## howtonote1803

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### Introduction: fiscal costs and scale of natural disasters
- Natural disasters often entail considerable physical and economic costs, with attendant adverse implications for external and fiscal balances owing to postdisaster relief and recovery efforts.
- Key statistics:
  - Between 1950 and 2015, 40 countries were hit by natural disasters that caused damage in excess of 10 percent of GDP.
  - Among small island states, 1 in 10 natural disasters involves economic damage costing more than 30 percent of GDP.
  - EM-DAT database: more than 13,000 natural disasters in 168 countries since 1950; in the decade and a half following the year 2000, natural disasters caused over $2 trillion in economic damages worldwide.
- Natural disaster types: geophysical; meteorological; hydrological; climatological; biological.

### Central objectives of the how‑to note
- Focus: management of the fiscal costs associated with natural disaster risks.
- Three central questions:
  - How large should fiscal buffers be?
  - How should fiscal buffers be built up?
  - How should fiscal buffers be used efficiently and transparently once a natural disaster has struck?
- Scope: fiscal strategies for financing recovery efforts; approaches to mitigate disaster impact; guidance on regular risk analyses of natural disasters’ potential fiscal consequences; best practices for defining and accounting for contingent liabilities related to natural disasters; risk reduction; disaster risk financing strategies; risk transfer mechanisms (including insurance instruments).

### Fiscal impacts and dynamics
- Impacts on public finances:
  - Natural disasters can erode the revenue base and increase expenditures directly and indirectly.
  - They can undermine economic growth and set back development objectives, especially in developing and low-income countries.
- Quantified effects:
  - Natural disasters have raised government expenditure by an average of 15 percent and lowered revenue by about 10 percent over the five years following a disaster (Melecky and Raddatz 2011).
- Fiscal consequences:
  - Resulting increases in public debt (including disaster-related contingent liabilities) can lead to higher borrowing costs and further dampen long-term growth.

### Identification and quantification of fiscal risk
- Comprehensive fiscal assessments should include contingent and implicit liabilities arising from natural disasters and integrate these into DSAs and MTFFs.
- Recommended step-by-step approach:
  - Quantify vulnerabilities using historical and peer-country data.
  - Invest in risk reduction through public investment strategies and diagnostics.
  - Adopt flexibility while preserving credibility: include well-defined escape clauses in fiscal rules; enable rapid redeployment of expenditures and streamlined budget revision processes.
  - Develop contingency financing plans combining self-insurance, contingent borrowing/grant plans, and risk transfer (insurance, SCDIs, capital markets).
  - Build fiscal buffers: international experience suggests reserving up to 3 percent of spending to deal with natural-disaster fiscal risks (Cebotari and others 2009); unused funds could be transferred to a notional natural disaster fund within certain limits.

### Guiding principles for sizing fiscal buffers
- Considerations affecting adequacy of buffers:
  - Expected fiscal costs: direct costs (immediate damage to public physical assets) and indirect costs (tax revenue losses from forgone economic activity).
  - Ability to borrow in an emergency: lower borrowing capacity increases need for buffers; borrowing speed depends on debt stock and market access.
  - Opportunity costs of building buffers: trade-offs with other high-return expenditures that raise long-term growth.
  - Funding needs across disaster phases:
    - Initial humanitarian relief (relatively small liquidity needs).
    - Recovery phase (restoring basic infrastructure).
    - Long-term reconstruction (often the greatest share of government spending).

### Modeling approaches and tools for damage estimation
- Damage concept: destruction of physical assets and projected economic losses during recovery (forgone production and income relative to predisaster potential growth).
- Example methodologies and tools:
  - World Bank Damage and Loss Assessment integrated into PDNA.
  - Monte Carlo simulations to assess appropriate government savings funds (Guerson 2016).
  - Pacific Catastrophe Risk Assessment and Financing Initiative: probabilistic disaster risk modeling for Pacific island countries.
  - Catastrophe Simulation model (International Institute for Applied Systems Analysis): stochastic analysis of natural disaster impacts.
- Guidance: update damage estimates periodically; use probabilistic risk modeling for insurance-sector preparedness and postcrisis response effectiveness.

### Building fiscal buffers and investing in risk reduction
- Budget integration:
  - Incorporate natural disaster risks into the budget process with a medium-term perspective, including into public investment planning and fiscal risk statements.
  - Budgets should include built-in buffers and flexibility to respond to disasters.
- Common budgetary instruments to build buffers: contingency reserves and dedicated funds (natural disaster funds).
- Risk reduction priorities:
  - Infrastructure programs that strengthen resilience (seawalls, bridge reinforcement, resilient construction).
  - Access to information (risk maps for flood zones, coastal erosion, landslides).
  - Property rights and regulations (land use, zoning, and building codes).
  - Fiscal incentives (targeted subsidies to encourage retrofitting, drought-resilient crops, forest protection, water preservation).
- Evidence of underinvestment:
  - Healy and Mulhotra (2009): in the United States, one dollar of investment in disaster preparedness yields a damage reduction of about $15.
- Diagnostic tool: IMF Public Investment Management Assessment (PIMA) covers investment planning, allocation, and implementation; countries should integrate risk reduction into public investment management stages.

