ADB climate migration report recommends catastrophe bonds, weather derivatives and index-insurance

by Artemis on March 13, 2012

The Asian Development Bank has published a report today on the topic of climate change, adaptation and the expected surge in migration that the variations in our climate will likely cause. The report, titled Addressing Climate Change and Migration in Asia and the Pacific, highlights that 42 million people in the region were displaced by environmental disasters in the last two years alone. An undetermined number of those people became migrants due to either being unable to return to their homes or choosing to move to safer locations.

“The environment is becoming a significant driver of migration in Asia and the Pacific as the population grows in vulnerable areas, such as low-lying coastal zones and eroding river banks,” said Bindu Lohani, ADB’s Vice President for Knowledge Management and Sustainable Development. “Governments should not wait to act. By taking steps now, they can reduce vulnerability, strengthen resiliency, and use migration as an adaptation tool rather than let it become an act of desperation.”

The report identifies likely policy responses to the growing problem and looks at issues such as infrastructure, education, sanitation, healthcare, resilience and improvement of disaster risk management systems. It also discusses possible mechanisms for funding climate-induced migration and discusses risk transfer tools which can help to offset the costs of these climate and weather disasters.

The report specifically discusses catastrophe bonds as one of the financial tools available which could be leveraged in the Asian region. It notes that catastrophe insurance has historically had a relatively low cost associated with it in Asian cities, outside of Japan, due to the diversification they offer reinsurers. However the report suggests that as the economics and demographics of these cities changes it is likely that capital market capacity will become an important source of capital to support increased penetration and usage of catastrophe insurance. They also note that due to the cost of issuing cat bonds it may be preferable for Asia Pacific countries to concentrate on developing reliable financial and insurance markets before seeking to issue their own cat bonds. Of course it is likely that the large global reinsurers would be the first to try to tap the capital markets for capacity for Asian risks either for themselves or as a transformer for their large insurance clients in the region.

Weather derivatives are cited as another financial tool which can be used in the Asia Pacific region to help mitigate and provide financing for these risks as many of the events which could cause the migrations the report discusses are weather linked events. Index-based insurance, which triggers policy payments based on an index of weather conditions such as temperature, rainfall etc. are also cited as a useful tool.

The report discusses the potential for creating a financial product, featuring some characteristics of a catastrophe bond or weather derivative, which has payments linked to a sea-level index. A product like this could make a higher payment to the policyholder if the sea-level rises more quickly than expected or lower (or zero) payment if the sea-level rises less quickly. The AFB notes a number of issues that would need to be addressed in the creation of such an insurance product:

The new financial product would need a carefully balanced structure to (i) keep premiums affordable, (ii) provide attractive long-term returns to investors, and (iii) provide a sufficiently secure source of payments in the event of rising sea levels.

The report is worth reading as it gives a good overview of what is a growing risk and one that is likely to become a focus for reinsurance and capital market risk transfer providers (there’s definitely a role for cat bonds) in the future.

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