Global risk pooling mitigates financial risk from drought in hydropower-dependent countries

Abstract

Abstract More than 50 countries rely on hydropower for over 25% of their electricity generation, making them vulnerable to drought and resulting revenue losses. Governments can offset financial losses for publicly-owned hydropower generators, but this can create fiscal pressures and lead to negative consequences, such as lower bond ratings. Index-based financial instruments, used to manage weather-related risk, offer an alternative, though data collection and index design are challenging. Using remotely sensed hydrometeorological data, we develop index insurance contracts to manage drought-related financial risk for hydropower-dependent countries. Low correlations in drought across these countries allow cost reductions when risks are pooled. Pooling the contracts yields average savings of 54% compared to individual risk management via reserves. These findings indicate that pooled index insurance can strengthen financial resilience in countries dependent on hydropower and support governments in mitigating drought-related economic risks.