**1 Introduction**

Climate risk has significant implications for economic development and living standards in Ethiopia. One of the Government of Ethiopia’s planned responses to this risk is the Productive Safety Net Programme (PSNP), a safety net program for chronically food insecure households in rural Ethiopia that has been designed to be able to be scaled in years of drought to provide supplementary support to households. However, the effectiveness of this scaling up of the PSNP depends on the effectiveness of the underlying financing – if additional financing in a drought year is insufficient and slow, response will be insufficient and slow.

Financial planning for the scalability mechanism of PSNP requires thinking through potential costs and benefits of a range of financial and budgetary instruments, including emergency budget reallocations, contingency funds, insurance, and emergency appeals from the international community. Comparative financial analysis of this full range of instruments in a single coherent framework is challenging, but without this informed decision making is particularly challenging. The objective of this paper is to present a methodology for quantitative assessment of the costs and benefits of risk financing strategies to support fast, drought-responsive scaling up of the PSNP. The paper also illustrates how the trade-offs and uncertainties associated with different financial instruments can be quantitatively evaluated when considering alternative risk financing strategies. The proposed methodology builds on that of Clarke et al. (2016), and the practical application to Ethiopia’s PSNP may be informative both for the case of Ethiopia, as well as for other climate-responsive social protection systems.

The structure of this paper is as follows. First, this paper specifies in Section 2 a set of hypothetical rules for how and when the PSNP would scale up in response to shocks, and therefore we clearly define the contingent financial liability of PSNP. Second, in Section 3 we propose three hypothetical risk financing strategies and present assumptions about the economic and commercial environment. Finally, in Section 4 we analyze the cost of each risk financing strategy, both on an average basis and for different shock severities. Sensitivity and scenario testing of results is presented to illustrate how the costs might differ under different assumptions, or under different specifications for PSNP scalability. A glossary is included in Annex 1 outlining key terminology used in this paper.

# **Approach and Limitations**

The analysis presented in this paper makes assumptions about disaster risk, economic environment, and risk transfer instruments. The analysis considers hypothetical risk financing strategies for the PSNP costs, assuming perfect knowledge of the planned PSNP expenditures for different drought severities. This analysis is based on historic drought and population information. Information used in the analysis was both quantitative (e.g. additional drought-affected people based on historic rainfall) and qualitative (e.g. description of the PSNP) in nature. The information was of a high quality and broadly sufficient for the intended purpose. Where possible relevant sensitivity analyses were performed on the assumptions made.

For the avoidance of doubt, this paper does not present a World Bank or Government Actuary’s Department view of actual poverty estimates or the actual contingent liability of the PSNP to drought in 2