on the additional loan amount or
funding the marginal cost of resilience and/or insurance, but decisions by recipient countries to fund the
additional cost of insurance should be taken in consideration of other spending priorities.

Challenges to Implementation•

Robust quantification of risk reduction associated with some resilience measures, infrastructure
types, and peril-regions. Commercial catastrophe models include as standard the ability to quantify therisk reduction associated with common resilient building design features for residential, commercial andindustrial structures for key natural perils such as wind and earthquake risk. They also typically include theability to model local defences against water perils such as raised entrance elevations, flood walls etc. As
a result, the impact of resilience investments can in many cases be robustly modelled for portfolios of assets.
However, potential risk reductions for some types of resilience measure such as green infrastructure (e.g.
mangroves, storm water storage systems) and some types of heavy infrastructure (e.g. roads and power)
are more challenging to quantify using commercially available models and may require bespoke solutions.
Catastrophe model coverage is expanding rapidly to cover global peril-regions, however, the completenessand resolution of models does vary regionally. Exposure and vulnerability data can be readily collected at
the point of construction, though for less developed regions, the availability of hazard models may inhibit
the ability to support such a product with robust risk modelling. Where this is the case – simplifying
assumptions may be sufficient to price the expected risk reduction into the product.

•

Ability to achieve risk-based pricing and full recognition of modelled risk reduction as a reductionin premium payments. See Section ‘Insurance Component and Monetisation of the Resilience Dividend’for further discussion.

•

Challenges in design and implementation of a suitable multi-year insurance product that provides
sufficient certainty at outset to allow the resilience to be fully funded and the resilience dividend to
be monetised, at least in part, upfront. See Section ‘Insurance Component and Monetisation of the
Resilience Dividend’ for further discussion.

•

Uncertainty in implementation of building standards and resilience measures, as well as efficacy ofresilience measures. The former may be mitigated by regular inspections during and on completion of
construction. Solutions at a sovereign level might include introduction of building certification policies.
Insurance contracts should allow for pricing to be reset to address changes in view of risk i.e. if new
information becomes available on the performance of resilience measures, pricing should be allowed toadjust.

•Motivation and ability for recipient country to bear additional cost of insurance, if insurance waspreviously absent or not assumed. In the applied example of a SIDS school portfolio, the cost of insurance
adds 9% onto the notional amount of the loan or as little as 4% if resilience measures are fully recognised
and expected insurance savings are used to reduce the notional amount. depending upon the fullrecognition of resilience measures. Whilst the additional cost of resilient construction is covered by the
reduced premium payments over the lifetime of the loan under the base cash flow analysis, if insurance
was not originally in place, this remains an additional cost of 4% compared to not taking out insurance.
Donor funding may be leveraged to ease funding challenges if the cost-benefit of insurance can be shown.

74

4.6. Discussion
4.6.1. General Findings on Capturing the Resilience Dividend
The product solutions proposed aim to capture a resilience dividend generated through building resilient
infrastructure and use it to contribute towards the additional initial costs of building resiliently. The most directmeans of monetising the resilience benefits is through creating a saving on insurance premiums, though
reducing the risk of physical asset damage. This approach has a number of challenges:•

Insurance Coverage – savings can only be made on insurance premiums if the asset is insured to begin
with. In instances where there is no provision for premium payments, it may be challenging to motivate riskholders to pay for premium while also promoting resilience. The sustainability of these types of product is
contingent on the ability of the risk holder to pay for premiums over the long-term, ideally for the full life of
the asset.

•

Insurance Pricing - savings on insurance premiums are only made if the insurance provider explicitly
recognises the risk reduction with a lower insurance premium. A range of interrelated factors influence thecost of an insurance premium, including the covered risk and associated uncertainty, the volume ofcoverage and number of covered assets, the peril-region, the administrative and distribution costs, and thecurrent market dynamic among others. The complexity of insurance pricing means that the modelled riskreduction may not be fully recognised in a reduced premium. These types of structure will work best if they
are developed in collaboration with insurance providers, and agreements are made as to the expected nearterm premium and recognition of risk reduction. They are also likely to be more feasible with large portfolios
of assets where the reduced uncertainty and volatility is more attractive to the insurer.

•

Benefit-Cost Ratio – the ability of insurance premium savings to contribute meaningfully to the cost ofresilience varies significantly. These types of product solutions are therefore best suited to use cases where
the underlying risk is high, the additional cost of resilience is low, and risk reduction is recognised with large
premium reductions. These factors vary between use cases; the Dominica schools hurricane risk analysis
demonstrated a use case where these conditions were relatively favourable:--

The annual average loss for the base schools construction is of the order of 0.43% of the total valueof the asset (loss cost of ~4.3), which would be considered a relatively high risk asset.
Additional assumptions and results include:
A flat technical premium loading factor of 2x AAL
Total additional cost of resilience of 5.9%
- Total risk reduction of 46% resulting from a combination of retrofit measures- Assuming no discount rate, the payback period is 15.8 years
However, if a discount rate of 10% is applied in a NPV calculation, the total accrued savings cannever pay for the additional cost of resilience. The challenges of high discount rates apply more
broadly for long-term investments in developing economies.

Additional factors which affect the total potential premium savings include:--

The additional costs of resilience increase the total value at risk, which acts to offset the risk
reduction benefit on insurance premiums. This is most pronounced where the additional costs arelarge compared with the value of the base asset.
The expected life of the asset, and the associated timescales over which premiums are paid, andsavings on insurance premiums can be accrued.

75•Timing – insurance premiums are typically paid annually, so the savings can only be realised on a similarbasis. The implications of this include:
-

-

-

-

For the resilience dividend to be made available up front expected future premium savings have tobe aggregated, either within a product structure, or by an entity who is willing and able to accrue
the savings over time.
Insurance providers ultimately retain control of the annual cost of premium in order to reflectchanging market dynamics and changes in the underlying risk, among other factors. Uncertainty infuture insurance savings means that the total size of the resilience dividend is also uncertain. A
possible solution to this problem is to fix the amount of capital that is available annually forinsurance, and to have contracts that vary the underlying coverage. However, this may lead to
unexpected underinsurance if the mechanisms are not transparent.
Insurance contracts are typically renewed on an annual basis – there may be options to extend
contracts to 3-5 years, and catastrophe bonds can extend to 5 years, though this still generally falls
short of the periods over which insurance savings can fully pay for the additional cost of resilience.
Given that future potential insurance savings are aggregated to form the overall monetised
resilience dividend, the present value of the resilience dividend can be strongly inhibited by theapplied discount rate. In developing economies where the discount rate can be of the order of 10%,it becomes significantly more difficult to realise positive cost benefit ratios on near-term horizons.

•Sustainability – as well as implementing resilience across the term of the financial instruments, it isimportant to consider how the resilience measures are maintained by the local asset holder or service
provider over the long-term. How the responsibility for maintenance and insurance premium paymenttransfers to the local agencies should be clearly defined at the start of the project – this is critical to ensurethat the products create sustainable resilience solutions.

•Captured Benefits – the benefit-cost analyses produced for this report mainly quantify reduction in direct
asset damage as the benefit, since this is what drives reduction in asset insurance premiums. The benefitsof resilient infrastructure extend beyond reduction in direct damage and loss – these benefits should also
be considered when assessing the value of products which motivate the development of resilient
infrastructure.

4.6.2. Product Assessment
The two developed product solutions were structured to address four defined ex-ante criteria. These criteria
and an assessment of how the product solutions address them is contained in the following tables:

Description

Motivate thedevelopment ofresilientinfrastructure

The product structure aims toincrease the resilience of theservices supported by the
infrastructure. The product therefore
explicitly promotes and financiallymotivates development of resilience
across multiple dimensions;
including physical, operational, andfinancial resilience.

Assessment+

The product goes beyond just promoting resilient
infrastructure, in that the operational and financial
resilience of the services are also considered. The
flexibility of this structure means that a targeted
approach to increasing resilience is possible under awide range of use cases.

-

Given that the outcome funder ultimately pays for the
resilience, they are probably motivated to develop
resilience in any case. The availability of a productsuch as this offers a means of developing resilient
infrastructure, rather than motivating it.

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Description

Monetise theresilience
benefits

Deliverresilience
benefits upfront

Involve risk
transfer

The impact investor is remunerated
for increasing resilience across themultiple dimensions. The resilience
benefits generated are therefore
monetised by the payments theinvestor receives. In addition, theentity who pays for asset insurance
stands to monetise savings on theirannual premium as a result of the
reduced physical vulnerability.

The investor is responsible forraising funds for resilience, theircapital is not limited, therefore theneed to monetise and bring forward
a resilience dividend is notapplicable. Impact investors arewilling to receive a return on theirinvestment across the term of thebond, as the resilience project iscarried out.