### Box 2. Approaches to Risk Reduction — key points
- Contingency financing instruments and fiscal buffers:
  - Contingency reserve: "a pool of resources within the annual budget that can be used to adapt the budget to changing circumstances or emergencies, including natural disasters."
  - Natural disaster fund: "a dedicated financing source for handling natural disaster risks; such funds have restrictive rules regarding how resources can be used."
  - Reducing debt is another mechanism to create fiscal space; "The trade-offs between reducing debt and building fiscal buffers are outside the scope of this note."
- MTFF and PFM:
  - Recommendation: "Countries that are more vulnerable to natural disasters should reserve sufficient fiscal space for prevention and mitigation programs, while simultaneously ensuring fiscal sustainability (IMF 2008, 2012, 2016b)."
  - MTFF best practice: "a top-down approach to budget preparation and approval," with "a binding decision on budget aggregates prior to the allocation of expenditures within that aggregate" and "a process of cascading decision making."
- Risk transfer instruments:
  - Governments can transfer risks through traditional insurance, parametric insurance, and SCDIs, but "risk transfer instruments are costly" and thus suitable for remote events or when access to financing may be disrupted.
  - Importance of an ex-ante strategy to cover postdisaster relief, recovery, and reconstruction needs.
- Traditional insurance vs parametric insurance:
  - Traditional insurance: "remains one of the best ways to minimize the fiscal costs of natural disasters." Primary insurers often transfer exposures to reinsurers due to "remote but very large losses."
  - Parametric insurance: payouts based on predetermined triggers (hurricane wind speed, rainfall levels, ground acceleration); advantages: "low transaction costs, swift payouts, and standardized contracts"; disadvantage: "basis risk."
- SCDIs and CAT bonds:
  - SCDIs embed an insurance component to "alleviate pressures on sovereign indebtedness and financing needs should a disaster occur (IMF 2017b)."
  - CAT bond: investor receives high coupon; bond principal forgiveness occurs on parametric trigger; benefits: quick action and protection against moral hazard; drawback: basis risk.
- Regional risk pools:
  - Examples: Caribbean Catastrophe Risk Insurance Facility (CCRIF); Pacific Catastrophe Risk Assessment and Financing Initiative (PCRAFI); Africa Risk Capacity (ARC).
  - These pools provide risk information, disaster-risk management tools, and financing; PCRAFI developed country risk profiles for 15 participants using geospatial information.
- Information asymmetries:
  - Governments may have better information about asset quality and mitigation efforts than insurers; this may lead to underinvestment in maintenance and risk mitigation and higher insurance pricing.

### Box 3. Risk Transfer Mechanisms — key points
- Fiscal Risk Statement (FRS):
  - Purpose: inform the legislature and civil society about fiscal risks and how the government plans to address them during budget preparation.
  - In disaster-prone countries, FRS should identify and disclose fiscal risks (IMF’s Fiscal Transparency Code identifies 12 potential major risks, including natural disasters), quantify relevant fiscal risks, discuss odds, detail contingent liabilities, and label them as probable, possible, or remote.
  - Propose mitigation and management measures: infrastructure investment, tax incentives, regulatory intervention, contingency planning, rapid-response procedures.
  - Country examples: Indonesia, New Zealand, and the Philippines.
- Contingency reserves in the budget:
  - Purpose: cover costs of moderate but frequent disasters and provide immediate liquidity.
  - Design considerations:
    - Amount: set at a small fraction of total expenditure to suffice for immediate needs.
    - Authorization: some modalities require legislative approval for each use; others grant standing executive authorization; ministry of finance should maintain control under stringent access conditions.
    - Transparency: require official declaration before use; disclose expenditures taken from the reserve in budget reports and classify by purpose and economic nature.
  - Selected country experiences:
    - Armenia: Maximum 5 percent of total budgeted expenditures.
    - Indonesia: Rp 4 trillion for natural disasters (around 0.2 percent of total expenditure); Rp 24.3 trillion for personnel expenditure; Rp 22.5 trillion for other expenses in 2016.
    - Japan: 350 billion JPY (0.36 percent of national government expenditure of original 2017 budget).
    - Philippines: 0.8 percent of GDP (4 percent of total expenditure).
    - South Africa: 2 percent of central budget expenditure.
  - Governance advice: stipulate clear and stringent conditions for use to increase transparency and avoid abuse (Tommasi 2016).
- Natural disaster funds:
  - Purpose: establish fiscal buffer to cover potential catastrophic-event costs without endangering long-term fiscal sustainability.
  - Types: response funds (short-term liquidity); recovery funds (medium-term recovery); resilience funds (long-term reconstruction and resilience investment).
  - IMF (2016a) design and operation recommendations:
    - Consolidate fund with budget information; show fund balance in financial statements and drawdowns in budget execution reports.
    - Have a standing appropriation allowing spending immediately after trigger events (e.g., executive declaration of a disaster emergency).
    - Apply best PFM practices: clear rules governing use, normal government accounting standards, publish audited financial statements, defined governance rules; adjust procurement rules for immediate access.
    - Authorize drawdowns only above a minimum fiscal cost level; fund for disasters with large fiscal impacts while smaller needs covered by budget contingencies.
    - Size the fund based on calibration of fiscal impact; fund needs to cover some expected medium- to long-term fiscal costs but not all.
    - Investment strategy: maintain a relatively high degree of liquidity; consider investing in liquid foreign assets to avoid postdisaster domestic market stress and support balance of payments via repatriation after disasters; keep only a small portion as domestic bank deposits.
  - Risks: if outside the usual budget process or poorly governed, such funds can undermine fiscal discipline and transparency (Allen and Radev 2010).
- Using fiscal buffers transparently:
  - Maintain flexibility for disaster response while preserving transparency in postdisaster fund use, budget reallocations, and triggering of fiscal rules’ escape clauses.
- Postdisaster budget execution modalities:
  - Virement: transfer between budget items within appropriations; does not require legislative authorization; useful for immediate humanitarian expenditure.
  - Supplementary budget: changes annual budget limit or fundamentally alters appropriations; requires legislative approval; use for large disasters.
  - Reprioritization among budgets: part of next year’s budget formulation—realign long-term investment plans based on detailed postdisaster needs assessment and inflows from multilateral institutions, bilateral donors, and NGOs.
  - Transparency measures: disclose virements to the legislature timely; publish supplementary budget with summary of key changes.
- Flexibility in fiscal rules:
  - Include predetermined, well-defined escape clauses for adverse shocks above prespecified thresholds to suspend numerical fiscal targets.
  - Escape clause design features:
    - Clearly specified links to independently verifiable events.
    - Applicability when projected fiscal impact exceeds a prespecified threshold (example: damage threshold set at the median loss as a share of GDP over the past quarter century).
    - Provisions for adjusting targets and reinstituting original rules within a specified timeframe in the postdisaster period (IMF 2014).
  - Automatic correction mechanisms: prescribe required adjustments or measures triggered when deviations occur; automatically implement corrective measures for debt accumulation according to a legally specified adjustment path.
  - Note: escape clause flexibility is a short-term cushion, not a substitute for disaster risk management.

