Financing Projects that Address the Physical Risks from Climate Change

I asked the Intentional Endowment Forum, run by a former boss of mine Dr. Tony Cortese, if they were aware of adaptation finance, that is, finance that addresses the physical risks of climate change.

I thought the response from Dr. Maximilian Horster a Partner at south pole group focused on the financial industry was particularly succinct, recapping what those of us in the adaptation finance investigation space are discovering. 

He writes:

“Currently, the investor focus is indeed mostly on transition risk: legislation, regulation, behavioral change, carbon pricing etc and the subsequent effects of asset stranding potential, energy transition and the like. Keep in mind that also here, we only see the beginning of actual stress tests among a – still small – group of investors and for only a few asset classes. Although the uptake is increasing rapidly, we are far from having established consistent standards, benchmarks or best practices.

For physical risks, we are even further away from an investor understanding. Often, data availability on physical climate risk is cited as the big hurdle but that is only half the story: Data on the likelihood of climate related extreme weather events (flooding, droughts etc) exist for most geographies and is used by insurance companies to price liabilities. However, it is not yet utilized for asset management, not even by that very same insurance firms that produce this data.  

What is missing is a mapping of these physical risks to the actual assets (such as production facilities), but also supply chain locations and end markets. We are developing this right now, but interestingly, investor interest is much less than one would think. Main reason is that - according to climate science - the full swing of physical risks are still 15-20 years away and therefore beyond most investors’ investment horizon (“tragedy of the horizons”).

Because of this, we see very few investments into climate change adaptation by mainstream investors. The exceptions are of course the multi-lateral funds under the UNFCCC and other outfits that have a strong focus on climate change adaptation, mainly for rural population and agriculture in developing countries since some time:http://www.climatefundsupdate.org/themes/adaptation.”

Financing Adaptation: The White House and The Global Adaptation & Resilience Work Group Exchange Ideas

At a White House roundtable on resilience investment with the Global Adaptation and Resilience work group and the Council on Environmental Quality last month, experts from government and the financial sector debated what the financial products are that will help people plan for the long term.

An optimistic bunch, there was general consensus that incentives are lining up – climate adaptation is smart business.

But do finance and policy advisors have the information they need to make decisions in the long-term interests of their shareholders and the public?

Three key questions emerged from the conversation, along with several sub issues: 

First, are there maps of climate risk to analyze, adaptation tools that resolve climate risk, and a known set of adaptation projects to use as best practice and to seed the resilience investment pipeline? Several insurance leaders noted that there are existing vectors of risk that the industry uses that are helpful for pricing climate risk. 

At the same time, part of making the environment for investment stable is having a clear awareness of the measure of progress the investment will cause. An initial step is to “weatherize data” showing what the impact of weather is on parts of the economy.  With these short term impacts explained, then it is important to build measurement models to extrapolate into the future.  The customization of predictive risk data is the next frontier in adaptation investments. 

These tools will be most useful when delivered along with narratives about best practice.  Several finance-industry adaptation project examples were shared, including a Nature Conservancy project that is allowing the Government of the Seychelles to swap some of its debt for climate adaptation projects and a Swiss Re project offering small holder crop insurance against drought and floods in Ethiopia.

Second, should the investment industry be focused just on increasing resilient investments – that is investments focused on adaptation projects – or should they also care about increasing the resilience of projects, that is the multi-trillion dollars of investments funded globally?  The focus of these investment leaders was generally on the latter.

Especially since insurance experts use a back-of-the-envelope calculation that basic productivity for a business needs to be restored within 2 weeks (as long as a typical business can stay afloat with no revenue) and full productivity in three months (which is tied to a timeline of when insurance pays for unrecoverable losses), it seems the resilience of all projects is imperative for the markets.  Understanding the local context of the physical changes caused by climate change for market sectors is complex, and private sector leaders are focused not just on the physical risks from climate changes, but also the social risks to their workforce and markets. These human factors are often related not just to the company, but also the communities within which they do business.  Thus, resilience is today’s problem of the commons. Of course, another major insurance issue is that only about 30% of extreme risk loss is insured around the world. 

