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2.4 Risk financing in practice at the macro level
Governments bear the greatest responsibility for meeting the financial cost of risk and for
regulating markets. Establishing risk-financing strategies and mechanisms in advance
enables governments to increase their financial capacity to respond while protecting their
long-term fiscal balances (World Bank, 2012c). Supporting the development of markets
offering risk-financing and risk-transfer products for organisations and individuals enables a
culture of greater voluntary risk management and could reduce the burden of sovereign
financing liabilities. Supporting governments to develop their own risk-financing strategies
and regulating markets providing private risk-financing and insurance products is therefore a
logical and potentially high-yield investment.
Sovereign risk-financing is rapidly evolving field. Various mechanisms designed to
increase the availability of risk-financing options for governments have been developed over
the last 10 years, including access to contingent credit, regional sovereign risk pools and
catastrophe bonds (Box 2.5).
Box 2.5: Recently emerged sovereign-risk-financing tools
Contingent credit lines are pre-negotiated credit arrangements that can provide rapid access to
funding at preferential rates to governments in the event of crises, including natural disasters and
economic shocks. They are typically available to existing loan customers and eligibility may be
contingent on demonstrating that effective disaster risk management planning and measures are in
place.
Examples include: Japan International Cooperation Agency (JICA)'s Stand-by Emergency Credit for
Urgent Recovery (SECURE); International Development Association (IDA)’s Immediate Response
Mechanism and Crisis Response Window; and IDB’s Contingent Credit Line.
Catastrophe bonds are a method of transferring insurance risk to capital markets. Insurance and
reinsurance companies, governments and corporations sell bonds on the private capital markets and
investors receive an attractive return on their investment, typically over a three to four-year period, on
the understanding that in event of a pre-defined crisis, part or all of their investment will be transferred
to the insurance company to meet the cost of disaster losses. Payments may be calibrated against
parametric triggers.
Examples include: Mexico's MultiCat catastrophe bond programme.
Sovereign risk pools pool resources to spread risk and negotiate preferential insurance and
reinsurance rates. The pool may retain part of the funds derived from subscriptions, may
progressively accumulate reserves, and transfer higher levels of risk to reinsurance and financial
markets at more favourable rates than individual states could otherwise achieve. Several regional risk
pools protecting against natural disaster risks and using parametric triggers have been established
since 2007.
Examples include: the Caribbean Catastrophe Risk Insurance Facility (CCRIF); the Pacific
Catastrophe Risk Assessment and Financing Initiative (PCRAFI); and the African Risk Capacity
(ARC).
Governments need targeting and distribution infrastructure as well as liquidity. In
addition to securing liquidity, complementary investments in targeting and distribution
networks to channel payments in event of a crisis also need to be developed. Social
protection schemes are a primary route for distribution of government transfers to
individuals, and these may rely on, and be complemented by, payment systems developed
by the private sector. As noted above, social protection has risen significantly as a policy
priority among development donors and multilateral agencies and an increasing number of
middle and in some cases low-income countries have established large-scale social
protection programmes. 11
A CALCULATED RISK: HOW DONORS SHOULD ENGAGE WITH RISK FINANCING AND TRANSFER MECHANISMS
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