There are various insurable
elements within this structure,including (i) the underlying asset, (ii)the operational costs of disaster
response, and (iii) the investors’
future cashflows. Any of these canbe explicitly required by the productstructure, and equally, the structure
can work without an insurance
element. In the developed example,
the investor is incentivised to ensurethat the underlying asset andoperational costs are covered bysome form of risk transfer.

Assessment+

The product structure offers a useful means of
capturing the broader benefits of resilience, byenabling the outcome funder to use theirunderstanding of the direct and downstream benefitsof resilient infrastructure to support pricing for the
returns they pay to the impact investor.

-

This may be considered an artificial way of monetising
the benefits of resilience, given that the outcome
funder determines the ROI to the investor based on
their understanding of the resilience benefits. In
addition, asset insurance is not strictly required under
this structure, so the insurance savings may not bemonetised at all in some cases (e.g. where there is notasset insurance, or when the insurance premiums arepaid by the asset owner or other entity).

+

The product solution matches resilience projects withan investor who has funds available to spend
immediately on the project.

-

Rather than bringing a future dividend up-front, thestructure provides the investor with a resilience-linked
ROI at payment dates throughout the term of the bond.

+

Risk transfer and insurance mechanisms areapplicable within the structure, as a means ofmanaging the risk to the assets, and as a means ofproviding liquidity when an event does occur. Funds
can be used for reconstruction, and to support disastercosts. The applied example shows that retrofit only
reduces disaster costs, and does not eliminate them,so insurance or some form of disaster fund is required
to pay for reconstruction costs.

-

The relatively short term of the bond (3-5 years)means that the risk to the investor’s capital is tied tothe catastrophe risk to the assets for a short enoughtime that the total risk of being impacted by an event isrelatively low. The investor may therefore feel that they
don’t require asset or operational insurance, andindeed may just take out insurance against their future
cash flows. The applied example is structured to makethis option less desirable. However, this introduces
inefficiencies into the process, in that the outcome
funder has to make insurance purchase financiallymore attractive than not purchasing insurance, atwhich point it may cost the outcome funder less todirectly purchase insurance. Ultimately, the mostsustainable and efficient option is for the asset ownerto purchase insurance, though this is a decision thatneeds to be made on an individual basis.

TABLE 21 RESILIENCE IMPACT BOND ASSESSMENT AGAINST EX-ANTE CRITERIA

77

Description

Motivate thedevelopment ofresilientinfrastructure

Monetise theresilience
benefits

Deliverresilience
benefits upfront

Involve risk
transfer

The ILLP aims to incentivise theadoption of resilient infrastructure
designs by using reductions ininsurance premia to offset theadditional cost of resilience, with aminimal level of donor involvement.

The rebate arising from the reduction
in insurance premia can bemonetised either by (1) reducing theinitial loan amount in recognition oflower expected future costs, (2) inoffsetting interest payments or (3)being made available through the
SPV, either gradually over time or
upfront and used for specified
resilience purposes.

Optionality exists within the productstructuring to bring the resilience
dividend upfront by allowing early
withdrawal from the SPV or in themedium term through reduced
interest repayments or release ofdividends as accrued.

Risk transfer is fundamental to the
product concept by taking standard
infrastructure loans and ring-fencing
a portion of the loan for future
insurance spending. Thismechanism is essential to capturing
the resilience dividend.

Assessment+

Cash flow analysis results show that under the basecase assumptions in the worked example, the net
resilience benefit is positive, incentivising the borrower
to choose the resilient option. In many cases expected
future saving in premium payments can cover a
substantial portion of the cost of resilient building.

-

Donor involvement (limited, on the interest portion of
repayments on the additional cost of resilient
construction) and a presupposition of insurance takeup is required. Sensitivity results show the net
resilience benefit may also be negative in many cases.
The opportunity cost of retaining funds in the SPV is
also not considered.

+

Significant risk reductions can be achieved throughresilient building, of the order of 50% in the example
provided. The high risk reduction relative to the cost ofresilience ratios mean a significant resilience dividend
is available to be monetised through the structure,
resulting in a positive net resilience benefit.

-

Challenges exist in the ability to achieve risk-based
pricing and in the implementation of an insurance
product that provides sufficient certainty at outset to
fully fund the SPV and estimate future savings.
Sensitivities suggest the structure may be uneconomic
in examples with higher marginal costs of resilient
building and lower risk or potential absolute risk
reduction.

+

The structure of the product has the flexibility torecognise future expected premium reductions bytransferring the need to wait to a party with greater
capacity to do so (either the lender or through an SPV
structure). If instead realised over the lifetime of theloan in reduced interest payments or otherwise, whilst
it is true that insurance risk reductions could be
accrued similarly on an annual basis outside of thisstructure, additional certainty around savings in themedium term is provided.

-

Delivery of the resilience dividend upfront is not an
implicit part of the product structure and may facechallenges through uncertainty in the total value of the
future saving in insurance over the lifetime of the loan.

+

Risk transfer is implicit in the structure which may
incentivise increased insurance uptake against natural
catastrophes so reducing the funding gap forreconstruction post event. Use of local providers can
aid with development of the insurance market.

-

Challenges remain in the detailed definition andattractiveness of the required insurance product whichneeds an element of multi-year commitment and preagreed recognition of risk reduction. Cash flow
analysis is also conducted against a non-resilient
counterfactual where insurance is already in place (oris mandatory). Where there is no motivation or ability
to seek insurance, the structure becomes lessattractive. The opportunity cost of additional spending
on insurance and the overall cost-benefit compared toother forms of financing should be considered.

TABLE 22 INSURANCE-LINKED LOAN PACKAGE ASSESSMENT AGAINST EX-ANTE CRITERIA

78

4.6.3. Summary and Next Actions
Within the analyses, the products have been structured to reflect the needs of the underlying use cases. Thereis sufficient flexibility within the product structures that they can and should be amended to reflect the specificneeds of any scenario in which they are applied. The appropriateness of the product solutions will vary by use
case, as will the results of the risk and cash flow analyses. The results we have presented demonstrate that the
products can be appropriate in certain hypothetical, but realistic examples – the analyses can be used as atemplate for the types of results that can support product structuring.
There are clear roles and opportunities within these types of product for the donor community, NGOs, local andinternational insurance and reinsurance markets, capital markets, development banks, investors, and local
service providers. The analyses suggest that both of the products are viable in the near-term, the following aresome actions that would support implementation:•

Development community--•

Identify appropriate use cases for these products and design pilot schemes to apply these products
at a reasonable initial scale.
These products are most appropriate in vulnerable high-risk areas, where the benefit of resilienceis greatest. A quantification of the non-monetiseable benefits of resilience within these use cases
will further amplify the value of using products that incorporate resilience.
Use partnerships with local agencies, development banks, impact investors, insurance and risk
service providers to structure pilot products that work to the benefit of all parties.

Insurance services-

As far as is possible, set appropriate expectations around long-term coverage so that products
which incorporate an insurance element can be costed appropriately at the start.
This may involve writing multi-year insurance contracts or entering into partnerships with donors
and development banks with the aim of supporting coverage across longer timescales.
Define clear and objective criteria which can be used to determine whether risk reduction measures
are recognised in a reduced insurance premium. This is expected to vary, though guidance on thispoint will be critical during the design stage of this type of product.

The innovation lab and product development have provided a foundation for further investigation into theseproduct solutions. Further work is required to develop these product solutions to a point where they can be fully
deployed, though the analysis indicates that there is good potential given the right use case.

795. APPENDIXi.

Summary of Existing Instruments

i.i.

Risk Transfer Instruments

Traditional insurance instruments effectively transfer risk but may not carry strong resilience building
incentives. Traditional insurance instruments, by definition, allow for the transfer of disaster risk to an insurer,
the market, investors or a pool of peers. However, their ability to provide economic incentives to build resiliently
are questionable. While it is possible that resilience investments could lead to lower future premium payments,
the incentive effect of this mechanism is often weak due to most insurance contracts only lasting for one year
(which means that the insured has less confidence over what premia may be beyond the term of the contract
and makes the insurer less interested in resilience investments) and due to the less than full use of risk-based
pricing. Another way traditional catastrophe insurance and reinsurance could motivate resilience building would
be through making resilience investments a prerequisite for providing an insurance cover, but in a competitive
industry such pre-conditions are often unrealistic.

FIGURE 26 TRADITIONAL INSURANCE IS WELL-ESTABLISHED BUT HAS SEVERAL BARRIERS TO DELIVERING RESILIENCE
BUILDING INCENTIVES. SOURCE: (KUNREUTHER ET AL. 2016; LLOYD’S OF LONDON 2017).

80

Multi-year contracts have the potential to create the correct resilience building incentives, but long-term
contracts may increase premiums. The longer-term relationship between insurer and insured could allow forthe benefits from resilience building to be internalized; the insured would be confident that their resilience
investments would be reflected in lower premia while the insurer would be motivated to support investmentsthat reduce the long-term risks they face. However, in practice, these contracts rarely exist as they entail
significantly higher capital requirements for insurers, which increases premia relative to single year contracts.
To deliver a resilience dividend, the instruments would also need to incorporate full risk-based pricing which
may be challenging for regulatory, social or data availability reasons. Used in isolation, they also would not allow
the resilience dividend to be captured upfront.