Third, what is the roles for the US Government in increasing the finance industry’s engagement with resilience?  While it was acknowledged that resilience is generally a shareholder issue, (vs. national security which is a government issue), and the private sector owns and operate a significant majority of infrastructure in the world, it was agreed there is a significant role for government. For instance, participants recommended that climate science risk be baked into codes and standards to motivate the private sector, since the general rule of thumb is that one dollar spent in risk mitigation saves four dollars in the future on recovery.

But the major issue is that the US government is the insurer of last resort, based on the Stafford Act, allowing developers to operate with the knowledge that if you invest now without paying any premium for future risk mitigation, the federal government (in the form of FEMA, the Federal Emergency Management Agency) will ultimately pay for damages incurred that are beyond the capacity of the private insurance market. Repealing the Stafford Act would transform the industry’s viewpoint on climate risk. 

Another recommendation for the government was to promulgate and enforce disclosure requirements for both acute and chronic types of risks.  Tax incentives or rebates could help ensure compliance with a Securities and Exchange Commission asset level climate risk disclosure.  Ultimately, the group agreed that the private sector takes on risks that it wants to take on, designing, building and repairing – all crucial to resilience.  But the private sector is not going to choose to invest in  what they cannot control - regulatory change. 

This is a crucial role for the US Government. Finance leaders will always innovate to get the most out of the market, and policy leaders can help make sure these decisions are in the long-term interests of the public with regulatory innovation.

The Insurance Industry: Adaptation Drivers

An edifying conversation with Tom Herbstein, programme manager for the ClimateWise[1] initiative of the University of Cambridge Institute for Sustainability Leadership, led me to peruse a ClimateWise case study I had skimmed when published in 2010. It is Adapting to the extreme weather impacts of climate change – how can the insurance industry help? And I was delighted to grasp so much from a resource whose lessons remain very relevant today. Here are my takeaways.  

Overall, the case study reminded me that the insurance industry provides a great resource for adaptation thought leadership. For instance, Swiss Re’s Sigma annual publication on natural catastrophes and man-made disasters and the intriguing and helpful Global Risk Map published by the United Nations’ Principals for Sustainable Insurance are referenced frequently referenced by those of us working in adaptation. Key is that insurance serves as an integral element of the entire risk-management cycle – from identification to risk transfer and recovery. The insurance industry:

• Contributes to a better understanding of risk through, for example, the development of forward-looking risk models.
• Adds to risk awareness through risk-based terms and conditions and advice to its customers, and offers incentives to increase prevention and other risk-management measures.
• Assists policymakers to guide society with such tools as land use planning and building codes.

The insurance industry and ND-GAIN possess a special relationship. ND-GAIN pursues its mission to increase global awareness of the need to adapt and thus inform investments that save lives and improve livelihoods. This helps the insurance industry enhance its customer understanding of risk and risk-reduction measures. As a third-party, university-lead entity, we serve as a tool used by the insurance industry to better promote adaptation with its clients.

It’s important to note that efforts to maintain or create insurability – a key adaptive capacity – provide business opportunities for the insurance and risk-management sector. A range of factors such as profit protection, strategic aims, public relations and corporate social responsibility drives insurers’ engagement in adaptation. But these factors do not necessarily drive insurers to operate in lower-income and least-developed countries, thus potentially contributing to a high percentage of uninsured. When considering adapting to climate change in developing countries, the insurance industry can support adaptation through:

• Expertise in risk management
  • Placing a price tag on risk.
  • Influencing the design of risk-reduction and risk-transfer activities.
• Expertise in adaptive capacity
  • Putting a price tag on resilience measures.
  • Influencing the design of adaptive capacity actions.

This expertise should help to incentivize loss reduction by informing stakeholders (governments and regulators, clients and business partners, business and industry, civil society and academia) about the risks they face, advising them on risk mitigation/adaptive capacity options and providing them with existing insurance options for loss reduction.

[1] The ClimateWise Principles were launched in September 2007 by the CEOs of 16 leading insurance industry players, thereby committing their organizations to a wide range of actions on climate change, to reporting in public on those actions on an annual basis and to subjecting themselves to independent review of their progress.

