Insurance, Cat Bonds Can Help Boost Poorer Countries’ Resilience to Climate Risks

By Alessandro Parodi, and | December 1, 2023

Low-income countries are struggling to access insurance, catastrophe bonds and other hedging mechanisms that could help protect them from the economic fallout of climate change, industry sources told Reuters.

Helping these countries, which face some of the biggest risks from climate change, access these will be a key aim during the COP28 climate talks underway in Dubai.

Multilateral lenders and rich nations aim to finance a special climate disaster fund, offer their own so-called “disaster clauses” in new loans and facilitate other lending structures as a way to shield vulnerable nations from the economic fallout of floods, wildfires, droughts and other extreme weather.

The efforts are slow, politically difficult and piecemeal, but expanding protection is an increasingly important focus for governments and vital for dozens of emerging countries, where damage can top 100% of economic output.

Ambitions for results at COP28 got off to a good start on the opening day on Thursday when countries approved plans for the climate disaster fund, after months of negotiations.

“COP28 is an opportunity to spread the message that it is better to spend money on prevention measures ahead of time, instead of waiting for the catastrophe to happen and scrambling to react,” said Ekhosuehi Iyahen, secretary general of the Insurance Development Forum (IDF), an industry-led group that promotes insurance for non-traditional markets.

There are myriad financial protection options, including pre-arranged finance (PAF) like catastrophe bonds, parametric insurance and other loan structures such as risk pools that guarantee a set, speedier payout in the event of disaster.

The different tools are used against different sizes and frequency of risk, such as, for example, cat bonds for hurricanes and earthquakes, risk pools for droughts and floods.

However, accessing them is hard for many countries amid punishing debt burdens, heightened by recent fast global interest rate hikes.

Debt and Costs

PAF totalled around $5 billion between 2017 and 2021, yet only $200.8 million reached low-income countries, the London-based Centre for Disaster Protection (CDP) said in a recent report. This is equivalent to just 3.7% of international development financing for PAF, the report found.

“Addressing this ‘access gap’ requires international cooperation and coordination,” said IDF’s Iyahen, suggesting that providing countries with grants or other financial support to pay required premiums could help.

About 60% of low-income countries are either in or at high risk of debt distress, the CDP said.

“Governments face increasingly difficult prioritization decisions, which is likely to adversely impact demand for PAF directly financed by governments,” authors of the CDP report Michèle Plichta and Lydia Poole said.

To help bolster countries’ resilience and spur the private sector to act, the European Bank for Reconstruction and Development (EBRD) plans to offer clauses in sovereign loans that allow automatic debt reprofiling following a disaster.

“This will be probably proposed to the set of countries which are … more prone to this kind of natural catastrophe, natural disaster. So it will be floods, earthquake, drought, basically,” EBRD President Odile Renaud-Basso said, without giving details.

Other multilaterals could make similar announcements during COP28.

Rising Costs

Global insured losses from natural catastrophes hit $50 billion in the first half of 2023, according to re-insurer Swiss Re SRENH.S, making up around a quarter of the $194 billion in total losses, as estimated by insurance broker Aon.

Some countries are banding together into so-called ‘risk pools’ with insurers and reinsurers to share the burden.

The Central Asia Regional Economic Cooperation Program, for example, aims to agree a disaster relief bond issuance and a regional risk transfer facility, the ADB’s Principal Disaster Risk Insurance and Finance Specialist, Thomas Kessler, told Reuters.

Some larger emerging economies already have provisions in place; Mexico will likely receive a payout of some $62.5 million from a catastrophe bond after Hurricane Otis wreaked deadly havoc in October. But such examples are limited.

Amidst efforts to provide more cover, the UN-led loss and damage fund approved at COP on Thursday could prove a key source of funding.

COP participants will study on Dec. 1 a report from the University of Cambridge’s Institute for Sustainability Leadership, which said the fund could help the most vulnerable countries cushion the hit from disasters for as little as $10 million each a year.

“We are ready to scale up climate protection through early warning systems, anticipatory cash, climate insurance and community-based resilience projects,” said Gernot Laganda, director of Climate and Disaster Risk Reduction at the United Nations World Food Programme. “But (we) need stronger engagement by climate and development funders to enable this vital protection.”

(Reporting by Alessandro Parodi; Simon Jessop and Libby George; additional reporting by Karin Strohecker; editing by Susan Fenton)

Photograph: Women carry belongings salvaged from their flooded home after monsoon rains, in the Qambar Shahdadkot district of Sindh Province, of Pakistan, on Tuesday, Sept. 6, 2022. More than 1,300 people were killed and millions lost their homes in flooding caused by unusually heavy monsoon rains in Pakistan, which many experts have blamed on climate change. (AP Photo/Fareed Khan)

Topics Catastrophe

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