Climate Risk Financing - STUDY A Brief Analysis of Financial Coping Instruments and Approaches to Close the Protection Gap - Brot für die Welt

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Climate Risk Financing - STUDY A Brief Analysis of Financial Coping Instruments and Approaches to Close the Protection Gap - Brot für die Welt
Analysis 87

              ST U DY

              Climate
              Risk Financing
              A Brief Analysis of Financial Coping Instruments
              and Approaches to Close the Protection Gap
Climate Risk Financing - STUDY A Brief Analysis of Financial Coping Instruments and Approaches to Close the Protection Gap - Brot für die Welt
ST U DY

                                        Climate
                                        Risk Financing
Published by

Brot für die Welt
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Phone: +49 30 65211 0
kontakt@brot-fuer-die-welt.de           and Approaches to Close the Protection Gap
www.brot-fuer-die-welt.de

Authors Thomas Hirsch (Climate and
Development Advice ‒ Lead Author),
Sara Jane Ahmed (Consultant on
Climate Risk Financing, Philippines),
Sabine Minninger
Editors Maike Lukow,
Antje Monshausen,
Nivene Rafaat (lingua transfair)
Legally responsible for content
Klaus Seitz
Photos Jens Grossmann (p. 5),
Stefan Hauck (p. 19), Christof
Krackhardt (p. 12), Thomas
Lohnes (p. 15), Christoph Püschner
(title), Frank Schultze (p. 13),
Carsten Stormer (p. 16), Thomas
Venker (p. 10)
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March 2019
Climate Risk Financing - STUDY A Brief Analysis of Financial Coping Instruments and Approaches to Close the Protection Gap - Brot für die Welt
Content

Executive Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2

Climate-Induced Economic Risks and the Relevance of Risk Financing . . . . . . . . . . . . . . . . . . . .  4

Instruments of Climate Risk Financing  . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .  9

Climate Risk Financing in the Context of the Insuresilience Global Partnership . . . . . . . . . .  13

The Remaining Climate Protection Gaps  . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .  16

New Options to Close the Climate Protection Gap  . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .  18

Concluding Policy Recommendations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .  19

Abbreviations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .  21

Glossary  . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .  22

Bibliography . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 23
Climate Risk Financing - STUDY A Brief Analysis of Financial Coping Instruments and Approaches to Close the Protection Gap - Brot für die Welt
Executive Summary

    Executive Summary

    This paper presents and discusses new and established        coping instruments, require proactive advance planning
    climate risk financing instruments and approaches and        and upfront investments. Post-disaster financing instru-
    how they could better contribute to closing the protection   ments, such as donor assistance, budget reallocation,
    gap in vulnerable countries. It provides information and     tax increase or credits, are sources that do not require
    new ideas to civil society organizations and policy-         advance planning. However, the mobilization of post-
    makers who are engaged in the broader debate on finding      disaster resources contains an element of uncertainty
    financing solutions to compensate climate-induced            and takes more time. Countries usually combine a mix of
    loss and damage following the principles of equity and       different instruments for their risk financing strategies.
    climate justice. A further aim is to address knowledge       However, analysis shows that the protection gap remains
    gaps and misconceptions about what can be expected           considerable.
    and what cannot be expected from risk financing instru-          This paper identifies key challenges to closing the
    ments. It is an analytical paper, presenting fact-findings   protection gap and increasing the resilience of poor and
    and some recommendations derived from research, but          vulnerable people against climate risks. Affordability of
    it is not a policy paper.                                    climate risk insurance and the introduction of innovative
        In terms of recommendations, Bread for the World         climate risk financing instruments, for instance a contin-
    (Brot für die Welt) supports the development of a fund       gent multilateral debt facility providing convertible con-
    or a new mechanism designed to compensate for cli-           cessional finance (CCF) that does not lead to the further
    mate-induced loss and damage that recognizes and             indebtedness of vulnerable countries, are considered
    follows the principles of equity and climate justice, as     important approaches given that sufficient finance is
    well as the “polluter pays” principle. Respective propo-     mobilized to operationalize these instruments in a way
    sals will be presented in a policy paper to be released at   that at least partially compensates for loss and damage,
    the end of 2019.                                             with the priority being on letting polluters pay.
        Climate-induced loss and damage are accelerating
    against the backdrop of unhindered global warming. The       This paper concludes with eight recommendations on
    cumulated economic losses as a result of extreme             how to move risk financing forward:
    weather events amounted to US$ 3.47 trillion between
    1998 and 2017 alone, with the Caribbean, Central             • The mobilization and provision of climate risk financ-
    America, South and Southeast Asia, Sub-Saharan Africa         ing in the context of comprehensive climate risk mana-
    and the South Pacific facing the highest macro-eco-           gement approaches is a crucial prerequisite to closing        When Typhoon Haiyan hit the Philippines in November 2013, thousands of people were killed and
                                                                                                                                injured. More than one million people lost their houses. The Philippines is among the countries that
    nomic risks.                                                  the climate protection gap faced by vulnerable people         are most vulnerable to climate change.
        As a consequence, sustainable development in cli-         and countries. Thus, it should be given significantly
    mate vulnerable countries, particularly small island de-      higher priority in international policy forums and
    veloping states (SIDS) and least developed countries          listed as a permanent agenda item, for instance at inter-
    (LDCs), is being hampered by recurrent damages, thus          national climate conferences (COPs ‒ Conferences            • New, innovative climate risk financing instruments,              • Regulatory harmonization towards one Vulnerable 20
    increasing the risk of lower investments, stranded infra-     of the Parties to the United Nations Framework               such as a CCF, should be designed and tested.                       (V20) market for financial services and products should
    structure investments, worsening credit ratings, higher       Convention on Climate Change, UNFCCC), G20 sum-                                                                                  be strengthened to enable effective bundling and diver-
    indebtedness and, ultimately, lowered adaptive capacity.      mits and regular meetings held by multilateral develop-     • The InsuResilience Global Partnership and its partners,            sification across geographical areas to reduce costs
        It is the role of comprehensive climate risk manage-      ment banks.                                                  as well as other institutions, should focus heavily on              such as premiums.
    ment strategies, with risk financing its core pillar, to                                                                   improving the accessibility and the affordability of
    reduce these risks and to protect vulnerable countries       • Options on how to mobilize new finance should be            protection provided by climate risk insurance to the              • NGOs should increase their engagement with climate
    and people from losses that go beyond their risk absorp-      developed, especially with regard to sourcing financing      most vulnerable.                                                    risk financing by carrying out policy analysis and
    tion capacity.                                                from the main polluters, industrialized countries and                                                                            research, and engaging with decision makers.
        Risk financing instruments are, in the narrow sense,      multilateral development banks for the offsetting of        • Regional risk pools like African Risk Capacity (ARC),
    categorized according to their sources (i.e. regional/        climate-induced loss and damage, by no later than            CCRIF-SPC Caribbean Catastrophe Risk Insurance
    national/international/risk transfer to third parties) and    COP25.                                                       Facility (CCRIF-SPC) and Pacific Catastrophe Risk
    whether they are ex-ante disaster or ex-post disaster in-                                                                  Assessment & Financing Initiative (PCRAFI), with the
    struments. Ex-ante disaster financing instruments, like      • Climate vulnerable countries should establish climate       support of developing partners, should work towards
    calamity funds, catastrophe bonds or other climate risk       risk financing strategies.                                   the formation of broader, more diversified risk pools.

