Start Financing Facility: Quantitative analysis of risk pooling
07 December 2020
Start Network is working to provide more effective and efficient financing models for humanitarian aid. Specifically, to enable a predictable continuum of funding for when risks of different scale and severity start to materialise. This report, commissioned from the UK Government Actuary Department, provides technical advice around the funding of the Start Financing Facility (SFF). In particular, by providing a theoretical illustration of the financial implications of pooling a number of risks into a central risk pool. The paper investigates how the number, frequency and size of the risks will affect the demands on the central risk pool, and highlights options for the financial management of the pool.
Alongside flexible discretionary funding, such as the existing Start Fund, the SFF is expected to provide pre-agreed funding which will be provided if a trigger is met. This trigger will depend on the specific circumstances but, for example, could be a storm’s wind speed or an earthquake’s magnitude. To provide certainty to recipients it is expected that the aid would only depend on the trigger and not on other factors such as the availability of funding. The SFF will therefore be responsible for ensuring that funding is available when it is needed.
- Q. What is the scenario used in the main body of the report?
The scenario used illustrates the efficiency of such a system working at full capacity, with close to 100 risk systems online. This is the very end picture for the SFF in the future but is used to illustrate the potential efficiency in the approach.
- Q. What are the possible payments required over any one year period?
Under these assumptions, the SFF, once scaled up, is assumed to have average annual payments from the risk pool of $63m a year and a total maximum loss if all risks triggered of $1470m. However, for most risks the maximum payment is only triggered by a 1 in 100-year event and so is very unlikely to occur. In most years the total amount paid out will be substantially less than this amount. In fact, there is only a 1 in 2 chance that the amount paid out will be more than $63m.
- Q. What financial management strategies can be used by the SFF to manage it’s contingent liabilities?
By pooling risks, the SFF can substantially reduce the need to hold capital reserves to meet the maximum possible payment of $1470m. For example, the SFF could choose to hold $97m (assuming a risk appetite of 90th percentile – 10% chance of exhaustion in any year). Various strategies can be used to meet needed payments on particularly bad years that go beyond this point. These could include purchasing aggregate insurance (re-insurance), raising additional funds from donors or scaling back payouts.
- Q What are the next steps?
The report makes a number of recommendations for next steps including engaging with donors, (re)insurers and our network NGOs on the appropriateness of the various financial strategies that could be employed to manage risks. Further modelling is also recommended as the SFF becomes operational.