Sovereign insurance against Drought: Cost- Benefit Analysis of African Risk Capacity facility May 2017

Outline A. Overview B. Objective of the study D. Methodology E. Findings F. Conclusions

Overview: What is the African Risk Capacity (ARC)? ARC is a Specialized Agency of the African Union Provides participating AU Member States contingent funds in the case of severe weather events Funds are linked to Operational Plans developed by Member States Risk is transferred to ARC Ltd. the financial affiliate of the ARC Agency ARC is designed to: Provide quick-disbursing funds after a severe weather event, enabling a more timely response Reduce risk management costs by pooling risk across regionally diverse weather systems Lower the cost to governments of disaster relief and impact of severe weather events By doing so, ARC: Transfers resources and decision-making to African governments Shifts risk away from vulnerable populations and their governments to the ARC which will be better equipped to handle it

ARC’s Two-Tier Structure

Overview: Current ARC Member States 32 AU countries have signed the ARC Establishment Treaty These countries constitute the ARC Conference of Parties (COP) ARC Agency Governing Board elected by the Conference of the Parties – 8 members of varying expertise - development economics and risk finance to climate change and food security

Overview : Why ARC ? ARC aims to provide cost-effective contingency funding to protect livelihoods and development gains

Overview : Why ARC ? A Specialised Agency of the African Union, established in 2012, is governed by a board of African ministers and experts The ARC Agency’s first financial affiliate, ARC Insurance Company Limited, was established in early 2014 Through its unique structure, ARC bring together three critical elements to create a powerful value proposition for it participants and their partners: Early Warning: Africa RiskView Response: Contingency Planning Insurance: Index-based insurance and risk pooling

Overview : Country Engagement Process

Overview : Risk Transfer

Overview : AfricaRiskView

Overview: ARC insurance process

Objective of study Objective: To examine the economic advantages and disadvantages of establishing such a risk pooling facility as an early response mechanism to severe drought in sub-Saharan Africa. Authors: Ruth Vargas Hill & Daniel Clarke, 2012

Methodology Key specifications ARC aims to give countries access to immediate funds, based on objective triggers, for use in extreme drought events Claim payments from ARC are based solely on response costs as modeled by Africa RiskView. The initial capitalization of ARC is paid for by donors. The majority of premiums are paid for by donors. Each country will purchase coverage for annual aggregate response costs between the one-in-five-year and one-in-50-year annual response costs. Each government develop a contingency plan for how it will use any claim payments.

Methodology Analyzing the welfare gain : Principles of analysis: Improved sovereign disaster risk financing Benefit from early assistance Principles of analysis: ARC Vs. Counterfactual (Countries receiving an equal amount of donor support) Assumptions: ARC claim payment (one-in – five ; p=20% ) Response cost needs (one –in-five; p=20%) Basis risk (20, 50, 75, 100 ) Premium Multiple = 1.5 Annual premium paid to ARC = 3% of the losses of severe drought Welfare function

Methodology Assumptions: ARC claim payment (one-in – five ; p=20% ) Response cost needs (one –in-five; p=20%) Basis risk (20, 50, 75, 100 ) Premium Multiple = 1.5 Annual premium paid to ARC = 3% of the losses of a severe drought Welfare function W(F, R) = - 1/(F-R) where F=resources available and R=response cost

Findings ARC is an innovation that brings elements of insurance into emergency financing in order to ensure timely, predictable payouts during times of need. ARC benefits are higher when: The insurance is for extreme rather than frequent events The cost of insurance is not too high The payouts are triggered by indexes that accurately capture the impact of extreme events

Conclusions ARC should acts as catastrophe insurance for the government’s contingent liability, and other instruments are used for regular, smaller losses ARC should minimize basis risk by using additional indicators to complement or verify weather-based indexes ARC should keep under control its operating cost

Website: www.africanriskcapacity.org Twitter: @ARCapacity