Contingency finance is a risk retention approach for addressing loss and damage associated with climate change impacts.
Introduction
Response actions in the days immediately after a disaster, such as a super typhoon, are crucial in helping the victims. Setting aside contingency or reserve funds before the disaster occurs enables countries to disburse funds faster in the wake of an emergency.
The United Nations Framework Convention on Climate Change (UNFCCC) recognizes contingency finance as a risk retention measure for addressing loss and damage associated with climate change impacts. In effect, governments are “self-insuring” themselves against loss and damage as they opt to retain the risks instead of transferring the risks to others such as insurers.
Risk retention measures, such as contingency finance, may be included in a broad set of approaches to manage climate-related loss and damage.
What Is Contingency Finance?
Contingency finance is used for early response and early recovery. Some governments set aside public funds or secure a loan from multilateral finance institutions for this purpose.
Disaster relief funds, restoration funds with preferential interest rate, contingent credit, and microcredit are among the contingency finance instruments that have been used worldwide.
What Are the Advantages?
One major advantage of contingency funds is that these can be rapidly disbursed. This is crucial in the aftermath of a disaster when governments need to act fast to help victims and provide relief.
Contingency finance also saves governments from having to sacrifice development goals or other policy objectives and diverting public funds in times of emergencies.
For countries that secured a contingency loan from a development bank, there is no cost until a disaster forces the government to draw from the loan. To be effective, though, all stakeholders must be involved in setting up the contingency plans that will deployed when a disaster occurs.
What Are the Disadvantages?
There are a number of drawbacks to this approach. One major concern is accessibility and costs. Heavily indebted countries may not be able to afford another loan. Governments that set aside contingency funds from their public coffers, meanwhile, may end up diverting funds away from development projects such as building roads, setting up much-needed health or education programs, among others.
Another drawback is that there is always a risk that the costs for disaster emergency response and recovery may exceed contingency funds. Governments raise additional funds through new loans, which will add to the country’s fiscal burden. Not having enough funds after a disaster can also lead to social and political tensions.
How to Make Contingency Finance More Effective?
Participants at the Forum of the UNFCCC’s Standing Committee on Finance in 2016 agreed that contingency finance could be an effective way of managing risks in the wake of disasters, but there are also cases when it may not be. To be successful in deploying such funds, governments need to consider what their needs are, what levels of risks they are aiming to address, and the costs and benefits of using such an approach. Governments also need to have clear trigger points and a plan at what stage to mobilize the contingency fund. There should also be a plan that determines at what stage a longer-term existing program can address the need and at what stage they need to look at alternative sources of financing. By identifying such risks and the costs associated with the contingency financing for each risk, the government can better structure the program and bridge gaps in public funds. Contingency finance for managing climate-related disaster risks should not be considered as a substitute for climate change mitigation efforts. Instead, it should work in parallel with adaptation initiatives in covering the risks associated with climate change.
Contingency Finance for Climate-Related Loss and Damage
Governments that have deployed contingency finance to respond to disasters include El Salvador, Nicaragua, Peru, Philippines, and some African countries.
Nicaragua secured a $186-million contingency loan with the Inter-American Development Bank to finance disaster response initiatives. The loan was used to cushion the impacts of catastrophic natural disasters on the country’s public finances.
Peru, the Philippines and El Salvador developed contingency plans for disaster risk reduction with assistance from the Japan International Cooperation Agency (JICA). They received a loan called Stand-by Emergency Credit for Urgent Recovery, which JICA set up in 2013. Under this facility, the recipient country needs to establish a disaster risk management program before signing the loan agreement.
Meanwhile, prospective members of the African Risk Capacity (ARC) need to submit contingency plans before they are accepted into the group. ARC is a Specialized Agency of the African Union set up to help member states better plan and prepare for, and respond to extreme weather events and disasters. Members receive payouts from the group’s pooled risk insurance facility when thresholds for specified disasters are exceeded. Access to the funds enables members to avoid straining their national budgets or exhaust aid from donors in times of disaster.
Resources
African Risk Capacity. Overview of the African Risk Capacity: Sovereign Disaster Risk Solutions. A Specialized Agency of the African Union. Johannesburg.
Climate and Development Lab, Brown University International Centre for Climate Change and Development. 2016. Financing Options for Loss and Damage: A Review and Roadmap. Rhode Island, USA.
P. Orquist. 2016. Country Experience on Contingency Finance: Nicaragua: Slide Presentation for SCF Forum. Managua.
UNFCCC. 2016. Report of the Standing Committee on Finance to the Conference of the Parties. Bonn.
Related links
Explainer: Understanding the Risks of Loss and Damage from Climate Change
Explainer: Understanding Different Approaches to Managing Climate Change Risks
Explainer: Ways to Pay for Climate-Related Loss and Damage
Explainer: Developing New Financing Tools for the Climate Vulnerable
Explainer: Catastrophe Bonds Explained
Explainer: What Countries Are Doing to Protect against Climate-Related Loss and Damage
Explainer: Key Lessons for Addressing Unavoidable Impacts of Climate Change
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Meet the experts
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Xianfu Lu is ADB’s focal point for climate change adaptation. Prior to joining ADB, she worked at UNDP’s Global Environmental Facility Unit and at the Secretariat of the UN Framework Convention on Climate Change. Trained as an applied meteorologist, she spent the first 10 years of her career researching climate scenarios and their use in climate change impacts and vulnerability assessments in different parts of the world.
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Rexel O. Abrigo supports key adaptation-related activities, including the implementation of ADB’s climate risk management framework. Prior to his current position, he was part of the team that mainstreamed climate change adaptation in the project development process for South Asia, and implemented several capacity building activities there. He has a Master of Science degree on Environmental Science and Management.
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