2                                                                                                                                                                                                                                                                  3
Climate Risk Financing - STUDY A Brief Analysis of Financial Coping Instruments and Approaches to Close the Protection Gap - Brot für die Welt
Climate-induced economic Risks and the Relevance of Risk Financing

    Introduction

    Climate-Induced Economic Risks
    and the Relevance of Risk Financing

    A widening range of disastrous, climate change-related,      one ‒ France ‒ is an industrialized country (see figure 2).    800
    sudden and slow onset events are increasingly causing        Most of these countries belong to the group of low-
    substantial socio-economic and financial risks that          income or lower middle-income developing countries.
    undermine sustainable development and provoke loss           While some of these countries rank high in the long-term
    and damage. It is the role of comprehensive climate risk     climate risk index because single extreme disasters have
                                                                                                                                600
    management and disaster risk financing strategies to         had very severe and long-lasting economic implications
    reduce these risks and to protect vulnerable countries       (e.g. Puerto Rico), an increasing number of high-risk
    and people from losses that go beyond their risk absorp-     countries have been recurrently hit by climate extreme                                                                                                                  Number of relevant natural
                                                                                                                                                                                                                                         catastrophes on the rise
    tion capacity. Three main dimensions of socio-economic       events in recent decades, for example the Philippines,
                                                                                                                                400
    risk related to a rising number of climate disasters can     Vietnam and Haiti. According to the latest scientific re-
    be identified.                                               port from the Intergovernmental Panel on Climate
                                                                 Change (IPCC), what all climate vulnerable countries
                                                                 have in common is that their exposure to climate hazards
    Loss and damage leading to reduced                           is very likely to increase sharply with rising temperatures.   200
    economic development and lowered                             What is more, a very rare one-in-250-year extreme event,
    adaptive capacity                                            for instance a massive cyclone, flood or drought, may be-
                                                                 come a more recurrent one-in-50-year event, implying
    Economic losses and damage due to climatological,            that disaster risk prevention and reduction will become a         0
    meteorological and hydrological extremes have been on        much more pressing topic, and disaster risk financing
                                                                                                                                        1980              1985              1990              1995               2000             2005            2010            2015
    the rise since the 1980s, both in terms of the number of     strategies an urgent necessity. Until recently, risk aware-
    catastrophes and the extent of economic losses. Accor-       ness has not been adequately cultivated in most coun-
    ding to data provided by the Munich Re NatCatService         tries. Despite climate-induced loss and damage in-                                                                                                                                         Hydrological
                                                                                                                                                                                                                                                            Meteorological
    (see figure 1), the cumulated economic losses as a result    creasing year upon year, comprehensive disaster risk
                                                                                                                                                                                                                                                            Climatological
    of extreme weather events between 1998 and 2017              financing and climate risk management, which leads to
                                                                                                                                                                                                                                                            Geophysical
    amounted to US$ 3.47 trillion, and those for the year 2017   better preparedness and more robust resilience, backed
    to as much as US$ 340 billion.                               up by risk insurance and other forms of risk transfer (see
        If indirect damages such as dropping consumption         glossary) to compensate for losses in the worst-case           Figure 1: Direct economic loss and damage caused by extreme events (1980‒2017)
                                                                                                                                Source: Munich RE NatCatService online
    are also included, the total losses would have amounted,     scenario, are, in most countries, not yet well enough
    on average, to as much as US$ 520 billion annually over      established to withstand a major disaster event. Unless
    the last decade (World Bank Group 2017). Accordingly,        attitudes shift, the trend of increasing economic loss and
    the loss in global GDP growth caused by climate-induced      damage is likely to continue. The more climate risks in-       write-downs. While in the climate change discourse                         infrastructure. Without additional protection measures,
    disasters has reached average levels of about 0.4‒0.7        crease, the less a country can afford to disregard disaster    stranded assets are mainly discussed within the context of                 the annual average economic losses resulting from a sea
    percent.                                                     risk financing options to improve its protection. This will    the fossil fuel industries, assets may also become stranded                level rise of 20 cm would amount to as much as US$ 4.791
        Climate change impacts are very unevenly distrib-        become particularly relevant if the 1.5 °C temperature         due to the physical risks of sudden or slow onset climate                  billion for Miami in 2050. The worst-case projection, with
    uted. Disasters have a much more disruptive impact on        threshold, which is now being considered by the IPCC           events, which may affect their operations, e.g. sea level rise.            sea level rise exceeding 20 cm, would see Miami facing
    less advanced economies (World Bank Group 2012).             (2018) as the new limit to avoid unmanageable climate               Many low-lying coastlines, e.g. in river deltas, belong               annual losses totaling US$ 228,589 million by 2050 (Stan-
    Developing countries are usually more geographically ex-     change, becomes reality.                                       to the most densely populated regions on earth, which are                  dard & Poors 2015, p. 67). Without substantial invest-
    posed to climate-induced hazards (being mostly located                                                                      inhabited by more than one billion people. Most are situ-                  ments in comprehensive climate risk reduction, coastal
    in the tropics and subtropics), have a higher socio-econo-                                                                  ated in Asia and fall under the category of cities. Coastal                communities and cities all over the world will face con-
    mic vulnerability (see glossary), and a lower technical      Increasing risk of stranded assets caused by                   communities and urban areas face growing financial risks                   siderable stranded assets, which will impact their entire
    and financial capacity (to resist and to recover). Accor-    climate extremes in vulnerable countries                       regarding their public and private infrastructure as a re-                 infrastructure. The stranded asset risk and cost would be
    ding to the latest global climate risk index (Germanwatch                                                                   sult of sea level rise. The credit rating agency Standard &                passed on to either consumers/tax payers, the public sec-
    2018), if we examine the effects of extreme weather events   Assets must be protected from damage in order to retain        Poor’s has analyzed the exposure of infrastructure in ten                  tor or investors/local banks that are looking to recover
    for the period between 1998 and 2017, we see that five of    their value ‒ the mere risk of potential damage being          US coastal cities to a sea level rise of 20 cm by 2050. Stan-              capital. To mobilize the necessary resources to signi-
    the ten most affected countries lie in Central America       caused by future climate extremes can lead to value loss.      dard & Poor’s has concluded that substantial investments                   ficantly reduce the risks caused by climate change, and to
    and the Caribbean, three in Southeast Asia and two in        Such “stranded assets” are investments that have become        in flood barriers are needed to avoid multi-billion assets                 make coastal cities and communities climate-resilient,
    South Asia. Eight of the next ten most-at-risk countries     worthless because they have lost value, become liabili-        becoming stranded due to the flooding of houses, roads,                    high upfront investments are needed, which again put an
    are in either of these world regions or in Africa. Only      ties or been subjected to unanticipated or premature           harbors, rail lines, bridges and other private and public                  extra financial burden on these communities.

