UN continues push for “loss & damage” solution. Cat bonds feature

The United Nations continues to move forwards, albeit slowly, its goal to address the issue of “loss and damages” from natural disasters and weather related climate risks, and catastrophe bonds, alongside other risk transfer tools, are set to feature.

The UN has been working with industry and various other international organisations on recommendations to address the issue of rising disaster losses, growing impacts of weather and climate related risks and the needed initiatives, both financial and practical or physical, to increase resilience to these threats.

As a result, the topic of risk transfer and how the insurance, reinsurance and capital markets can play a role to help mitigate impacts and speed recovery feature heavily in a lot of the UN’s recent work.

A UN committee met in Germany yesterday with the goal of moving forwards this agenda, which faces a number of meetings in the coming months at which it is hoped the conversation becomes more focused and solutions closer to agreement. The committee has produced an action plan, featuring the various work group items that are to be progressed under the banner of the Warsaw International Mechanism for Loss and Damage associated with Climate Change Impacts.

Loss and damage is becoming a key component of the range of climate related discussions held at the UN and under the UN banner, with an expectation that some progress will be announced at the Sendai, Japan meeting regarding the Hyogo Framework for Action next year.

It has increasingly become apparent that losses and damages from natural disasters, weather and climate related extremes are growing, both as mankind puts itself into ever more exposed regions and as developing countries grow and infrastructure becomes more valuable.

Part of the UN’s push is for a concept of disaster disclosure to be adopted and recommended for corporations, investment organisations and others which put themselves in these exposed regions of the world. If disaster risk and resilience were disclosed on the balance sheet, or a factor in investment decisions, it is hoped that greater resilience can be achieved, through mitigation measures, more sensible investment, use of risk transfer and hedging as well as the transparency impacting how business is done around the world and hopefully making it more sympathetic to risks and exposed communities.

The action plan produced yesterday details a number of key work streams, one of which is directly related to risk financing, re/insurance and the use of financial tools to provide post-event capital for improved response and recovery from loss and damages.

The action plan says:

Encourage comprehensive risk management by the diffusion of information related to financial instruments and tools that address the risks of loss and damage associated with adverse impacts of climate change, to facilitate finance in loss and damage situations in accordance with the policies of each developing country and region, taking into account necessary national efforts to establish enabling environments.

The financial tools the action plan details include; Comprehensive risk management capacity with risk pooling and transfer; Catastrophe Risk Insurance; Contingency Finance; Climate-themed Bonds and their certification; Catastrophe Bonds; and financing approaches to make development climate-resilient, among other innovative financial instruments and tools.

Activities will include:

1. Encourage public bilateral and multilateral institutions and funds, and private investors, to incorporate climate risk and resiliency in development projects, and in investment criteria and decisions.
2. Encourage, promote, and coordinate with research and development processes on financial instruments and tools that address the risks of loss and damage associated with the adverse effects of climate change.
3. Invite the SCF, in their next Biennial Assessment of Climate Finance Flows, to include information on financial instruments that address the risks of loss and damage associated with the adverse effects of climate change.
4. Invite Parties and relevant organizations to provide information on best practices, challenges and lessons learned from existing financial instruments at all levels that address the risk of loss and damage associated with adverse effects of climate change.
5. Facilitate diffusion of comprehensive information through a section of the UNFCCC website, reports of the Excom to the COP, side event(s), and an invitation to the SCF to dedicate the 2016 Forum to financial instruments that address the risks of loss and damage associated with the adverse effects of climate change.

With the goal being:

Improved understanding by public bilateral and multilateral institutions and funds, private financial institutions, and developed and developing countries on the range of financial instruments and tools to enhance action and support, including finance, technology and capacity-building to address loss and damage associated with the adverse effects of climate change.

It continues to seem like one of the key initiatives is the one to address disclosure of disaster risk and resilience. If major multi-national corporations had to disclose their supply chain exposure to disaster and weather risks they would be encouraged to buy more risk transfer.

Much of this risk transfer could be parametric in nature, given its contingency on occurrence of events. As a way of hardening the balance sheet, protecting investors, protecting developing country operations and building resilience through risk finance and risk transfer, the corporations could become much more responsible as a result.

For organisations that invest into regions of the world with high disaster and weather risks, a culture of disclose would also be groundbreaking. It would encourage responsible investment, the use of risk transfer and hedging (which is next to non-existent in some investment operations) and also a more responsible and thoughtful approach to investment in the developing world.

The timeline for many of these initiatives remains long, with progress likely to start to be seen in 2015, possibly around the Hyogo Framework meeting. The first activity we list above, encouraging the incorporation of climate risk and resiliency in development projects, investment criteria and decisions, has an indicative timeline of Janaury to June 2015, which would put the Hyogo Framework meeting right in the middle. It is to be hoped that progress is seen in that timeframe.

The opportunities for the reinsurance and insurance-linked securities (ILS) market are clear, with a need for additional risk transfer capacity almost guaranteed if these initiatives make the progress that many now expect. Tools such as catastrophe bonds, parametrics, weather indices, derivatives and other structures, alongside capital and capacity from both the traditional and alternative reinsurance markets will be required to make this happen. The risk needs to be channeled into true private markets, not subsidised and packaged away where the exposures can still impact resilience.

These UN discussions, and one occurring later this month in September featuring the World Bank, are set to pave the way for a new culture of disaster and risk protection around the world, if successful. As a result we will be following them closely and hope that a new process to build risk transfer and resilience into the way corporations and investors think about profits can become a standard part of global business and development in the future.

You can download the work plan from the UN committee here in PDF format.