How to make climate disasters pay

The concept of making money off disasters has a poor reputation. But obtaining sustainable private sector funding for emergencies has long been on the wish list of many professional humanitarians. Now, with government aid budgets increasingly strained, some humanitarians say they have found a new way to supplement their budgets with private money. The International Federation of Red Cross and Red Crescent Societies launched a new kind of insurance policy designed for its Disaster Response Emergency Fund, dubbed DREF Insurance, with firms Aon and Lloyds on Sept. 6. The new instrument will help an additional six million people per year, quadruple the donations used for premiums, and save donors 15% on humanitarian aid funding, according to the people behind it. At the same time, they say, it will keep insurance companies coming back for more and potentially create a humanitarian market for insurance companies. “This structure will allow insurance companies to compensate themselves,” said Nena Stoiljkovic, under secretary general for global relationships, humanitarian diplomacy, and digitalization at IFRC. “I think this is the first time ever in the humanitarian sector that we have this type of instrument, which goes beyond grants.” The number of climate-related emergencies is increasing, piling pressure on DREF, which has been involved in more than 1,600 humanitarian efforts targeting 201 million people since 2009, according to IFRC. The fund has been described as a “critical part of international humanitarian response” by Andrew Mitchell, United Kingdom’s international development minister. Already, 83% of the disasters that the fund responded to in its three decades were climate-related, such as fires, floods, and droughts, according to Stoiljkovic. During disasters, DREF provides money quickly to any of the 191 national Red Cross and Red Crescent societies for basic humanitarian necessities like food and shelter. It sent 1 million Swiss francs ($1.1 million) to the Moroccan Red Crescent after the Sept. 8 earthquake, which killed at least 2,900 people. Like other humanitarian funds — which are almost universally underfunded — DREF has, until now, relied entirely on grant funding from donors — an increasingly scarce and unpredictable resource. With increasing calls for massive funding for a climate loss and damage fund, those budgetary pressures are only set to go up. The new mechanism, which has a 5 million francs premium, will be triggered once a disaster costs DREF 33 million francs. This will release payouts of up to 20 million francs to supplement DREF’s reserves, helping it stay funded for the next disaster. DREF’s pre-existing operational practices remain unchanged. IFRC is now looking to grow DREF to 100 million francs with the support of the new scheme. Stoiljkovic hopes the new tool will be a “sustainable instrument” to fund up to 20 million of the fund. She said it will create a “multiplier effect” for government donors, who “will be getting four times the impact” of their funding, and be “replicable” for other humanitarian budgets and organizations, providing a model to further ease pressure on donors. It’s also “sustainable, it’s not a one-year type of instrument,” added Stoiljkovic. How does it work? “The simplest way to explain it is that we are buying insurance, the same as insurance for our cars and telephones and houses,” said Stoiljkovic. The difference is that DREF uses government donor funds to buy the policy. “Until we reach that [33 million francs] trigger … we are funding DREF through pure grants, the traditional model,” Stoiljkovic said. But once the financial trigger is pulled, “insurance companies will pay into DREF,” said Stoiljkovic. Stoiljkovic said that DREF would need to buy the insurance policy from providers every year at the price of 5 million francs per year. She said DREF would use grant funding it receives to buy the policy and that the instrument was unique because it was the “first time that this is structured on the basis of indemnity insurance,” triggered by a monetary value. The insurance was brokered through Aon, a professional services firm, which is supported by reinsurers “backing this up through their own business model,” Stoiljkovic said. Why does it matter? The project comes under the blended finance banner, a type of financing that uses publicly funded aid budgets to leverage private finances for aid purposes. It has become more popular in aid policy circles in times of rising humanitarian needs and shrinking public aid budgets. But DREF’s insurance could fund 15 million francs of the planned budget of 100 million francs by 2025, meaning only 85% will need to be grant-funded — a valuable saving in a time when resources are scant. While this instrument is still in an early phase, testing to “model something that can be replicable,” if it works as intended, Stoiljkovic thinks it could be used to help remedy the humanitarian sector’s broader funding crisis. She said: “We can scale this up. It can be much bigger amounts in so many ways. A lot of the humanitarian sector potentially could be funded through this scheme, especially when it gets to climate events.” This view was echoed by Emma Karhan, head of U.K. public-private partnerships at Aon. “We're paving this way to create, hopefully, a new market for humanitarian organizations,” which she said would provide “diversification” for insurance companies. “There is an absolute appetite out there for the right model in the private sector to help these humanitarian organizations. It's just a matter of … matching the risk and understanding that risk and matching it to the capital at the right price,” added Karhan. She said the product was more suited to the “volatility of the unexpected” rather than long-term, ongoing humanitarian appeals. What’s in it for the private sector? Traditionally, the private sector’s contribution to humanitarian budgets has been through grants, with no expectation of a return. But the prospect of humanitarian responses becoming a new insurance market could change that. “We’re always looking to grow a market,” Karhan told Devex. “We want there to be more insurance, we can create more markets …. And this is an untouched sector.” The scheme is said to fit Aon’s expertise in finding sources of capital to manage risk. Karhan said there wasn’t necessarily a profit motivation but “we can't do this in a scalable, sustainable way unless there is some money made.” Aon, Karhan said, was “definitely not making what we would call our commercial rates.” “It's more about creating new products in new markets and having a greater impact to help people against climate change,” Karhan added. And referencing the environmental, social, and corporate governance, or ESG, targets many companies have, Karhan said the project was also an “opportunity to grow these types of products for people under that ESG banner”. But she said DREF Insurance was not primarily designed as an ESG project. Aon was attracted to the work because of an opportunity to try something new and create impact in support of a “strategic objective to protect the underserved” and fight climate change, Karhan said. Involving the private sector so intricately in humanitarian responses is not simple. Stoiljkovic said IFRC was reassured about the potential “moral dilemma” of paying money to a private company rather than using it immediately to save lives after the project was given a value-for-money stamp of approval by the Center for Disaster Protection, a research group based in the U.K. And the fiscal space the scheme should provide is no match for the old-fashioned way of doing things. Stoiljkovic warned: “What we are trying here is to test some possible new models that could take a little bit of pressure off the traditional grants. It will never be the more commercial schemes funding the humanitarian sector, we have to be very clear on that.” Karhan agreed: “It is all about taking volatility out of people’s balance sheets and out of their cash flows, and transferring it to a third party.” Update, Sept. 20, 2023: This piece has been updated to reflect the correct description of insurance company Aon.