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Climate Risk Financing - STUDY A Brief Analysis of Financial Coping Instruments and Approaches to Close the Protection Gap - Brot für die Welt
Climate-induced economic Risks and the Relevance of Risk Financing

    Worsening capital market access
    caused by climate risks leading to higher
    indebtedness and lower investment

    Worsening conditions in terms of access to international
    capital have become another huge concern, particularly
    for climate vulnerable countries and SIDS. They feel they
    are being penalized by the financial markets for being
    vulnerable. Research findings from Buhr and Volz (2018)
    conclude that for every US$ 10 paid in interest by these
    countries, an additional dollar will be spent due to cli-
    mate vulnerability. The study further shows that over the
    past decade alone, a sample of developing countries have
    had to pay US$ 40 billion in additional interest payments
    just on government debt. Econometric modelling sug-
    gests that climate vulnerability has already raised the
    average cost of debt in a sample of developing countries
    by 1.17 percent ‒ and a further increase is almost certain,
    given that the underlying climate risks will intensify. Ac-
    cordingly, it is estimated that climate change-induced
    additional interest costs are set to rise to between US$ 146
    billion and US$ 168 billion over the next decade (ibid).              Countries most affected
                                                                          by extreme weather events
        Recognizing the importance of greenhouse gas
                                                                          (1998‒2017)
    mitigation and of resilience building through adaptation
    in order to minimize climate disaster risks, the credit               1    Puerto Rico
                                                                          2    Honduras
    rating agency Moody’s has developed six indicators to
                                                                          3    Myanmar
    assess the possible climate risks of credit borrowers. They
                                                                          4    Haiti
    include the share of economic activity that comes from                5    Philippines
    coastal areas, hurricane and extreme weather damage as                6    Nicaragua
    a share of the economy, and the share of homes in flood-              7    Bangladesh
    plains and drought-affected areas. In 2016, Moody’s pub-              8    Pakistan
                                                                          9    Vietnam
    lished assessment results, signaling that small islands
                                                                          10   Domenica
    could have GDP levels four percent lower by 2030
    (Climate Analytics 2018) compared to a world with no
                                                                          Italics: Countries where more than 90 percent
    man-made climate change, which would impact these
                                                                          of the losses or deaths occurred in one year or event
                                                                                                                                         1‒10           11‒20          21‒50          51‒100           > 100       No data
    countries’ economies as a whole. For example, Fiji’s recent
    credit profile was determined by not only assessing exis-
    ting debt and political stability, but also by including vul-   Figure 2: World Map of the Global Climate Risk Index (1998‒2017)
                                                                    Source: Germanwatch 2018
    nerability to climate events and gradual climate change
    trends (Libanda 2018). Many small island states are al-
    ready rated below investment grade by Moody’s, making           the polluters, which further reduces their financial                   Jackson (2018) pointed to the fact that climate disas-      disadvantaged while developed countries stand to recei-
    it difficult to maintain and attract new investments,           scope to invest in sustainable development. Simon                  ters “can both cause governments to spend more than             ve high ratings on their bonds simply because they are
    including for climate risk management and adaptation.           Zadek, Co-Director of the UN Environment Inquiry into              they ideally should (i.e. more or less as much money as         less vulnerable and have the technology, institutions and
        Because of the climate risks they face ‒ for which          the Design of a Sustainable Financial System, calls it             they collect in tax over the long term) but can also reduce     means to rapidly recover from climate shocks (ibid). The
    they are not responsible ‒ poor and climate vulnerable          “… blindingly obvious they’ll pay more. We’ve been                 growth.” He called it a “double-whammy effect on credit-        more climate change accelerates, the higher the risk of
    countries have to contend with lower credit ratings and         pushing finance to recognize climate change as a risk.             worthiness, as debt levels increase and with lower growth,      being downgraded will become for climate vulnerable de-
    are thus forced to make higher interest payments. They          Now it has resulted in increased costs to climate vulnera-         the ability to service that debt decreases” (ibid). He criti-   veloping countries. Escalating climate-induced financial
    are the ones having to cover these additional costs, not        ble countries” (Jackson 2018).                                     cized that developing countries would be highly                 risks will eventually erode their ability to attract

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Climate Risk Financing - STUDY A Brief Analysis of Financial Coping Instruments and Approaches to Close the Protection Gap - Brot für die Welt
Instruments of Climate Risk Financing

                                                                                                                                           Instruments of Climate
                                                                                                                                           Risk Financing

                                                                                                                                           In the narrow sense, risk financing instruments are cate-    catastrophe (cat) bonds and other securitized instru-
                                                                                                                                           gorized according to their sources and whether they are      ments where the risk is transferred to capital markets. In
     Risk assessment
                                  Risk prevention                                                                                          ex-ante or ex-post disaster financing instruments (World     any of these cases, the risk is ceded to a third party, and
                                  & reduction                  Risk preparedness                                                           Bank 2012): Ex-ante disaster financing instruments,          the sovereign state has to pay a premium (insurance) or
    Climate risk &                                             & emergency aid
    impact modelling &           Preventing hazards                                     Risk financing                                     like contingent credit lines, calamity funds, catastrophe    interest (cat bonds) to the third party for agreeing to take
    mapping                      from happening and            Early warning,                                      Resilient recovery      bonds or climate risk insurance, require proactive advan-    the risk. The higher the risk, the higher is the price to
                                 reducing possible             evacuation and contin-   Financing adaptation                               ce planning and upfront investments. In turn, funds          transfer it.
                                 impacts (land use             gency planning, etc.     and disaster risk reduc-   Rehabilitation &        would be available almost immediately after a disaster           Though financing resilience building ‒ including
                                 planning, building                                     tion; building reserves/   building back better
                                 codes, coastal protec-                                 calamity funds; catas-                             happened, e.g. to support relief operations and the first    climate risk prevention ‒ reduction and preparedness are
                                 tion, livelihood diver-                                trophe bonds, climate                              recovery phase. A climate risk financing strategy must       the most crucial investments to reducing the impact of
                                 sification, etc.)                                      risk insurance, emer-                              take the critical time dimension ‒ when and how many         climate disasters (apart from mitigating greenhouse
                                                                                        gency loans, conting-
                                                                                        ency credits, etc.
                                                                                                                                           resources will be required for disaster risk reduction,      gases). They are not categorized as disaster risk financing
                                                                                                                                           emergency aid and resilient recovery ‒ into account.         in the narrow sense: Risk financing is thus defined as in-
                                                                                                                                               Ex-post disaster financing instruments, like donor       vestments to address or compensate for residual loss and
                                                                                                                                           relief and rehabilitation assistance, budget reallocation,   damage that could not be prevented for different reasons.
    Figure 3: Elements of existing comprehensive climate risk management
    Source: Thomas Hirsch                                                                                                                  tax increase or conventional credits, are sources that do    In terms of financing resilience building in the wider
                                                                                                                                           not require advance planning or upfront investments.         sense, multilateral climate finance instruments (inclu-
                                                                                                                                           Mobilizing resources in such a way entails an element        ding the Green Climate Fund (GCF), the UN Adaptation
    commercial capital. This would ultimately include non-                 way to reduce disaster impacts over time is through             of uncertainty and takes more time. Thus, these instru-      Fund and the Global Climate Resilience Partnership
    climate-related finance that is used to boost the economy              investments in risk reduction and building resilience           ments are more ideally suited to the reconstruction phase    (GCRP)) could be used, in addition to resources provided
    and to invest in sustainable development (Climate Ana-                 against disaster risks” (OECD 2017). Comprehensive              and longer-term recovery programs with expenditures          through bilateral assistance, national budgets and loans,
    lytics 2018). In a worst-case scenario, poor, climate vul-             risk management strategies in accordance with the “pre-         that are due three or more months after the disaster         including green bonds. Figure 4 provides an overview
    nerable countries, particularly small ones, may end up                 vent ‒ reduce ‒ absorb” maxim are essential to reduce           takes place.                                                 of risk financing instruments.
    caught in a financial trap and highly indebted due to                  climate risks and vulnerabilities, and to enable climate-           Some of the aforementioned instruments fall into
    climate change, having lost their already limited ability              resilient sustainable development (for further details, see     the category of risk transfer instruments, like climate
    to attract the investments necessary to overcome poverty.              Brot für die Welt 2017, 2018). Figure 3 highlights the key      risk insurance where the risk is transferred to an in-
    Thus, without taking specific disaster risk financing                  steps in a comprehensive risk management approach.              surer, or alternative risk transfer instruments, such as
    measures, climate change may put vulnerable countries
    at the ultimate risk of either ending up as fragile states or
    becoming largely dependent on international support.                                                                                                                 Ante-disaster              Post-disaster                   Financing
                                                                                                                                                                         risk financing             risk financing                  resilience building
         To strengthen financial stability (see glossary) and to
    avoid such a detrimental downward spiral of increasing
    climate, economic and financial vulnerability (see glos-                                                                                 National sources            Calamity fund/disaster     Budget reallocation             Own budget lines/
                                                                                                                                                                         reserve fund                                               national funds
    sary), comprehensive climate risk management measu-                                                                                                                                             Tax increase
    res need to be established, an integral part of which                                                                                                                Budget contingency                                         Domestic credit
                                                                                                                                                                                                    Domestic credit
    needs to be a disaster risk financing strategy. Such a stra-
    tegy, according to the OECD Recommendation on Disas-                                                                                     International               Contingent debt facility   Donor assistance                Bilateral donor assistance
    ter Risk Financing Strategies (2017), “should be anchored                                                                                sources
                                                                                                                                                                                                    External credits & bonds        Multilateral climate funds
    in an integrated framework of hazard identification, risk
                                                                                                                                                                                                                                    External credits &
    and vulnerability assessment, risk awareness and educa-
                                                                                                                                                                                                                                    (green) bonds
    tion, risk management, and disaster response and resili-
    ent recovery”. It should consist of a mix of climate risk
                                                                                                                                             Risk transfer to            Climate risk insurance
    financing instruments (see next chapter), reflecting an
                                                                                                                                             third parties
    approach that considers risk transfer tools as important                                                                                                             Sovereign (regional)
                                                                                                                                                                         climate risk pools
    instruments to reduce the economic impacts of disasters,                 Sea level rise due to climate change is dangerous in Tuvalu
    not as a silver bullet but as an integral component, and                 since the average height of the islands is less than two                                    Catastrophe (Cat) bonds
                                                                             metres. The frequency of tropical cyclones and king tides
    thereby reduce the costs and increase the effectiveness of               is also increasing due to climate change.                     Figure 4: Climate (Risk) Financing Instruments
    even more crucial interventions: “The only sustainable                                                                                 Source: Thomas Hirsch

