banks and global reinsurance and capital markets, would developing countries be in the position to adequately meet their demands for risk capital to fund economic losses inflicted by natural disasters.

In the larger industrial countries, losses from natural disasters are typically funded through a combination of private risk financing arrangements and an efficient public revenue system relying on wide and deep taxation catchments. In the case of developing countries, which have relatively low tax ratios and ongoing fiscal pressures, funding sources for post disaster reconstruction tend to be more varied, with a strong emphasis on assistance from international donors. Multilaterally sourced infrastructure loans and relief aid from donor agencies are among the most common sources of such disaster funding.

A number of developing countries exposed to natural disasters have a limited capacity to absorb economic shocks caused by such disasters, thus relying on external sources of funding. Due to agency and information problems, new external capital is usually more expensive than internal capital (Froot, Scharfstein and Stein 1993). These frictional costs make the country risk averse to catastrophic events and increase the value of ex ante risk management strategies.<sup>3</sup> The World Bank Insurance for the Poor Program has been developing a country catastrophic risk management model which is partly based on corporate risk management principles but also factors in key economic and social metrics such as government fiscal profiles, the living conditions of the poor, and investment in risk mitigation (Gurenko and Lester 2004, Mahul and Gurenko 2006). This risk management approach at the country level relies on the assessment of the country fiscal exposure when all the cost-effective risk mitigation measures have been implemented, the identification of potential funding gaps between damages sustained by the country and funds available, and the financing of these gaps through private capital markets, and World Bank lending instruments.

This framework has been extended to natural disasters in agriculture (Goodwin and Mahul 2004, Gurenko and Mahul 2004, Mahul 2005). It can be broken down into five main pillars.

**_Differentiating market-based insurance and social insurance._** The inherent lack of clarity regarding the objectives of the public intervention in agricultural insurance has contributed to its inefficiencies.  Social insurance, or the safety-net, aims at assuring a minimum level of economic security to all farmers, and particularly those involved in low profit activities.  These social objectives rely on wealth transfer instruments.  Market-based insurance is oriented toward viable business activities that generate enough profit to cover insurance premium.  These instruments, which are based on sound actuarial principles, should apply only to viable farms whose survival may be jeopardized by the occurrence of an insured event.

**_Assessing agricultural production risks._** The existence of reliable and accurate long-term loss data series is a precondition for the development of any market-based product, as they are used to assess the future probable losses.  Individual farm data are almost always missing or unreliable. Consequently, loss assessment is usually performed using aggregate data.  This analysis based on catastrophic risk modeling techniques provides objective estimates of potential losses and captures the spatial correlation of losses caused by widespread events (e.g., droughts, floods, epidemics).  The following measures of loss can be estimated either from historical data or from losses simulated with probabilistic risk models:

- _Value at risk_ is the total loss exposure of the assets at risk.

> 3 In a perfect market where external capital would not be more expensive than internal capital, i.e., in the absence of friction costs, risk management would be irrelevant.

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