Community supply chains: resilience through insurance innovation

Community supply chains:  resilience through insurance innovation At last week’s World Economic Forum in Manila, every presentation I heard mentioned the devastation of Typhoon Haiyan (aka Yolanda). A special session on decision tools for preparing for climate and natural disaster offered the chance for a panel of insurance brokerage executives, a Philippine Senator, a representative from the world’s most engaged foundation on climate resilience and a senior executive at the International Red Cross to develop an innovation – one salient project – to save the world.

Specifically, we looked at ways to avoid a breakdown in community supply chains when a major disruption occurs. This was of special interest to the Senator since after the typhoon, no goods were available for weeks after the storm at the sari sari store, the grocery store or warehouses.  And when the government and development agencies brought in relief materials, this forced out local sellers with goods to sell at legitimate prices. A black market in relief goods emerged, although in a limited way, it turns out.

With this backdrop, we pondered what sort of mechanism could help solve for these issues in future crisis. Here is what we devised: community-based, parametric-triggered insurance. Talk about jargon. WEF participants roared at that winning title – but we surprised them with functional ideas, which envisioned that starting now, in risk-prone communities:

1. Create a method for community payment into an insurance fund.
2. Ensure that all members pay in their portion, and price the payment equitably.
3. Ensure financial contact information for all participants.
4. Index levels and types of events that could trigger loss.
5. Pay out to all insurance holders immediately, regardless of proven loss from a disaster.

This idea isn’t brand new. I am aware of drought-triggered parametric insurance for Ethiopian farmers, for instance. But it is novel enough that most of us needed a guide to its distinction from indemnity insurance, which requires proof of harm before payout (a time-consuming process).

A lot of what ifs and issues aren’t addressed here, such as:

• How to determine the level of storm event.
• How to collect the insurance payment in cases where community members aren’t bankable.
• How to ensure that all or most buy in, particularly in more urban areas where the “street-level bureaucracy” of rural communities is weak or non-existent.

Still, I bet this type of mechanism will grow in popularity and positive impact for natural disasters, and put my vote behind it as a resiliency innovation worth supporting.

And since this idea is going to be around for a while, please help us think of a better title with a catch acronym that translates around the world. Fine, OK and Swift come to mind as acronyms I’d be relieved to see in my community if all of my hopes and dreams were wrapped up in my family and rural sari sari store in Tacloban, Philippines, or in any of millions of communities like it around the world.

Feeding a climate-altered world

How will we feed the world amid drought, fire, floods and population shifts?  While I don’t yet envision a Malthusian catastrophe, per se, I think it critical to begin a conversation about this question as it relates to our work.  At last month’s ND-GAIN Annual Meeting at the Wilson Center in Washington, D.C., I derived several key takeaways from our panelists*:

1. Climate change could undermine development advances of the 20th Century, such as the interrelated issues of food security, global health and poverty reduction, the World Bank contends.

2. The largest demand for funds in the Pilot Program for Climate Resilience is for agricultural and landscape-management projects and, among fund recipients, water is the second largest.  Project examples include $5M to Mozambique (ND-GAIN Rank 137 http://index.gain.org/country/mozambique ) for drip irrigation and other agriculture enhancements, $15M to Zambia (ND-GAIN Index http://index.gain.org/country/zambia ) to insure farmers against extreme weather and $22M to Bangladesh, (ND-GAIN Rank 145 http://index.gain.org/country/bangladesh) for a seed selection and storage and cropping cycles project.

1. As climate portfolios grow to include resiliency and adaptation, in addition to greenhouse gas mitigation, the World Bank notes a decreased participation from the private sector, says Patricia Bliss-Guest Program Manager of Climate Investment Funds there. Through its pilot program for climate resilience, the Bank works to incent additional private participation in addition to government assistance.

1. Microinsurance is a major priority for the insurance sector in emerging markets and insurance can send important price-based signals to the market, notes Lindene Patton Chief Climate Product Officer at Zurich Insurance Group Ltd. She cautions against subsidizing insurance too much, adding that the question of climate risk is generally understood by the reinsurance industry to be a people, not a physical science, problem.

2. The key to resiliency in the food supply (taking cocoa as a case) involves examining all the vectors impacting farmers, including demographic shifts, community engagements, diversity of crops and agrarian livelihoods, maintains Perry Yeatman Principal, Mission Measurement, based on her work at Kraft Foods. She says it matters to our ample supply of chocolate bars that cocoa farmers are aging, their children are migrating to cities, the farmers need to raise chickens to diversify their nutrition and their community structures are crucial to their farms’ viability.

