public borrowing. Consequently, SIDS require access to non-debt creating contingent funds which can be disbursed quickly in the event of a disaster, and which match the need for the incremental fiscal funding arising from the disaster.

Relying on commercial insurance to fund the fiscal needs arising from natural disasters is unlikely to be optimal for SIDS. It is usually expensive, with the cost, in terms of premiums, between 1.5 times and twice the expected payout from claims (Guerson, 2020; Ando et al, 2022). In addition, commercial disaster insurance for governments generally entails parametric triggers<sup>22</sup> for the payout of insurance which is not well correlated with fiscal costs for disasters with small or moderate fiscal costs. For these reasons, Guerson (2020) recommends that governments accumulate savings funds from budget resources which would hold resources equivalent to 6 to 12 percent of GDP and would be used to fund the fiscal costs of small and moderate natural disasters. These funds would need to be governed by strong institutional safeguards to prevent them from being used for purposes other than that for which they are intended.<sup>23</sup> The savings funds should be complemented by governments contracting contingent finance (i.e. lines of credit which would be made available in the event of a disaster) and insurance cover for larger natural disasters from commercial insurance funds such as the Caribbean Catastrophe Insurance Facility, possibly supplemented by issuing catastrophe (CAT) bonds.<sup>24</sup> Although commercial insurance is expensive, it could be justified on grounds of risk aversion, given the very large costs of major natural disasters. Development partners could support SIDS in funding insurance premiums for commercial insurance against substantial disasters.<sup>25</sup> Finally, if SIDS are to scale up public investment in adaptation in an efficient manner, many of them will require technical assistance (TA) to build technical capacity to prepare long term adaptation strategies and strengthen their capacities for public investment management, budget planning and fiscal risk analysis. This is because planning efficient adaptation investments and evaluating projects is likely to be much more complex than would be the case for other public investment projects. One reason for this is that the benefits of adaptation are uncertain; they

> 22 A parametric trigger pertains to a major physical feature of a catastrophe, such as the magnitude of an earthquake on the Richter scale, information on which is usually readily available. It is possible to base insurance contracts on the magnitude of losses incurred by the insured, but the verification costs are much larger and the time required for verification is longer (Ando et al, 2022).

> 23 Whether it is realistic, financially and politically in a fiscally constrained country, to hold such a substantial amount of budget resources in a savings fund, for use only if a natural disaster occurs, must be doubtful.

> 24 Catastrophe bonds (CAT bonds) are securities, usually short to medium term, in which the repayment of principal and coupon is linked to the occurrence of a catastrophic event. The proceeds of the bond issue are held in a special purpose vehicle (SPV) and invested in safe and liquid assets (rather than being spent by the issuer as would be the case for a normal bond). If the catastrophic event occurs, all or part of the proceeds are transferred to the issuer; if it does not occur, the proceeds (plus interest) are paid to the bond investors as scheduled. The CAT bond therefore provides insurance to the issuer against the risk of a specified catastrophic event, with the risk transferred to the investors in the bonds. Traditionally CAT bonds have been issued by insurance and reinsurance companies as a form of reinsurance against the liabilities they would face from catastrophic events, but in recent years a number of sovereigns have issued CAT bonds, including some EMDEs and at least one SIDS; Jamaica in 2021. The World Bank provides SPV services for sovereign CAT bonds (Ando et al, 2022).

> 25 Burns et al (2021) use the World Bank’s macrostructural model MFMod, adapted to take account of hurricane damages to the capital stock, to analyse and compare alternative risk management strategies for hurricanes in Jamaica. They compare four risk management strategies; adaptation investment to strengthen infrastructure, purchasing commercial insurance from the private sector, establishing a budget contingency fund and creating fiscal space through debt reduction, and a baseline of no risk management. The economic gains from adaptation investment are greatest when it is targeted at small shocks but dissipate as shocks get larger. Purchasing insurance from the private sector is more costly than either establishing a budget contingency fund or freeing up fiscal space.

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