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current IBRD variable rate). The market premium for excess of loss reinsurance at this level is 7-8% of the loss layer covered, though a 7% rate was used. The same exercise was also applied to IFC loan terms using a 10 year maturity, 2 year grace, and an interest rate of 10.5% reflecting the high end of IFC pricing which ranges between LIBOR + 2 to LIBOR + 4. Commercial credits were also tested using maturities of 6 years with 1 year grace at 11% interest cost. A 5% risk free rate was used as the discount factor. This rate is extremely conservative and tends to bias results in favor of reinsurance cover when compared to utilizing an opportunity cost of capital rate which might be double the risk free rate and which would tend to bias results towards credit instruments.

For commercial financing, an IBRD guarantee was assumed in order to provide credit enhancement for private sector lenders to participate. The type of guarantee is not specified because both a partial credit guarantee would apply (e.g.: to ensure a minimum maturity period of the loan or loans) or a partial risk guarantee (to ensure contractual commitments on the debt service obligations). In both the cases of risk transfer (reinsurance) versus risk financing (lending), the net present values for the "insured" were negative, that is, after taking into account the indemnity payments received following a disaster, the policy holder or primary insurer would not "profit" from the coverage, which is consistent with the use of insurance for protecting against cash flow shocks and drastic reductions in asset wealth. The results are as follows:

# **Testing Alternative Risk Financing Instruments: IBRD, IFC and Commercial Loan Terms Using 5% Catastrophe Event Probability**

||**Reinsurance**|**IBRD Terms**|**IFC Terms**|**Commercial**|
|---|---|---|---|---|
|Simulation period|200 years|200 years|200 years|200 years|
|Event probability|5%|5%|5%|5%|
|Premium Rate|7%||||
|Interest Rate|na|6.5%|10.5%|11.0%|
|Commitment fee|na|0.75%|0.5%|1%|
|Front end fee|na|**I%**|1%|1%|
|Maturity/grace|na|15/5|10/2|6/1|
|Guarantee fee|na|||0.7%|
|**Financial Results**|||||
|PV Cost Ratio:<br>Financing / Reins.|1.0|0.6|1.4|2.0|
|Ratio of: avg. debt<br>service / Premium|1.0|1.9|2.5|3.5|

The above results show that in present value terms, the cost of utilizing IBRD financing would, over a 200 year period constitute only 60% of the conservatively estimated cost of reinsurance for the specified level of risk. As seen, however, for both IFC and commercial lending (the latter including a small guarantee fee of 0.70%), the long term cost is substantially higher in present value terms (1.4 and 2.0 respectively). The second ratio shown, attempts to demonstrate during any given period of utilizing loan proceeds, what the ratio of debt service (P+I) would be during such period versus having used and paid reinsurance premiums. Such a ratio is useful to determine the level of reserves needed at any time to ensure sufficient liquidity and solvency to repay the required debt service. The following table shows a 400-yr. simulation period for an event probability of 1% (i.e., less frequent but potentially of much larger loss magnitude) using