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Climate Risk Financing - STUDY A Brief Analysis of Financial Coping Instruments and Approaches to Close the Protection Gap - Brot für die Welt
Instruments of Climate Risk Financing

                                                                     International climate risk financing                          exposures faced by the policyholders in an insurance            investors will lose the principal they invested and the
                                                                     sources                                                       pool, the lower the costs of insurance coverage. Thus,          issuer (often insurance or reinsurance companies, but
                                                                                                                                   sovereign risk pools provide an effective mechanism to          also states; for instance, the national government of
                                                                     • Contingent credits: A contingency loan or a financial       address losses from less frequent but severe disasters.         Mexico or the State of Florida in the case of hurricanes)
                                                                      guarantee will be initiated once a disaster-related          The Caribbean Catastrophe Risk Insurance Facility ‒             will receive that money to cover their losses (for rein-
                                                                      trigger has been breached. The World Bank Group              Segregated Portfolio Company (CCRIF-SPC, formerly               surance, see glossary). Catastrophe bonds were first
                                                                      provides such contingent credit lines through their          the Caribbean Catastrophe Risk Insurance Facility)              issued in the 1990s after Hurricane Andrew.
                                                                      contingent financing programs, allowing borrowers            was the world’s first regional risk pool to use parametric
                                                                      to rapidly meet financial requirements in case of a          insurance (since 2007), followed by the Pacific Catas-
                                                                      medium or large-scale disaster. Contingent credit lines      trophe Risk Assessment and Financing Initiative                Financing resilience building through
                                                                      are agreed ex ante.                                          (PCRAFI) (since 2013) and the African Risk Capacity            climate risk management and adaptation
                                                                     • Donor assistance: Post-disaster assistance provided by      (ARC) (since 2014) (for further information, see
                                                                      international donors for relief, recovery and reconstruc-    Brot für die Welt 2017, p.22 f.).                              • Domestic sources: To finance climate adaptation and
                                                                      tion. Donor assistance can be provided in the form of       • Catastrophe bonds: Also known as cat bonds. These              risk reduction, governments usually create own budget
                                                                      grants, concessional loans or equity capital. This is an     are capital market-based, risk-linked securities that           lines (e.g. for a ministry for disaster management) or set
                                                                      important source of risk financing, particularly for poor    transfer an ex-ante defined set of risks (for instance          up national climate change funds (e.g. the Bangladesh
                                                                      countries and in the aftermath of medium or large-scale      cyclone, flood or drought) to investors. Cat bonds are          Climate Change Trust Fund ‒ BCCTF).
                                                                      disasters. However, these funds usually require months       usually used for insurance securitization to create risk-      • Bilateral donor assistance: Grants or concessional
                                                                      if not years to be raised and disbursed, apart from          linked securities that transfer a specific set of risks from    loans, e.g. for financing coastal protection, water
                                                                      immediate support, which is usually minimal.                 an issuer or sponsor to investors. In this way, investors       conservation (e.g. German International Climate Initia-
                                                                     • External credits & bond issues: Resources mobilized         take on the risk of a specified catastrophe or event            tive ‒ ICI)
                                                                      on capital markets, i.e. the most expensive form of cli-     occurring in return for attractive rates of investment.        • Multilateral climate funds: Grants or concessional
                                                                      mate risk financing, particularly in the case of poor and    Should a qualifying catastrophe or event occur, the             loans (e.g. Green Climate Fund)
                                                                      vulnerable countries with low credit ratings (see above).
       Increasing water scarcity endangers the existence of people
       living in Ukamba region in Kenia.

                                                                     Risk transfer to third parties

     Domestic climate risk financing sources                         • Climate risk insurance: Transfer of climate risks to an
                                                                      insurer, guaranteeing a payout should a certain disaster
     • Calamity fund/disaster risk reserve: Created by the            occur; insurance premiums to be paid by the policy-
      government before a disaster happens, providing re-             holder reflect the risk: The higher the probability of a
      sources for immediate relief and recovery in the case of        disaster, and the higher the payout, the higher the pre-
      recurrent, low to medium severe disaster events. Ex-            mium; climate risk insurance can be parametric (pay-
      amples: Calamity Funds/Philippines, FONDEN ‒                    out is triggered automatically if a pre-defined para-
      Mexico’s National Disaster Fund                                 meter, for instance extreme wind speed, is breeched) or
     • Budget contingencies: Set aside by the government be-          indemnity-based. The latter ensures a better fit, i.e.
      fore a disaster happens, serving as a budgetary reserve         compensating payout (i.e. payout reflects actual loss).
      to compensate for losses of recurrent, low to medium            However, indemnity-based payouts are complex and
      severe disaster events.                                         costly. Climate risk insurance can be an efficient and
     • Budget reallocation, tax increase and domestic                 effective protection mechanism against loss and
      credits are ex-post disaster sources to mobilize additio-       damage caused by extreme events that are not very
      nal resources in the recovery and reconstruction phase;         frequent but of an extreme magnitude.
      mobilizing finance from these sources usually requires         • Sovereign (regional) climate risk pools: Mutual risk
      additional legal steps and thus takes more time as com-         insurance, in most cases owned by the insured sover-
      pared with ex-ante risk financing. These instruments            eign states themselves. Risk pooling across countries,
      should be used only once calamity funds and budget              or even regions, can reduce insurance costs signifi-         These people displaced by climate change from Shyamnagar, Bangladesh were seeking
                                                                                                                                   shelter from Cyclone Aila on higher grounds.
      contingencies have been exhausted.                              cantly: The more heterogeneous the risks and risk

