When weather events and climatic processes collide with society, an array of setbacks can occur like injury or loss of life or health, damaged infrastructure, and interruption to livelihoods, education, and other parts of normal life. Financial resources can help society deal with these setbacks—a vital part of resilience—and there are a variety of different types of funding used today.
Traditionally, funding is provided to country recipients by bilateral, multilateral, and international organizations. Funding may be provided directly by bilateral donors or through multilateral funds or development banks that have created special facilities, trust funds or programmes to channel available resources. These types of funding may not always be best suited to the needs of country recipients, which suggests space for innovation.
The comprehensive risk management cycle (assessment, reduction, transfer, retention) is important. Adopting a holistic view to funding for risk management can help decision makers plan for, pre-empt and reduce risks and make contingency arrangements which can further contribute to a better coordinated and optimal response to impacts.
Across this risk management continuum different financial instruments and tools can be applied to finance activities and to avoid potential financing gaps in case of disaster occurring, such as grants, (concessional) loans, contingent credit or loans for external contingency finance, capital contributions, subsidies for risk transfer solutions, technical assistance, etc.
Risk transfer redistributes the financial consequences of risk to those entities better able to bear the costs, in exchange for a premium to cover the potential resources needed to pay out to beneficiaries when a hazard occurs.
Some ways that funding can be applied to address climate-related risks are:
Premium support is direct or indirect support that lowers the cost of insurance premiums.
Direct premium support provides financial resources to the purchasers of insurance. The support can cover both the mark-up part and the risk based part of insurance premiums.
Insurance premium support can come in various forms, with two key distinctions being:
- Targeted or not: Premium support can either be targeted at a particular recipient, or given to the premium pool;
- Fixed support, fixed premium, relative support: Support can set at a fixed level per insured, as a percentage of the sustainable premium level, or to cap the premium level at a defined level.
- The Indian government pays any premium above the cap in the National Agricultural Insurance Scheme (NAIS).
- Regional Insurance Facility for Central America (RIFCA) of the Inter-American Development Bank directs the donors’ contributions to capitalize the countries’ individual insurance facilities or partial premiums financing during an initial take-off period; countries that are not in a position to fully pay their annual premiums are assisted with direct premiums from donors.
- Caribbean Development Bank (CDB) has provided grants for full payment of Haiti’s premiums to the Caribbean Catastrophe Risk Insurance Facility (CCRIF)
Donors can provide a recurring support to cover operational costs of insurance schemes. Although the operational costs of sovereign disaster insurance schemes are typically relatively low compared to the cost of underwriting risk, any reduction in the operational cost can benefit beneficiary countries.
Paying the reinsurance costs of an insurance scheme has broadly the same effect on premium levels as donor capitalization, as it effectively reduces the costs of underwriting risk to an insurance pool. Put differently, both donor capital provision and donor payment of reinsurance costs reduce the cost of financing risk layers for the insurance pool. The difference is that donor capitalisation directly uses donor capital to finance risk layers, whereas payment of reinsurance costs uses donor funds to pay private reinsurance, through reinsurance premiums, to finance a risk layer.
The Beijing Municipal Government subsidises reinsurance premiums for local agricultural insurers providing agricultural insurance to around 400,000 businesses around Beijing. Reinsurance providers insure losses between 160 and 300 per cent of annual premiums. The government itself provides reinsurance by guaranteeing losses above 300 percent of annual premiums.
Donors can directly provide capital to a scheme. This may be in the form of a grant, a guarantee, in return for equity, or contingent on certain triggers. Donor provided capital reduces the cost of capital that the insurance provider faces, and the resulting savings can be used to lower premium levels.
There are two main uses for donor capital:
- Typically, the main use of donor capital is to finance a risk layer. In other words, the provided capital is exposed to risk, reducing the need to purchase reinsurance, which reduces the premiums the risk pool needs to charge countries.
- Furthermore, particularly at the inception of a scheme, the flexibility to use capital for a variety of measures may be useful; indeed, all sovereign risk pools have received some degree of capital at their inception to aid with start-up costs.
- Capital contributors have provided African Risk Capacity Ltd. (ARC) with equity capital which was used by ARC to fund setup costs, and partially exposed to risk to reduce reinsurance costs. The capital is provided for a definite investment period, after which ARC will repay the investment.
- Donor partners have supported the development of the PCRAFI insurance program since its inception and will continue to play a critical role through (i) providing the PCRAFI MDTF with capital to support the establishment of the facility, (ii) supporting the incremental buildup of capital over its first years of operation, and (iii) providing financial support to the PCRAFI TA Program Contributions by donor governments to the Regional Insurance Facility for Central America of the IDB (including (capitalization of pool, and technical assistance for comprehensive risk management planning).
Technical assistance can come in a number of forms. Typically, technical assistance is provided as grant expert resource. In the context of sovereign risk pools, there are three main categories of technical support; assistance with scheme design, risk layering and insurance brokering; and managerial and operational assistance.
The provision of technical assistance can reduce the cost of risk modelling and data collection to an insurer which can translate into lower premiums. Higher quality risk modelling also allows for greater diversification of risk which benefits comprehensive risk management efforts and financial risk management for beneficiary countries.
Disaster Risk Financing and Insurance (DRFI) Program supports governments to implement comprehensive financial protection strategies, and brings together sovereign disaster risk financing, agricultural insurance, property catastrophe risk insurance, and scalable social protection programs. It also helps governments work with the private sector to facilitate public-private partnerships.
Donors and multilateral agencies can provide funding (and technical assistance) to directly reduce the risk level faced by the insured. By reducing risk, the expected loss should decrease. With respect to sovereign disaster risk pools, the majority of risk reduction potential can be gained through cooperation with governments. For example, donor attention could focus on the enforcing appropriate building codes, or improved urban drainage systems to reduce flooding risk.
R4 Rural Resilience Initiative reached over 43,000 farmers (about 200,000 people) in Ethiopia, Senegal, Malawi, Zambia and Kenya through a combination of four risk management strategies: (i) improved resource management through asset creation (risk reduction); (ii) insurance (risk transfer); (iii) livelihoods diversification and microcredit (prudent risk taking); and (iv) savings (risk reserves).