UK development policy shake-up: Role for risk transfer, cat bonds, private capital?

In a shake-up of the UK government’s international development policy as well as its approach to humanitarian and aid funding that will be announced today, Artemis understands there will be a nod to a growing role for insurance risk transfer, while the use of private capital from investors is going to be highlighted, suggesting catastrophe bonds could be an increasingly relevant and supportive structure.

We understand the wide-ranging development plan will have a focus on climate change and humanitarian aid, as well as concepts such as debt forgiveness triggered by the occurrence of extreme climate linked weather disasters.

Among sources we’ve spoken with, there is an overwhelming feeling that the new development policy proposal will place a significant emphasis on leveraging the private capital markets as a source of aid financing, as the UK government tries to protect a stance that has seen it roll-back the reliance on taxpayer funding.

As a result, we’re told that going forwards there will be a focus on mobilising capital using efficient structures that can provide contingent sources of financing when humanitarian situations occur, delivering funding for recovery, rebuilding and relief in a rapid and structured manner.

The UK government is set to put more funding to work through a new resilience and adaptation focused climate fund, but with a mission to find new sources of private capital financing to work alongside this funding such as from pension funds, to make the countries foreign aid spending go further.

A white paper is set to be published today that has been reviewed by financial experts and multilateral financing organisations, which will explain that countries should leverage structures and appetites of private capital to make aid funding go further, and to deliver it in a more effective, anticipatory and structured manner.

As well as direct funding for climate resilience and adaptation, insurance and reinsurance solutions are also expected to feature, with structures proposed to ensure humanitarian funding can be delivered at the point disasters strike.

All of which speaks to the use of instruments such as catastrophe bonds, as well as parametric triggers, which we’ve already seen successfully deployed in sovereign and humanitarian scenarios, as ways to crowd in private capital to support climate resilience and humanitarian responsor to climate catastrophes.

There is a desire to lock-in pre-agreed and contingent sources of humanitarian financing, which is precisely the way we see the cat bond structured used in the case of the sovereign catastrophe bonds issued by the World Bank.

It also speaks to initiatives such as the Red Cross volcano catastrophe bond, which saw parametric triggers used to structure a private capital funded source of humanitarian financing that can be deployed on the occurrence of a major volcanic eruption.

We’re told that the UK government wants to reposition the value of humanitarian and international development aid with the help of private capital, to reduce the focus on taxpayers being the main source, while making the amounts of funding available much more significant, using financial market techniques to lock-in funding over multi-year periods, while still ensuring certainty on its deployment when a humanitarian disaster occurs.

All of which suggests contingent capital structures, including the catastrophe bond, could occupy a key role, as tools that can mix the expertise of insurance and reinsurance markets with those of the capital market, to deliver responsive disaster and humanitarian financing, that can provide liquidity just at the point in time countries really need it.

Cat bonds are an appropriate tool that can be used for the transfer of financing responsibilities to private markets, while transferring risks from those countries facing the greatest climate related humanitarian risks and so likelihood of requiring aid, locking in development type financing from institutional investors that can then be deployed rapidly, contingent on the conditions demanding use of aid occurring, with the use of parametric triggers ensuring a rapid delivery of the relief that is required.

Finally, we’re told there will also be a focus on using technology such as artificial intelligence to improve the ability to model the effects of climate change and its impacts on areas such as food security and the need for humanitarian relief. The UK wants to become a leader in this area and of course modelling fits well with the role of risk transfer and private capital, as advanced models can assist in structuring financial mechanisms to deploy aid that are both responsive and also anticipatory in nature.