Climate risk financing should close protection gap against loss & damage

Developing countries need support in dealing with climate induced Loss and Damage Photo: Christoph Püschner/Diakonie Katastrophenhilfe

Climate change has increasingly led to more climate induced loss and damage (L&D) over the last years. According to data provided by the Munich Re NatCatService, the cumulated economic losses as a result of extreme weather events between 1998 and 2017 amounted to US$ 3.47 trillion, and those for the year 2017 to as much as US$ 340 billion. Countries in the Caribbean, Central America, South and Southeast Asia, Sub-Saharan Africa and the Pacific are facing the highest economic risks. Poor countries that are especially vulnerable to the consequences of climate change are thus hampered in their sustainable development through the destruction caused by natural disasters. This is particularly the case for the Least Developed Countries (LDC) and Small Islands Developing States (SIDS) that increasingly face the risk of lower investments, stranded infrastructure investments, worsening credit ratings, higher indebtedness and, ultimately, lowered adaptive capacity.

Brot für die Welt has published a study on „Climate Risk Financing“ in April 2019 analyzing new and established climate risk financing instruments and approaches and how they could better contribute to closing the protection gap in vulnerable countries. The results support the need for a fund or a new mechanism designed to compensate for climate-induced loss and damage that recognizes and follows the principles of equity and climate justice, as well as the “polluter pays” principle.

Gaps in existing risk financing instruments

A comprehensive climate risk management and disaster risk financing strategies can reduce these risks and protect vulnerable countries and people from losses that go beyond their risk absorption capacity. Climate risk financing is at the heart of such strategies.

In the narrow sense, risk financing instruments are categorized according to their sources and whether they are ex-ante or ex-post disaster financing instruments (see table 1). Ex-ante disaster financing instruments require proactive advance planning and upfront investments. In turn, funds would be available almost immediately after a disaster happened, e.g. to support relief operations and the first recovery phase. Ex-post disaster financing instruments are sources that do not require advance planning or upfront investments. Mobilizing resources in such a way entails an element of uncertainty and takes more time. Thus, these instruments are more ideally suited to the reconstruction phase and longer-term recovery programs with expenditures that are due three or more months after the disaster takes place. Some instruments fall into the category of risk transfer instruments, where the risk is ceded to a third party, and the sovereign state has to pay a premium (insurance) or interest (cat bonds) to the third party for agreeing to take the risk. Though financing resilience building ‒ including climate risk prevention ‒ reduction and preparedness are the most crucial investments to reducing the impact of climate disasters. A climate risk financing strategy must take the critical time dimension ‒ when and how many resources will be required for disaster risk reduction, emergency aid and resilient recovery ‒ into account. The different instruments should thus be selected and combined in a way to achieve an optimal mix of climate risk financing instruments through risk layering, and also consider the frequency and intensity in the occurrence of natural disasters.

Table 1: Climate (Risk) Financing Instruments

The Insuresilience Global Partnership – developed out of the Insuresilience Initiative initiated by Germany in 2015 – aims at developing comprehensive climate risk finance strategies in collaboration with the group of the 20 most vulnerable countries (V20). It has thus broadened its scope from insurance to different climate risk financing solutions. Yet the actual added value for vulnerable countries remains to be seen. Its success will be defined by the degree to which it will actually implement a broader approach to climate risk financeing and if poor and vulnerable communities will have access to them. The current focus on insurance should not cover up that it is no silver bullet, but that current initiatives have yet to succeed in massively scaling up their protection shields for climate vulnerable people.

In consequence there are significant gaps in the protection of vulnerable countries and communities through climate risk financing. Affordability of climate risk insurance for the most vulnerable is not ensured and will become even more limited if the frequency and/or magnitude of climate disasters further increase, as forecasted. Climate risk insurance is also limited to the hedging of rare but very serious events that cause high levels of damage. It is neither suitable for insurance against frequently recurring damage nor as coverage against gradual damage, such as that caused by sea level rise. To close this gap it needs more diversified, large risk pools, preferably across a large and diverse geographical area, a targeted premium support provided by international donors based on the polluter pays principle and a combination of climate risk financing with climate finance.

Recommendations for political decision makers and civil society

The study concludes with the following political recommendations on how to move risk financing forward:

• The mobilization and provision of climate risk financing in the context of comprehensive climate risk management approaches is a crucial prerequisite to closing the climate protection gap faced by vulnerable people and countries. Thus, it should be given significantly higher priority in international policy forums and listed as a permanent agenda item, for instance at international climate conferences (COPs ‒ Conferences of the Parties to the United Nations Framework Convention on Climate Change, UNFCCC), G20 summits and regular meetings held by multilateral development banks.
• Options on how to mobilize new finance should be developed, especially with regard to sourcing financing from the main polluters, industrialized countries and multilateral development banks for the offsetting of climate-induced loss and damage, by no later than COP25.
• Climate vulnerable countries should establish climate risk financing strategies.
• New, innovative climate risk financing instruments, such as a CCF, should be designed and tested.
• The InsuResilience Global Partnership and its partners, as well as other institutions, should focus heavily on improving the accessibility and the affordability of protection provided by climate risk insurance to the most vulnerable.
• Regional risk pools like African Risk Capacity (ARC), CCRIF-SPC Caribbean Catastrophe Risk Insurance Facility (CCRIF-SPC) and Pacific Catastrophe Risk Assessment & Financing Initiative (PCRAFI), with the support of developing partners, should work towards the formation of broader, more diversified risk pools.
• Regulatory harmonization towards one Vulnerable 20 (V20) market for financial services and products should be strengthened to enable effective bundling and diversification across geographical areas to reduce costs such as premiums.
• NGOs should increase their engagement with climate risk financing by carrying out policy analysis and research, and engaging with decision makers.

Sabine Minninger / Brot für die Welt

Read more: The complete study can be accessed here