Pre-arranged financing reaches “unique moment of possibility”
Pre-arranged financing (PAF) for disaster response has entered a unique moment of possibility, but substantial changes to the types of instruments and financing on offer will be needed to overcome growing affordability challenges in poorer countries.
These are among the key takeaways of a new report from the Centre for Disaster Protection and UK Aid which warns that international development financing for PAF is not reaching the poorest and most vulnerable.
PAF was elevated to become a key focus of international climate policy at COP27 through the formal launch of the Global Shield against Climate Risks, as well as the landmark agreement among the parties to establish a fund to respond to loss and damage.
Data from the Global Shield Secretariat shows continued growth in the maximum coverage provided by PAF instruments, which rose to $9bn in 2022, compared with $8.8bn in 2021 and $7.4bn in 2020.
Contingent credit instruments represented the largest volume, generating $16.3bn of the 2020-22 total, followed by sovereign risk transfer instruments which provided $8.2bn in coverage over the three-year period. Corporate or risk transfer arrangements represented $52.9mn in coverage. Microinsurance represented just $1.8mn of the total, although it should be noted that the Global Shield members do not capture a broad scope of the microinsurance schemes currently active.
The World Bank is currently the largest provider of contingent credit for PAF, with its Catastrophe Deferred Drawdown Options (cat DDOs) linking pre-identified triggers to immediate funding, typically when a government declares an emergency.
Between 2009 and 2023, cat DDOs paid out $1.3bn in relation to tropical cyclones and a further $834mn in response to flood and landslide events.
Regional sovereign risk pools first emerged with the launch of the Caribbean Catastrophe Risk Insurance Facility in 2007, with pools now also operational in Africa, Southeast Asia and the Pacific.
The report notes that growing demand and uptake of policies have proved challenging for the latter three pools, with countries also dropping out because of domestic political changes and unmet expectations around payouts.
The report noted that while the increased focus on PAF is needed as part of the drive to increase focus on financial protection, there are many areas in which PAF is falling short in meeting the needs of vulnerable countries and people.
Notably, the types of international development financing for PAF and the instruments available do not meet the needs of the poorest and most vulnerable countries.
Across the 2020-2022 reporting period, for example, the majority of coverage (82.1 percent) was concentrated in middle-income countries.
International development financing is usually provided via loans rather than grant financing, making it unattractive and unaffordable for countries struggling with high levels of debt and many urgent demands on national budgets. Debt sustainability is a growing concern for many countries which is likely to hamper the use of PAF.
Premium subsidies are one mechanism to reduce constraints on uptake, but this is typically provided with the expectation that countries will eventually take these payments onto their own balance sheets.
As the report warns, this expectation is becoming increasingly untenable. As governments face increasingly challenging prioritisation decisions, demand for PAF directly financed by governments is likely to be adversely affected.
The report highlights a range of practical challenges around delivering effective PAF, including developing reliable triggers and effective response plans that pay out when most needed.
Some instruments are highlighted as ineffective in certain contexts – insurance, for example, is perceived as prohibitively expensive for more frequent or severe risks.
As a result, the report highlights increasing pressure for country and locally led solutions that go beyond insurance and do not exacerbate debt vulnerabilities.
“Substantial changes in the instruments, types and terms of financing on offer will be needed to overcome growing affordability challenges the poorest countries now face,” the report warned.