Climate Risk Insurance and Risk Financing in the Context of Climate Justice: A Manual for Development and Humanitarian Aid Practitioners


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Climate-related hazards cause substantial humanitarian and development risks. They cause loss and damage and undermine the achievement of the Sendai Framework for Disaster Risk Reduction (SFDRR) and the UN Sustainable Development Goals. It is the role of climate risk management to identify and reduce these risks and to protect vulnerable people, communities, and countries from intolerable humanitarian catastrophes and losses that go beyond their capacity to absorb these risks. Climate risk insurance and other forms of climate risk financing are key elements of climate risk management. They complement risk prevention and risk reduction by compensating for a part of the residual risk that cannot be avoided. Climate risk transfer relies on data provided by climate risk assessments.

Risk transfer refers to the transfer of the financial costs and the potential future damage caused by climate risks to a broader collective. In the case of insurance, risks are transferred to insurance companies that are contractually obliged to make a disbursement in the event of loss or damage. Insurance companies have to provide the capital to do so themselves. As a rule, they transfer part of the risk they take on to larger insurance pools via reinsurance with broader levels of risk diversification or they use capital market instruments to limit their own risk.

Looking at climate risk insurance and risk financing from a climate justice perspective, the biggest challenge lies in the fact that the insurance concept (unless the insurance premium is paid by a third party) builds on the principle of mutuality: The insured form a pool and mobilize the financial means needed from within the pool, that is, usually no transfer payments are made to the pool from outside the pool. The same is true for most forms of risk financing. The costs have to be covered by those at risk, and the higher the risk, the higher the protection costs are. Overcoming this injustice, and introducing the justice principles of solidarity and accountability (“polluter pays”) to the risk transfer discourse, is an important goal of climate advocacy.

It is not enough to make climate risk insurance available. The extent to which insurance helps to close the gaps in the protection of vulnerable groups against climate risks depends on the way in which insurance is structured. Respective guidance is provided by the pro-poor principles for climate risk insurance. ACT Alliance and other faith-based organizations (FBOs) often work with marginalized communities at the frontlines of climate change. Knowing their needs as well as their specific capacities, FBOs have a huge potential to serve as bridge- and trust-builder, linking communities with state authorities, insurers, and development partners and thus facilitating the development of climate risk finance and insurance solutions that are designed in a truly pro-poor way and that benefit climate-vulnerable people in their struggle for resilience, dignity, and sustainable development.

If communities cannot maintain their human–ecological systems in a safe operating space, lives, livelihoods, and social cohesion are threatened. In these cases, risk transfer options can be considered as part of a community-based risk management strategy. While risk sharing within a community is a widely practised strategy, the insurance concept of risk transfer to a third party outside the community is new and little known. Because of the advantage of insurance — that fewer financial resources are to be raised from within the community to cover high risks — it is worth it to raise insurance literacy of communities and introduce micro insurance. FBOs can greatly contribute by building bridges and connecting communities with governments, experts, insurers, and investors that are willing to contribute to finding climate risk insurance and risk financing solutions for communities; by supporting the development and testing of innovative pilot projects; by subsidizing insurance coverage for poor households that cannot afford it; and by promoting and enabling the participation of socially excluded groups in community-level risk sharing and risk insurance schemes.

In order to select the most cost-efficient climate risk transfer instrument, and to decide whether an insurance is appropriate, the climate risk layering approach is used. The main selection criteria for risk layering are the frequency and the severity of disasters. A bottom-up approach is suggested: The government, the community, or the individual household creates savings to deal with relatively frequent but less severe events (low-risk layer). Climate risk insurance, social security nets, credits, and donor assistance are most appropriate to deal with moderate, less frequent risks (medium-risk layer). Risks of high severity and very low frequency are best transferred to climate risk insurance, including regional insurance pools (high-risk layer).

Most climate risk insurances in the Global South are parametric or index-based, that is, a payout is triggered automatically if certain indicators defined in the policy are reached or exceeded at the measurement site. These are usually meteorological indicators, such as the length of a dry period, the quantity of rain, and the wind speed. Micro-level insurance directly insures private individuals or micro-, small- and medium-size companies. The Rural Resilience Initiative (R4) is an interesting example of a micro insurance scheme that specifically tries to support the most vulnerable populations. Mesolevel insurance provides insurance to intermediaries, such as co-operatives, rural development banks, and microfinance institutions. Macro-level insurance directly insures states (and indirectly, vulnerable populations) against damage to critical infrastructure or crop damages, as is the case of regional risk pools: African Risk Capacity (ARC), Caribbean Catastrophe Risk Insurance Facility (CCRIF SPC), Pacific Catastrophe Risk Assessment and Financing Initiative (PCRAFI), and Southeast Asia Disaster Risk Insurance Facility (SEADRIF).

