UK development policy shake-up: Role for risk transfer, cat bonds, private capital?

In a shake-up of the UK government’s international development policy as well as its approach to humanitarian and aid funding that will be announced today, Artemis understands there will be a nod to a growing role for insurance risk transfer, while the use of private capital from investors is going to be highlighted, suggesting catastrophe bonds could be an increasingly relevant and supportive structure.

We understand the wide-ranging development plan will have a focus on climate change and humanitarian aid, as well as concepts such as debt forgiveness triggered by the occurrence of extreme climate linked weather disasters.

Among sources we’ve spoken with, there is an overwhelming feeling that the new development policy proposal will place a significant emphasis on leveraging the private capital markets as a source of aid financing, as the UK government tries to protect a stance that has seen it roll-back the reliance on taxpayer funding.

As a result, we’re told that going forwards there will be a focus on mobilising capital using efficient structures that can provide contingent sources of financing when humanitarian situations occur, delivering funding for recovery, rebuilding and relief in a rapid and structured manner.

The UK government is set to put more funding to work through a new resilience and adaptation focused climate fund, but with a mission to find new sources of private capital financing to work alongside this funding such as from pension funds, to make the countries foreign aid spending go further.

A white paper is set to be published today that has been reviewed by financial experts and multilateral financing organisations, which will explain that countries should leverage structures and appetites of private capital to make aid funding go further, and to deliver it in a more effective, anticipatory and structured manner.

As well as direct funding for climate resilience and adaptation, insurance and reinsurance solutions are also expected to feature, with structures proposed to ensure humanitarian funding can be delivered at the point disasters strike.

All of which speaks to the use of instruments such as catastrophe bonds, as well as parametric triggers, which we’ve already seen successfully deployed in sovereign and humanitarian scenarios, as ways to crowd in private capital to support climate resilience and humanitarian responsor to climate catastrophes.

There is a desire to lock-in pre-agreed and contingent sources of humanitarian financing, which is precisely the way we see the cat bond structured used in the case of the sovereign catastrophe bonds issued by the World Bank.

It also speaks to initiatives such as the Red Cross volcano catastrophe bond, which saw parametric triggers used to structure a private capital funded source of humanitarian financing that can be deployed on the occurrence of a major volcanic eruption.

We’re told that the UK government wants to reposition the value of humanitarian and international development aid with the help of private capital, to reduce the focus on taxpayers being the main source, while making the amounts of funding available much more significant, using financial market techniques to lock-in funding over multi-year periods, while still ensuring certainty on its deployment when a humanitarian disaster occurs.

All of which suggests contingent capital structures, including the catastrophe bond, could occupy a key role, as tools that can mix the expertise of insurance and reinsurance markets with those of the capital market, to deliver responsive disaster and humanitarian financing, that can provide liquidity just at the point in time countries really need it.

Cat bonds are an appropriate tool that can be used for the transfer of financing responsibilities to private markets, while transferring risks from those countries facing the greatest climate related humanitarian risks and so likelihood of requiring aid, locking in development type financing from institutional investors that can then be deployed rapidly, contingent on the conditions demanding use of aid occurring, with the use of parametric triggers ensuring a rapid delivery of the relief that is required.

Finally, we’re told there will also be a focus on using technology such as artificial intelligence to improve the ability to model the effects of climate change and its impacts on areas such as food security and the need for humanitarian relief. The UK wants to become a leader in this area and of course modelling fits well with the role of risk transfer and private capital, as advanced models can assist in structuring financial mechanisms to deploy aid that are both responsive and also anticipatory in nature.

Update:

The UK government’s white paper on international development has now been published, confirming that there will be a clear role for risk transfer, insurance and instruments such as catastrophe bonds, as well as structural innovations including parametric triggers.

The white paper states that, on disaster resilience:

A major shift is needed in the way that low- and middle-income countries are supported to prepare for and respond to disasters. Humanitarian appeals are generally launched after a disaster has already hit. So it can be weeks or months until pledged assistance arrives. It is much quicker and more efficient to act in advance, with reliable funding assured through insurance or other arrangements that trigger automatically and disburse funds rapidly to deliver a pre-agreed contingency plan. Ideally funds will flow through existing systems, such as social protection that can be scaled up quickly to reach those in need.

Pre-arranged finance, such as insurance, ensures fast disbursements and minimises economic scarring. Countries need more support to identify the main risks they are facing and the best instruments to mitigate these risks. Responses with pre-arranged finance are much cheaper and more effective, as damage is pre-empted by acting quickly. Currently only 2.7% of global crisis finance is pre-arranged. This figure can and should be much higher.

Disaster risk financing mechanisms need to be scaled up and strengthened, with greater coverage of vulnerable populations. This includes expanding the regional insurance risk pools in Africa and the Caribbean to enable them to cover more hazards and ensure that countries and humanitarian agencies can afford the insurance they need. The Global Shield against Climate Risks will be a framework for co-ordinated action on this issue. The City of London can be the insurance market of choice for developing and underwriting pre-arranged finance, using the extensive capacity and skills available.

The UK government is committing to making greater us of “pre-arranged finance, such as insurance and other support for early and anticipatory action,” to help in reducing the impact of climate change on the poores and most vulnerable.

The government also commits to “partner with the City of London insurance market to develop and underwrite pre-arranged deals for finance to manage disaster risks.”

Saying, “We will ensure that UK brokers are involved in deals that build confidence, trust and drive value for money, enabling more public private partnerships.”

In addition, the UK wants to be a leader on advising and assisting countries to access disaster financing, with the government’s white paper stating, “We will do this through support to the Global Shield, and the Centre for Disaster Protection, solely funded by the UK and the go-to resource for information on disaster risk financing.”