with differing outcomes having a clear and robust explanation. It is therefore acceptable to refrain from modeling any features of reality that affect all potential strategies in the same way, without having a material impact on the differences between strategies.

In the CC-DFA model, a risk financing strategy is a decision about the size of the contingent credit facility to purchase at the outset and rules about reinsurance purchase and the drawdown of any contingent credit. The only source of uncertainty in the model is that of the losses incurred in each year, which are assumed to be drawn from a specified loss distribution. The model abstracts from the nature of the losses, and can therefore be applied to a range of disaster risks, such as earthquakes, hurricanes or droughts.

The CC-DFA model outlined in this paper does not allow for other potential elements of a risk financing strategy, such as a dynamic fiscal allocation rule, or other sources of variation, such as investment returns, future portfolio size or composition, or reinsurance prices. These features could be easily added but, whilst adding further realism to the model, are second order from the point of view of contingent credit purchase, and may make interpretation of the model outputs more difficult.

At its core, a DFA model takes a risk financing strategy and a set of assumptions about future experience as inputs and deterministically projects the outcome. The core equations at the heart of the CC-DFA model are as follows: Equation ( 15 ) can be explained as follows. It is assumed that the government has a dedicated reserve fund which starts year with liquid reserves of and outstanding drawn down contingent credit of . The fund is assumed to immediately receive an annual budget allocation to a dedicated reserve fund, resulting in net increase in liquid reserves of . The fund then pays any reinsurance ( ), and in some years will pay a contingent credit upfront or renewal fee ( ). Reinsurance and contingent credit purchase is determined by the risk financing strategy, with reinsurance premiums calculated based on the assumed multiples. The financial conditions of the World Bank’s DPL with CAT DDO are used: the upfront fee of 0.50% of the contingent loan facility is payable at the start of year 1 and renewal fee of 0.25% of debt that has not yet been drawn down is payable at the start of years 4, 7 and 10. The fund earns interest of on its reserves, and then at the end of the policy year may receive claim income from reinsurers ( ) and must meet additional expenditure of . The government must meet the interest cost of any loan outstanding at the start of the year ( ) and may receive additional cash from drawing down additional debt of . Finally, the insurer earns interest on its reserves between the end of the policy year and the start of the next of .

Net reserves at time , , are equal to the total liquid reserves of the fund minus any outstanding drawn down contingent loan .

Given this core functionality, a large number of Monte Carlo simulations can be run using a specified risk financing strategy but with assumptions about future experience drawn from a specified probability distribution. A decision maker can then compare the simulated distribution of outcomes for different risk financing strategies, and choose the strategy with the preferred distribution of outcomes.

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