Insurers are adding a new vector to climate finance

Assisting developing countries is normally associated with development banks and non-governmental organisations, but climate finance initiatives are drawing from an additional pool of expertise and increasingly insurance is joining forces with the established development community, both to complement their existing approaches and to offer new solutions to funding disaster relief.

In an interview with Insurance Day, Ekhosuehi Iyahen, secretary-general of the Insurance Development Forum (IDF), points out historically insurers and development banks operated in separate spheres. Insurers have traditionally focused on commercial risks, while development banks concentrate on concessional finance – specialised financing provided below market rates – and infrastructure investment.

“Within the private insurance sector, aligning commercial insurance models with the needs of low-income and vulnerable markets remains a challenge,” Iyahen says.

Traditional insurance products have not been designed for the specific risks faced by communities in developing countries. Affordability is also a problem, leading to growing calls for premium subsidies. Beyond subsidies, however, Iyahen says the real need is innovation. Some progress has been made on this front in the form of parametric products, as well as through regional risk-pooling efforts.

The other hurdle is a lack of technical ability within governments on integrating financial risk solutions into their national financial planning. They tend to prioritise any immediate fiscal needs, sometimes at the cost of long-term risk management, Iyahen says, adding this can make it difficult to secure funding for insurance-based solutions.

Recognising the role of insurance

This is changing as the role of insurance gains wider recognition in the international development community. “This shift is driven by the broader reality that capital will not flow where risk is not understood or measured,” Iyahen says.

Several factors have driven this change, including the increasing frequency and severity of climate shocks, a decline in access to financing following the Covid-19 pandemic, and the increasing strain on government resources because of an unstable geopolitical situation. These factors are driving governments and development organisations increasingly towards integrating insurance solutions into their resilience strategies.

Ekhosuehi Iyahen, Insurance Development Forum

“The industry has moved beyond traditional risk transfer to becoming a proactive partner in resilience-building and risk-informed financing,” Iyahen says.

She continues: “Sustainable growth requires a proactive risk management strategy, reinforcing the inherent role of insurance – one that is often taken for granted in the development space. Insurance is not just about payouts after catastrophes; it also fosters confidence, enabling investments to happen in the first place.”

Evidence of greater collaboration is apparent in several ways: an increase in sovereign risk financing solutions, such as risk pools and parametric insurance policies, to provide pre-arranged crisis funding; an increase in the use of insurance by development banks to help build resilience in communities receiving finance; and more co-financing initiatives.

“In some cases, the most effective solution may not be insurance but rather investments in infrastructure, such as better drainage systems, to mitigate risks at their source. These approaches are not mutually exclusive”
_{Ekhosuehi Iyahen
Insurance Development Forum}

In April last year, the IDF announced plans to facilitate insurance sector investments in resilient infrastructure to enhance the resilience of vulnerable communities in emerging and developing economies to risks from climate change and other natural disasters.

Its infrastructure taskforce has developed a blueprint to drive greater mobilisation and more impactful insurance sector investment in what the IDF describes as a critical, underserved segment of the infrastructure market. This blueprint reflects the need to partner with development finance institutions and other credit enhancement providers to create new, innovative investment structures that meet the credit quality requirements for insurer investments.

A long time coming

The evolution of insurers’ role in development finance has been a long time in the making. When Sylvain Coutu, head of innovation and sustainability and parametric lead at Africa Specialty Risk (ASR), joined the insurance sector in 2014, work was already under way to integrate the industry into the development community. Initiatives like the Global Index Insurance Facility, the African Risk Capacity and Caribbean Catastrophe Risk Insurance Facility had already been established, and all have “scaled significantly” since then, he says.

Commitment to green and sustainability initiatives has been “more recent and certainly more hesitant”, Coutu stresses, and started around 2018 with some attempts to understand, flag and in some cases reject business that did not meet environmental, social or governance (ESG) objectives.

However, the direction of travel has not been one-way. “Unfortunately, we have seen some major players in the industry stepping back from their commitments and the global geopolitical situation does not seem favourable to massive development in this space, although I personally believe it remains critical,” Coutu says.

As for the insurance industry’s relationship with development banks, Coutu says what began as experimentation in the early 2000s, accelerated after 2010 when the development community started supporting large index insurance programmes. “Index insurance happened to be a great product to rapidly scale and protect a large number of vulnerable people in developing regions,” he says. “Since 2010, it seems development banks have evolved from funders of pilot projects to market enablers and policy shapers,” he adds.

