The index uses 12 social, economic, political, and military indicators to rank 177 states in order of their vulnerability to violent internal conflict and the deterioration of their civil society.
Bangladesh suffered the most drastic decline in the past year, rising to 12th on the list after a year of internal political crisis and the effects of a deadly cyclone that left 1.5 million people homeless.
Israel and the occupied West Bank got into the index's top 60 - at No. 58 - for the first time, just behind Angola and Georgia.
Iraq improved slightly from last year and is now the world's fifth most unstable country.
But the report warns that any improvements there could only be temporary and do not reflect long-term or permanent changes.
"In many ways, Somalia has failed already as the unpopular transitional government lacks control of the streets of Mogadishu - much less the rest of the country," the report's authors wrote.
Somalia, at the tip of the Horn of Africa, has been without a functioning central government since Mohamed Siad Barre, the former leader, was overthrown in 1991.
The top 10 most unstable states according to the report are: Somalia, Sudan, Zimbabwe, Chad, Iraq, Democratic Republic of Congo, Afghanistan, Ivory Coast, Pakistan and the Central African Republic.