10                                                                                                                                                                                                                                                                      11
Climate Risk Financing in the Context of the Insuresilience Global Partnership

                                                                                                                                                     Climate Risk Financing in the Context
                                                                                                                                                     of the Insuresilience Global Partnership

                                                                                                    Risk prevention & reduction                      Germany launched the InsuResilience Initiative at the               In 2017, InsuResilience’s start-up phase came to an
                                                                                                             + retention
                                                                                                                                                     2015 G7 Summit with the aim of significantly improving          end. The main features of its multi-actor partnership ap-
                                                                                                    + other forms of risk transfer
                                                                                                      (such as combination ot                        the protection provided by climate risk insurance in the        proach were finalised, and the implementation started by
                                                                                                    national/regional insurance                      Global South: By 2020, 400 million additional poor and          testing and putting into place the ideas developed.
     Losses in                                                     Risk prevention & reduction      pools, public financing, etc.)
     proportion                                                    + risk transfer to insurance/                                                     vulnerable people are to be provided with climate risk in-      Testing approaches to the transfer of knowledge to devel-
     to GDP in %                          Risk prevention              reinsurance markets                                                           surance coverage. This should ensure a fivefold increase        oping countries has been placed high on the agenda.
                                            & reduction
                                          + risk financing                                                                                           in the number of people with climate risk insurance             This includes supporting the creation of needs analyses
              Risk prevention
                                                                                                                                                     within five years, with the greatest potential in Sub-Saha-     and cost-benefit calculations for climate risk insurance,
     14         & reduction                                                                                   Very low
                + retention                                                                                  frequency                               ran Africa, the Caribbean, the South Pacific and South          data analysis, risk modelling and risk pooling, the
     12                                                                        Low
                                                                            frequency                        very high                               Asia (BMZ 2015). In the run-up to the establishment of          creation of the necessary framework conditions, and rais-
     10                                      Medium
                                                                           moderate to                        severity                               InsuResilience, consultations were conducted with               ing awareness about climate risk management, as well as
      8                                     frequency
                   High                                                    high severity                                                             potential partner countries, insurance initiatives and de-      evaluating lessons learnt from climate risk insurance ap-
                                            moderate
      6         frequency
                                             severity                                                                                                velopment banks as well as with the private insurance           proaches in consideration of their benefits for poor and
      4            low
                 severity                                                                                                                            industry and NGOs. InsuResilience has always argued             climate vulnerable people. A good impact assessment is
      2
                                                                                                                                     Probability     that it will not be successful without broad participation      particularly important, answering questions such as:
      0                                                                                                                              of occurrence
                                                                                                                                     in years        (Brot für die Welt 2017). By and large, climate risk in-        How many people are actually protected? Are the most
          0                 20                 40                 60                  80             100             120
                                                                                                                                                     surance is a little-known instrument beset with many            vulnerable people being reached? And is their resilience
                                                                                                                                                     misconceptions and false expectations, for instance the         being strengthened in the face of disaster? InsuResi-
     Figure 5: Optimal sovereign disaster risk financing according to different risk layers.
     Source: MCII, Climate Risk Adaptation and Insurance in the Caribbean Project, 2018                                                              expectation that risk insurance would deliver fast bene-        lience has developed the tools needed for monitoring and
                                                                                                                                                     fits to policy holders, or that insurance premiums would        evaluation, but a standardized reporting system, covering
                                                                                                                                                     be paid back if no damage occurs. It thus takes time to         all insurance systems and risk pools that work together
     External credits and green, blue and                                            The InsuResilience Secretariat is also active in this area      increase understanding, develop targeted instruments            with the Initiative, is still to be established (ibid).
     resilience bonds                                                                (coastal resilience).                                           and to widen protection. In this context it is crucial to
                                                                                                                                                     understand that climate risk insurance is not a suitable
     Resources mobilized on capital markets is usually the                                                                                           risk transfer instrument either in the case of frequent
     most expensive form of financing resilience building.                           Selecting the optimal mix of climate risk                       extreme events or in the case of slow onset events, such
                                                                                     financing instruments through risk layering                     as sea level rise, desertification or the adverse impacts of
     Green bonds are a special category of bonds, intended to                                                                                        glacier retreat (see glossary).
     encourage sustainability and to support climate-related or                      Climate risk layering is an approach used to design risk            Affordable access to climate risk insurance has been a
     other types of special environmental projects. If certified,                    financing strategies with an optimized mix of climate           key concern of the InsuResilience Initiative from the out-
     green bonds sometimes come with tax incentives such as                          risk financing instruments. The main selection criteria         set. In 2017, a working group was established to develop
     tax exemption and tax credits, making them a more at-                           for risk layering are the frequency and the severity of         proposals for smart support. It has started to investigate
     tractive investment compared to a comparable taxable                            disasters. Usually a bottom-up approach is suggested:           the options that exist to make climate risk insurance more
     bond. To qualify for certified green bond status, they have                     The government secures funds (i.e. a calamity fund,             accessible for poor and vulnerable countries. The aim is to
     to be verified by a third party, for instance the Climate                       budget contingencies) to deal with relatively frequent but      enable countries to decide which solutions are appropriate
     Bond Standard Board (for more information, see https://                         less severe events (low risk layer). Contingent credits,        in which context. Important principles for this under-
     www.climatebonds.net/standard/governance/board).                                conventional credits, donor assistance and budget real-         taking could include avoiding the creation of dependen-
                                                                                     locations, combined with risk transfer instruments, are         cies and disincentives to do less in terms of disaster pre-
     Resilience Bonds have become very attractive since they                         most appropriate to deal with moderate, less frequent           vention, while underlining the exceptional nature of dis-
     not only guarantee money flows (e.g. like cat bonds in the                      risks (medium risk layer). Risks of high severity and           aster relief (ibid). Furthermore, it has always been rightly
     case of losses) but also guarantee a structural improve-                        very low frequency should best be transferred to third          stressed by InsuResilience that climate risk insurance
     ment in an area of resilience building and thus lower the                       parties, including regional insurance pools (high risk          coverage should follow the pro-poor principles as adopted
     actual risk over time. Concrete examples are the “Blue                          layer) (for more information, see MCII 2016, World Bank         by InsuResilience to provide guidance on designing
     Forest Resilience Bond Idea” (http://www.blueforestcon-                         2012, 2017). To reach a comprehensive risk coverage that        climate risk insurance solutions that support closing the
     servation.com/old4/) or the financing of marine re-                             ensures cost effectiveness, climate risk financing strate-      climate protection gap of climate vulnerable populations.
     silience building by The Nature Conservancy (TNC)                               gies should shrewdly combine different ex-ante and              These principles include comprehensive needs-based                The Caribbean country Haiti is regulary battered by
                                                                                                                                                                                                                       tropical storms such as Hurricane Matthew which hit this
     (https://www.reinsurancene.ws/swiss-re-backs-innovati-                          ex-post risk financing instruments, as well as risk pre-        solutions, client value, affordability, accessibility, parti-     house in Les Cayes in 2016.
     ve-coral-reef-insurance-solution/).                                             vention and reduction measures, to leverage their costs.        cipation, sustainability, and an enabling environment.

