Understanding Different Approaches to Managing Climate Change Risks

Risk reduction, retention, and transfer are risk management approaches that can be used to address loss and damage associated with climate change impacts.

Introduction

There exists a range of approaches and instruments to manage the loss and damage associated with the impacts of climate change. The challenge for decision makers is to identify which ones are more appropriate not only to the type of risk but al so to the socioeconomic circumstances of the people and communities that are at risk.

Three risk management approaches can be identified for climate change risks. These are risk reduction, risk retention, and risk transfer.

In this explainer, we define each approach, give examples of related instruments or measures, and discuss the pros and cons. Lastly, we present the implementation requirements of each approach.

Risk Reduction

The risk reduction approach entails putting in place measures (either structural or non-structural) before an event occurs with the goal of reducing loss and damage, which could be caused by slow onset events, such as desertification, sea level rise, and ocean acidification, or by extreme weather events, such as storms and flash floods

Table 1: Examples of Structural and Non-Structural Risk Reduction Measures

Source: Adapted from UNFCCC (2012). Available at: http://unfccc.int/resource/docs/2012/tp/01.pdf

While the implementation of risk reduction measures may be costly, the benefit of such measures (where the benefit is the estimated reduction in expected loss and damage) should justify implementation costs.

Risk Retention

Risk retention is defined as an approach by which a society or community (at national or local level) would accept a degree of risk of loss and damage associated with impacts from slow onset and/or extreme weather events.

Table 2: Examples of Planned and Unplanned Risk Retention Measures

Source: Adapted from UNFCCC (2012). Available at: http://unfccc.int/resource/docs/2012/tp/01.pdf

A distinction is made between planned and unplanned risk retention measures. Planned risk retention measures involve setting aside public funds explicitly to respond to emergency needs. Unplanned risk retention measures involve drawing from the general budget for an unforeseen emergency, making it an unexpected burden to fiscal resources.

Risk Transfer

This approach involves shifting the risk of loss and damage from one entity to another. It is typically undertaken when the potential loss and damage is greater than the ability to manage it. Insurance (including microinsurance) is a risk transfer measure and so are catastrophe bonds, risk pooling, conditional risk transfer, and combined insurance-credit programs.

Risk transfer measures can be invaluable to governments, or even households, as they help limit the financial burden of rebuilding or recovering from loss and damage.

Comparison of Risk Management Approaches

In this video, Swenja Surminski, senior research fellow at the Grantham Research Institute on Climate Change and the Environment, talks about the different approaches used in identifying the right combination of financial instruments and tools to address the risks of loss and damage.

 

Loss and damage can be triggered by extreme weather or by slow-onset hazard. In general, risk reduction should be undertaken in either case wherever cost-effective risk mitigation can take place.

Similarly, risk retention is likely to be effective in both types of situations. However, this risk management approach is likely to be of greater importance to mitigate the impact of slow-onset hazards, which are projected to happen with a great degree of certainty (such as sea-level rise).

The use of risk transfer instruments is focused mostly on addressing the impacts of extreme weather events. However, these instruments may also be useful for addressing the impacts of slow-onset events. For example, there are well-developed insurance schemes designed to protect against loss and damage from drought.

The selection of an approach or combination of approaches also depends on the frequency and level of impact of the event.

In the case of extreme weather events that occur with a high degree of frequency but with low impact (or low severity)—such as recurring localized annual floods, risk retention (accompanied by risk prevention and reduction) may be a better suited approach.

In the case of extreme weather events with a low degree of frequency but high impact (such as a 1-in-100 year typhoon affecting a large territory), risk transfer (accompanied by risk prevention and reduction) may be a more suited and economically effective approach.

The gradation from risk retention to risk transfer is referred to as risk layering.

Source: Adapted from Poundrik, S. 2011. Disaster Risk Financing: Case Studies. The World Bank. Washington, D.C.

The relative advantages of each risk management approach is presented in Table 3 while limitations are presented in Table 4.

Table 3: Advantages of Different Risk Management Approaches

Approaches	Advantages
Risk reduction	Reduction of mortality and injuries Reduction of damage to private and public infrastructure Less interruption of business activities, including tourism Increased awareness of hazards and of their potential impacts Improved efficacy of response and recovery
Risk retention	Ability to target specific groups to build up their resilience to the impacts of extreme weather events Possibility of setting aside financial resources and using these resources (if needed) without disruption other uses of fiscal resources
Risk transfer	Reduction of the volatility of losses Allow public sector to plan the use of scarce financial resources knowing that part of the losses have been transferred to a third party Increase willingness to invest The cost of risk transfer may be lower than the cost of risk retention

Source: Adapted from UNFCCC (2012). Available at: http://unfccc.int/resource/docs/2012/tp/01.pdf

Table 4: Limitations of Different Risk Management Approaches

Approaches	Limitations
Risk reduction	Public expenditure on structural and non-structural measures Public must be convinced of investing in risk reduction measures while the benefit (reduced loss and damage) is in the future and uncertain Revising building codes may be costly and may lead to higher construction costs Changes in land-use and zoning may affect property values
Risk retention	Opportunity costs of earmarking scarce fiscal resources to a fund Risk retention may require governments to raise post-disaster capital
Risk transfer	Funds are needed to cover the costs of risk transfer (such as insurance premium) Monitoring requirements may be demanding as triggers need to be put in place to signal payouts Some residual risk remain after risk transfer (since not all risk can be transferred)

Source: Adapted from UNFCCC (2012). Available at: http://unfccc.int/resource/docs/2012/tp/01.pdf

Implementation Requirements of Different Approaches

Different risk management approaches require different elements to be in place for the approach to be effective.

Table 5: Implementation Requirements of Different Risk Management Approaches

Source: Adapted from UNFCCC (2012). Available at: http://unfccc.int/resource/docs/2012/tp/01.pdf

Conclusion

Risk reduction, risk retention, and risk transfer are the three broad risk management approaches to address the loss and damage associated with climate change impacts. Each approach has its own strengths and weaknesses.

Risk reduction will reduce damages. However, it is often costly and its benefits remain only “expected benefits” at the time that risk reduction measures are implemented.

When applied to extreme weather events, risk retention is more likely to be a preferred approach to mitigate the loss and damage resulting from  events with smaller impacts and occurring relatively often.

Risk transfer is more likely to be a more effective approach to mitigate the loss and damage resulting from events occurring infrequently, but with larger impacts.

This article is part of a series of explainers developed based on discussions and contributions at the 2016 Forum of the Standing Committee on Finance of the United Nations Framework Convention on Climate Change, which focused on financial instruments that address the risks of loss and damage associated with the adverse effects of climate change. The forum was held at the Asian Development Bank in Manila on 5-6 September 2016.

Resources

Poundrik, S. 2011. Disaster Risk Financing: Case Studies. Working Paper No. 23. EAP DRM Knowledge Notes: Disaster Risk Management in East Asia and the Pacific. Washington, D.C.: The World Bank.

UNFCCC. 2012. A Literature Review on the Topics in the Context of Thematic Area 2 of the Work Programme on Loss and Damage: A Range of Approaches to Address Loss and Damage Associated with the Adverse Effects of Climate Change.

Related links

Explainer: Understanding the Risks of Loss and Damage from Climate Change

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: Mobilizing Contingency Funds for Climate-Related Disasters

Explainer: Key Lessons for Addressing Unavoidable Impacts of Climate Change

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