The Importance of Transferring Risk in Climate Adaptation

The Importance of Transferring Risk in Climate Adaptation

Global efforts to address climate change have been in disarray following the failed talks in Copenhagen. But even if all carbon emissions were stopped at once, climate trends would continue to expose local populations to the mounting challenges -- and costs -- of protecting greater property values against weather-related risks.

These range from more frequent and severe storms, floods, droughts and other natural disasters to sea level rise, crop failures and water shortages. Innovative insurance solutions involving partners from the public and private sectors offer local decision-makers cost-effective ways to secure funding before a disaster strikes and make their communities more resourceful when it does.

Economic losses from climate change are substantial and on the rise. Over half of the world's population is presently threatened by natural hazards, and insured losses from weather-related disasters have jumped from USD 5.1 billion  per year in the period between 1970 and 1989 to USD 27 billion annually over the last two decades. Climate Week

The most vulnerable and least prepared regions are in the developing world. Climate risks could cost emerging economies up to 19 percent of their total gross domestic product by 2030, predicts the Economics of Climate Adaptation (ECA) working group in its 2009 study "Shaping Climate-Resilient Development."

A Case for Preventive Action and Risk Transfer

These are gloomy projections. But the ECA findings tell another, more upbeat story. Case studies in eight different regions of the globe, ranging from Maharashtra, India, to Florida and Northern England, showed that up to 68 percent of expected losses from climate change can be averted using cost-effective adaptation measures. These include improved drainage and irrigation systems, sea barriers and enhanced building codes, vegetation buffers and disaster awareness campaigns, among others.

The ready availability and proven value of such measures make a strong case for preventive action. Yet, no community can afford to prevent damage from every imaginable risk event, especially from those hazards that are least likely to occur and can only be averted at a prohibitively high cost -- if at all.

In southern Florida, for example, annual losses from hurricanes are estimated to rise to a staggering USD 33 billion by 2030 under a high climate change scenario. That represents about 10 percent of the region's total GDP. And yet, a significant proportion of the loss -- some 40 percent -- is unlikely to be averted cost effectively.

In such instances, off-loading risk to the private insurance and capital markets usually proves to be the most economical adaptation measure. This can be done through a variety of risk transfer methods, such as traditional indemnity-based insurance, parametric index solutions, catastrophe bonds or other similar financial arrangements. These instruments cap losses and smooth the cost to individuals, businesses and public institutions, thereby protecting local economies from the impact of catastrophic events.

Designing a Well-Balanced Adaptation Strategy

But risk prevention and risk transfer are mutually reinforcing. While insurance is a useful component in a given adaptation portfolio, keeping insurance prices in check by minimizing residual risks through prevention measures is equally important. In turn, properly set insurance premiums provide a strong incentive to invest in those types of prevention activities that promise to yield net economic rewards.

For decision makers, the real challenge then is to adopt a risk management approach that strikes the right balance between loss prevention and risk transfer measures. The task of collecting and analyzing the data needed to make an informed decision demands a high degree of coordination among relevant public and private entities. And so it would seem that a central figure at government level -- a country risk officer or minister -- would usefully be appointed to head up such efforts.

Although politically difficult, it may be necessary to resist action based on immediately perceived risks that could worsen future adaptive capacity. To ensure efficient allocation of resources for adaptation, it is important to take a long-term view and assess a location's total climate risk. Such an approach must consider not only the threat posed to society from today's climate, but also the impact of potential climate futures and the expected future value of economic development.

By combining all these factors and using a cost-benefit analysis to create a list of location-specific adaptation measures, it is possible to evaluate current and potential costs of climate change to a community and determine how to prevent them in the most economical way.

Public-Private Partnerships are Vital to Insure Large Natural Disasters

There is much more potential for risk transfer to strengthen the climate resilience of local economies. The role of insurance is of particular relevance in the most vulnerable regions of the developing world, where resources are scarce and the potential impact of climate change fierce. With its financial clout and geographically diversified reach, the global insurance and reinsurance industry is a key ally for national and local decision-makers who have to make policy and investment choices about climate adaptation under a large degree of uncertainty.

But as risks become increasingly complex and connected through climate change, they also become more costly and difficult to insure. Strong public-private partnerships are therefore vital to provide adequate coverage to local populations threatened by large natural disasters.

Such collaboration has already produced a number of innovative transactions. Among them are weather index solutions in Africa and India, catastrophe bonds in Mexico, and parametric earthquake and hurricane covers for Caribbean nations. Most recently this approach has also been adopted in the developed world. In June, Alabama's State Insurance Fund purchased a three-year index-based insurance product to hedge against the risk of hurricane damage.

Many of these solutions can be replicated elsewhere and adjusted to the specific risk exposure of other parts of the world. But since one approach clearly does not fit all circumstances, protecting communities against the unpredictable consequences of climate change will require constant innovation. The specific resources and expertise that public and private institutions bring to the table have much to contribute toward these efforts.

For more information, please see www.swissre.com/rethinking/climate/

Andreas Spiegel is the senior climate change advisor for Swiss Re as part of the Sustainability & Emerging Risk Management unit.

Articles, analyses and resource material about the Climate Week NYºC 2010 conference, which ran September 20 through 26, are available at: www.greenbiz.com/topic/climate-week-nyc-2010. For more information, visit www.climateweeknyc.org.

Image CC licensed by Flickr user Trodel.