FIGURE 27 MULTI-YEAR INSURANCE CAN THEORETICALLY BOTH PROMOTE RESILIENCE AND INSURE AGAINST DISASTERS,BUT THE HIGH COSTS FOR BORROWERS AND LOW FLEXIBILITY FOR LENDERS MAKES IT UNATTRACTIVE. SOURCE:(KUNREUTHER & MICHEL-KERJAN 2015; MAYNARD & RANGER 2011; MAYNARD & RANGER 2013; KUNREUTHER ET AL. 2016).

81

i.ii.

Alternative Risk Transfer Instruments

Risk pools can be a cost-effective way for smaller countries (or other administrative entities) to transfer
risks; some risk pools mandate members develop contingency plans with resilience improvements as
a condition for entry. Recent risk pool arrangements such as CCRIF and ARC have enabled greater accessto disaster risk transfer to some of the most vulnerable countries in the world. These can allow countries totransfer risks more cheaply than if they acted unilaterally, and resilience can be boosted indirectly byrequirements for post-disaster contingency plans that can encourage building-back-better. In principle,
resilience investments could also be incentivised through the prospect of future lower premia, but for the same
reasons as discussed in section 1.3.1, the power of this incentive is likely to be weak. The dividend is also notavailable to the insured upfront at the point of making the resilience investment.

FIGURE 28 RISK POOLING IS ECONOMICAL BUT DOES NOT DIRECTLY INCENTIVISE RESILIENCE. SOURCE: (DLUGOLECKI ET
AL. 2013; OECD 2015B; UK GOVERNMENT 2016; WORLD BANK 2017).

82

Catastrophe (cat) bonds have seen increasing penetration in recent years as a risk transfer tool –however they are not typically structured to provide a resilience dividend. To some extent, formulaic
pricing at the annual resets of indemnity bonds, which allow coupon payments to be adjusted for exposure/risk
growth, would also recognize modelled risk reductions in a reduction in coupon payment. However, to date thisfeature has not been used in this way and is typically capped.

FIGURE 29 CATASTROPHE BONDS DO NOT HAVE DIRECT RESILIENCE BENEFITS BUT ARE EFFECTIVE RISK TRANSFER TOOLS.
SOURCE: (ARTEMIS, 2017A, 2017B, 2017C; CAVALLO, BORENSZTEIN, & JEANNE, 2017; CLARKE, DE JANVRY, SADOULET, &SKOUFIAS, 2015; CLARKE, MAHUL, POULTER, & LING TEH, 2016; IBRD, 2010; RE:FOCUS PARTNERS, 2017).

83

The resilience bond concept is potentially very relevant to this project as it aims to both transfer risk
and promote resilience; but it has not yet been used in practice. Resilience bonds are intended to provide
a reduction in insurance costs that can be captured as a resilience dividend or 'rebate'. The bond can be'triggered' during the bond term in the event of a disaster in an identical fashion to a catastrophe bond. However,in addition, it is also intended to simultaneously promote investment in resilient infrastructure projects. This isachieved by having a caveat where insurance premiums fall after resilience measures are implemented,
reflecting the lower risk investors face. This reduction on the insurance premium is then returned to the bondsponsor as a rebate, which can subsequently be used to invest in resilience projects. An analogy is a life
insurance policy offering rebates for actions that lessen health risks. Whilst it does manage to create a monetary
resilience dividend, the strict requirements such as data on risk exposure and modellable benefits fromresilience measure has so far prevented issuance.

FIGURE 30 RESILIENCE BONDS REQUIRE ACCURATE ESTIMATES FOR EXPOSURE AND RESILIENCE BENEFITS THAT MAKE
IT DIFFICULT TO ISSUE. SOURCE: (RE:FOCUS PARTNERS 2017).

84

i.iii.

Funding Instruments

Whilst delivering upfront capital for project financing is a missing feature amongst existing risk-transfer
products, other types of financing instruments have been able to achieve this in a variety of ways. These
financing-focused instruments span both the public and private sector, ranging from basic grants andconcessional lending from development agencies, bond-based capital market instruments and more innovative,
donor-supported bond issuances such as the IFF's Vaccine Bond program. Studying and incorporating theuseful design elements from these upfront financing instruments will be key to developing an end product thatinvolves risk transfer, encourages resilience and can deliver resilience dividends upfront for project financing.
This section outlines the basic mechanisms and potential application to resilient infrastructure of fivefinancing instruments – loans from multilateral development banks, Green Bonds, Social/Development
Impact Bonds, Environmental Impact Bonds, IFFIm's Vaccine Bond Program and the CAT DDO
instrument developed by the World Bank. This set of instruments offers an overview of both the common
mechanisms and some of the latest innovative designs in financing instruments, as well as helping to illustrate
how capital markets, private investors and donor support can be leveraged effectively to provide project
financing.
Multilateral lending for infrastructure by international development institutions can be extended either
on concessional or commercial terms. Concessional loans are loans that are extended on moregenerous terms than market loans. The concessionality is achieved either through interest rates below thoseavailable on the market or by grace periods, or a combination of these. For example, the World Bank’s IDA
extends concessional lending to the poorest developing countries – it provides credits at little or no interest rate
and repayments are stretched over 25 to 40 years, including 5-to 10-year grace period. Multilateral lenders canalso provide loans on commercial terms, often offering long-term source of finance (20/30-year loans) criticalfor infrastructure projects.
Green bonds leverage capital markets to provide upfront funding for projects with positiveenvironmental benefits, but do not generate a resilience dividend or involve risk transfer. They are similar
to traditional bonds, but the funding generated from the green bond can only be used for 'green' projects withenvironmental and/or climate benefits. The mechanism is simple and tested, and is effective at generating large
volumes of capital over long durations, making it suited for the demands of infrastructure projects. The rapid
growth in green bonds in recent years demonstrates the growing investor appetite for financial instruments withstrong ESG credentials, with over $250 billion of green bonds outstanding in 2017.

Impact bonds, also known as pay-for-performance contracts, transfer the risk of implementing a project
to private investors who receive principal repayment plus a financial return if – and only if –independently verified performance targets have been achieved. They are therefore not ‘bonds’ in theconventional sense as investors stand to lose part or all of their investment if unsuccessful. Depending on thenature of outcomes pursued, these contracts can be social (SIB), development (DIB) or, more recently,
environmental (EIB) impact bonds, typically issued by a government or a donor, funded upfront by private sector
investors and executed by private sector service providers. This effectively transfers the project execution risk
from governments and donors to investors. Impact bonds are an attractive option in theory as they promoteprivate sector involvement. However, adapting them to resilient infrastructure investment may prove difficult.
First, they typically tackle easy-to-measure social, environmental and development outcomes. Applying thesame outcome simplicity to resilience can be limiting, given the complicated nature of resilience measures andthe associated measurement issues. Second, commercial viability of these instruments for large infrastructure
projects is questionable – SIBs have mostly been used for smaller scale projects, there is only one example ofa privately invested EIB23; though a number of DIBs are in development, there has been no large scale
deployment so far.
The International Finance Facility for Immunization's vaccine bonds convert long-term donor pledges
into upfront capital for immediate project finance. IFFm sells 'vaccine bonds' in capital markets that are23

In 2016, DC Water raised $25 million to test the feasibility of green infrastructure for controlling storm water runoff. Should green
infrastructure outperform expectations, investors will receive an additional $3.3 million but will lose $3.3 million if it underperforms.

85effectively backed by the pledges from donors – this secures favorable pricing and provides immediate
resources to support immunization programs (Gargasson & Salomé 2010). IFFIm's structure of involving
developed country funding and capital markets to improve outcomes could provide a source of inspiration forthis project for how donor support can be utilized effectively. Whilst the instrument does not have any risk
transfer element, it has been able to generate large amounts of funding (nearly $6 billion from 2006-2016) andhas been effective in mobilizing action. However, thought should be given as to whether the same investor
appetite would exist for bonds supporting resilient infrastructure where the outcomes of projects are less obvious
and potentially less marketable than for vaccination programs.
The World Bank's Catastrophe Deferred Drawdown Option (CAT DDO) in an innovative form ofcontingent capital to provide immediate liquidity in the immediate aftermath of a disaster. The CAT DDO
is separated from more basic contingent credit options by the 'soft trigger' it employs and the flexibility in its
terms. Funds of up to $500 million from the CAT DDO are available immediately once a state of emergency isdeclared due to a disaster, allowing funds to be dispersed rapidly as no evaluation of damages needs to beundertaken (GFDRR 2011). The CAT DDO has a renewable draw down period that can be extended up to 15
years as well as a 'revolving feature' where any funds repaid can subsequently be re-withdrawn if required. This
flexibility in access, repayment time and the continued availability of repaid amounts has enabled the CAT DDO
to be often used – eight out of twelve countries with CAT DDO agreements in 2016 had utilized it to somedegree (The World Bank 2016b), including the Philippines withdrawing $500 million in 2011 after Storm Washi(The World Bank 2011).