### Country case studies — selected highlights and quantitative points
- Dominica: Natural Disaster Fund
  - Following Tropical Storm Erika in 2015, IMF recommended establishing a Vulnerability Risk and Resilience Fund (VRRF) as a budgetary financing instrument under PFM legislation (not a separate legal entity).
  - Recommended funding sources: Dominica’s Citizenship by Investment (CBI) scheme and the national budget.
  - Recommended structure: series of subfunds with clear outflow rules; immediate response resources held in highly liquid forms and released after a cabinet-level decision; reconstruction/rehabilitation subfund to provide funding to the public sector investment program within formal budget cycles; create a resilience subfund if resources exceed a significant level.
  - Asset management: hold assets offshore and denominated in US dollars to avoid Dutch disease–like issues and support balance of payments postdisaster.
  - VRRF establishment interrupted by Hurricane Maria in September 2017; relief, recovery, and reconstruction took priority.
- Grenada: State-Contingent Debt Instruments
  - Post-2011–12 crisis, Grenada restructured debt issuing new SCDIs with a hurricane clause.
  - Hurricane clause features:
    - Verifiable trigger measured by an independent entity: Grenada’s CCRIF parametric insurance triggers the clause simultaneously if triggered.
    - Payment deferral for up to two payment periods; no nominal principal or interest rate reduction. Deferred interest is capitalized; deferred principal is distributed equally over remaining scheduled payments until final maturity.
    - Maximum number of triggers: clause may be invoked up to three times.
  - Fiscal impacts:
    - One-off trigger could provide cash flow relief of up to 2.6 percent of GDP.
    - This cash flow relief is roughly equivalent to the probable maximum loss from an event that occurs once every 25 years in Grenada.
    - Comparison values provided: approximately 1.5 percent of GDP for the probable maximum loss incurred from an event that occurs once every 25 years, and the average annual loss experienced in Grenada (9.87 percent of GDP).
    - If three events are triggered, total cash flow relief could be as much as 7.4 percent of GDP.
- Mexico: Combined Financing Strategy
  - Between 1999 and 2011, postdisaster reconstruction costs of public assets and low-income housing amounted to $1.46 billion.
  - Federal framework: two-pronged strategy:
    - Retain some risks: annual budget provision flows into the Natural Disaster Fund (FONDEN). Federal Budget Law and Fiscal Responsibility Law stipulate a minimum 0.4 percent of programmable spending each year to be channeled into FONDEN and FOPREDEN.
    - Transfer some risks: use of reinsurance and issuance of catastrophe (CAT) bonds. Mexico issued a parametric CAT bond in 2006 to cover earthquakes in three zones; subsequent issuances pooled multiple risks across regions.
- New Zealand: Natural Disaster Fund (NDF) under Earthquake Commission (EQC) Act (established 1993)
  - Funding: charge against the premium paid for building insurance by residential homeowners; premium fixed in law and not actuarially based.
  - Coverage: residential structures, land, and contents for earthquake, landslide, volcanic eruption, hydrothermal event, or tsunami. Homeowners must buy insurance beyond caps provided by the NDF for full coverage.
  - Government guarantee: legislated guarantee to compensate for any shortfall.
  - Investment strategy: mainly New Zealand fixed interest securities; part invested in international equities to ensure tradable assets outside New Zealand and to allow selling international equities first if drawdown required.
  - Transparency: frequent publication of comprehensively audited financial statements; NDF fully incorporated into central government balance sheet and income statement; published statement of investment policies and formal annual statements of intent.
  - Outcomes: since 1993 mandatory insurance increased coverage against earthquakes to about 90 percent of all residential buildings. The Canterbury earthquakes caused damage of about 10 percent of GDP; high level of insurance coverage (6 percent of GDP) transferred much of reconstruction cost onto the global insurance market via reinsurance.
- Philippines: Natural Disaster Fund and governance (2010 law)
  - The Philippines faces significant risks; on average, more than a thousand lives are lost to natural disasters every year; typhoons account for 74 percent of fatalities and over 60 percent of economic damages.
  - 2010 Disaster Risk Reduction and Management Law redistributed previous calamity funds into National Disaster Risk Reduction and Management Fund (NDRRMF) and Local Disaster Risk Reduction and Management Fund (LDRRMF).
  - NDRRMF: 30 percent of the amount appropriated is allocated to the Quick Response Fund for immediate relief and recovery. Ministry of Finance provides amounts to NDRRMF and recipients approved by the president on recommendation from the NDRRMC; recipient units follow accounting/auditing rules and submit monthly statements.
  - LDRRMF: No less than 5 percent of estimated revenue from regular sources set aside for LDRRMF. 30 percent of LDRRMF appropriations allocated to the Quick Response Fund. Unexpended LDRRMF funds can roll over and accrue to a special trust fund for up to five years; if unused after five years, funds revert to the general fund.
- Turkey: Turkish Catastrophe Insurance Program (TCIP)
  - Overview:
    - Established in 2000.
    - Nonprofit public entity supervised by the undersecretariat of treasury; operational management subcontracted to private insurance companies.
    - Conventional indemnity-based catastrophe insurance pool, retaining some risk and reinsuring the balance in the international market.
    - Public-private partnership; became the largest insurance program in Turkey, reduced government’s fiscal exposure to natural disaster risk, and raised public awareness about risk mitigation.
  - Policy design and operations:
    - Compulsory nationwide earthquake insurance for all dwellings within the scope of the scheme.
    - Stand-alone property earthquake policy with a deductible of 2 percent (to reduce administrative costs associated with small claims).
    - Annual premium rate determined according to construction type and location (five seismic zones).
    - Operational model: public sector insurance company functions with operational management subcontracted to private insurers; retains part of risk and transfers a portion to international reinsurance market.
  - Objectives:
    - Provide nationwide compulsory insurance against earthquakes at an affordable premium.
    - Ensure risk sharing within the country and transfer a portion to the international reinsurance market.
    - Reduce government fiscal exposure to earthquakes; encourage risk mitigation and earthquake-resistant construction; accumulate long-term resources to cover catastrophic damages; contribute to development of insurance.
  - Impacts and policy implications:
    - Reduced government fiscal exposure through risk retention and reinsurance.
    - Largest insurance program in Turkey achieved via public-private partnership and compulsory coverage.
    - Raised public awareness about risk mitigation and earthquake-resistant construction.
    - Administrative choices to control costs: 2 percent deductible; differentiated premium rates by construction type and seismic zones.

