Editing IPCC:AR6/SRCCL/Chapter-7 (section)

==== 7.4.7.2 Instruments to manage the financial impacts of climate and land change disruption ====

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Comprehensive risk management (Section 7.4.3.1) designs a portfolio of instruments which are used across a continuum of preemptive, planning and assessment, and contingency measures in order to bolster resilience (Cummins and Weiss 2016 <sup>[[#fn:r817|817]]</sup> ) and address limitations of any one instrument (Surminski 2016 <sup>[[#fn:r818|818]]</sup> ; Surminski et al. 2016 <sup>[[#fn:r819|819]]</sup> ; Linnerooth-bayer et al. 2019 <sup>[[#fn:r820|820]]</sup> ). Instruments designed and applied in isolation have shown short-term results, rather than sustained intended impacts (Vincent et al. 2018 <sup>[[#fn:r821|821]]</sup> ). Risk assessments limited to events and impacts on particular asset classes or sectors can misinform policy and drive misallocation of funding (Gallina et al. 2016 <sup>[[#fn:r822|822]]</sup> ; Jongman et al. 2014 <sup>[[#fn:r823|823]]</sup> ).

Comprehensive risk assessment combined with risk layering approaches that assign different instruments to different magnitude and frequency of events, have better potential to provide stability to societies facing disruption (Mechler et al. 2014 <sup>[[#fn:r824|824]]</sup> ; Surminski et al. 2016 <sup>[[#fn:r825|825]]</sup> ). Governments and citizens define limits of what they consider acceptable risks, risks for which market or other solutions can be developed and catastrophic risks that require additional public protection and intervention. Different financial tools may be used for these different categories of risk or phases of the risk cycle (preparedness, relief, recovery, reconstruction).

In order to protect lives and livelihoods early action is critical, including a coordinated plan for action agreed in advance, a fast, evidence-based decision-making process, and contingency financing to ensure that the plan can be implemented (Clarke and Dercon 2016a). Forecast-based finance mechanisms incorporate these principles, using climate or other indicators to trigger funding and action prior to a shock (Wilkinson 2018 <sup>[[#fn:r826|826]]</sup> ). Forecast-based mechanisms can be linked with social protection systems by providing contingent scaled-up finance quickly to vulnerable populations following disasters, enhancing scalability, timeliness, predictability and adequacy of social protection benefits (Wilkinson 2018 <sup>[[#fn:r827|827]]</sup> ; Costella et al. 2017b <sup>[[#fn:r828|828]]</sup> ; World Food Programme 2018 <sup>[[#fn:r829|829]]</sup> ).

Measures in advance of risks set aside resources before negative impacts related to adverse weather, climatic stressors, and land changes occur. These tools are frequently applied in extreme event, rapid onset contexts. These measures are the main instruments for reducing fatalities and limiting damage from extreme climate and land change events (Surminski et al. 2016 <sup>[[#fn:r830|830]]</sup> ). Finance tools in advance of risk include insurance (macro, meso, micro), green bonds, and forecast-based finance (Hunzai et al. 2018 <sup>[[#fn:r831|831]]</sup> ).

There is ''high confidence'' that insurance approaches that are designed to effectively reduce and communicate risks to the public and beneficiaries, designed to reduce risk and foster appropriate adaptive responses, and provide value in risk transfer, improve economic stability and social outcomes in both higher – and lower-income contexts (Kunreuther and Lyster 2016 <sup>[[#fn:r832|832]]</sup> ; Outreville 2011b <sup>[[#fn:r833|833]]</sup> ; Surminski et al. 2016 <sup>[[#fn:r834|834]]</sup> ; Kousky et al. 2018b <sup>[[#fn:r835|835]]</sup> ), bolster food security, help keep children in school, and help safeguard the ability of low-income households to pay for essentials like medicines (Shiferaw et al. 2014 <sup>[[#fn:r836|836]]</sup> ; Hallegatte et al. 2017 <sup>[[#fn:r837|837]]</sup> ).

Low-income households show demand for affordable risk transfer tools, but demand is constrained by liquidity, lack of assets, financial and insurance literacy, or proof of identity required by institutions in the formal sector (Eling et al. 2014 <sup>[[#fn:r838|838]]</sup> ; Cole 2015 <sup>[[#fn:r839|839]]</sup> ; Cole et al. 2013 <sup>[[#fn:r840|840]]</sup> ; Ismail et al. 2017 <sup>[[#fn:r841|841]]</sup> ). Microinsurance participation takes many forms, including through mobile banking (Eastern Africa, Bangladesh), linked with social protection or other social stabilisation programmes (Ethiopia, Pakistan, India), through flood or drought protection schemes (Indonesia, the Philippines, the Caribbean, and Latin America), often in the form of weather index insurance. The insurance industry faces challenges due to low public awareness of how insurance works. Other challenges include risk, low capacity in financial systems to administer insurance, data deficits, and market imperfections (Mechler et al. 2014 <sup>[[#fn:r842|842]]</sup> ; Feyen et al. 2011 <sup>[[#fn:r843|843]]</sup> ; Gallagher 2014 <sup>[[#fn:r844|844]]</sup> ; Kleindorfer et al. 2012 <sup>[[#fn:r845|845]]</sup> ; Lazo et al. <sup>[[#fn:r846|846]]</sup> ; Meyer and Priess 2014 <sup>[[#fn:r847|847]]</sup> ; Millo 2016 <sup>[[#fn:r848|848]]</sup> ).