12                                                                                                                                                                                                                                                                                                13
Climate Risk Financing in the Context of the Insuresilience Global Partnership

                                                                                                                                            the poor and vulnerable, and their micro, small and              the V20 is currently developing the Sustainable Insu-
                                                                                                                                            medium enterprises, at the core of the Partnership and           rance Facility (SIF). The SIF, aligning with the objectives
                                                                                                                                            strengthen this aspect within such a broad forum.                of the Partnership, is envisioned as a V20-initiated tech-
                                                                                                                                            Moreover, an assessment of the continued development             nical assistance facility that enables country-level insu-
                                                                                                                                            of the Partnership needs to take another important               rance solutions aimed at medium and small enterprises
                                                                                                                                            criterion into account: the extent to which the V20              for the financial protection of key economic sectors and,
                                                                                                                                            remain involved.                                                 in particular, their value chains. A second objective will
                                                                                                                                                                                                             be the de-risking of investments in renewable energy
                                                                                                                                                                                                             and financial protection.
                                                                                                                                            The road ahead: Strengthening cooperation                            Over time, the SIF would ideally substantiate the gra-
                                                                                                                                            with the V20 climate vulnerable countries                        dual build-up of regional risk transfer solutions that con-
                                                                                                                                                                                                             nect several, country-led initiatives across V20 econo-
       The tiny island state Kiribati is particularly affected by climate change. Due to sea level rise, its 33 atolls are sinking.             But to what extent has the InsuResilience Global             mies, allowing pooling across different geographical are-
       Coastal erosion and coral bleaching further endanger the life of the islands’ 95,000 inhabitants.
                                                                                                                                            Partnership already managed to operationalize its poten-         as and addressing the common market constraints and
                                                                                                                                            tial to reduce the gaps in protection by increasing climate      barriers the V20 face. Furthermore, the V20 strongly be-
                                                                                                                                            risk financing, particularly to the benefit of climate vul-      lieve that there is a need to not only come up with a broa-
     Moving from a G7 to a G20 risk                                               There are more differences to the initial G7 Insu-        nerable countries?                                               der range of finance instruments, but to also ‒ with inno-
     insurance and risk financing initiative                                 Resilience strategy. Whereas from a development coope-             At least at the discourse level, the acceptance and          vative linkages between existing financial instruments ‒
                                                                             ration perspective, the G7 is viewed as a donor communi-       readiness to provide (temporary) premium support has             build the most cost-effective, complementary solutions
     In 2017, Germany used its G20 presidency to place the                   ty with a long tradition of and vast commitment to inter-      increased, as the discussion at the 2nd InsuResilience           that provide resilience dividends. Over time, such shaped
     issue of climate resilience high on the G20 agenda. On                  national development and climate financing, this is not        Partnership Forum in Katowice, which took place back to          climate and disaster risk financing architecture should
     the recommendation of a study conducted by the World                    the case with the G20. In this respect, the InsuResilience     back with the COP24 in 2018, showed. Apart from buil-            develop into a wider agenda of economic resilience and
     Bank (2017), the InsuResilience Global Partnership for                  approach cannot simply be transferred; it needs to be          ding in-country climate risk insurance knowledge and             financial stability in the face of climate change.
     Climate and Disaster Risk Finance and Insurance Solu-                   embedded within a broader context. The approach to             capabilities at all levels, putting this approach into practi-       The launch of the InsuResilience Investment Fund
     tions was initiated at the G20 summit and formally laun-                building regional risk pools, with the aim of finding ways     ce at a significant scale should be one of the top priorities    (IIF) and the Solutions Fund (ISF), both initiated by Ger-
     ched at COP22 in Bonn in 2017. The InsuResilience Glo-                  to reduce the cost of risk financing, is one of the features   in 2019. Unless such steps are taken, climate risk insu-         many under the auspices of InsuResilience and designed
     bal Partnership brings together governments, internatio-                that has gained in relevance. It presents an approach that     rance will remain inaccessible for the climate vulnerable        to be instrumental for the development of climate risk
     nal organizations, and actors from civil society, the private           could also be applied to South-South cooperation and to        and the widening protection gap will continue to grow.           insurance products, are steps towards that end (for
     sector and academia. According to its understanding, it                 national initiatives in populous countries that face highly        In terms of governance, it is an encouraging sign for        further information, see https://www.insuresilience-solu-
     particularly builds on collaboration between G20 and                    heterogeneous risk structures, such as India or China.         enhanced cooperation between V20 and G20 countries               tions-fund.org/en and http://www.insuresilienceinvest-
     V20 countries. The V20 Group of Finance Ministers was                        The multi-stakeholder approach of the Insu-               that the Minister of Finance of the Republic of the Mar-         ment.fund). However, not only is climate risk insurance
     founded in October 2015 to act as a high-level policy dia-              Resilience Global Partnership brings together different        shall Islands and the German Parliamentary State Secre-          no silver bullet, the products and regional risk pools cur-
     logue and action group pertaining to climate change and                 actors with partially divergent interests, such as stakehol-   tary to the Federal Ministry for Economic Cooperation            rently operating have yet to succeed in massively scaling
     the promotion of climate-resilient and low-carbon deve-                 ders from multilateral development banks, governments          and Development co-chair the Partnership’s High-Level            up their protection shields for climate vulnerable people.
     lopment. Despite its name, the V20 Group now spans                      from industrialized and developing countries, and actors       Consultative Group (HLCG). However, the real litmus              For instance, according to its first evaluation, the African
     over 48 countries and represents over one billion people.               from the humanitarian aid and development cooperati-           test for successful V20-G20 cooperation on reducing              regional risk pool, African Risk Capacity (ARC), founded
                                                                             on sectors, academia and the insurance industry. The           climate disaster risks will be whether it can produce            in 2012 and operational since 2014, is struggling to main-
     Compared to the 2015 initiative, the InsuResilience                     level of coordination that this involves is very high and      concrete results in terms of reducing vulnerabilities            tain ‒ let alone significantly enhance ‒ its protection
     Global Partnership is broader in its scope:                             the difficult negotiations that led to the formation of the    and fairly offsetting the climate-induced losses and ex-         shield (E-Pact 2017). Aggressive steps are thus needed to
     • Focusing on different climate risk financing solutions,               InsuResilience Global Partnership illustrate how chal-         tra financial burdens suffered by vulnerable countries.          ensure InsuResilience meets its objectives, namely of
       including but not limited to insurance                                lenging it is to agree on a coherent approach, with com-           As stated in the HLCG, the V20 made it clear that its        “closing the protection gap and increasing the resilience
     • Has no quantified targets (e.g. 400 million people                    mon ownership of all actors involved. It therefore re-         members need to protect critical infrastructure, indust-         of poor and vulnerable people against climate risks and
       additionally insured by 2020), and runs indefinitely,                 mains to be seen how well the approach can be imple-           ries and small enterprises as their economic backbone            disasters”, as jointly stated by the co-chairs of the High-
       i.e. beyond 2020.                                                     mented. From the perspective of the vulnerable states,         against climate change. To facilitate the necessary pro-         level Consultative Group of the Partnership at its 2nd
                                                                             the crucial question is whether the Partnership can pro-       tection, the V20 endeavors to enable private sector              forum in Katowice (see https://www.insuresilience.org/
         The German government, however, still sticks to the                 vide them with added value. In fact, the success of the        uptake of insurance in V20 economies. V20 national               second-insuresilience-partnership-forum-in-katowice-
     former benchmark of providing climate risk insurance                    InsuResilience Initiative will be measured on whether it       markets, however, are often too small to be viable and the       paving-the-way-to-effective-risk-financing-solutions/).
     coverage to 400 million additional people by 2020.                      is able to place the primacy of climate risk insurance for     risks faced are too distinct to be diversified. That is why