*Source: howtonote1803 (Fiscal Affairs Department How‑To Notes; International Monetary Fund | May 2018)*

### references.

### references.

### Identifiers and publication details
- ISBN: 978-1-48435-945-7
- Classification: LCC HJ192.5.E97 2017
- Subjects: LCSH: Fiscal policy—Rules and practice.
- Publication orders may be placed:
  - International Monetary Fund, Publication Services, PO Box 92780, Washington, DC 20090, U.S.A.
  - Tel.: (202) 623-7430 Fax: (202) 623-7201
  - Email: publications@imf.org
  - www.imf bookstore.org
- Document series and date: Fiscal Affairs Department How-To Notes; International Monetary Fund | May 2018

### Introduction: fiscal costs and scale of natural disasters
- Natural disasters often entail considerable physical and economic costs, with attendant adverse implications for external and fiscal balances owing to postdisaster relief and recovery efforts.
- Between 1950 and 2015, 40 countries were hit by natural disasters that caused damage in excess of 10 percent of GDP.
- Among small island states, 1 in 10 natural disasters involves economic damage costing more than 30 percent of GDP.
- The EM-DAT database provides detailed information, beginning in 1950, on more than 13,000 natural disasters in 168 countries; in the decade and a half following the year 2000, natural disasters caused over $2 trillion in economic damages worldwide.
- Natural disasters may be geophysical; meteorological; hydrological; climatological; or biological events.

### Central objectives of the how‑to note
- Focus: management of the fiscal costs associated with natural disaster risks.
- Three central questions addressed:
  - How large should fiscal buffers be?
  - How should fiscal buffers be built up?
  - How should fiscal buffers be used efficiently and transparently once a natural disaster has struck?
- Scope: fiscal strategies for financing recovery efforts, approaches to mitigate disaster impact, guidance on regular risk analyses of natural disasters’ potential fiscal consequences, best practices for defining and accounting for contingent liabilities related to natural disasters, and risk reduction, disaster risk financing strategies, and risk transfer mechanisms (including insurance instruments).

### Fiscal impacts and dynamics
- Natural disasters can:
  - Erode the revenue base and increase expenditures directly and indirectly.
  - Undermine economic growth and set back development objectives, especially in developing and low-income countries.
- Estimates of fiscal impacts:
  - Natural disasters have raised government expenditure by an average of 15 percent and lowered revenue by about 10 percent over the five years following a disaster (Melecky and Raddatz 2011).
- Fiscal consequences:
  - Resulting increases in public debt (including disaster-related contingent liabilities) can lead to higher borrowing costs and further dampen long-term growth.

### Identification and quantification of fiscal risk
- Comprehensive fiscal assessments should include contingent and implicit liabilities arising from natural disasters and integrate these into DSAs and MTFFs.
- Recommended step-by-step approach:
  - Quantify vulnerabilities using historical and peer-country data.
  - Invest in risk reduction through public investment strategies and diagnostics.
  - Adopt flexibility while preserving credibility: include well-defined escape clauses in fiscal rules; enable rapid redeployment of expenditures and streamlined budget revision processes.
  - Develop contingency financing plans combining self-insurance, contingent borrowing/grant plans, and risk transfer (insurance, SCDIs, capital markets).
  - Build fiscal buffers: international experience suggests reserving up to 3 percent of spending to deal with natural-disaster fiscal risks (Cebotari and others 2009); unused funds could be transferred to a notional natural disaster fund within certain limits.