An additional caveat is that countries must have disaster risk management programs in place to be eligible for
the CAT DDO, further encouraging disaster resilience. In Colombia, 627 municipalities created disastermanagement plans and there was significant expansion of disaster monitoring stations around the country (TheWorld Bank 2017a). The CAT DDO represents an example of how basic, existing funding instruments can be
modified to be better suited for developing countries and providing disaster relief.

86

ii.

OECD-DAC Database Donor List

DAC Countries

Non-DAC Countries

Multilateral Agencies

Australia
Austria
Belgium
CanadaCzech Republic
Denmark
FinlandFranceGermany
GreeceHungary
Iceland
Ireland
Italy
Japan
Korea
Luxembourg
Netherlands
New Zealand
NorwayPolandPortugal
Slovak Republic
Slovenia
Spain
SwedenSwitzerland
U.K.
U.S.

Azerbaijan
Bulgaria
Croatia
CyprusEstonia
IsraelKazakhstan
KuwaitLatviaLiechtenstein
Lithuania
Malta
Romania
RussiaSaudi Arabia
Chinese Taipei
Thailand
Timor-Leste
TurkeyUnited Arab Emirates

IMF (Concessional Trust Funds)
African Development Bank, Total
African Development Bank [AfDB]
African Development Fund [AfDF]
Asian Development Bank [AsDB]AsDB Special Funds
Inter-American Development Bank [IDB]IDB Invest
IDB Special Fund
Caribbean Development Bank [CarDB]
Council of Europe Development Bank [CEB]
European Bank for Reconstruction and Development [EBRD]
Islamic Development Bank [IsDB]
Food and Agriculture Organisation [FAO]
International Atomic Energy Agency [IAEA]
IFADInternational Labour Organisation [ILO]
UNAIDS
UNDP
UNECE
UNEP
UNFPA
UNHCR
UNICEFUN Peacebuilding Fund [UNPBF]
UNRWA
WFP
World Health Organisation [WHO]World Tourism Organisation [UNWTO]
International Bank for Reconstruction and Development [IBRD]
International Development Association [IDA]International Finance Corporation [IFC]
Adaptation FundArab Bank for Economic Development in Africa [BADEA]
Arab Fund (AFESD)
Climate Investment Funds [CIF]
Global Alliance for Vaccines and Immunization [GAVI]Global Environment Facility [GEF]
Global Fund
Global Green Growth Institute [GGGI]Green Climate Fund [GCF]Montreal Protocol
Nordic Development Fund [NDF]
OPEC Fund for International Development [OFID]OSCETABLE 23 A LIST OF THE DONORS ACCOUNTED FOR IN THE OECD-DAC AID DATABASE.

iii.

Innovation Lab Use Cases

The following use cases were used to stimulate discussion at the Innovation Lab.

87

USE CASE 1
SMALL, LOW INCOME COUNTRY – SCHOOLS – EARTHQUAKE-GROUND SHAKING– BUILDING TO CODEThe Gorkha earthquake in April 2015 destroyed 35k classrooms and left more than 1m children with no school
to return to24. There are ongoing efforts in Nepal to build according to government approved seismic-resistantdesigns, however effectiveness of implementation during the construction phase is variable. If constructed using
suitable design codes, which are fully implemented, school structures can remain largely intact following
earthquakes, protecting the occupants, and subsequently acting as safe communal spaces in the months that
follow. This use case presents several challenges to the implementation of innovative financing that are more
specific to countries in similar low-income country.

Effective
enforcementof building
codes iscurrently
challenging

Low uptake of
insurancecoverage

Highlyconstrained
national
budgetLimited DRFI
capacity

Case Study
300 Primary Schools in Kathmandu Valley to bebuilt-back-better (rebuild only, no retrofit)
Building to higher seismic design standards
creates a resilience dividend (risk reduction)
Assumption 1: Construction costs for 1-storey
schools in an urban setting cost ~$1kper. student. Total portfolio value = $28million

Assumption 2: Reinforced Concrete Moment
Resisting Frame (RC MRF), with excellent
construction quality costs 1.25x more than the
traditional Masonry alternative
FIGURE 1 MAP OF 300 PRIMARY SCHOOLS IN KATHMANDU VALLEY (CIRCLES SIZE PROPORTIONAL TO NUMBER OFSTUDENTS).

24 https://plan-international.org/press-releases/nepal-earthquake-urgent-need-rebuild-and-repair-schools#

88PRIMARY RESILIENCE DIVIDEND (REDUCTION IN PHYSICAL ASSET DAMAGE)
A comparative risk analysis has been completed to quantify the potential risk reduction possible from building 300 primaryschools according to well implemented ‘resilient’ seismic-resistant design codes rather than using poorly implemented
standard design practices25.
••••

Base Case: Schools built using confined masonry and with poorly implemented
building codes
Resilient Case: Schools built to better than code (reinforced concrete moment
resisting frame) and building standards are enforced
Risk Reduction: Up to 50% reduction in damage experienced during an eventand expected annual loss (comparative vulnerability curves shown in Figure 3).
Gorka Earthquake Analysis: For the portfolio of primary schools in Kathmandu,
the ground shaking in MMI at each location is calculated from the USGS
ShakeMap26 of the event (Figure 2), and the potential damage reduction between
construction types and methods is shown in Figure 3.
FIGURE 2 USGS SHAKEMAP (MMI) FOR
GORKA EARTHQUAKE OVERLAID ON
PRIMARY SCHOOL LOCATIONSFIGURE 3 COMPARISON OF VULNERABILITY CURVES FOR BASE (CONFINED MASONRY – POOR CONSTRUCTION) AND RESILIENTCASES (MRF – EXCELLENT CONSTRUCTION), INCLUDING AN INTERMEDIATE ANALOGY WHERE SCHOOLS ARE BUILT TO EXISTINGCODES BUT BUILDING STANDARDS ARE ENFORCED. GORKHA MMI RANGE OVERLAID.

25

For the purposes of this analysis, representative asset loss exceedance probability curves have been developed using a combination of RMS earthquake
source models incorporating Nepal alongside RMS model components from comparable/neighboring regions.
26
https://earthquake.usgs.gov/earthquakes/eventpage/us20002926#executive

89

RESILIENCE METRICS
AAL Reduction and Discount Adjusted Return on Investment (ROI10y):
•
•
•
•
•
•
•

•

The case study assesses 300 schools with a total replacement value of $27.9m.
The Base Case average annual loss (AAL) from ground shaking due to earthquake is $47.8k or 0.17% of total
replacement value.
Building the 300 schools to better than code, the Resilient Case, has an associated cost of resilience of an additional$7.0million or 25%.
This corresponds to an 53% reduction in the AAL to $25.2, or a $22.6k reduction in absolute terms.
This reduction in AAL, or ∆AAL, can be equated to an equivalent reduction in insurance premium payment if thepremium is purely risk based.
This reduction in premium payment could be made available as the resilience dividend.
The cost benefit of investment in resilience can be approximated using the Net Present Value (NPV) of the additional
cost of resilience at outset and the discounted27 future potential cash flow of annual resilience dividends over a 10-yeartime horizon in the form of a reduction in premium. The Return on Additional Investment is presented as an absolute
number describing benefit-cost, and as a percentage
ROI10y = -$6.83m (total additional cost of resilience = $6.99m), or -97.7% (e.g. -20% implies that 80% of the total initialinvestment has been made up by 10y of accrued PV adjusted benefits)

TAIL RISK
1 in 100 Saving:
•
•

•
•

•

Earthquake risk is typically low frequency but
high severity.
Decision making around investment in resilienceshould consider the potential for damage
reduction across a range of event severities andlikelihoods.
Figure 4 illustrates the different risk profile of thetwo construction types.
The red curve shows the Base Case probabilityof exceeding a range of loss thresholds on a per
occurrence basis, e.g. there is a 1% annual
probability that the 300 primary schools will incurat least $1.2 million worth of damage from anearthquake.
The blue curve shows the Resilient Case, and thedashed curve shows the probabilities of making
a range of savings.

FIGURE 4 EXCEEDANCE PROBABILITY CURVEDISPLAYING EVENT LOSSES FOR A RANGE OF
EXCEEDANCE PROBABILITIES ($5M IS ~20% OF THE
TOTAL PORTFOLIO VALUE)27

The 10% discount rate is based on the Green Book guidance that discount rates for appraisals in developing countries should be based on the social time
preference rate appropriate to those countries. Existing DFID and World Bank practice points to rates in the region of 10-12%. The first resilient dividend isassumed to be realized in year 0 as a simplifying assumption and inflation in insurance premium payments is not considered. More detailed and comprehensive
NPV calculations will vary depending upon the product solution and associated cashflows.

