The design of the FCB draws on the lessons learned from the Risk Financing component of the PSNP, which was triggered in 2009, 2011, 2014 and 2015 following periods of drought. The FCB for 2015/26 was approximately US$50 million.

# **The Illustrative Contingent Liability**

The PSNP has been designed to be able to scale up in times of drought, providing benefits to additional households beyond the core caseload. This use of the contingency budgets of the PSNP has been carriedout in concert with the humanitarian appeal, which has continued to launch international appeals for food assistance. However, often the amount of additional benefits provided in times of drought through the PSNP and humanitarian system is driven by the availability of financial resources. This makes financial analysis of disaster risk finance strategies difficult as changes in the financial strategy can also impact the extent to which the PSNP will scale up and the humanitarian system will respond. Also, the availability of resources has little to do with the actual need on the ground, and so the scale up of the PSNP and humanitarian system should theoretically be based on need rather than resources.

To sidestep this challenge, the key assumption of all subsequent analysis in this paper is that pre-agreed rules are in place which fully define the supplementary funding provided to woredas in times of drought. These rules are assumed to be fixed, regardless of the financing strategy in place. With pre-agreed rules, the total financial expenditure of a scale-up under each scenario will remain constant. With expenditure fixed, it is possible to focus on the _financial_ costs and benefits of alternative risk financing strategies, appraising the different risk financing strategies in their ability to cost-effectively finance the pre-specified contingent financial liability. For this analysis we make hypothetical assumptions about the rules for supplementary funding provided to woredas in times of drought, based on a crude microeconomic analysis of drought-induced transitory poverty. Other papers have proposed a range of benefits from implementing a rules-based approach for PSNP scale-up and humanitarian response, including speed, accuracy (Drechsler 2016) and provision of good incentives to woreda administrations and vulnerable populations (Clarke and Wren-Lewis 2016). This paper does not consider the costs or benefits of moving to a rulesbased approach, but rather it focuses on potential financing strategies if the PSNP were to move to a rulesbased approach.

To further focus our analysis on the financial costs and benefits of alternative risk financing strategies, in the analysis that follows we assume that the cost of delivering the additional benefits is fixed, and does not depend on the financing strategy. To do this, we assume that the additional benefits to be financed through the risk financing strategies are delivered through the scaling-up of the PSNP. This allows us to use the existing unit cost of delivering the PSNP, as described below. In using this approach, the paper is not taking a view on whether one delivery mechanism is better than another or that the costs of delivery are higher or lower. Rather, the purpose is to allow us to focus the analysis squarely on the risk financing issues at hand. The methodology proposed in the following sections could equally be extended to allow for different delivery instruments, provided that the differential costs of delivery could be estimated.

In this paper the hypothetical PSNP scale-up rules and corresponding contingent liability were constructed using the crude econometric methodology detailed in Annex 2. First, historical household survey data and satellite data on drought intensity were combined to estimate how different rainfall patterns, as measured by a satellite-based index of rainfall deficit (the Water Requirements Satisfaction Index, WRSI), might be 4