Figure 1. Risk layering and disaster risk financing strategy <!-- Start of picture text --> High severity<br>International Donor<br>Assistance<br>Insurance Linked<br>Securities<br>Risk<br>Transfer<br>Insurance/Reinsurance<br>Contingent credit Risk<br>Retention<br>Reserves<br>Low severity<br>Low frequency High frequency<br><!-- End of picture text --> Source: Ghesquiere and Mahul (2010) In practice governments may find the decision about what precise disaster risk financing strategy to implement to be somewhat challenging. In addition to theoretical models, this paper presents output of a dynamic financial model, developed to run in MS Excel, which allows decision makers to compare alternative risk financing strategies. The model has been designed as a tool to assist countries in developing cost-effective disaster risk financing strategy based on a combination of reserves, contingent credit and risk transfer instruments (e.g. reinsurance). The tool does not calculate an optimal strategy, but rather calculates projections that can help financial specialists to engage with governments on disaster risk financing.

While the principles in this paper apply more generally, particular attention is given to the World Bank’s Development Policy Loan (DPL) with Catastrophe Risk Deferred Drawdown Option, DPL with CAT DDO. This product offers IBRD-eligible countries immediate liquidity up to USD$500 million or 0.25 percent of GDP (whichever is less) if they suffer a natural disaster, providing bridge financing while other sources of post-disaster funding are being mobilized and allowing for budget support to governments hit by a natural disaster. Funds are disbursed when a country suffers a natural disaster and declares a state of emergency; since a state may declare a state of emergency for a number of reasons, some difficult to foresee, this _soft trigger_ may capture more events than reinsurance. Eligible borrowers must have an adequate macroeconomic framework in place at inception and renewal, and a disaster risk management program that is monitored by the World Bank.

The first DPL with CAT DDO was approved by the World Bank’s Board of Executive Directors in September 2008. The US$65 million contingent loan to the Government of Costa Rica aims to enhance its capacity to “implement a Disaster Risk Management Program for natural disasters.” This program is described in the loan doument and agreed upon before signing. Following the 6.2 magnitude earthquake that hit Costa Rica on January 8, 2009, the Government of Costa drew down approximately US$15 million. DPLs with CAT DDO have since been negotiated with Colombia ($150m), Peru ($100m), El Salvador ($50m) and Guatemala ($85m) and are currently under preparation in various other countries.

As of May 2010, the DPL with CAT DDO has the same lending base rate as regular IBRD loans. The front-end-fee, payable upon effectiveness, is 0.5% and there is no commitment fee. The draw down period is for three years, renewable up to four times (with a renewal fee of 0.25%). Repayment terms may be determined either upon commitment, or upon drawdown within prevailing maturity policy limits. Repayment schedule would commence from date of drawdown. The CAT DDO is an example of contingent credit that governments in developing countries can use to strengthen their 3