The Africa-focused specialty re/insurer’s responses to climate risk include addressing the problem that volatility in energy prices can result in solar plants becoming uneconomical when energy prices dip below production costs. ASR developed an innovative parametric insurance solution that ensures the on­going commercial viability of photovoltaic installations and improves their appeal to investors, helping solar plants secure the necessary resources for funding, operation and growth.

Climate change is bad for business

Bronwyn Claire, senior climate specialist at investment advisory firm Ortec Finance, says there are multiple reasons businesses are looking to engage in development and sustainability initiatives. The first stems from the simple fact climate change is bad for business. “If you’ve made net-zero commitments, you’re looking to put into practice what you might be saying about the transition. But you’re also looking to avoiding the risk of higher global temperatures,” she says.

Another reason is insurers are increasingly looking to engage with emerging markets. By investing in these markets, they can demonstrate their commitment to being part of a country or region’s financial community. “[Insurers are saying] we want to be present in these markets, we want to be genuinely involved and that means they’re looking for investment opportunities to back that up,” Claire says.

Bronwyn Claire, Ortec Finance

She continues: “With that comes first-mover advantage; you’re creating a lot of really good, valuable relationships with brokers and the ecosystem for insurance, and that gives a lot of non-financial benefits as well: brand reputation, being seen out there sponsoring things or being involved in [recruiting] new talent.”

Engagement like this has been around for years, Claire says, but climate change has shifted the conversation. More recently, discussions with insurers, particularly larger businesses with an established presence in developing countries, have shifted towards how these firms can stay active in regions that are becoming more exposed to physical climate risk.

“If you’re looking to establish yourself in emerging markets, that’s more like a 10- or 20- or 30-year decision. You’re making much more of those strategic investments and that’s where the climate risk becomes much more pertinent”
_{Bronwyn Claire
Ortec Finance}

“Acute or chronic physical risks are quite high in tropical locations, but [as an insurer] you don’t want to say, ‘This is a red mark, I need to step away from that,’” Claire says. It may be an insurance company has a main office in a developing country or it is a jurisdiction where the business has customers and clients. Instead of stepping away, Claire says insurers accept they need to understand adaptation and transition plans and have a “much more nuanced” appreciation of their clients and the given sovereign nation.

Claire says insurers looking to engage with developing markets tend to take a much longer-term view than they would with their other areas of business. To do that, the sector is examining the climate risks and how they might change over time. “If you’re looking to establish yourself in emerging markets, that’s more like a 10- or 20- or 30-year decision,” she continues. “You’re making much more of those strategic investments, and that’s where the climate risk becomes much more pertinent.”

Insurers are also looking for long-term partners and are taking a joined-up approach to investment in development and green financing, Claire says, by linking the development banking sector with local insurers. This more holistic solution “recognises the part each party plays”, she adds.

Ortec Finance recognises climate change is a complex financial risk and there is a need to identify and understand how physical climate risk impacts, the net-zero transition and associated financial market responses could manifest and impact investment portfolios. ClimateMAPS, the climate scenario analysis solution it developed with Cambridge Econometrics, enables financial institutions to quantify climate change risks and identify opportunities, across all asset classes and macroeconomic variables.

Work to be done

There is still work to be done on all sides of the finance community, Iyahen stresses. From a government perspective, risk financing needs to feed into broader policy discussions on risk reduction. “In some cases, the most effective solution may not be insurance but rather investments in infrastructure, such as better drainage systems, to mitigate risks at their source,” she says. “These approaches are not mutually exclusive; addressing residual risk through financial mechanisms must go hand-in-hand with proactive investments in risk reduction to optimise resilience outcomes and maintain insurability.”

At the same time, insurers can take a more active role in shaping both global and local policy decisions around financial resilience and can invest more in improving insurance literacy. “This is a task not only for insurers but also policymakers, regulators and insurance supervisors,” Iyahen stresses.

She concludes: “While development banks provide long-term capital for infrastructure and economic development, insurers offer financial protection and incentivise proactive risk reduction. These approaches should not operate in silos. Rather, they need to work together to support robust risk-layering strategies for governments, whether in response to disasters or other risk financing contexts.”