Countries also request grant assistance, and contingency debt finance that includes dedicated funds, set aside for unpredictable climate-related disasters, household savings, and loans with ‘catastrophe risk deferred drawdown option’ (which allows countries to divert loans from development objectives such as health, education,  and infrastructure to make immediate disbursement of funds in the event of a disaster) (Kousky and Cooke 2012 <sup>[[#fn:r849|849]]</sup> ; Clarke and Dercon 2016b <sup>[[#fn:r850|850]]</sup> ). Contingency finance is suited to manage frequently occurring, low-impact events (Campillo et al. 2017 <sup>[[#fn:r851|851]]</sup> ; Mahul and Ghesquiere 2010 <sup>[[#fn:r852|852]]</sup> ; Roberts 2017 <sup>[[#fn:r853|853]]</sup> ) and may be linked with social protection systems. These instruments are limited by uncertainty surrounding the size of contingency fund reserves, given unpredictable climate disasters (Roberts 2017 <sup>[[#fn:r854|854]]</sup> ) and lack of borrowing capacity of a country (such as small island states) (Mahul and Ghesquiere 2010 <sup>[[#fn:r855|855]]</sup> ).

In part because of its link with debt burden, contingency, or post-event finance can disrupt development and is not suitable for higher consequence events and processes such as weather extremes or structural changes associated with climate and land change. Post-event finance of negative impacts such as sea level rise, soil salinisation, depletion of groundwater, and widespread land degradation, is likely to become infeasible for multiple, high-cost events and processes. There is ''high confidence'' that post-extreme event assistance may face more severe limitations, given the impacts of climate change (Linnerooth-bayer et al. 2019 <sup>[[#fn:r856|856]]</sup> ; Surminski et al. 2016 <sup>[[#fn:r857|857]]</sup> ; Deryugina 2013 <sup>[[#fn:r858|858]]</sup> ; Dillon et al. 2014 <sup>[[#fn:r859|859]]</sup> ; Clarke 2016 <sup>[[#fn:r860|860]]</sup> ; Shreve and Kelman 2014 <sup>[[#fn:r861|861]]</sup> ; Von Peter et al. 2012 <sup>[[#fn:r862|862]]</sup> ).

In a catastrophe risk pool, multiple countries in a region pool risks in a diversified portfolio. Examples include African Risk Capacity (ARC), the Caribbean Catastrophe Risk Insurance Facility (CCRIF), and the Pacific Catastrophe Risk Assessment and Financing Initiative (PCRAFI) (Bresch et al. 2017 <sup>[[#fn:r863|863]]</sup> ; Iyahen and Syroka 2018 <sup>[[#fn:r864|864]]</sup> ). ARC payouts have been used to assist over 2.1 million food insecure people and provide more than 900,000 cattle with subsidised feed in the affected countries (Iyahen and Syroka 2018 <sup>[[#fn:r865|865]]</sup> ). ARC has also developed the Extreme Climate Facility, which is designed to complement existing bilateral, multilateral and private sources of finance to enable proactive adaptation (Vincent et al. 2018 <sup>[[#fn:r866|866]]</sup> ). It provides beneficiaries the opportunity to increase their benefit by reducing exposure to risk through adaptation and risk reduction measures, thus side-stepping ‘moral hazard’ problems sometimes associated with traditional insurance.

Governments pay coupon interest when purchasing catastrophe (CAT) bonds from private or corporate investors. In the case of the predefined catastrophe, the requirement to pay the coupon interest or repay the principal may be deferred or forgiven (Nguyen and Lindenmeier 2014 <sup>[[#fn:r867|867]]</sup> ). CAT bonds are typically short-term instruments (three to five years) and the payout is triggered once a particular threshold of disaster/damage is passed (Härdle and Cabrera 2010 <sup>[[#fn:r868|868]]</sup> ; Campillo et al. 2017 <sup>[[#fn:r869|869]]</sup> ; Estrin and Tan 2016 <sup>[[#fn:r870|870]]</sup> ; Hermann et al. 2016 <sup>[[#fn:r871|871]]</sup> ; Michel-Kerjan 2011 <sup>[[#fn:r872|872]]</sup> ; Roberts 2017 <sup>[[#fn:r873|873]]</sup> ). The primary advantage of CAT bonds is their ability to quickly disburse money in the event of a catastrophe (Estrin and Tan 2016 <sup>[[#fn:r874|874]]</sup> ). Green bonds, social impact bonds, and resilience bonds are other instruments that can be used to fund land-based interventions. However, there are significant barriers for developing country governments to enter into the bond market: lack of familiarity with the instruments; lack of capacity and resources to deal with complex legal arrangements; limited or non-existent data and modelling of disaster exposure; and other political disincentives linked to insurance. For these reasons, the utility and application of bonds is currently largely limited to higher-income developing countries (Campillo et al. 2017 <sup>[[#fn:r875|875]]</sup> ; Le Quesne 2017 <sup>[[#fn:r876|876]]</sup> ).

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