Risk-sharing systems must be a pillar of Loss and Damage architecture: Report

A new report calls on the world to implement risk-sharing systems, such as parametric triggers in insurance, reinsurance and insurance-linked securities (ILS) such as catastrophe bonds, as a central pillar of the loss and damage architecture necessary to protect the most vulnerable. nations against climate, bad weather and natural disasters.

cop27-loss-damageThe report published by lead author Dr Ana Gonzalez Pelaez, a member of the Institute for Sustainability Leadership at the University of Cambridge and prepared with support from insurance and reinsurance broking group Howden, examines how the transfer risk can be a key element of the global mechanism of loss and damage. design.

Specifically, the report proposes a risk-sharing action plan to increase financing for the much-talked-about loss and damage (L&D) that countries in the Global South are among the most vulnerable to climate change and disasters.

The study finds that the smallest and most vulnerable countries risk losing more than 100% of their GDP to extreme weather shocks next year.

But it has been noted that these are insurable risks and the research undertaken claims that they will remain insurable, using insurance industry techniques, until at least 2050.

“A solution leveraging the power of insurance and capital markets could significantly increase the impact of loss and damage financing,” the report suggests.

It suggests using donor financing to pay risk transfer premiums, using the most appropriate instruments in insurance, reinsurance and capital markets, including catastrophe bonds, and leveraging structuring techniques such as parametric triggers to provide just-in-time financing. .

The goal would be to provide “guaranteed financial protection to exposed communities from now until at least 2050,” the report explains.

The report estimates that $1 billion in pure annual donor-backed premium could be used to protect the world’s 30 countries, among the smallest and most vulnerable to climate change, with populations of less than 1 million. inhabitants, against a loss of more than 10% of their GDP due to climate shocks. thanks to an umbrella stop-loss mechanism design.

By making risk sharing, insurance, reinsurance and instruments such as catastrophe bonds a central pillar of the Loss & Damage initiative, the report’s authors argue that the economies of the most vulnerable countries can be protected.

The report shows that risk-sharing systems, such as insurance and risk transfer in financial markets, can be an effective way to leverage the expertise and financing available in private markets.

By earmarking a portion of donor funding that could be dedicated to losses and damages to pay premiums, long-term risk transfer can be locked in to protect the economies of regions most vulnerable to climate, weather and natural disasters.

The study found that the pure annual premium of $10 million per country, supported by donors, could equate to around $25 billion in financial protection, contractually guaranteed, across 100 countries.

This is important work because it takes a quantitative approach to demonstrate how financing can go further, while sharing risks, using the concepts of insurance markets and insurance-linked securities (ILS), in order to mobilize significant private capital to support the most vulnerable country in the world.

As we have said before, responsive risk transfer and effective capital markets can combine to provide the kind of protection that vulnerable countries need, while ensuring that donor financing is used in a way that provides real liquidity when it is needed. most of them.

As we have been saying for over a decadeinsurance-like structures should be integrated into these climate and disaster risk financing efforts, such as the Loss and Damage Initiative, to ensure access to capital for climate change disaster response, recovery and reconstruction.

Finally, there is work that can help demonstrate the utility of this approach, which should help to gain more traction for this idea in development circles as COP28 quickly approaches.

The backgrounder on this important study can be viewed here.

Dr Ana Gonzalez Pelaez, a member of the Institute for Sustainable Leadership at the University of Cambridge and lead author, explained: “We have demonstrated how public and private funding can be combined to protect billions of people, now and in the decades to come. We call on the international community to make risk-sharing systems a pillar of the loss and damage architecture for all countries and to introduce general stop-loss mechanisms to protect the economies of the smallest and most vulnerable countries to the world’s climate.

“The action plan presented in this study is ready and can be implemented using existing institutions to provide vulnerable countries with guaranteed payments in venture capital markets after a disaster. These funds could be used for critical priorities such as humanitarian aid; rebuild schools, hospitals and vital infrastructure; sovereign debt repayments; restoration of agriculture and ecosystems.

Howden undertook actuarial analysis and financial modeling to establish the technical cost of reducing financial risk through the use of parametric solutions to implement the so-called umbrella stop loss concept and the standard pure premium allocation of 10 millions of dollars.

Stop-loss umbrella protection is already a well-established concept in the global insurance and reinsurance industry.

This means that all defined losses above a given threshold are protected, providing comprehensive and strategic protection beyond lower-level losses.

This study saw the global stop-loss structure applied for the first time to protect national economies on a large scale, using GDP as a benchmark and in the face of six climate hazards.

The research notes that seizure thresholds can be set at any chosen level, but in their analysis the authors opted for 10% as this can provide significant protection to small, vulnerable countries at risk of losing more than 100% of their GDP while remaining affordable for them. donors.

Rowan Douglas CBE, CEO of Climate Risk and Resilience at Howden and chair of the Insurance Development Forum operational committee, added: “The pure mathematics and unbiased economics of this analysis are clear. Risk-sharing systems allow hard-earned funds to provide structural financial security to the widest range of vulnerable countries. We can mobilize existing expertise, institutions and partnerships to quickly put this essential protection in place. With this groundbreaking research from CISL, world leaders are guided by an action plan based on open science, rigorous analysis, shared alignment and collective purpose.

Dr. Mahmoud Mohieldin, UN High-Level Champion on Climate Change, also said: “This innovative initiative has the potential to protect vulnerable countries from climate-related losses through large-scale pre-arranged financing, freeing up thus the venture capital markets to multiply the impact. donor funds. Mobilizing private finance alongside the new Loss and Damage Fund is crucial to addressing these impacts, and more initiatives of this type are needed.

Dr Youssef Nassef, Head of Adaptation at the United Nations Framework Convention on Climate Change, also commented: “The Stop-Loss umbrella provides a practical concept to the L&D sector’s common position that it is of an international responsibility that countries and individuals should not suffer due to climate change. , above a certain limit.

Co-author Dr James Daniell, Natural Hazards Engineer, Risklayer GmbH; The Center for Disaster Management and Risk Reduction Technology (CEDIM) at the Karlsruhe Institute of Technology and the University of Adelaide further explained: “We produced plausible, average estimates of climate risk for these countries using leading data sources and robust methodologies. This analysis frames the implementation of loss and damage within the framework of objective physical and economic realities, essential to obtaining effective results. This pioneering research also paves the way for a broad global community of academic and professional expertise that is ready to build on this work and support the urgent mission of providing protection against loss and damage to vulnerable countries around the world. .

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