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2015/SFOM13/028 Session: 5

Managing Risk-Related Contingent Liabilities in Public Finance Frameworks

Purpose: Information Submitted by: OECD

13th Senior Finance Officials’ Meeting Bagac, Philippines

11-12 June 2015

MANAGING RISK-RELATED CONTINGENT

LIABILITIES IN PUBLIC FINANCE

FRAMEWORKS

Cathérine Gamper

OECD Public Governance and Territorial Development Directorate, Reform of the Public Sector Division

APEC Senior Finance Officials Meeting, June 11&12, 2015

Bagac, Bataan

BACKGROUND

UNEXPECTED EVENTSGreat East Japan Earthquake 2011

9.0 Magnitude !

EARTHQUAKE…..

TSUNAMI…….

NUCLEAR ACCIDENT……

UNEXPECTED EVENTSIceland Volcanic Eruption 2011

104 000 flights cancelled;

10 million people stranded

UNEXPECTED EVENTSHurricane Sandy 2012

$50 billion in reconstruction costs

UNEXPECTED EVENTSBP Gulf of Mexico Oil Spill 2010

Deepwater Horizon Oil Spillcaused BP stock price to plummet (60 % drop)

20

25

30

35

40

45

50

55

60

Sto

ck P

rice

in U

SD

Deepwater

Horizon oil spill 20

April 2010

• Past decade: USD 1.5 trillion in economic damages from man-made disasters (industrial accidents, terrorist attacks) and natural disasters (primarily storms and floods)

Major economic losses

0

50

100

150

200

250

300

350

1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012

Ann

ual e

cono

mic

loss

es in

US

D b

illio

n

Source: EM-DAT: The OFDA/CRED International Disaster Database, Université catholique de Louvain, Brussels, Belgium, www.emdat.be(accessed 14 November 2013).

Economic losses due to disasters in OECD and BRIC countries, 1980-2012 (USD Billion)

• Some disasters caused economic losses in excess of 20% of GDP(Chile, NZ), with local economies especially affected

• Shocks propagate across economic sectors and geographic boundaries through interconnected economies

• Considerable uncertainty challenges good policy making for resilience

Why boosting resilience matters

-10%

-5%

0%

5%

10%

15%

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

An

nu

al R

egi

on

al G

DP

gro

wth

to

pre

vio

us

year

The impact of disasters on local economies

Abruzzo Queensland New York

9/11 AttacksL‘Aquila Earthquake6/4/2009

QueenslandFlooding2010/11

Source: OECD (2012), Large regions, TL2: Demographic statistics, OECD Regional Statistics (database), accessed on 14 November 2013, doi: 10.1787/data-00520-en

Why boosting financial resilience matters….

Source: OECD Economic Outlook No. 94

0

20

40

60

80

100

120

2008 2009 2010 2011 2012 2013 2014 2015

Year

Sh

are

of

GD

PGeneral Government Gross Financial Liabilities, % of GDP, OECD 2008-2015

THE NEED FOR GOVERNMENT PLANNING

FOR CONTINGENCIES

The need for planning for contingencies..

• Governments are held accountable for responding to disasters :

how can their financial preparedness be strengthened in light of optimal financing of public policies?

What risk financing options are there?

What risk financing options are there for

the government?

Ex-ante: reserve funds (funded by tax increases and/or spending reductions), contingent spending arrangements, contingent debt facilities, and private and public insurance (including catastrophe bonds or other catastrophe-linked securities and financial derivatives), as well as re-insurance with international financial institutions

Ex-post: domestic and/or foreign borrowing as well as ad-hoc tax increases or spending reductions in other policy areas

MAIN ISSUES AND POLICY CHALLENGES

Main Issues and Policy Challenges

• The costs of disasters often represent a contingent liability –both on the expenditure side and the revenue side of national budgets

• Big events have low probabilities but potentially high financial and economic impacts, and are often difficult or impossible to predict

• These kinds of costs are not easily incorporated into traditional budgeting frameworks

• Risk financing may entail significant costs for (potentially already constraint) national budgets

Main Issues and Policy Challenges (ctd)

• Governments often expected to fund reconstruction, but also post-disaster relief for citizens and businesses

• Disasters often associated with reductions in expected tax revenues

Financial risks may be positively correlated

• National government policies (whether they use ex-ante or ex-post approaches) interact with the policies of other levels of government and actions of the private sector, leading to problems associated with moral hazard

Key Findings and Policy Recommendations

1. Clarify objectives

2. Recognise all disaster-related contingent liabilities in national budget documents and make them fully transparent

3. Determine the government’s degree of prudence and risk aversion

4. Where possible, determine the magnitude and probability of contingent liabilities

5. Be mindful of correlation structure of risks

6. Discount risky revenue streams appropriately

7. Carefully assess the costs and benefits of appropriately structured reserve funds

Key Findings and Policy

Recommendations (continued)

8. Carefully assess the interaction between ex-ante and ex-post funding mechanisms and moral hazard

9. Clarify rules ex ante for government funding mechanisms

10. Look for alternative ways recouping disaster-related costs

11. Where disaster-related risks are quantifiable, assess the costs and benefits of a variety of more formal risk assessment approaches

12. Where disaster related risks are not quantifiable, assess the costs and benefits of a “traffic light” approach

13. Engage in stress testing exercises

THE OECD RECOMMENDATION ON THE GOVERNANCE OF CRITICAL

RISKS

Its objective:

The Recommendation proposes a whole-of-society approach that addresses dimensions that are relevant for all the stakeholders of risk management policies including the private sector, civil society and voluntary organisations

The OECD Recommendation on

Governance of Critical Risks

OECD Recommendation on the

Governance of Critical Risks

Five Core Principles

Establish a comprehensive, all-hazard and trans-boundary approach to risk governance at the national level

Anticipate and build preparedness through foresight capacities and financing frameworks

Raise awareness to foster whole-of-society investments in prevention

Develop adaptive and inter-agency crisis management capacities

Include principles of good governance in risk management decision-making including transparency, accountability and continuous improvement

“Plan for contingent liabilities within clear public finance frameworks by enhancing efforts to

minimise the impact that critical risks may have on public finances and the fiscal position of a

country in order to support greater resilience.”

Contingent Liabilities as part of principle

2 of the OECD Recommendation

• Calls for a comprehensive financial protection strategy for APEC economies in light of climate change adaptation agenda and the incidence of natural calamities

• It is suggested to develop a catalogue of DRF options plus a feasibility study for regional risk pooling

• OECD suggests to expand the current study framework to provide a cross-country study on government financial contingency planning – sharing lessons from OECD countries with wider APEC economies (such as proposed more widely in the alignment part of the CN on DRF)

CEBU action plan

THANK YOU!

catherine.gamper@oecd.org