90

KEY TAKEAWAYS AND METRICS▪
▪
▪
▪

Adherence to existing building codes can yield substantial resilience benefits (~25% reduction in damage between poorand good construction)
Return on investment calculations provide minimal support for investment in resilience measures that are tailored at
low frequency events
Seismic resistant buildings are more designed to protect life than to minimise building damage
ROI calculations that use reduction in AAL (based only on asset damage) do not account for the additional benefits that
result from building more resiliently

TECHNICAL CHALLENGES
•

•
•
•
•
•

Cost-benefit of resilience spending to protect against low probability high severity events. There are factors beyond
the asset damage costs that must be considered for low-frequency high-severity events in particular▪
Economic loss▪
Protection of life▪
Continuity of education services
How can the challenge presented by high discount rates be overcome in incentivising spending on resilience?
Can reductions in AAL translate into meaningful reductions in premium when other contributing factors to thetechnical premium and pricing are considered e.g. pricing in of data uncertainty?
What are the challenges of deploying insurance in a non-insured world
How can the correct implementation of design codes be enforced?
How should maintenance costs be considered?

91

USE CASE 2
SMALL ISLAND STATE – LOW-INCOME HOUSING – HURRICANE – BUILD BACKBETTER
Low-income housing in Dominica was heavily damaged during the hurricane season of 2017. There is apressing need to ensure that replacement housing is built in a resilient and sustainable manner, and thatpartially-damaged and undamaged housing is addressed to ensure that it performs well in the years to come.
A combination of rebuild, repair, and retrofit is required to ensure that communities are well protected against
wind risk. This use case presents an opportunity to develop a product that is appropriate for lighter infrastructure(shelter & housing), for a combination of rebuild and repair, in a setting which requires immediate attention.

Urgent need torebuild andrepairdamagedproperties

Limited local
resources(amplified
reconstruction
costs in SIDS)

Exposure to
multiple perils(wind, flood,
landslide,earthquake,
volcano)Highlycorrelated risk
across island

Case Study
3000 low-income properties distributed acrossDominica, combination of rebuild and repair
Build structural resistance to wind risk
Assumption 1: Single storey masonry
construction, 500 sq. ft. ($50 psf. base cost = $25k
property value) - assume simiar costs across island
Assumption 2: Additional costs of resiliencemeasures based on US analogy, from National
Institute of Building Sciences

FIGURE 1 MAP OF 3000 LOW-INCOME PROPERTIES ACROSS DOMINICA – DISTRIBUTED ACCORDING TO LOCATIONS OF
INSURED PROPERTIES IN THE RMS EXPOSURE DATABASE28

28

http://www.nibs.org/page/mitigationsaves

92

PRELIMINARY IMPACT ASSESSMENT FROM 2017 HURRICANE SEASONFIGURE 2 PRELIMINARY DAMAGE ASSESSMENTS FOR HOUSING IN DOMINICA (90% DAMAGED OF ~30K PROPERTIES)RESILIENCE OPTIONS (REBUILD AND RETROFIT)
The RMS North Atlantic Hurricane model has been used to quantify the risk reduction to be expected for a range of building
and retrofit options across our hypothetical housing portfolio. Results for a range of options are presented below:
Resilience Options
Resilience Measure (Base Cost +X%)
No Protection (+0%)
Roof Anchor & Sheathing (+1%)
Roof Cover & Sheathing (+2.5%)
Roof Anchor & Covering, and Opening Protection (+4.4%)
Full Roof Retrofit (+8%)
Full Retrofit (+9.9%)

Cost
Additional
Cost (%)
0.0%
1.0%
2.5%
4.4%
8.0%
9.9%

Total Cost($million)
96.2
97.2
98.6
100.5
103.9
105.8

Risk
Absolute
AAL ($k)
289.5
203.0
192.2
195.0
131.1
119.9

Reduction in Average Annual Loss
(Relative to Base)
AAL
0%
30%
34%
33%
55%
59%

XS25
years
0%
34%
35%
35%
58%
62%

XS100
years
0%
33%
31%
36%
54%
60%

XS250
years
0%
29%
26%
33%
48%
55%

TABLE 24 COSTS AND SAVINGS FOR A HYPOTHETICAL HOUSING PORTFOLIO AND A RANGE OF RESILIENCE OPTIONSFIGURE 3 RESILIENCE OPTIONS FOR REBUILD AND RETROFIT: COSTS AND RESILIENCE DIVIDENDS

93

SAVINGS EXCEEDANCE PROBABILITY▪

The below curves show:▪
Loss exceedance probability for ‘base structure’ (no additional wind protection)▪
Savings exceedance probability curves for range of rebuild and retrofit options

FIGURE 4 SAVINGS EXCEEDANCE PROBABILITY CURVESKEY TAKEAWAYS AND RESILIENCE METRICS
▪
▪
▪
▪
▪
▪

Large and immediate need for investment in repair and rebuild of homes
Low-cost resilience measures can yield a tangible resilience dividend when the peril has high frequency. However, they
may generate lower damage reductions at higher wind speeds
Combinations of resilience measure can increase resilience across range of wind speeds (need targeted investment
based on defined resilience targets/ risk tolerance levels)
Possible to generate savings of up to 60% for 10% of additional up front investment
Even for low-cost resilience measures, present value adjusted resilience dividends are unlikely to pay off additional costof resilient infrastructure (due largely to discount rate of 10%)
ROI calculations do not consider other forms of benefit from resilient building such as welfare and other socioeconomic
factors

94

TECHNICAL CHALLENGES
•

•
•
•
•
•

Exposure across multiple perils including landslide – only wind is considered here for simplicity.
▪ Mitigation of landslide risk requires larger scale land planning than consideration of individual
building risk.
Low insurance penetration rates
Risk ownership and responsibility for premium payments (question of premium financing)
Very high-risk environment, island has been repeatedly impacted by large hurricane events (David 1979,
Erica 2015, Maria 2017)
Limited local resources for rebuilding (<10 architects across the whole island)
How to maintain resilience of building stock95

USE CASE 3
CARIBBEAN SMALL ISLAND – PORTS – HURRICANE –DEFENCES+PREPAREDNESS
Tourism provides significant income for Small Island Developing States (SIDS) in the Caribbean. During the
2014-2015 cruise season, cruising generated $2.4 billion in direct economic impact for the Caribbean andcreated nearly 55,000 jobs and $842 million in wages throughout the region 29. Maintaining functioning ports
helps to promote continuity in jobs and income for impacted islands following disaster30. There may be potential
to reinforce existing ports to make them more resistant to storm damage, or to develop coastal protection
measures to protect the areas surrounding terminals. The benefactors of more resilient terminals vary from thecruise ship companies, to the local business owners and general population. This use case presents an example
where defences and/or preparedness plans may be appropriate to reduce the severity of impact.

Coastalprotection
infrastructure
can beexpensive

Diverse rangeof benefits andbeneficiaries
associatedwith
operational
ports

Justifying
resilience invulnerable andchanging
coastalenvironments

Sustainabilityof green
versus grey
protective
infrastructure

Case Study
Hurricane risk from wind and storm surge to 1 port facility in the
Caribbean (illustrative example for Turks & Caicos)

Quantify the reduction in number of days to full recovery that
result from; (a) storm surge protection, and; (b) better
preparedness plans

Assumption 1: port location is suitable forconstruction of surge defence infrastructure(defences are 100% effective at specified defence
level)
Assumption 2: business interruption vulnerability
curves are approximately equivalent to the numberof days the port is unoperational for
FIGURE 1 TURKS & CAICOS PORT LOCATION WITH THEORETICAL COASTAL PROTECTION MEASURES

29
30

http://www.f-cca.com/downloads/2015-cruise-analysis-volume-1.pdf
http://www.caribbeanforeveryone.com/

96

RISK TO PORTS
The RMS North Atlantic Hurricane model has been used to quantify the Business Interruption (BI) risk to an illustrative port
in the Caribbean.
The resilience dividend for this example is measured in ‘Days of Downtime’. The cost of 1 day of BI varies significantly
between beneficiaries of a functioning port, from cruise operators to local business owners.

