# _Financing the resource gap_

The seriousness of the post-disaster resource gap, as well as the emergence of novel insurance instruments for pricing and transferring catastrophe risks to the global financial markets, has motivated developing country governments, as well as development institutions, NGOs and other donor organizations, to consider pre-disaster financial instruments as an important component of disaster risk management (Linnerooth-Bayer et al., 2005). Donor-supported pilot insurance programs are already demonstrating their potential to pool economic losses and smooth incomes of the poor facing weather variability, climate extremes and geophysical disasters. These schemes provide insurance to farmers, property owners and small businesses, as well as transfer the risks facing governments to the global capital markets. Particularly, the latter risk management options, where donors or governments cede risk, are particularly interesting. A few examples shown in box 1 may serve to illustrate the issues.

## **Box 1: Novel mechanisms for sharing extreme event risks in developing countries**

##  **_The Ethiopian weather derivative_**

To supplement and partly replace their traditional food-aid response to famine, the World Food Programme (WFP) designed an index-based insurance system to provide extra capital in the case of extreme drought, the amount being based on contractually specified catastrophic shortfalls in precipitation measured in terms of the Ethiopia Drought Index (EDI). Rainfall data is taken from 26 weather stations representing the various agricultural areas of Ethiopia. In 2006, WFP successfully obtained an insurance contract based on the EDI through AXA Re, a Paris-based reinsurer (Wiseman and Hess, 2007).

##  **_The Mexican catastrophe bond_**

In 2006, the Mexican government chose to insure its catastrophe reserve fund, FONDEN, against major earthquakes with a mix of reinsurance and a catastrophe bond. The resulting contract is linked to a parametric trigger in terms of magnitude and depth of seismicity for the three-year period 2007-09. The catastrophe bond provides cover of US$160 million out of a total cover of $450 million for a premium/interest totalling $26 million. The major reinsurance company, Swiss Re, issued the bond, which pays an interest of 230 basis points if payment is not triggered. Mexico received substantial technical assistance from the World Bank and Inter American Development Bank over the years, but ,as a middle-income developing country and member of the OECD, it financed the transaction out of its own means. (Cardenas, et al., 2007)

##  **_The Caribbean Catastrophe Risk Insurance Facility (CCRIF)_**

The _Caribbean Island States_ in 2007 formed the world’s first multi-country catastrophe insurance pool, reinsured in the capital markets, to provide governments with immediate liquidity in the aftermath of hurricanes or earthquakes. 16 Caribbean countries contribute resources ranging from US$200 thousand to US$ 4 million depending on the exposure of their specific country to earthquakes and hurricanes. This better-diversified portfolio is expected to result in a substantial reduction in premium cost of about 45 – 50% for the participating countries. The fund covers up to 20% of the estimated loss, and claims will be paid depending on an index for hurricanes (wind speed) and earthquakes (ground shaking). Initial funding by donor organizations provided support for start-up costs and helped capitalize the pool. The facility transfers the risks it cannot retain to the international financial markets through reinsurance or through other financial instruments (for example, catastrophe bonds). In addition, donors are adding to the reserves. The governments of Bermuda, Canada, France, the United Kingdom, as well as the Caribbean Development Bank, the World Bank and the EU recently pledged in excess of US $50 million to the CCRIF (Ghesquiere, et al., 2006; World Bank, 2007) 4