14                                                                                                                                                                                                                                                                                       15
The remaining Climate Protection Gaps

     The Remaining Climate
     Protection Gaps

     To what extent are the climate disaster risk financing in-      close the protection gap. This would also be a first im-     vulnerable developing countries, are facing large-scale           climate change, which they bear no responsibility for,
     struments put forth in this paper suitable for closing the      portant step to fulfilling human rights obligations and      stranded assets that will impact their entire infrastruc-         they also have to pay higher interest rates because of the
     protection gaps ‒ and what are the main challenges? To          to paving the way for the introduction of the polluter       ture. Mobilizing the resources to enable resilience will          accelerated climate risks they may face in future, which
     answer these questions, we must reexamine the main              pays principle into climate risk financing.                  overburden these states if they are left either alone or          they also have played no part in causing. This market lo-
     socio-economic risk dimensions related to climate              • Better linking of social protection with climate resi-      solely dependent on regular capital markets. These                gic leads to a perpetuated discrimination that needs to
     disasters.                                                      lience building: Adaptive and transformative social          nations require financial support to build their resilience       be addressed by the international community through
                                                                     protection systems, with the support of climate risk         at scales that far exceed the current climate finance levels      new risk financing approaches aimed at compensating
                                                                     financing mechanisms (e.g. international donor assis-        (ACT 2018). This is an issue that must be addressed when          for this unfair discrimination. Therefore, it is another
     The main challenges in offsetting the                           tance, climate risk insurance, contingent debt facility),    designing the future climate financing architecture.              important issue to be addressed by:
     economic loss and damage associated                             could mobilize several synergies that exist between so-                                                                        • the UNFCCC, particularly the International Warsaw
     with climate events                                             cial protection and risk management if they enable                                                                              Mechanism (WIM) in its discussions on comprehen-
                                                                     counter-cyclical social expenditure to stabilize the         The main challenges to avoiding                                    sive risk management and on enhancement of finan-
     Climate risk insurance has become the most promoted             socio-economic situation in times of disaster.               worsening capital market access as a                               cial support to address loss and damage,
     instrument for the transfer of climate extreme event risk,                                                                   result of climate risks                                           • the consultations of the G20 and V20 on collaboration
     particularly due to InsuResilience. Climate risk insu-         Climate risk insurance is also limited to the hedging of                                                                         and facilitation of support in addressing climate risks,
     rance is an important instrument, yet it remains un-           rare but very serious events that cause high levels of        It is a fact that climate vulnerable countries already pay         which disproportionally – and through no fault of their
     known in many climate vulnerable countries. It may             damage. It is neither suitable for insurance against          significantly higher interest rates solely because they are        own – affect V20 countries,
     have the potential to avoid humanitarian disasters in the      frequently recurring damage nor as coverage against           climate vulnerable, and that the projected increase in            • multilateral development banks and other relevant
     aftermath of a climate-related extreme event by distribu-      gradual damage, such as that caused by sea level rise.        severe flooding and disastrous cyclones may further                stakeholders in the international finance system in the
     ting the burden across many shoulders, and if access and       The more frequently extreme events occur, the more da-        worsen their credit rating by an average of 20 percent ac-         context of designing effective and efficient climate risk
     affordability are ensured, it might even be the most effici-   mage will be caused by less extreme but highly recurrent      cording to simulated models (Buhr/Volz et al. 2018). This          financing strategies, instruments and facilities, and
     ent instrument to help the poor recover quickly from           events ‒ as well as by sea level rise ‒ and the larger that   further penalizes these countries and deprives them of            • national political decision makers and stakeholders
     an extreme event. Climate risk insurance essentially has       specific area of the protection gap that cannot be closed     fair conditions in accessing capital markets in order to           from civil society and the business sector to overcome
     two immanent limitations that restrict its coverage            by risk insurance will become due to the instrument’s im-     finance low carbon, climate-resilient, sustainable de-             widely spread insurance illiteracy and to find natio-
     against climate risks:                                         manent limitations. If climate change continues unaba-        velopment pathways. Not only do these countries suffer             nally appropriate and fair solutions.
                                                                    ted, the efforts and funding currently committed to insu-     disproportionally from economic loss and damage due to
     Affordability of climate risk insurance for the most           rance also runs the risk of being lost. Due to the inverse
     vulnerable is not ensured and will become even more            relationship between greenhouse gas emissions and
     limited if the frequency and/or magnitude of climate           insurability, mitigation action must be scaled up signifi-
     disasters further increase, as forecasted. There are a         cantly to maintain the feasibility and potential of insu-
     number of options to extend affordability and co-              rance solutions. In addition, the use and benefit of com-
     verage. These three are currently the most promising:          bining insurance with other risk financing approaches
     • Reducing insurance premium prices by bundling more           previously discussed in this paper should continue to
      diversified, large risk pools, preferably across a large      find equal consideration and not be neglected to the
      and diverse geographical area and including as many           benefit of currently popular risk transfer instruments.
      different policyholders as possible. According to a re-
      cent World Bank Study (2017), the formation of a broad
      risk pool that includes around 90 low- to middle-in-          The main challenges to avoiding stranded
      come countries from Asia, Europe, Latin America and           assets as a result of climate extremes
      the Pacific could reduce costs by up to 50 percent com-
      pared to regional risk pooling.                               The only way to prevent public and private infrastructure
     • Premium support provided by international donors ‒           in zones with high risk exposure, such as low-lying coast-
      or, better yet, by the main GHG polluters ‒ is a prere-       lines, becoming stranded assets due to the physical risks
      quisite to massively scaling up insurance in the most         of sudden and slow onset events (e.g. sea level rise) are
      vulnerable countries, as the experience gained from the       massive investments in risk prevention and reduction
      first regional risk pools (e.g. ARC) shows. The Insu-         (e.g. flood barriers) combined with fast and deep GHG           Climate-induced droughts endager the livelihood of people and animals especially in Sub-Saharan Africa.
      Resilience Global Partnership, amongst others, should         emission cuts as demanded by the IPCC (2018). SIDS,             Consequently, conflicts and migration are rising.
      take steps to fund insurance premiums for the poor to         as well as coastal communities and cities in other

16                                                                                                                                                                                                                                                                          17
New Options to close the Climate Protection Gap
                                                                                                                                                                                                                                                       Concluding Policy Recommendations

             New Options to Close the                                                                                                           Concluding Policy
             Climate Protection Gap                                                                                                             Recommendations