FIGURE 2 EXCEEDANCE PROBABILITY CURVES SHOWING: (LEFT) DOWNTIME PROBABILITY FOR WIND AND WIND+SURGECOMBINED, AND: (RIGHT) STORM SURGE HAZARD

EXAMPLE RESILIENCE OPTION 1 – COASTAL DEFENCES (ENGINEERED/NATURAL)
Storm Surge Protection:
▪
▪
▪
▪

▪

Surge defences can reduce the impact from events thatcause low levels of storm surge
Impact to ports is measured in ‘Days of Downtime’(annualised metric is Average Annual Downtime – AAD)
There may be additional benefits to coastal communities
from reduced storm surge risk
There may be negative impacts to local ecosystems or
nearby unprotected communities from large defence
infrastructure
Natural defences (coral) could be deployed to reduce
storm surge impact
Surge
Protection (ft.)
No Protection
3
4
5
6
7

AAD
0.85
0.78
0.51
0.27
0.14
0.09

AAD
Reduction
9%
41%
68%
84%
89%

1 in 25 year
saving (days)
1.4
3.91
5.8
6.37
6.51

FIGURE 3 DOWNTIME SAVINGS FORRANGE OF DEFENCE HEIGHTS (3-9FT)

1 in 100 year
saving (days)
2.22
6.28
9.97
12.33
13.41

97

EXAMPLE RESILIENCE OPTION 2 – CONTINGENCY PLANNING
The level of preparedness of a port with regards to storm surge will also affect the level of business interruption, so should
be considered when assessing resilient solutions. The preparedness level relates to business continuation plans thatincorporate the following:••••

Critical spare parts are stored on site to ensure that post disaster recovery of equipment is as fast as possible
On site fuel storage and generators so there is power available even if public grid infrastructure is downContingency plans to minimise damage to equipment e.g. storing valuable assets inside or strapping down
items
Mitigation techniques such as boarding up windows

Wind and Storm Surge
Preparedness

AAD

Minimal

2.23

Average

1.86

Extensive

1.41

Change AAD Change AAD (%) 1 in 25 Loss 1 in 100 Loss
0.36

0.20

14.32

28.45

-

-

11.93

23.70

-0.46

-0.24

8.95

17.78

FIGURE 4 DOWNTIME EXCEEDANCE PROBABILITY CURVE FOR RANGE OF PREPAREDNESS OPTIONS (WIND AND SURGE)

TECHNICAL CHALLENGES••••

It takes time to fully implement coastal protection measures
Coastal protection may not be 100% effective when surge events do occur
Storm surge risk is amplified by rising sea-level. How to justify building resilience in a changing environment
Challenges of green infrastructure (coral reefs, mangroves)▪
Requires long-term investment of resources▪
Sensitive to changes in local conditions▪
How to capture environmental and social benefits of natural defences▪
Not appropriate in all locations▪
Can be severely damaged during hurricanes

98

USE CASE 4
SOUTH-EAST ASIA – TRANSPORT INFRASTRUCTURE – EQ – RAPID RECOVERY/
MAINTAINING A SERVICE

Working transportation networks are fundamental to recovery following large disaster events. They enable themovement of rescue teams and the distribution of resources immediately following an event, and in the longer
term, the transportation of goods and people. Damages resulting from both seismic and hydrologic events canquickly render a road impassable. It may be uneconomical to make roads universally resistant to earthquakes.
Recovery mechanisms that quickly and effectively restore networks may therefore be more appropriate tobuilding road resilience to earthquake risk. This use case provides an example where a financial product could
be designed to increase resilience of a service, as well as the physical asset. Products might concentrate on
funding effective maintenance or recovery for infrastructure that is ‘designed to fail’, rather than funding new
construction or upgrade.

Essential
services need
to be restored
quickly
following
damageLargeambitions for
upgradinginfrastructure
in Indonesia

Decentralised
governanceslows approval
for large
infrastructure
projects

Responsibility
for
maintenanceand repair
variessubnationallyCase Study
Restoring function to essential services following damage(example uses transportation infrastructure in Indonesia)

Presents simple parametric risk transfer trigger to highlightpotential role in rapid recovery mechanisms

Assumption 1: Value and vulnerability of all majorroad infrastructure in Indonesia is equivalent

Assumption 2: Road incurs 'total' damage when it
experiences ground shaking in excess of MMI=8.5

FIGURE 1 EXISTING PRIMARY ROAD NETWORK ACROSS INDONESIA31

31

https://www.pwc.com/id/en/cpi/asset/indonesian-infrastructure-stable-foundations-for-growth.pdf

99PROBABILITY OF IMPACT

Probability of Impact – the earthquake risk to 100,000 km of the primaryroad infrastructure in Indonesia is presented in the Exceedance Probability
curves. The severity is measured as % of Road Impacted, and the separate
curves describe the probability of impact by ground shaking in excess of arange of MMI thresholds.
For example: the grey dot shows that there is a 2.5% annual
probability (1 in 40) that 3.3% of the total road network will be
impacted by ground shaking in excess of MMI=6. Road damage
experiences significant damage (>10%) in the range MMI=8-10.

Key Metric: ~1% annual probability (1 in 100)that 1% (1,000km) of road will be impacted by
MMI in excess of 8.5

FIGURE 2 EXCEEDANCE PROBABILITY DISPLAYING PROBABILITY OF EARTQUAKE IMPACT TO ROAD (BY LENGTH OF ROAD AFFECTED)RESILIENCE OPTIONS

Rapid recovery - reduces socio-economic impact• Building redundancy• Rapid access to funds and services for repair and build back quicker

Physical resilience - reduces damage occurrence• Maintenance• Slope stabilisation and drainage• Structural improvement of road100

POTENTIAL FOR COMBINED INDEMNITY-PARAMETRIC COVER

FIGURE 3 CONTRIBUTION TO AVERAGE ANNUAL LOSS BY GRID CELL (1X1 DEG)

Parametric•Based on earthquake location or ground motion thresholds (event parameters)•Can provide rapid payouts and efficient cover for large events

Indemnity•Could combine rapid damage and loss assessments for smaller events/ maintenance•More suitable for frequent events but likely to be local in scale

MAIN CHALLENGE
How to design a financing and risk transfer product that ensures continuity of service as a primaryfunction, provisioning for impacts across the range of frequency and severity (from potholes tosinkholes).

TECHNICAL CHALLENGES••

Tension of scale – infrastructure investment/ maintenance at a local level, versus risk transfer at a large scale.
Does rapid restoration compromise the ability to build-back-better?

•••

Scarcity of data on public infrastructure assets drives high premiums
Challenging legal and regulatory environment
Defining risk ownership and key stakeholders across national scale infrastructure101

USE CASE 5
CARIBBEAN –RAPID RECOVERY OF CRITICAL SERVICES – EDUCATION
Natural disasters and man-made shocks impact tens of millions of children every year, causing both direct
damage (e.g. loss of classrooms and books) and, much more critically, indirect damage through lost schoolingdays and increased permanent drop-out rates. This has long-term impacts on individual prospects and wider
economic development. The November 2017 Post-Disaster Needs Assessment (PDNA) for Dominica foundthat 137 out of 163 (84%) educational facilities have some level of damage (damages of $74m). Access toschooling was interrupted for 100 percent of the student population. Total recovery needs for the sector were
estimated to be US$94million. Four months on, Dominica has made steady progress with 94 per cent of schools
re-opened albeit with some children accessing schools in temporary settings due to a shift in operations.
Rapid recovery of services is critical to reducing the long-term impacts. In Dominica, the learning time forstudents is estimated to have been decreased by at least 40 percent, from 930 hours per year to 584 hours per
year. Can we build systems that respond quickly while also building resilience long-term?
The recovery of critical services like education is exacerbated by the disruption of access to electricity, water,
and waste management. Almost four months since hurricanes Irma and Maria hit the Caribbean islands, thereturn of some critical services remains slow in some countries. For example, in Dominica, only around 10% of
people, mainly in the cities, have access to electricity.
This case study considers whether a risk transfer product could finance rapid recovery of basic services
associated with critical infrastructure in immediate aftermath of future events (e.g. schools, hospital, water,
power), but linked to preparedness and contingency planning investments pre-disaster that ensure rapid
response. How could such an instrument be embedded within programmes to build the resilience of thisinfrastructure and facilitate longer-term reconstruction where necessary? The case study particularly focusses
on education services.

Low
resilience of
criticalinfrastructuresuch asschools

Parametric
instruments
exist but are
not sector
specific

Dependence
on water,
power,
sanitation

Needsystems to
respondquickly

Major
programmes
to build
resilience but
no link to risk
transfer

PREVIOUS HISTORICAL EVENTS
Hurricane David (1979) - Strong winds from Hurricane David destroyed or damaged 80 percent of the homes (mostlywood) on the island, leaving 75% of the population homeless, with many others temporarily homeless in the immediate
aftermath. In total, 56 people died in Dominica and 180 were injured.
Tropical Storm Erika (2015) - Fourteen people were reported dead, 16 missing, 574 rendered homeless, and 1,034
people evacuated due to the unsafe conditions in their communities. Damage and losses were estimated at US$483
million (90% of the country’s GDP). Of the 75 schools impacted on the island, 21 schools remained closed at the start ofterm.
Hurricane Maria (2017).

102

SCALE OF 2017 IMPACT

Case Study

Hundreds ofRapid recovery
schools
has major
potentiallybenefits but
damaged, withrisks of tradedependencies
offs with longer
on power,water,
term resiliencetransport etc.

