Increasing countries’ financial resilience through global catastrophe risk pooling

Abstract

Extreme weather events can severely impact national economies, leading the recovery of low- to middle-income countries to become reliant on foreign financial aid. Foreign aid is, however, slow and uncertain. Therefore, the Sendai Framework and the Paris Agreement advocate for more resilient financial instruments like sovereign catastrophe risk pools. Existing pools, however, might not fully exploit their financial resilience potential because they were not designed to maximize risk diversification and because they pool risk only regionally. Here we introduce a method that forms pools by maximizing risk diversification and apply it to assess the benefits of global pooling compared to regional pooling. We find that global pooling always provides a higher risk diversification, it better distributes countries’ risk shares in the pool’s risk and it increases the number of countries profiting from risk pooling. Optimal global pooling could provide a diversification increase to existing pools of up to 65 %.