Catastrophe bonds are an innovative financial tool that can be leveraged in the goal to provide the world with access to the $200-$300 billion of capital required to help countries combat climate change shocks, according to the Rockefeller Foundation.
It’s not the first time that catastrophe bonds have been cited as a financial innovation, with a structure that can be tweaked to assist the world in meeting social and development goals.
But the Rockefeller Foundation is offering cat bonds as an example of “one of seven potentially game-changing trends we believe will be the next frontier of climate resilience.”
With the Paris COP21 United Nations Climate Change Conference and climate negotiations underway, the subject of catastrophe bonds (or other insurance-linked securities (ILS)) or other innovative financial tools and the role these instruments can play in helping to finance adaptation, mitigation, build capacity for protection and resilience, to climate or weather related risks is once again on the agenda.
The Rockefeller Foundation has a focus on “unlocking private capital for social good” something that catastrophe bonds have achieved, by channeling private capital from investors to the insurance and reinsurance industry, as insurance, reinsurance or retrocessional capacity.
By enabling private investors to assume catastrophic risks, risks which in many cases the traditional insurance or reinsurance sector would find it hard to bear alone, catastrophe bonds transfer peak disaster or insurance-linked risks out to the capital markets, enabling access to the deepest and most liquid pool of capacity available to assume risk.
As a tool or mechanism for transferring some of the climate related risks to private capital, the catastrophe bond provides a mechanism that the Rockefeller Foundation believes will answer a core need associated with resilience.
“One of the great challenges for cities and other principalities is a persistent global funding gap for tools to meet pressing challenges,” Judith Rodin, President of the Rockefeller Foundation explained.
Rodin continued, calling for “innovative, systems-deep approaches” to help our increasingly interconnected world to achieve “real and lasting resilience.”
One of the seven “potentially game-changing trends” that the Rockefeller Foundation believe can help to build climate resilience is the “huge and largely untapped opportunity to use new financing mechanisms,” Rodin said.
Among these Rodin cites “blended investments” linked to certain social goals, which she provides catastrophe bonds as an example of, saying that “investors get their money back, plus interest, if certain social scenarios are met.”
Innovative financial instruments such as these, so including catastrophe bonds, “Can help pay the annual $200-300 billion needed to help countries combat climate change shocks,” Rodin explained.
In order to attract more private capital to investments that can also finance, help to meet or reinforce social goals, the Rockefeller Foundation is working with initiatives that it feels can help to mobilise more private capital to help provide the necessary funding to address global challenges such as climate risk.
The Rockefeller Foundation aims to encourage and facilitate “the use of financing mechanisms to mobilize private sector capital in new and more efficient ways for projects to create a more resilient and inclusive world.”
To meet this goal the Foundation works to “develop new financing mechanisms to mobilize large pools of private capital, identifying, and supporting innovations that have the potential to create outsized impact.”
One of the “innovative financing mechanisms” that the Foundation is working with is the African Risk Capacity’s (ARC) Extreme Climate Facility (XCF) initiative. The Rockefeller Foundation describes the XCF initiative as:
An African-led effort designed to access private capital, diversifying the sources and increasing the amount of international funding available for climate adaptation in Africa. XCF is a data-driven, multi-year vehicle that will provide financial support to eligible African countries to help them build climate resilience and be financially prepared to undertake greater adaptation measures, should extreme weather event frequency and intensity increase in their region.
Of course, regular readers of Artemis will recognise that the XCF is the ARC’s idea for climate change catastrophe bonds, an initiative that was announced in 2014.
The Rockefeller Foundation provided ARC with a grant of just over $1 million to support design and development of the Extreme Climate Facility (XCF).
While the XCF is focused on Africa, given the African Risk Capacity is running the initiative, it could perhaps have application around the world in regions where climate or weather risks, exacerbated by change and warming, need financing and help with building resilience.
The XCF is designed to access private sources of capital and to diversify the sources of funding available for climate risk financing. It is expected to be structured as a catastrophe bond program, meaning its financial obligations to countries will be securitized, issued as cat bonds with multi-year terms and financed by the capital sourced from private investors and the capital market, with ILS investors expected to be attracted to any notes issued by the XCF.
The Rockefeller Foundation is also involved in another interesting climate and weather risk resilience related catastrophe bond innovation, RE:bound.
RE:bound wants to leverage catastrophe bond technology to design and structure new risk transfer solutions that provide a mechanism for resilient infrastructure project financing. As such it is another example of cat bonds as innovative financial tool for increasing resilience, as well as transferring climate and weather risks.
Additionally the Rockefeller Foundation is a leader in initiatives such as 100 Resilient Cities, which aims to help 100 cities around the world build resilience to shocks such as catastrophic natural disaster events and weather extremes, as well as chronic stresses including climate change.
Again, with risk financing and transfer a key aspect of the 100 Resilient Cities initiative, catastrophe bonds seem an appropriate financial innovation that can help to deliver benefits to the cities taking part.
Putting these initiatives together, the Extreme Climate Facility (XCF), RE:bound, 100 Resilient Cities, alongside other topics such as the recent discussions of using catastrophe bond technology for pandemic risks like Ebola, and you can begin to see that the cat bond market could play a key role in discussions on global issues of social importance such as these.
The Rockefeller Foundation sees these initiatives as paving the way for a new social impact investment trend, which leverages blended investments that are linked to social goals and outcomes, which it sees as supportive of global initiatives such as the Sustainable Development Goals (SDG’s), which need financing and private capital support.
The catastrophe bond market can play a key role in providing access to the some of the capital required to begin to work towards such global goals through the insurance-linked investor base that it already manages assets for.
The ILS markets’ portfolio management ability, alongside its understanding of climate, weather and disaster exposures and how best to assess, invest in and manage them could also play a key role in helping initiatives such as this to become accepted by institutional investors.
With a potential $200-$300 billion required to help the world combat climate shocks the opportunity is clear.
Leveraging the catastrophe bond structure to create socially linked investments, that mitigate, finance, protect against and transfer risks, while encouraging resilience and adaptation, could become a major contributor to the future of this asset class.
Read our series of articles focused on the insurance protection gap – under-insurance in emerging and developing economies, the gap between economic and insurance losses, and transferring risk from public sector to private – the opportunity that is on every reinsurance CEO’s lips and which presents the largest opportunity to put excess risk transfer capital to use, requiring both traditional and capital markets support.
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