### Guiding principles for sizing fiscal buffers
- Adequacy of buffers depends on country-specific circumstances; considerations include:
  - Expected fiscal costs: include both direct costs (immediate damage to public physical assets) and indirect costs (tax revenue losses from forgone economic activity).
  - Ability to borrow in an emergency: lower borrowing capacity increases need for buffers; borrowing speed depends on debt stock and market access.
  - Opportunity costs of building buffers: trade-offs with other high-return expenditures that raise long-term growth.
  - Funding needs across disaster phases: initial humanitarian relief (relatively small liquidity needs), recovery phase (restoring basic infrastructure), and long-term reconstruction (often the greatest share of government spending).

### Modeling approaches and tools for damage estimation
- Natural disaster damage covers destruction of physical assets and projected economic losses during recovery (forgone production and income relative to predisaster potential growth).
- Example methodologies and tools:
  - World Bank Damage and Loss Assessment integrated into PDNA (postdisaster exercise).
  - Monte Carlo simulations to assess appropriate government savings funds (Guerson 2016).
  - Pacific Catastrophe Risk Assessment and Financing Initiative: probabilistic disaster risk modeling for Pacific island countries.
  - Catastrophe Simulation model (International Institute for Applied Systems Analysis): stochastic analysis of natural disaster impacts.
- Guidance: update damage estimates periodically; use probabilistic risk modeling for insurance-sector preparedness and postcrisis response effectiveness.

### Building fiscal buffers and investing in risk reduction
- Budget integration:
  - Incorporate natural disaster risks into the budget process with a medium-term perspective, including into public investment planning and fiscal risk statements.
  - Budgets should include built-in buffers and flexibility to respond to disasters.
- Common budgetary instruments to build buffers: contingency reserves and dedicated funds (natural disaster funds).
- Risk reduction priorities:
  - Infrastructure programs that strengthen resilience (seawalls, bridge reinforcement, resilient construction).
  - Access to information (risk maps for flood zones, coastal erosion, landslides).
  - Property rights and regulations (land use, zoning, and building codes).
  - Fiscal incentives (targeted subsidies to encourage retrofitting, drought-resilient crops, forest protection, water preservation).
- Evidence of underinvestment: Healy and Mulhotra (2009) estimate that in the United States, one dollar of investment in disaster preparedness yields a damage reduction of about $15.
- Diagnostic tools: IMF Public Investment Management Assessment (PIMA) covers investment planning, allocation, and implementation; countries should integrate risk reduction into public investment management stages.

*International Monetary Fund | May 2018*

### Box 2. Approaches to Risk Reduction

### Box 2. Approaches to Risk Reduction

### Contingency financing instruments and fiscal buffers
- Contingency reserve: "a pool of resources within the annual budget that can be used to adapt the budget to changing circumstances or emergencies, including natural disasters."
- Natural disaster fund: "a dedicated financing source for handling natural disaster risks; such funds have restrictive rules regarding how resources can be used."
- Reducing debt is another mechanism to create fiscal space in preparation for a natural disaster; "The trade-offs between reducing debt and building fiscal buffers are outside the scope of this note."

### Medium-Term Fiscal Framework (MTFF) and public financial management (PFM)
- Recommendation: "Countries that are more vulnerable to natural disasters should reserve sufficient fiscal space for prevention and mitigation programs, while simultaneously ensuring fiscal sustainability (IMF 2008, 2012, 2016b)."
- From a PFM perspective, robust MTFF implementation requires:
  - "a top-down approach to budget preparation and approval," which entails "a binding decision on budget aggregates prior to the allocation of expenditures within that aggregate" and "a process of cascading decision making."
  - "comprehensive revenue" (text fragment indicates comprehensive revenue consideration as part of MTFF design).

### Risk transfer: insurance, parametric insurance, and state-contingent debt instruments (SCDIs)
- General guidance: "Governments can transfer some of their natural disaster risks through traditional insurance, parametric insurance, and state-contingent debt instruments (SCDIs). Since risk transfer instruments are costly, however, this strategy is most appropriate for remote events or in cases in which access to financing may be disrupted."
- Need for ex-ante strategy: "In choosing among various disaster risk finance instruments, an ex-ante strategy is necessary to adequately cover postdisaster relief, recovery, and reconstruction needs (World Bank 2014a; Hofman and Brukoff 2006; Clarke and others 2017)."

### Traditional insurance and parametric insurance—advantages and drawbacks
- Traditional insurance:
  - "remains one of the best ways to minimize the fiscal costs of natural disasters."
  - Primary insurers often transfer "considerable portions of their catastrophe exposures to reinsurers" because loss distributions feature "remote but very large losses."
- Parametric insurance:
  - Payouts are "based on predetermined triggers such as hurricane wind speed, rainfall levels, or ground acceleration from earthquakes."
  - Key advantages: "low transaction costs, swift payouts, and standardized contracts."
  - Main disadvantage: "basis risk: model parameters are only loosely related to losses (for example, wind speed fails to fully capture a storm’s destructive power)."