Reconstruction
costs,eg. for
Dominica$94m

FIGURE 1 DOMINICA POST-DISASTER NEEDS ASSESSMENT.

PROBABILITY OF IMPACT

FIGURE 2 50KM RADIUS CIRCLE AROUND DOMINICA – THERE IS A 0.37% ANNUAL PROBABILITY THAT A HURRICANE WILL
INTERSECT THIS REGION WITH MAX 1-MIN SUSTAINED WIND SPEEDS AT LEAST EQUIVALENT TO THOSE EXPERIENCED
DURING HURRICANE MARIA (~160MPH). ON THIS BASIS, MARIA WAS A 1-IN-270 YEAR EVENTTECHNICAL CHALLENGES•••

Re-establishing education services in a post-disaster setting where other infrastructure has been heavily damaged
Building resilience in a country that has been severely impacted by multiple recent events
Building effective disaster response plans into financing and risk transfer instruments

103

iv.

Key Terms and Calculation Methods

AAL: Average Annual Loss (AAL) is equivalent to the expected cost of damage to an asset in a single year.

∆AAL: The reduction in Average Annual Loss (AAL) is the difference between the AAL of a traditional build anda resilient alternative. Absolute reduction in Average Annual Loss (∆AAL) is one measure of the resilience
dividend.

∆𝐴𝐴𝐿 = 𝐴𝐴𝐿𝐵𝑎𝑠𝑒 − 𝐴𝐴𝐿𝑅𝑒𝑠𝑖𝑙𝑖𝑒𝑛𝑡
AAD: Average Annual Downtime (AAD) is equivalent to the expected downtime, measured in days, that a pieceof infrastructure is non-operational for. AAD is indicative of the severity of business interruption after an event.

Exceedance Probability (EP): EP is the probability that a loss will exceed a given threshold amount in a single
year. It is displayed as a curve, to illustrate the probability of exceeding a range of losses, with the losses
represented along the X-axis, and the exceedance probability along the Y-axis.

FIGURE 1 EXCEEDANCE PROBABILITY CURVE

Return Period Loss: Rather than describing the probability of exceeding a given amount in a single year,
return periods describe how many years might pass between times when such an amount is exceeded. For
example, the figure above corresponds to a 20-year return period loss exceeding $150 million.

𝑅𝑒𝑡𝑢𝑟𝑛 𝑃𝑒𝑟𝑖𝑜𝑑 =1
𝐸𝑃+Cost: The additional cost of a resilience build, represented as a percentage of the total traditional
asset value.
Resilience Ratio: A ‘resilience ratio’ is a measure of risk reduction in comparison to the additional construction
costs for resilient structures. This cost-benefit of building more resiliently can be captured using this ratio:

104

𝑅𝑒𝑠𝑖𝑙𝑖𝑒𝑛𝑐𝑒 𝑅𝑎𝑡𝑖𝑜 (𝑦) =𝐴𝑑𝑑𝑖𝑡𝑖𝑜𝑛𝑎𝑙 𝑐𝑜𝑠𝑡 𝑜𝑓 𝑟𝑒𝑠𝑖𝑙𝑖𝑒𝑛𝑐𝑒 ($)∆𝐴𝐴𝐿 ($ ∙ 𝑦 −1 )Net Present Value: NPV is a measure of the profitability of a given project, by calculating the difference between
the present value of incoming and outgoing cash flows over a period of time. For a 10 year NPV, all incoming
and outgoing cash flows within 10 years are discounted, with a discount rate of 10% for this report32, to calculate
the present value of the project.
For example, the following diagram illustrates the method to calculate the NPV from a project that requires aninitial investment of $Y, and receives payments of $X over the next 10 years. The payments $X are thendiscounted, to produce the PV of the cash flows, $Z. For the purpose of this report, the initial investment $Y canbe thought of as the additional cost of resilience, $X can be the ∆𝐴𝐴𝐿 and $Z is the present value of the ∆𝐴𝐴𝐿.
10

𝑁𝑃𝑉10𝑦 = −𝐼𝑛𝑖𝑡𝑖𝑎𝑙 𝐼𝑛𝑣𝑒𝑠𝑡𝑚𝑒𝑛𝑡 + ∑𝑃𝑎𝑦𝑚𝑒𝑛𝑡𝑡 ∙ 𝑒 (−𝑟 ∙ 𝑡)

10

10

𝑡=0

= −$𝑌 + ∑$𝑋 ∙ 𝑒 (−0.1 ∙ 𝑡) = −$𝑌 + ∑

𝑡=0

𝑍𝑡

𝑡=0

FIGURE 2 DIAGRAM OF FUTURE CASH FLOWS IN 10 YEAR PERIOD

Benefit Cost: The benefit cost of investment in resilience can be captured using the Present Value of the initialcost and discounted future potential cash flow of resilience dividends over a 10-year time horizon.

𝐵𝑒𝑛𝑒𝑓𝑖𝑡 𝐶𝑜𝑠𝑡 =𝑃𝑉𝑟𝑒𝑠𝑖𝑙𝑖𝑒𝑛𝑐𝑒 𝑑𝑖𝑣𝑖𝑑𝑒𝑛𝑑 ($)
𝑃𝑉𝑐𝑜𝑠𝑡 𝑜𝑓 𝑟𝑒𝑠𝑖𝑙𝑖𝑒𝑛𝑐𝑒 ($)

Discounted Return on Investment (ROI): The ROI is the return that the owner of the asset will receive fromall future discounted resilience dividends, relative to the initial resilience cost.

𝑅𝑂𝐼 =𝑁𝑃𝑉10𝑦𝑃𝑉𝑐𝑜𝑠𝑡 𝑜𝑓 𝑟𝑒𝑠𝑖𝑙𝑖𝑒𝑛𝑐𝑒 ($)= 𝐵𝑒𝑛𝑒𝑓𝑖𝑡 𝐶𝑜𝑠𝑡 − 1

32

The 10% discount rate is based on the Green Book guidance that discount rates for appraisals in developing countries should be based on the social time
preference rate appropriate to those countries. Existing DFID and World Bank practice points to rates in the region of 10-12%. More detailed and comprehensive
NPV calculations will vary depending upon the product solution and associated cashflows.

105

LIST OF FIGURES
Table Number

Title

Page
NumberTable 1

Overview of Potential Performance Criteria for Impact Bond

43

Table 2Modelling and Economic Assumptions Used for Analysis

46

Table 3

Construction and Retrofit Cost Assumptions

47

Table 4

Risk Reduction and Resilience Dividend Metrics

47

Table 5

Applied Impact Bond Performance Criteria

51

Table 6

Cash Flow Scenarios Which Yield a Positive Investor RoI

52

Table 7

Cash Flow Scenarios Which Demonstrate the Return on Investment, And Cost Incurred to
The Outcome Funder, Based on Situations in Which the Project Fails to Deliver Against
the Defined Performance Criteria.

53

Table 8

Product Stakeholders

59

Table 9ILLP Components

60

Table 10Modelling Assumptions Used in The RMS Analysis for Base and Resilient Case63

Table 11

Costs, Average Annual Losses and Associated Standard Deviations for Base Case andResilient Case64

Table 12

Product Loan and Insurance Assumptions

66

Table 13

Key Metrics

67

Table 14

Key Cashflow Metrics

68

Table 15

Insurance Premium Sensitivity Testing

68

Table 16

AAL Sensitivity Analysis

69

Table 17

Risk Reduction (AAL) Sensitivity Analysis

70

Table 18

Earthquake Risk Sensitivity Analysis

70

Table 19

Earthquake Risk Sensitivity Risk Results

70

Table 20

Discount Rate Sensitivity Analysis

70

Table 21

Resilience Impact Bond Assessment Against Ex-Ante Criteria

75

Table 22

Insurance-Linked Loan Package Assessment Against Ex-Ante Criteria

76

Table 23

A List of the Donors Accounted for In The OECD-DAC Aid Database.

85

FigureNumber

Title

Page
NumberFigure 1

There Are Eight Success Criteria in Total That Should Be Met.

6

Figure 2

The Report Has Four Sections, Moving from A Background Literature Review, ThroughOur Innovation Lab and An Analysis of Solutions, Through to Potential Next Steps.

7

Figure 3

Global Infrastructure Needs To 2040 In Billion USD By Geography and by Sector (Source:
Global Infrastructure Hub 2017).

9

Figure 4

Development Financing Plays a Small but Significant Role in Infrastructure Financing.
Source (OECD & World Bank, 2015).

12

Figure 5

ODA for Infrastructure Sectors Is More Concentrated in Lower Income and Lower-Middle
Income Countries. Source (OECD, 2017C).

12

106

FigureNumber

Title

Page
NumberFigure 6

There Have Been Strong Increases in ODA From Multilateral Agencies in Recent Years.
Source (OECD, 2017C).