Even though 68 countries participate in these four regional risk pools, only about a third (32 percent) purchased insurance coverage in 2019, with almost half (46 percent) of the eligible countries not deploying any disaster risk finance instruments at all. These numbers hint at the challenges of regional climate risk pools. They are new and thus still relatively unknown instruments. Many governments lack experience and remain hesitant to purchase insurance. A second main hurdle is the high cost of premiums. Thirdly, unmet expectations — either because of the uninsured basis risk or because a member expected payouts without the insurance trigger being reached — also seems to be another critical factor for the still relatively low uptake

The growing interest in climate risk insurance, and the need to make it accessible and affordable for the climate vulnerable, is reflected in the fast-growing landscape of initiatives created to support the development of climate risk insurance and broaden its global coverage. The most prominent one, InsuResilience Global Partnership for Climate and Disaster Risk Finance, was founded in 2017. As a multi-stakeholder alliance, it brings together different actors with partially divergent interests. It therefore remains to be seen how well the approach can be implemented. From the perspective of vulnerable states, the crucial question is whether the partnership can provide them with added value. In fact, the success of the InsuResilience initiative will be measured by whether it is able to place the primacy of climate risk insurance for the poor and vulnerable and their micro, small, and medium enterprises at the core of the partnership and strengthen this aspect within such a broad forum.

Apart from climate risk insurance, disaster risk financing is the second main financial pillar of countries’ comprehensive climate risk management. Risk financing instruments can be categorized according to their sources and whether they are ex-ante or ex-post disaster financing instruments. Ex-ante disaster financing instruments, like contingent credit lines, calamity funds, catastrophe bonds, or climate risk insurance, require proactive advance planning and upfront investments. In turn, funds would be available almost immediately after a disaster happened, for example, to support relief operations and the first recovery phase. Ex-post disaster financing instruments, like donor relief and rehabilitation assistance, budget reallocation, tax increases, or conventional credits, are sources that do not require advance planning or upfront investments. Mobilizing resources in such a way takes more time. Thus, these instruments are better suited for the reconstruction phase and longer-term recovery programmes with expenditures that are due months after the disaster takes place. Some of these instruments fall into the category of risk transfer instruments, such as catastrophe (cat) bonds and other securitized instruments where the risk is transferred to capital markets. In any of these cases, the risk is ceded to a third party, and the sovereign state has to pay an interest to the third party for agreeing to take the risk. The higher the risk, the higher the transfer price. Adaptation measures are not categorized as disaster risk financing in the narrow sense.

A new and innovative climate risk financing instrument proposed by the Climate Vulnerable Forum (CVF) is a contingent multilateral debt facility providing convertible concessional finance (CCF). The provision of CCF would be contingent on using the finance provided for ex-ante agreed disaster risk management measures that effectively reduce risks and address damages. Risk financing in the form of CCF would consist of highly concessional convertible debt instruments and grant-to-concessional debt, working with the following incentive: Building resilience against climate risks should first be supported by grants. If successful, the support could be converted into pre-approved concessional debt terms. Should a project financed by concessional debt fail, then the debt should be converted into a grant. Such an approach would help to overcome the dangerous spiral of worsening credit ratings, rising indebtedness, and more stranded assets caused by climate change. It would enable climate-vulnerable countries to mobilize risk capital for investment into resilience building. It would benefit vulnerable communities and people, and it would factor solidarity and justice into climate risk financing by offsetting economic loss and damage caused by climate extremes.

FBOs should scale up their engagement on climate risk insurance and risk financing at both levels, advocacy and programme work, and should focus on the specific needs and circumstances of vulnerable communities and how they can be better included in and protected by these approaches. Enhanced engagement may start with, among other things, capacity development, climate risk assessments, field research, policy analysis, stakeholder consultations, and pilot projects in close co-operation with communities, taking fully into consideration, on the one hand, community priorities, experience, value basis, and capacities and, on the other hand, the promotion and support of the full participation of socially excluded groups in community-level risk sharing and risk transfer schemes.

Climate risk insurance and risk transfer may be quite new approaches for most humanitarian and development practitioners and FBOs as a whole. That may raise the question of whether it is worth it to spend scarce resources to enter new territories. The answer to this question is very clear. The climate crisis requires much more than just continuing business-as-usual approaches. This also applies to disaster risk management and climate adaptation, where transformational pathways are required in the 2020s to better protect climate-vulnerable communities from climate-induced havoc and intolerable risk that are going far beyond traditional knowledge and community-based adaptive capacities.

  • Publisher: ACT Alliance
  • Author(s): Thomas Hirsch (Lead author)
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