### State-contingent debt instruments and CAT bonds
- SCDIs embed an insurance component within a financing instrument to "alleviate pressures on sovereign indebtedness and financing needs should a disaster occur (IMF 2017b)."
- CAT bond described:
  - Offers "an institutional investor a high coupon but provides for bond principal forgiveness in the event of a disaster."
  - Principal forgiveness depends on "a parametric trigger that is similar to the trigger used in parametric insurance."
  - Benefits: "facilitates quick action in the event of a disaster, while simultaneously protecting investors from the moral hazards arising from asymmetric information (IMF 2016b)."
  - Drawback: "As with parametric insurance, basis risk is a drawback of the CAT bond."

### Regional risk pools and examples
- Programs cited as "innovative examples of risk assessments and transfers":
  - Caribbean Catastrophe Risk Insurance Facility (CCRIF)
  - Pacific Catastrophe Risk Assessment and Financing Initiative (PCRAFI)
  - Africa Risk Capacity (ARC)
- Roles and features:
  - "These programs build on regional coordination among small Caribbean and Pacific island states and African countries, and provide both risk information and disaster risk-management tools at the regional level, as well as financing when a natural disaster strikes (World Bank 2013)."
  - PCRAFI example: "country risk profiles have been developed for each of the 15 participants on the basis of geospatial information, allowing for improved catastrophe risk modeling and more accurate estimations of the monetary damages caused by natural disasters."
  - To compensate for lower costs and underdeveloped insurance markets in the region, "the disaster risk financing segments of CRRIF, PCRAFI, and ARC pool risks. These regional pools buy insurance on the private market to enhance countries’ disaster response capacities."

### Information asymmetries and implications for insurance pricing and maintenance
- Asymmetric information problem: "Governments often have better information about the quality levels of insured objects and the efforts involved in upkeep and risk mitigation than the investors who provide the insurance, for whom many of these factors are unobservable."
- Consequences:
  - This "may result in underinvesting in maintenance and risk mitigation."
  - Insurers "may try to price these effects in their policies, rendering insurance coverage very expensive and resulting in poor value for money for the government (Akerlof 1970)."

*Source: howtonote1803 - Box 2. Approaches to Risk Reduction*

### Box 3. Risk Transfer Mechanisms

### Box 3. Risk Transfer Mechanisms

### Fiscal Risk Statement (FRS)
- The FRS is a report composed by the government at the time of budget preparation to inform the legislature and civil society about fiscal risks and how the government plans to address them.
- In countries prone to large natural disasters, the FRS should:
  - Identify and disclose fiscal risks: The IMF’s Fiscal Transparency Code identifies 12 potential major risks, including natural disasters. The FRS should describe and quantify the most relevant fiscal risks and discuss their odds, detailing quantifiable and unquantifiable contingent liabilities and labeling them as probable, possible, or remote.
  - Propose mitigation and management measures: Steps may include public infrastructure investment, tax incentives to encourage resilience-building behavior, regulatory intervention, and guidance for contingency planning and rapid-response procedures.
- Country examples with detailed FRS coverage of natural disasters: Indonesia, New Zealand, and the Philippines.

### Contingency Reserves in the Budget
- Purpose: Cover costs of moderate but frequent natural disasters and provide flexibility to respond quickly in the immediate aftermath.
- Design considerations:
  - Amount: The general contingency reserve should be set at a small fraction of total expenditure to suffice for immediate liquidity needs.
  - Authorization: Modalities vary—some require legislative approval for each use; others grant standing authorization to the executive. The ministry of finance should maintain control under stringent access conditions.
  - Transparency: Require an official declaration or public announcement before use; ministry of finance should disclose expenditures taken from the reserve in budget reports and classify them by purpose and economic nature.
- Selected country experiences (Table 1 highlights):
  - Armenia: Maximum 5 percent of total budgeted expenditures. Purpose includes financing nonbudgeted outlays, including natural disasters. A contingency reserve fund is included in the budget; proposals come from public administration bodies and government authorizes use.
  - Indonesia: Rp 4 trillion for natural disasters (around 0.2 percent of total expenditure); Rp 24.3 trillion for personnel expenditure; Rp 22.5 trillion for other expenses in 2016. Natural disasters listed; the item for natural disaster is social assistance.
  - Japan: 350 billion JPY (0.36 percent of national government expenditure of original 2017 budget). Reserve allows for unforeseen and unavoidable expenditures, including those incurred by natural disasters.
  - Philippines: 0.8 percent of GDP (4 percent of total expenditure). Includes several special-purpose funds (Calamity Fund, Contingent Fund, Unprogrammed Fund). Use of contingency reserve can be authorized by the executive branch.
  - South Africa: 2 percent of central budget expenditure. Within the main budget, a contingency reserve is set aside for each of the next three years; in outer years the reserve is partly drawn down to fund new priorities.
- Governance advice: Stipulate clear and stringent conditions for use to increase transparency and avoid abuse (Tommasi 2016).

