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

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

3. 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

4. ARC’s Two-Tier Structure

5. 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

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

7. 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

8. Overview : Country Engagement Process

9. Overview : Risk Transfer

10. Overview : AfricaRiskView

11. Overview: ARC insurance process

12. 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

13. 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.

14. 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

15. 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

16. 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

17. 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

18. Website: www.africanriskcapacity.org