Contingent Liabilities: Issues and Practice; Aliona Cebotari; imf working Paper 08/245; October 1, 2008

The decision on whether to insure government’s post-disaster liabilities should be made 
on the basis of a cost-benefit analysis.
The outcomes of such an analysis would differ 
depending on the country, the type of risk faced, and the impact of the event. Obtaining 
insurance against natural catastrophe or other risks may be worthwhile in managing only 
very large disaster risk exposures. In the U.S., market participants often do not find it cost-
effective to issue catastrophe bonds below a certain level ($100–$800 million), i.e., to cover 
risks that are considered the lowest probability and highest severity, such as those occurring 
once every 100
–
250 years (GAO, 2003). For moderate and small risks, self-insurance—
through contingency funds or using flexibility within the budget—appears to be more cost-
effective. Many countries have indeed set up natural disaster or calamity funds that are 
funded from the budget (Colombia, India, Mexico, Philippines). These outcomes appear 
consistent with the theoretical literature that finds that insurance through the financial 
markets is preferable to self-insurance in the case of losses that occur rarely, because the cost 
of market insurance falls with the probability of loss while that of self-insurance does not 
(see Ehrlich and Becker, 1972). 
 
Contingency and Emergency Loans 
Contingency loans have been used as an instrument to finance disaster and other risk. 
The World Bank, for example, offers two contingency financing facilities that function 
similarly to a line of credit and are designed to provide an immediate source of financing in 
the event of unforeseen adverse economic events (Deferred Drawdown Option for 
Development Policy Loans facility, launched in 2001) or natural disasters (the Catastrophe 
Risk Deferred Drawdown Option facility, launched in 2008). The latter provides bridge 
financing of up to 0.25 percent of GDP or $500 million, whichever is smaller, while other 
sources of funding are being mobilized.