ARC focusing on multi-hazard index for climate cat bond facility XCF

The African Risk Capacity (ARC) continues to work towards the implementation of its climate catastrophe bond backed Extreme Climate Facility (XCF), focusing on the development of a robust multi-hazard index that can be used to trigger the instruments.

The Extreme Climate Facility (XCF) is a proposed multi-year funding mechanism which will be able to issue climate change catastrophe bonds to provide the necessary risk capital to support African nations as they transfer climate change related exposures to the capital markets.

The African Risk Capacity (ARC) has been more focused on single peril or hazard index based parametric insurance products so far, with drought insurance, tropical cyclone and flood coverage all areas of focus, with the resulting risk pool backed by efficient reinsurance capital from traditional and alternative sources.

But with the implementation of the XCF targeting a risk transfer and financing facility to protect African nations against climate change related exposures, in order to create a robust and responsive index to use in the trigger of any climate cat bonds issued, there is a need for multiple perils or hazards to be taken into account.

To this end, ARC is working on the development of the Extreme Climate Index (ECI), a multi-hazard index that will track changes in the frequency and/or magnitude of extreme weather events across the African continent.

The idea is that the Extreme Climate Index (ECI) should be capable of indicating when a shift in the climate that could be impactful to covered nations is underway in a particular area of the continent. So, payouts would be triggered to all countries covered by the XCF and its climate cat bonds whenever the index exceeds a pre-defined threshold, so indicating a changing climate in that area.

The multi-hazard index will be primarily focused on temperature and precipitation, in order to ensure it responds to conditions such as drought and extreme temperatures.

But it will be designed such that it will also be able to factor in other hazards as well, so it can capture both extreme individual events as well as monitoring changes in extreme climate event frequency and intensity over a 30-year or more time frame.

First and foremost the climate index is being designed to detect the number of extreme climate related events in a given area across a given period of time, while the XCF itself will also include a strategy to detect changes in the frequency of extreme events, by comparing to historical data.

Once the change in frequency is considered assured by the triggering of the index, a payout should be forthcoming to the covered nations, in regional clusters, with a graduated payout the current thinking for the XCF facility and its cat bond coverage.

The development of the XCF concept continues, with ARC working to define a robust mechanism and index for triggering the underlying coverage instruments.

The concept still targets these instruments being catastrophe bonds, to provide the kind of long-term and efficient reinsurance risk financing required to back a climate risk transfer facility.

As the insurance-linked securities (ILS) market continues to focus on the ESG qualities of the asset class, any successfully issued XCF climate cat bonds will surely tick a lot of boxes when it comes to ESG and responsible investing, which could make them very popular with large institutional investors.

Through the creation of standardised indices for temperature and precipitation, as well as any other appropriate hazards, then comparing them to observed data on extreme climate events to detect any changes in frequency of climate extremes, the protection afforded by the XCF could be extremely beneficial to African nations and perhaps also replicable elsewhere around the world.

Climate change cat bonds can provide the much-needed risk financing and reinsurance capacity to deliver protection to those countries most exposed to extreme weather and climate related threats related to the current climate crisis, helping to protect against the severe financial losses that can occur due to changing climate and weather variability.

Also read:

ARC progresses climate cat bond facility XCF, signs up UN support.