The Next Disaster Is Coming. Where Is the Pre-Arranged Financing?

For too long disasters have been considered unexpected and unforeseeable. A force majeure on a country’s development and fiscal planning. This has led to governments largely taking a reactive approach to financing the response, recovery, and reconstruction from disasters. However, the data and science tell a different story–one of recurrent and increasingly expected events. 

Between 2004 and 2023, disasters triggered by extreme weather and geophysical hazards resulted in a reported $4.2 trillion in economic losses (in constant 2015 prices), compared to $2 trillion over the previous 20 years. In 2023 alone, global economic losses surpassed $300 billion for the eighth time in a row and were 22 percent higher than the long-term average. According to Swiss Re, only 38 percent of those losses in 2023 were insured, largely concentrated in the industrialised world. 

In Asia-Pacific—the world’s most disaster-hit region—2023 saw the highest number of reported casualties and economic losses, as many countries in the region experienced their hottest year on record, reflecting that warming has nearly doubled since the 1961–1990 period. Perhaps most concerning is that disaster-related economic impacts in Asia-Pacific are projected to amount to annual losses nearing $1 trillion or 3 percent of regional GDP under a scenario of 2°C warming. 

Looking at the maximum annual damage from disasters as a share of GDP underscores the need for recovery finance (figure 1). Small island developing states (SIDS) already face annual expected losses from disasters equivalent to 2-3 percent of GDP.  

Figure 1: Maximum annual damage from disasters as share of GDP in selected Asia-Pacific Countries, 2002-2023  

As ministries of finance increasingly understand the potential impacts of disasters on the economy, a greater focus is being placed on strengthening the resilience of public finance around it. Understanding vulnerabilities, contingent liabilities, and fiscal risks can lead to more efficient use of public resources, and risk information can help governments better anticipate, prepare, and respond by designing financial protection strategies and instruments. 

A risk layered approach uses different instruments to bridge the financial gaps identified, through risk transfer and risk retention measures (figure 2). While national emergency funds and budget reserves and reallocations are part of the mix, additional and rapid liquidity is critical for higher intensity events.  

Figure 2: Three-tiered risk layering strategy for governments 

For low- and middle-income countries, this is where pre-arranged financing, supported by international development finance, comes into play. This is financing that has been approved in advance of a disaster and can be disbursed quickly when a specific pre-agreed trigger has been met.  

There are four main pre-arranged financing instruments supported by international development finance, primarily the multilateral development banks (MDBs) and a few bilaterals: (i) contingent disaster loans (and grants), (ii) climate resilient debt clauses, (iii) catastrophe insurance, and (iv) catastrophe bonds (box 1). 

Despite the significant and increasing costs countries face in responding and recovering from disasters, pre-arranged financing has remained low. According to the Centre for Disaster Protection, only 1.1 percent of total crisis financing flows from international development finance in 2022 was pre-arranged compared with 0.5 percent in 2017. In 2023, pre-arranged financing coverage supported by international development financing reached a high of $9.8 billion, largely in the form of contingent disaster loans and grants ($6.7 billion or 68.3 percent of the total reported) followed by insurance and bonds ($2.8 billion or 28.6 percent of the total reported). However, the coverage was found to be concentrated in middle-income countries, with just 3.2 percent in low-income countries.  

As explored in a recent paper by the Centre for Disaster Protection, countries are often insufficiently equipped to make informed decisions given the technical nature of these provider-driven instruments. Take coverage in Asia-Pacific, where contingent disaster loans and grants have proven to be popular in the Pacific, with the Asian Development Bank (ADB) providing coverage to 10 countries over five programs. However, the uptake in the rest of the region has been low. This is also the case for sovereign risk pools. Only Lao PDR has sought coverage from the Southeast Asia Disaster Risk Insurance Facility and three countries in the Pacific (Cook Islands, Samoa, and Tonga) have active policies from the Pacific Catastrophe Risk Insurance Company (PCRIC). Indeed, the record of PCRIC is poor, with less than half of the eligible countries participating, and of the participating countries half have discontinued their involvement because the disasters experienced did not meet the insurance payout trigger. 

Regionally, there is been limited interest in World Bank supported catastrophe bonds, with no bonds issued for Pacific countries and the Philippines declining to renew its bond for typhoons. Although it is early days, no country in the region has yet activated a World Bank or ADB supported climate resilient debt clause. However, uptake is likely to be high, given fees can be covered from concessional resources for eligible countries, and the World Bank recently announcing expanding coverage for all natural hazards.  

In response to this mixed picture, the World Bank and ADB have introduced new measures to incentivise greater use of pre-arranged financing. As explored in a recent CGD paper, the World Bank’s Comprehensive Toolkit to Support Countries After Natural Disasters, announced in June 2023, provides new and expanded support to SIDS and other vulnerable countries, including through the introduction of three new disaster financing options that allow countries to access some of their unused funding when a crisis occurs by repurposing unused bank financing, increased country limits, and providing contingent finance for pre-specified expenditures.  

ADB’s Asian Development Fund 14—a vehicle to provide grants to ADB's poorest and most vulnerable countries facing high or moderate debt distress risks—also introduced a number of new measures, including the crisis response window that allows eligible countries to receive upfront allocations for contingent disaster financing and the use of grant resources for other ex-ante financing instruments and arrangements, and non-debt risk transfer and risk-sharing solutions, including catastrophe bonds, disaster relief bonds, and regional risk pool arrangements. 

National disaster risk financing strategies provide a vital tool for countries to assess and decide on the types of instruments and volume of coverage in order to take full advantage of the available pre-arranged financing instruments. However, while these instruments and incentives are aimed to better accommodate the needs of low-income countries, and increase the use and scale of pre-arranged financing, there is not necessarily new or additional resources being made available. 

It is clear from the plethora of guidance notes, road maps, and related materials on disaster risk financing strategies that there is not a lack of knowledge on offer. What is needed are greater efforts to connect the knowledge with available (and new) finance in the context of specific country circumstances. This will require working with ministries of finance and decision-makers on understanding the benefits and limitations of instruments, the need to build a layered approach, and managing basis risk and expectations on an instrument’s timeliness and predictability. 

Ultimately, the effectiveness of any disaster risk financing strategy rests on its ability to secure the resources for implementation. In terms of new and additional resources, while the Loss and Damage Fund provides an obvious, albeit still underfunded, vehicle, it’s unlikely to fill the gap in the foreseeable future. Expanding the number of bilateral development partners, beyond Germany, Japan, and the United Kingdom, would help, although this won’t provide the certainty of resources these instruments require. While MDBs are innovating, the appetite of their shareholders to provide additional resources for these instruments for the most vulnerable countries remains to be seen.