             In order for any disaster risk financing strategy to be suc-        accessing these credit lines in order to recover from cli-     Adequate climate risk financing is an integral part of          damage, a new fund to compensate for loss and dama-
             cessful, it is key that it mitigates the risk of a state’s credit   mate-induced losses and damages. Higher indebted-              developing climate risk management strategies for vul-          ge needs to be established. This fund is required to sup-
             rating being downgraded due to its level of exposure to             ness, in turn, will negatively affect the country’s credit     nerable developing countries. It is vital that they be          port disaster risk financing and offset climate-induced
             climate change risks. The Warsaw International Me-                  rating and with it its access to finance, thus limiting its    operationalized effectively and efficiently. Finally, it is     loss and damage, and should be mobilized based on the
             chanism, multilateral climate funds and other relevant              long-term ability to invest in a climate-resilient, low car-   key to address, minimize and offset climate-induced             polluter pays principle. As mandated at COP22 in 2016 in
             stakeholders, in cooperation with V20, should there-                bon future. The negative effects of contingent debt facili-    economic loss and damage.                                       Marrakesh (4/CP.22 paragraphs 2(f ) and (g)), a technical
             fore design new hedging instruments for developing                  ties could be alleviated if the sovereign debt guarantee           Risk financing has to be provided under fair terms          paper detailing possible sources of financial support ai-
             countries to mitigate climate risks when issuing                    component were to be reduced or suspended.                     and with a view to avoiding any discrimination or penali-       med at addressing loss and damage shall be prepared by
             bonds. At national level, such approaches should be                     A new and innovative instrument based on this ap-          zation of a state and its ability to access funds that would    the UNFCCC Secretariat. It shall serve as an input to the
             backed by the design and implementation of climate                  proach of resilient debt management could be a contin-         offer it protection against climate risks for the sole reason   review of the WIM in 2019. The WIM’s Executive Com-
             risk management strategies that are responsive to                   gent multilateral debt facility providing convertible          that the state is climate vulnerable due to reasons beyond      mittee is to assist the Secretariat in determining the
             identified climate change impacts and that enhance                  concessional finance (CCF). The provision of CCF               its control. This relates to the protection of climate vul-     scope of the technical paper that shall be available to
             resilience. In order for them to be operational, they need          would require the alignment of incentives in the design        nerable countries, communities and people against:              Parties by June 2019. At the eighth meeting of the WIM’s
             to be well capitalized and managed sustainably. Further-            phase and the implementation phase, i.e. it would be           • climate-induced loss and damage leading to reduced            Executive Committee, its members agreed on the terms
             more, mainstreaming and incorporating climate change                contingent on using the finance provided for ex-ante ag-        economic development and lowered adaptive capacity;            of reference for the technical paper as well as on an out-
             risk into development planning and budgeting processes              reed disaster risk management measures that effectively        • increasing risks of stranded assets caused by climate         line. Observers criticized that industrialized countries
             is key to achieving resilience and attaining a sound                reduce risks and address damages. Risk financing in the         extremes in vulnerable countries;                              blocked a decision to include an assessment of how much
             credit rating (Jackson 2018).                                       form of CCF would consist of highly concessional con-          • and worsening capital market access caused by climate         finance is needed as well as to establish new and addi-
                 What options are available to offer climate vulnerable          vertible debt instruments and grant-to-concessional             risks leading to higher indebtedness and lower in-             tional sources for such a fund ‒ though the so-called
             countries access to the necessary financial means to im-            debt, working with the following incentive: To build resi-      vestment.                                                      Suva Expert Dialogue in 2018 made clear that finance is
             plement their disaster risk financing strategies? It is clear       lience against high climate risks, this step should first be                                                                   a crucial issue. The assessment that has now been agreed
             that dynamic access to innovative financing for a socio-            supported by grants. If successful, the support could be           So far there has been no commitment by industria-           upon will thus only entail an assessment of already
             economic transformation towards climate-resilient, low              converted into pre-approved concessional debt terms.           lized countries and other major polluters to provide any        existing funds.
             carbon development is required while avoiding further               Should a project financed by concessional debt fail (sub-      finance to compensate for loss and damage occurring in              As this paper shows, the existing instruments are
             indebtedness. Innovative financing implies accessibili-             ject to ex ante agreed indicators for success and failure),    poor and vulnerable countries as is already the case for        insufficient to close the protection gap as required. Effec-
             ty, predictability and that financing conditions are fair           the debt should be converted into a grant. Such an ap-         mitigation and adaptation.                                      tive and efficient risk financing and the offsetting of
             in the sense that they do not bear the risk of further in-          proach would help overcome the dangerous spiral of                 Despite efforts made to provide climate risk finan-         climate-induced loss and damage requires new funds
             debtedness caused by the impacts of climate change.                 worsening credit ratings, rising indebtedness and more         cing on a voluntary basis, such as the InsuResilience           that are provided to the climate vulnerable in a way that
             Furthermore, innovative financing options should incen-             stranded assets caused by climate change. It would enab-       Global Partnership and initiatives undertaken by the            delivers climate justice and that is sourced in line with
             tivize transparency of action as well as support strong             le climate vulnerable countries to mobilize risk capital for   V20, the protection gap remains significant and is likely       the polluter pays principle. It is therefore of the utmost
             ownership and intense collaboration between vulner-                 investment into resilience building and higher climate         to widen even further in future due to ongoing global           urgency that the community of states, and especially
             able countries and the financing partner institutions.              ambition. It would benefit climate vulnerable communi-         warming.                                                        the Parties to the Paris Agreement and the Executive
                 Contingent debt facilities are contingent financing             ties and people, and it would factor solidarity and justice                                                                    Committee of the Warsaw International Mechanism,
             programs that are usually offered by multilateral de-               into climate risk financing by offsetting economic loss        Thus, Bread for the World puts forward the following            develop options to mobilize these funds in 2019 with
             velopment banks. They allow for concessional debt based             and damage caused by climate extremes. It would pro-           policy recommendations:                                         a clear outcome adopted by COP25.
             on loans that are extended on terms substantially more              mote socio-economic and financial inclusion as well as         1. The mobilization and provision of climate risk finan-
             generous than market loans and, as previously menti-                climate resilience. Finally, it would be a new hedging         cing in the context of comprehensive climate risk               3. Climate vulnerable countries should establish
             oned, are already a typical disaster risk financing instru-         strategy of global common interest that helps to stabilize     management approaches is a crucial prerequisite to              climate risk financing strategies, being informed by the
             ment. However, it is important to further improve such              the international financial and economic systems against       closing the climate protection gap for vulnerable peop-         OECD Recommendation on Disaster Risk Financing
             facilities by better aligning incentives on the design              climate-induced disasters, which will occur more fre-          le and countries. Thus, it should be given significantly        Strategies (2017):
             and implementation side: If disaster strikes, contingent            quently and on a larger scale in future.                       higher priority in international policy forums, becoming        • that effectively manage the financial impacts of climate
             credit lines are usually provided by multilateral banks,                However, new finance is required to capitalize a           a permanent agenda item, for instance at COPs, G20               disasters,
             such as the World Bank, to vulnerable countries as a                contingent multilateral debt facility that provides conver-    summits and regular meetings held by multilateral               • that form an integral part of climate risk management
             main financial source to recover from the shock. These              tible concessional finance for climate disaster risk finan-    development banks.                                               strategies,
             loans are concessional, i.e. provided below market rates,           cing and resilience building, and that offsets climate         2. In light of insufficient global mitigation efforts, the      • that are effectively aligned with national adaptation plan-
             but linked to a sovereign debt guarantee provided by the            induced loss and damage. Thus, how the facility could          inadequate provision of climate finance to help coun-            ning, sustainable development planning and budgeting,
             borrowing country, meaning that the repayment is gua-               be provided with adequate funding is a key issue that          tries adapt to the effects of climate change, and the           • that build on a sound multi-hazard risk assessment
             ranteed. Countries will thus be further indebted when               needs to be addressed with urgency.                            complete lack of funding to compensate for loss and              (for hazard and risk assessment, see glossary),

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