### Natural Disaster Funds
- Purpose: Establish a fiscal buffer to cover the potential cost of a catastrophic event in a timely manner without endangering long-term fiscal sustainability.
- Types: Response funds (short-term liquidity), recovery funds (medium-term recovery), resilience funds (long-term reconstruction and resilience investment).
- IMF (2016a) recommendations for design and operation:
  - Consolidate the fund with budget information; at minimum show fund balance in financial statements and drawdowns in budget execution reports.
  - Have a standing appropriation allowing spending immediately after trigger events (e.g., executive declaration of a disaster emergency).
  - Apply best PFM practices: clear rules governing use, normal government accounting standards, publish audited financial statements, defined governance rules. Adjust procurement rules to allow immediate access to resources.
  - Authorize drawdowns only above a minimum fiscal cost level; use fund for disasters with large fiscal impacts while smaller needs covered by budget contingencies.
  - Size the fund based on calibration of fiscal impact of natural disasters; fund needs to cover some expected medium- to long-term fiscal costs but not all.
  - Investment strategy should maintain a relatively high degree of liquidity; consider investing in liquid foreign assets to avoid postdisaster domestic market stress and to support balance of payments via repatriation after disasters. Keep only a small portion as domestic bank deposits.
- Risks: If kept outside the usual budget process or poorly governed, natural disaster funds can undermine fiscal discipline and transparency (Allen and Radev 2010).

### Using Fiscal Buffers Transparently
- Principles: Maintain flexibility for disaster response while preserving transparency in postdisaster uses of funds, budget reallocations, and triggering of fiscal rules’ escape clauses.

Postdisaster Budget Execution
- Key characteristics: speed and flexibility to provide emergency first aid and relief supplies.
- Three modalities of budget reallocation:
  - Virement: Transfer between budget items within appropriations; does not require legislative authorization and does not affect total budgeted expenditures. Useful with contingency reserve for immediate humanitarian and relief expenditure.
  - Supplementary budget: Changes the annual budget limit or fundamentally alters appropriated allocations; requires legislative approval. Use for large disasters when virements and contingency reserves are insufficient.
  - Reprioritization among budgets: Part of the next year’s budget formulation—realign long-term investment plans and reprioritize next year’s budget based on detailed postdisaster needs assessment and inflows from multilateral institutions, bilateral donors, and NGOs.
- Transparency measures: Disclose virements to the legislature timely; executive should summarize net impact of frequent/extensive virements. Publish supplementary budget with summary of key changes.

Flexibility in Fiscal Rules
- Fiscal rules should include predetermined, well-defined escape clauses for adverse shocks above prespecified thresholds to suspend numerical fiscal targets and avoid amplifying macroeconomic impact.
- Escape clause design features:
  - Clearly specified links to independently verifiable events (often subject to legislative approval).
  - Applicability when projected fiscal impact exceeds a prespecified threshold (example: damage threshold set at the median loss as a share of GDP over the past quarter century).
  - Provisions for adjusting targets and reinstituting original rules within a specified timeframe in the postdisaster period (IMF 2014).
- Automatic correction mechanisms: Prescribe required adjustments or measures triggered when deviations occur, and automatically implement corrective measures for debt accumulation according to a legally specified adjustment path.
- Note: Flexibility in escape clauses or correction mechanisms is a short-term cushion, not a substitute for disaster risk management.

### Country Case Studies
- Dominica: Natural Disaster Fund
  - After Tropical Storm Erika in 2015, Dominica considered establishing a Vulnerability Risk and Resilience Fund (VRRF).
  - IMF recommended the VRRF be a budgetary financing instrument, a special fund under PFM legislation (not a separate legal entity).
  - Recommended funding sources: Dominica’s Citizenship by Investment (CBI) scheme and the national budget.
  - Recommended structure: series of subfunds with clear outflow rules; immediate response resources held in highly liquid forms and released to the budget after a cabinet-level decision on advice of national disaster coordinator; reconstruction/rehabilitation subfund to provide funding to the public sector investment program within formal budget cycles; create a resilience subfund if resources exceed a significant level.
  - Asset management: Fund’s assets should be held offshore and denominated in US dollars to avoid Dutch disease–like issues and to support balance of payments postdisaster.
  - Dominica’s VRRF establishment was interrupted by Hurricane Maria in September 2017; relief, recovery, and reconstruction took priority.
- Grenada: State-Contingent Debt Instruments
  - After the 2011–12 crisis, Grenada restructured debt issuing new SCDIs with a hurricane clause to change scheduled debt service payments when an exogenous natural disaster occurs.
  - Key features of the hurricane clause:
    - Verifiable trigger measured by an independent entity: Grenada’s CCRIF parametric insurance triggers the clause simultaneously if triggered.
    - Changes to cash flow: Payment deferral for up to two payment periods, with no nominal principal or interest rate reduction. Deferred interest is capitalized; deferred principal is distributed equally over remaining scheduled payments until final maturity.
    - Maximum number of triggers: Clause may be invoked up to three times.
  - Fiscal impacts:
    - One-off trigger could provide cash flow relief of up to 2.6 percent of GDP.
    - The cash flow relief is roughly equivalent to the probable maximum loss from an event that occurs once every 25 years in Grenada.
    - Comparison values: approximately 1.5 percent of GDP for the probable maximum loss incurred from an event that occurs once every 25 years, and the average annual loss experienced in Grenada (9.87 percent of GDP).
    - If three events are triggered, total cash flow relief could be as much as 7.4 percent of GDP.
- Mexico: Combined Financing Strategy
  - Between 1999 and 2011, postdisaster reconstruction costs of public assets and low-income housing amounted to $1.46 billion.
  - Federal framework includes a two-pronged financial risk-management strategy:
    - Retain some risks: Annual budget provision flows into the Natural Disaster Fund (FONDEN) to meet costs of the most frequent disasters. Federal Budget Law and Fiscal Responsibility Law stipulate a minimum 0.4 percent of programmable spending each year to be channeled into FONDEN and FOPREDEN.
    - Transfer some risks: Use of reinsurance and issuance of catastrophe (CAT) bonds. Mexico issued a parametric CAT bond in 2006 to cover earthquakes in three zones; subsequent issuances pooled multiple risks across regions.
- New Zealand: Natural Disaster Fund
  - In 1993, New Zealand established the Natural Disaster Fund (NDF) under the Earthquake Commission (EQC) Act; administered by the EQC on an autonomous, arm’s length basis.
  - Funding: Charge against the premium paid for building insurance by residential homeowners; premium fixed in law and not actuarially based.
  - Coverage: Provides insurance layer for residential structures, land, and contents for earthquake, landslide, volcanic eruption, hydrothermal event, or tsunami. Homeowners must buy insurance beyond caps provided by the NDF for full coverage.
  - Government guarantee: Legislated guarantee to compensate for any shortfall if balance is insufficient.
  - Investment strategy: Mainly New Zealand fixed interest securities; part invested in international equities to ensure tradable assets outside New Zealand and to allow selling international equities first if drawdown required.
  - Transparency: Frequent publication of comprehensively audited financial statements; extensive information in government aggregate financial statements; NDF fully incorporated into central government balance sheet and income statement; published statement of investment policies and formal annual statements of intent.
  - Outcomes: Since 1993 mandatory insurance has increased coverage against earthquakes to about 90 percent of all residential buildings. The Canterbury earthquakes caused damage of about 10 percent of GDP; high level of insurance coverage (6 percent of GDP) transferred much of reconstruction cost onto the global insurance market via reinsurance.
- Philippines: Natural Disaster Fund
  - The Philippines faces significant risks; on average, more than a thousand lives are lost to natural disasters every year, with typhoons accounting for 74 percent of fatalities and over 60 percent of economic damages.
  - 2010 Disaster Risk Reduction and Management Law redistributed previous calamity funds into National Disaster Risk Reduction and Management Fund (NDRRMF) and Local Disaster Risk Reduction and Management Fund (LDRRMF).
  - NDRRMF: 30 percent of the amount appropriated is allocated to the Quick Response Fund for immediate relief and recovery. Ministry of Finance provides amounts to NDRRMF and recipients approved by the president on recommendation from the NDRRMC; recipient units follow accounting/auditing rules and submit monthly statements.
  - LDRRMF: No less than 5 percent of estimated revenue from regular sources set aside for LDRRMF. 30 percent of LDRRMF appropriations allocated to the Quick Response Fund. Unexpended LDRRMF funds can roll over and accrue to a special trust fund for up to five years; if unused after five years, funds revert to the general fund.
- Turkey: Mandatory Earthquake Insurance Scheme
  - Context: Multiple fault lines and exposure to large-scale earthquakes; Marmara earthquake in 1999 caused loss of 15,000 lives and substantial macroeconomic and fiscal burden, prompting policy responses including the establishment of the Turkish Catastrophe Insurance Program (TCIP).

