outweigh their costs. Almost without exception, financially vulnerable countries are highly unlikely to be able to implement pre-disaster risk financing instruments themselves. Thus, there is a need for technical and financial assistance from the donor community. Our estimates may inform decisions pertaining to a “climate insurance fund” absorbing extreme event country risk, which exceeds the ability of any given country to absorb the losses in a given event. We find the costs of such a high risk layer backup fund to be in the lower billions of dollars annually. Our assessment relates to today’s climate, yet we suggest that estimates of today’s climate variability and related risks, although also associated with substantial uncertainty, can be interpreted as a baseline for vey uncertain future projections.

The report proceeds as follows. In section 2, we discuss the developmental challenges imposed by disaster risk and the case for prefinancing disaster risk. In section 3, we present our methodology for assessing country-wide financial vulnerability to extreme events based on the CATSIM model. Section 4 finally presents salient findings and a short discussion of key implications.

# **2 Disasters and development: The financial dimension**

Climate-related disaster losses<sup>1</sup> have escalated in recent decades. Although largely driven by socioeconomic change, the increase in monetary losses by an order of magnitude within the last four decades cannot entirely be explained by population or economic growth only (Mills, 2005). The 4<sup>th</sup> assessment report of the IPCC found increased impacts of extremes such as cyclones and flooding due to altered intensities and frequencies of natural hazards (Parry et al., 2007), many of which are expected to increase in frequency or severity in various places in a future warmer climate (Solomon et al., 2007). Disaster impacts can be devastating, particularly in heavily exposed low- and middle-income countries, and especially the vulnerable within these countries suffer the most. During the 25 year period from 1979 to 2004 over 95% of natural disaster deaths occurred in developing countries and direct economic losses averaged US$54 billion per annum. Not only are there considerable differences in the human and economic burden, but also in insurance cover. In the richest countries average total losses during this period amounted to 3.7% as measured in gross national income with about 30% of the losses insured. In low-income countries, total losses amounted to 12.9% with 99% of these losses uninsured (Munich Re, 2005).<sup>2</sup> It should be emphasized that these disaster statistics do not (for the most part) reflect medium to long-term indirect losses, which can be very significant, particularly in countries with little capacity to cope with extremes, yet are generally very difficult to parcel out from other effects.

There are many ways for absorbing the financial burdens of disasters, with market-based insurance being one, albeit prominent, option. Households often use informal mechanisms relying on family and relatives abroad; governments may simply rely on their tax base or international assistance. Yet, it is a fact that in the face of large and covariate risks, such ad hoc mechanisms often break down and a severe shortfall, a resource gap, remains (see LinneroothBayer and Mechler, 2007).

> 1 The literature does often not clearly distinguish between _losses_ and _damages_ . We refer to damages as the physical impacts, and losses as the monetized values (direct losses) or the economic follow on effects (indirect losses).

> 2 These losses are mostly _direct_ losses of productive assets and property ( _stocks_ ); only to a minor extent are _indirect_ losses of value added ( _flows_ ), such as business interruption losses, accounted for and insured.

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