13

Figure 7

Greater Issuance of Loans Rather Than Grants Appears to Have the Driver of Recent
Growth in ODA from Multilateral Agencies. Source (OECD, 2017C).

13

Figure 8

Existing Instruments Either Focus on Providing Risk Transfer or Financing. Source (Vivid
Economics).

17

Figure 9

Summary of Findings According to Our Success Criteria. Source (Vivid Economics).

18

Figure 10

There Are Eight Success Criteria in Total That Should Be Met. Source (Vivid Economics).

21

Figure 11

Summary of Practical Challenges to Resilient Infrastructure and Post Disaster Recovery.
Source (Vivid Economics).

22

Figure 12

Three Key Themes Should Be Considered When Designing a Solution. Source (Vivid
Economics).

23

Figure 13

Vulnerability Curves for Base School Construction and Schools with Retrofit Measures.
Black Curves Show Damage Reduction as A Percentage, And in Absolute Terms.

26

Figure 14

Dominica Wind Speed Hazard Occurrence Exceedance Probability Curve.

27

Figure 15

Time Series of Net Present Value Benefit-Cost Ratio for A Range of Premium andDiscount Rate Assumptions

30

Figure 16

Overview of Product Solutions

31

Figure 17

Cashflows Underpinning the Resilience Bond

35

Figure 18

Illustrative Cashflows In the ReSCo Model.

38

Figure 19

Preliminary Schema for Resilience Impact Bond (Rib)45

Figure 20

Loss Occurrence Exceedance Probability Curves for Base and Retrofit Cases, And forEvent Savings (Including 5X Saving Sensitivity to Represent Non-Direct Benefits).

48

Figure 21

Generic Example Product Structure for Insurance-Linked Loan Package

60

Figure 22

Loss Occurrence Exceedance Probability Curves for Base and Resilient Cases

64

Figure 23

Cash Flow Analysis, All Amounts in Us$ Unless Specified

66

Figure 24

Time Series of Loan Savings That Result from Building Resiliently

67

Figure 25

Summary of Sensitivity Results. Showing the Points at Which the NPV Of The Structure
Reaches A Breakeven Point For A Selection Of Assumptions On The Cost Of Resilience
And Insurance Premium Calculation.

69

Figure 26

Traditional Insurance Is Well-Established But Has Several Barriers To Delivering
Resilience Building Incentives. Source: (Kunreuther Et Al. 2016; Lloyd’S Of London 2017).

78

Figure 27

Multi-Year Insurance Can Theoretically Both Promote Resilience and Insure Against
Disasters, But the High Costs for Borrowers and Low Flexibility for Lenders Makes It
Unattractive. Source: (Kunreuther & Michel-Kerjan 2015; Maynard & Ranger 2011;
Maynard & Ranger 2013; Kunreuther Et Al. 2016).

79

Figure 28

Risk Pooling Is Economical but Does Not Directly Incentivise Resilience. Source:(Dlugolecki Et Al. 2013; OECD 2015B; UK Government 2016; World Bank 2017).

80

Figure 29

Catastrophe Bonds Do Not Have Direct Resilience Benefits but Are Effective Risk
Transfer Tools. Source: (Artemis, 2017A, 2017B, 2017C; Cavallo, Borensztein, & Jeanne,
2017; Clarke, De Janvry, Sadoulet, & Skoufias, 2015; Clarke, Mahul, Poulter, & Ling Teh,
2016; IBRD, 2010; re:focus partners, 2017).

81

Figure 30

Resilience Bonds Require Accurate Estimates for Exposure and Resilience Benefits That
Make It Difficult to Issue. Source: (re:focus partners 2017).

82

107

v.

Innovation Lab Attendee List

EntityAttendee

EntityAttendee

ARTA
ARTA
Amlin
Arup
AWHA Consulting
Beazley
Clyde &Co
DFID
DFID
DFID
DFID
DFID
European Commission
First River Partners
GAD
Global Partnership
HiscoxLloyd's
Lloyd's
LSE
Mott Macdonald
Munich Re
NephilaNERC
ODI
Parhelion
PwC
PwC

Harvey Duckers
Paul Bispham
Gilbert Harrap
Jo da Silva
Claire Souch
Emma Whiteacre
Nigel Brook
Daniel Clarke
Harvey Naylor
Mark Povey
Nicola Ranger
Peter Bentley
Federico Berna
Peter Buettner
Ian Rogers
Theodore Purnendu Talbot
Benjamin Baltesar
Lucy StanbroughTrevor Maynard
Swenja Surminski
Madeleine Rawlins
Michael RothAdam Beatty
Ruth Hughes
Emily Wilkinson
Tony Stubbs
Nick Lane
Tom Strickland

Refocus
Refocus
Ren Re
RMS
RMS
RMS
RMS
RMS
S&P Global
Securis Investment Partners
Social Finance UK
START Network
Swiss Re
The Nature Conservancy
Vivid Economics
Vivid Economics
Vivid Economics
Westminster University
Willis Towers Watson
Willis Towers Watson
Willis Towers Watson
Willis Towers Watson
Willis Towers Watson
World BankWorld BankXL Catlin
XL Catlin
York University

Jamie Rhodes
Shalini Vajjhala
Ian Branagan
Charlotte Acton
Conor Meenan
Jed Scanlon
Peter Datin
Robert Muir-Wood
Miroslav Petkov
Espen Nordhus
Jane Newman
Judith Amar
Andreas Prystav
Kerstin PfliegnerDavid Ren
Irena Sekulska
John Ward
Tony Lloyd-Jones
Carlos Sanchez
David Simmons
Gavin Newton
Jacqueline Wharton
Simon Young
Jun Rentschler
Rashmin Gunasekera
Brendan Plessis
Emma Radcliffe
Piran WhiteACKNOWLEDGEMENTS
We extend our warmest thanks to the Innovation Lab attendees and to all those who contributed
throughout the duration of the research. This would not have been possible without your invaluable
insights.

108

CONTACTKey contact-

Nicola Ranger, Senior Adviser
n-ranger@dfid.gov.uk

.
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Contributors
RMS project team
Dr Charlotte Acton, Director
Conor Meenan, Senior Consultant
Jed Scanlon, Analyst
Daniel Stander, Global Managing Director

Vivid Economics project teamJohn Ward, Managing Director
Irena Sekulska, Engagement Manager
Ed Day, Engagement Manager
Dr Luke Kemp, Senior Economist
David Ren, Economist

DfID project team
Dr Nicola Ranger, Senior Adviser
Dr Daniel Clarke, ActuaryPeter Bentley, Adviser
Dr Harriette Stone, Adviser
Harvey Naylor, Programme Manager
Mark Povey, Infrastructure Adviser

Lloyd’s project teamDr Trevor Maynard, Head of Innovation
Lucy Stanbrough, Innovation Associate

re:focus partners project team
Dr Shalini Vajjhala, Founder & CEO
Dr Jamie Rhodes, Senior Fellow

DISCLAIMER

This report, and the analyses, models, methodologies, and predictions contained herein ("Information"), are based on RMS research, expertise, data provided
by third parties, and where applicable, proprietary computer risk assessment technology of Risk Management Solutions, Inc. ("RMS").
The findings and recommendations detailed in the Information are based on the RMS’ analysis of the available data sources as described in the document.
They do not constitute a complete view of the risk to low and low-middle income countries. As with other research of this kind, the findings rely upon historical
data to develop our recommendations to the UK Department for International Development (DFID).
The Information in this report may not be copied, photocopied, reproduced, translated, reduced to any electronic medium or machine-readable form forpresentation in any other format without the prior written consent of RMS. This Information should not be used under any circumstances in the development
or calibration of any product or service offering that competes with RMS.
The recipient of this Information is further advised that RMS is not engaged in the insurance, reinsurance, or related industries, and that the Information provided
is not intended to constitute professional advice.
RMS SPECIFICALLY DISCLAIMS ANY AND ALL RESPONSIBILITIES, OBLIGATIONS, AND LIABILITY WITH RESPECT TO ANY DECISIONS OR ADVICEMADE OR GIVEN AS A RESULT OF THE INFORMATION OR USE THEREOF, INCLUDING ALL WARRANTIES, WHETHER EXPRESS OR IMPLIED,INCLUDING BUT NOT LIMITED TO, WARRANTIES OF NON-INFRINGEMENT, MERCHANTABILITY, AND FITNESS FOR A PARTICULAR PURPOSE. IN
NO EVENT SHALL RMS (OR ITS PARENT, SUBSIDIARY, OR OTHER AFFILIATED COMPANIES) BE LIABLE FOR DIRECT, INDIRECT, SPECIAL,INCIDENTAL, OR CONSEQUENTIAL DAMAGES WITH RESPECT TO ANY DECISIONS OR ADVICE MADE OR GIVEN AS A RESULT OF THE CONTENTS
OF THIS INFORMATION OR USE THEREOF.

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