*Italic: Source: Box 3. Risk Transfer Mechanisms, howtonote1803 - Box 3. Risk Transfer Mechanisms (PDF).*

### 2000. Although it is a nonprofit public entity super-

### howtonote1803 - 2000. Although it is a nonprofit public entity super-

### Overview
- Established in 2000.
- Although it is a nonprofit public entity supervised by the undersecretariat of treasury, the TCIP’s operational management is subcontracted to private insurance companies.
- The TCIP is a conventional indemnity-based catastrophe insurance pool, retaining some of the risk within the scheme and reinsuring the balance in the international market.
- As a public-private partnership, the TCIP has become the largest insurance program in Turkey, has reduced the government’s fiscal exposure to natural disaster risk, and has raised public awareness about risk mitigation.
- This country case study is based primarily on information provided by Ghesquiere and Mahul (2010) and TCIP (2015).

### Policy design and operations
- Compulsory nationwide earthquake insurance for all dwellings within the scope of the scheme.
- Policy design:
  - Stand-alone property earthquake policy.
  - Maximum insured amount per policy (maximum amount not specified in excerpt).
  - Deductible of 2 percent (to reduce administrative costs associated with small claims).
  - Annual premium rate determined according to:
    - Construction type (steel or reinforced concrete, masonry, and so on).
    - Location (five seismic zones throughout the country).
- Operational model:
  - Public sector insurance company functions with operational management subcontracted to private insurers.
  - Retains part of risk within the scheme and transfers a portion to the international reinsurance market.

### Objectives (as stated for TCIP)
- Provide nationwide compulsory insurance against earthquakes for all dwellings within the scope of the scheme at an affordable premium.
- Ensure risk sharing within the country and transfer a portion of the risk to the international reinsurance market.
- Reduce government fiscal exposure to the impact of earthquakes.
- Encourage risk mitigation and earthquake-resistant construction practices.
- Accumulate long-term resources to cover catastrophic damages.
- Contribute to the development of insurance.

### Impacts and policy implications
- Fiscal risk management:
  - Reduced the government’s fiscal exposure to natural disaster risk through risk retention and international reinsurance arrangements.
- Market and social outcomes:
  - Largest insurance program in Turkey, achieved through public-private partnership and compulsory coverage.
  - Raised public awareness about risk mitigation and earthquake-resistant construction practices.
- Administrative design choices to control costs:
  - Use of a 2 percent deductible aimed at reducing administrative costs associated with small claims.
  - Differentiated premium rates by construction type and by five seismic zones to reflect risk heterogeneity.

*Source: howtonote1803 - 2000. Although it is a nonprofit public entity super-*

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_Source: https://www.imf.org/-/media/files/publications/howtonotes/howtonote1803.pdf_