3. While climate change might favor the Eastern Europe and the Americas, a tremendous amount of investment for water infrastructure is necessary elsewhere in the world, believes David Gustafson Senior Fellow and Environmental and Ag Policy Modeling Lead at Monsanto. He favors partnerships with local and global institutions to address this concern, especially as the global agricultural community looks to intensify its production efforts sustainably to feed our  ever-growing world population.

In a future post, I plan to address the approaches for increasing this agricultural intensity. As I write this, my alumni magazine arrived with the cover story, “GMO vs. Fresh Food….”   I’ve had a study diet of this issue and look forward to continuing the dialogue.

*A video of the panel can be found here:  https://www.youtube.com/watch?v=V09U8W00Mk4&feature=c4-overview-vl&list=PLF545132229EF6E68

Ten Point Checklist for Making Corporations Resilient

The United Nations International Strategy for Disaster Reduction has published an interesting guide:  Making Cities Resilient:  My City is Getting Ready. Its ten-point checklist for making cities resilient begs for a companion list.  I’ve added my two cents by developing a “Ten Point Checklist for Making Corporations Resilient.” http://www.unisdr.org/english/campaigns/campaign2010-2015/documents/campaign-kit.pdf

Ten-Point Checklist
	For Making Cities Resilient (UNISDR)	For Making Corporations Resilient
1	Put in place organization and coordination to understand and reduce disaster risk, based on participation of citizen groups and civil society. Build local alliances. Ensure that all departments understand their role regarding disaster risk reduction and preparedness.	Include climate adaptation in a member of the C-suite’s job description. Establish a cross-function climate adaptation working group and connections with local and regional governments in key geographies in your enterprise – especially operations and supply chain.  Consider collaborating with key members of your supply chain, industry peers and neighboring businesses on climate adaptation planning and execution. Ensure that all departments understand their role regarding disaster risk reduction and preparedness.
2	Assign a budget for disaster risk reduction and provide incentives for homeowners, low-income families, communities, businesses and the public sector to invest inreducing the risks they face.	Include budget lines for both proactive adaptation measures and recoup from extreme event.  Include climate adaptation in performance reviews for the C-suite, lieutenants and managers.
3	Maintain up-to-date data on hazards and vulnerabilities; prepare risk assessments; and use these as the basis for urban development plans and decisions. Ensure that this information and the plans for your city’s resilience are readily available to the public and fully discussed with them.	Include climate adaptation in your emergency preparedness and continuity plans initially, with annual updates.  Ensure that this information and the plans for your corporation’s resilience are readily available to your leadership team and fully discussed with them.
4	Invest in and maintain critical infrastructure that reduces risk, such as flooddrainage, adjusted where needed to cope with climate change.	Invest in and maintain critical infrastructure that reduces risk, such as flood drainage, snow removal, vector-borne disease prevention, and heat mitigation for workers and machinery, adjusted where needed to cope with climate change. Consider supply chain and building decisions with these risks in mind.
5	Assess the safety of all schools and health facilities and upgrade these asnecessary.	Assess the safety of all facilities, especially those in locations vulnerable to extreme weather events (coastal, arid) and upgrade or move.
6	Apply and enforce realistic, risk-compliant building regulations and land-use planning principles. Identify safe land for low-income citizens and develop upgrading of informal settlements, wherever feasible.	Engage with local governments to ensure that climate adaptation regulations protect residents and economic growth. Identify your most vulnerable employees (age, income, tasks, geography) and plan especially for their safety.
7	Ensure education programs and training on disaster risk reduction are in place in schools and local communities.	Ensure education programs and training on disaster risk reduction are in place throughout your enterprise, not just for disaster preparedness, but also for heat exhaustion, vector-borne disease, and the like.
8	Protect ecosystems and natural buffers to mitigate floods, storm surges and other hazards to which your city may be vulnerable. Adapt to climate change by building on effective risk-reduction practices.	Protect and enhance ecosystems and natural buffers in and near your holdings to mitigate floods, storm surges, extreme heat and other hazards.
9	Install early warning systems and emergency management capacities in your city and hold regular public preparedness drills.	Install early-warning systems and emergency-management capacities in your enterprise and hold regular preparedness drills.
10	After any disaster, ensure that the needs of survivors are placed at the center of reconstruction with support from them and their community organizations to design and help implement responses, including rebuilding homes and livelihoods.	After any disaster, ensure the needs of survivors are placed at the center of reconstruction.  See http://climateadaptationexchange.com/crisis-communications-are-you-ready-for-a-climate-related-crisis-in-your-business/ for communications guidelines.

