Contingent financing provides quick, flexible financing for vulnerable countries in the Pacific to respond and rebuild after disasters
Developing countries in the Pacific are exposed to a range of natural hazards like almost no other region on earth. From tropical cyclones, floods, and storm surges to droughts, earthquakes, tsunamis, and volcanic eruptions, the Pacific islands encounter a disproportionately high share of global disasters relative to their demographic and economic size. The Pacific accounts for only 0.1% of the world’s population but suffers 2.3% of disasters globally. Three of the 10 economies with the highest potential annual losses relative to gross domestic product are in the Pacific. In per capita terms, Pacific economies face the highest disaster risk globally. Disaster risk, of course, is also growing with the impact of climate change.
Further, most Pacific countries have relatively small populations widely dispersed over several islands—many of which are isolated and difficult to reach when disasters strike. These geographical challenges contribute to the relatively high cost of responding to disasters. With their small economies and limited access to international financial markets, these countries also have limited resources to invest in disaster risk reduction and for timely post-disaster recovery and reconstruction. Delays in response and recovery, in turn, exacerbate the indirect economic and social costs of disasters, effectively extending and deepening their impacts at the expense of a government’s long-term fiscal position.
In normal circumstances, governments set aside contingency budgets and reserves to cover lower-layer disaster risks (in up to three-year cycles), while insurance schemes such as the Pacific Catastrophe Risk Assessment and Financing Initiative and international assistance cover high-layer risks (from 10-year events). However, medium-layer risks involve events that would exhaust annual contingency budgets and reserves but are too frequent to be covered cost-effectively through insurance.
So, what’s the solution? Contingent financing is one particularly cost-effective method for responding to medium-layer disaster risks. It establishes a contingent line of financing through policy-based operations, in which a country’s eligibility to draw financing is based on prior actions to strengthen policy and institutional arrangements for disaster risk management. However, actual disbursements are deferred and only triggered after a government declares a state of disaster or emergency after a natural hazard event, providing resources for response, early recovery, and reconstruction. This complements existing disaster risk financing instruments. It can make a payment quickly as it does not require any damage or loss assessments; allows for flexible use of funds; and the amount released can be significant in terms of immediate response needs.
In 2016, ADB piloted contingent financing in the Pacific with the Cook Islands Disaster Resilience Program, and again in 2017 with a regional approach covering Samoa, Tonga, and Tuvalu. Palau was recently added to the fold, and initial consultations are underway to include more Pacific countries under the contingent financing umbrella in coming years.
Proof-of-concept came in February 2018, when Cyclone Gita struck Tonga’s main island of Tongatapu and neighboring ‘Eua island with winds reaching 230 kilometers per hour. The cyclone damaged homes, government buildings, and infrastructure for basic services, including water supply, sanitation and waste management, electricity, and communications. The Ministry of Finance and National Planning estimated the damage at $164 million, equivalent to about 38% of Tonga’s annual gross domestic product.
With contingent financing in place, the government was able to obtain $6 million within days to help fund priority recovery activities. This marked the first time that ADB provided post-disaster funds through contingent financing, allowing the government to respond quickly to evolving needs. Contingent financing successfully supplemented Tonga’s available financial resources to fund critical early response and recovery efforts.
Tonga has since requested a replenishment of its line of contingent finance—a clear testament to the overall benefits of this approach. Further innovations that can ensure more immediate availability of much needed financing in the aftermath of disasters will be important steps toward building resilience in the Pacific.
This blog post relates to the 2019 ADB Annual Meeting institutional event Accelerating Private Sector Financing for Disaster Risk Management and Climate Resilience in the Asia and Pacific Region.