Can Insurers Drive Corporate Climate Adaptation?

Can Insurers Drive Corporate Climate Adaptation? It’s been a tough year for insurance companies: blizzards in the Midwest, fires in the Southwest, severe tornados in the Southeast, a damaging Oklahoma hailstorm and flooding along hundreds of rivers.

And it makes me ask: Can the insurance industry drive a change in corporate behavior toward climate adaptation?  Judging from the September 2011 report, “Climate Risk, Disclosure by Insurers,” by the non-profit Ceres organization, the answer appears to be not yet.  The report notes that information from a limited number of insurers responding to a National Association of Insurance Commissioners survey found that the vast majority (88%) don’t even have a climate policy, let alone specific climate change–management investment policies in place.

But a changing climate demands that insurers price physical risk differently and manage for those new liabilities that threaten their investment portfolios.  The industry is focusing much of its attention on a narrow set of coastal risks, but as 2011 has demonstrated, extreme weather in the non-coastal U.S. is becoming costlier, too.

So what might it require for the insurance industry to change?  Since every catastrophe leaves lessons learned behind, we could be moving toward greater awareness sparking changes in the insurance market.  With each new extreme event, the disaster scenarios on which the industry models its risk become more realistic. And as a recent Bloomberg article makes clear, those models need to reflect a lot more than just wind, hail and water damage. They also should consider how communities tolerate risk and whether they invite it by allowing buildings to be sited in vulnerable locations.

That’s a concept that Swiss Re, which I consider a climate-adaptation leader, uses to manage its portfolio.  Swiss Re now speaks about climate risk – not climate change – to reflect its understanding that when natural disaster destroys the built environment, it’s not nature’s fault. Rather, it’s ours for building in the wrong place, the wrong way.  It maintains that the insurance industry should focus on “loss mitigation,” encouraging potential customers to keep their property from being destroyed in the first place.  (and by the way, Swiss Re is also capitalizing on climate adaptation as an opportunity: They've developed tailored insurance products, including weather risk insurance, for rural poor in developing countries).

Let’s hope that its influence trickles down to the rest of the market.

Building Site & Climate Resiliency

Building Site & Climate Resiliency

When determining where to site a new building project, business executives usually base their decision on a short list of key criteria: the vibrancy of the local economy and hiring base; the adequacy of transportation and water resources; the strength of schools; and the diversity of housing.  “Resiliency” attributes – think community response to an extreme weather event – are usually overlooked (unless you’re locating offices in hurricane-prone Florida).

Ignoring such conditions today in site selection can prove shortsighted.  A recent conversation with Steve Adams, managing director of The Resource Innovation Group’s Climate Leadership Initiative suddenly brought this issue to the forefront for me.  Our conversation reminded me that developers and national corporate real-estate agents undoubtedly rank among the earliest climate-adaptation leaders in the corporate space.

These climate-adaption leaders should be looked to for counsel when siting a location.  They can identify possible crises that could occur with a site.  For instance, what happens if your cloud-computing operations are swept away from a flood or hurricane, especially abroad in developing countries ill-prepared for such an event?  As a result of that possibility, some companies are locating their cloud-computing operations off-shore.

Steve noted that some communities, such as a few along Florida’s Gulf of Mexico, successfully woo developers and corporations by marketing their response capacity, the depth of continuity planning and their track record at protecting economic loss from extreme weather.

I wager that business leaders’ short list of siting criteria soon will include a question or two that relate to preparation for, and response capacity to, extreme weather disruption. This might trigger broader demand for developers’ (and local governments’) adaptation thinking and action.  And if it doesn’t, insurability might. Increasingly, siting a structure in a questionable location can make it uninsurable or require it to pay higher premiums with a higher deductible.