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Q&A with African Risk Capacity: How Innovative Financing Models Can Build Climate Change Resilience

Communities across the world continue to experience weather-induced food shortages due to drought, floods, devastating wildfires, and other climate change impacts. These populations—particularly those in rural, developing regions—will require tools and significant investment to protect themselves and their livelihoods from a warming world.

This week, the Board of the Green Climate Fund (GCF)—a mechanism that aims to channel billions of dollars of finance from developed to developing countries to tackle climate change and its impacts—is meeting to discuss, among other topics, how the GCF will receive and disburse money through various financial inputs and instruments.

The African Risk Capacity (ARC) provides an innovative and unique financing model that the GCF can both emulate and leverage to protect vulnerable communities. The new, African-owned institution—the first of its kind on the continent and only the second in the world—aims to channel investment into adaptation activities to safeguard communities from drought and other climate change-induced impacts.

We spoke with ARC’s Director General, Dr. Richard Wilcox, about the institution, its potential impact, and the role it could play in attracting and distributing international climate finance. Here’s what he had to say:

What is the African Risk Capacity, and what role can it play in climate change adaptation?

Africa accounts for less than 3 percent of global greenhouse gas emissions, yet the continent is widely recognized to be the most vulnerable to the effects of climate change. Natural disasters, driven by climate change, threaten to undermine the hard-fought development gains made over the last decade, just as Africa is beginning to realize its vast potential. The goal of the ARC is to protect these gains and African communities’ livelihoods as they adapt to the adverse consequences of climate change.

The African Union (AU) created the ARC to enable governments to better protect food-insecure populations on the continent. More specifically, ARC is a ground-breaking extreme weather insurance mechanism that aims to use modern financial instruments to help AU member states mitigate and recover from the ravages of drought. Given projected increases in global temperatures — which are likely to give rise to longer, more intense droughts and greater weather variability across parts of sub-Saharan Africa — the risks facing agriculture-dependent households are more pressing than ever.

What need will the ARC fill and how will it work?

ARC is an African solution to one of the continent’s most pressing challenges. It transfers some of the burden of climate risk away from governments—and the farmers and pastoralists whom they protect — to the ARC, which can handle that risk much better. For many countries on the continent, the ARC provides access for the first time to a modern financial risk management tool tailored to the African context.

This African-owned, AU-led financial entity will use an advanced satellite weather surveillance and software programme called Africa RiskView – developed by the UN World Food Programme– to estimate and trigger readily available funds to African countries hit by severe drought. Because we are focused on food security, we will use Africa RiskView to insure seven rainfall/agricultural seasons across Africa, beginning with planting and ending at harvest.

Because Africa’s droughts do not happen in the same year in all parts of the continent, pan-African solidarity in the creation of a disaster risk pool like ARC is financially effective. Our financial analysis suggests that pooling risk across the continent could save countries up to 50 percent in the cost of emergency contingency funds while decreasing reliance on external aid.

The ARC Agency Governing Board, Chaired by Dr. Ngozi Okonjo-Iweala, Coordinating Minister for the Economy and Minister of Finance for Nigeria, formally approved the drought contingency plans of the following six countries: Kenya, Malawi, Mauritania, Mozambique, Niger, and Senegal, allowing them to purchase coverage for seasons beginning in 2014.

For the time being, we are focused on providing coverage against droughts. We are working on a flood product, which we hope to have available to our member states within two years.

Why drought insurance?

Droughts significantly threaten record GDP growth in sub-Saharan Africa. To give an idea of the magnitude, according to a cost benefit analysis (CBA) commissioned last year, a 1-in-10-year drought event would reduce Malawi’s annual GDP by an estimated 4 percent. You can imagine substantially larger impacts for 1-in-15 and 1-in-25 year events. Such decreased productivity not only detracts from economic growth, but also diverts public resources from other priorities, erodes development gains and resilience, and requires additional emergency aid from the international community in the future.

These adverse macro impacts manifest themselves at the household level in devastating ways, especially in communities where there is high dependence on rain-fed agriculture and/or pastures. Following a drought, these households often suffer reduced food consumption, livestock death, and reduced earnings. The CBA estimates the economic benefits of acting early and thus protecting a household’s economic growth potential – could prevent losses of up to $1,300 per household. This is no small sum.

In total, we estimate that $1 spent on early intervention through ARC—i.e. scaling up national, regional, and local social safety net programmes in the first three months after a drought—can save as much as $3.50 spent after a crisis unfolds and households have taken negative coping actions.

Those cost savings sound significant, but is insurance really the right tool to address climate change?

We believe that insurance is an important part of a holistic approach to address the adverse impacts of climate change. It is in no way a panacea, and it’s not the correct tool to deal with chronic, year-on-year risks faced by many African countries. In order to improve countries’ resilience to natural disasters, risk management must be coupled with investments.

Investments and risk-reduction activities in the agricultural sector that support long-term resilience and food security – such as social protection programmes, irrigation schemes, or agricultural inputs and techniques that reduce reliance on predictable rains — can address chronic climate risks and provide a base of predictable on-going assistance. These funds can support poor and vulnerable households to build assets and livelihoods, which will in turn help them develop resilience to cope with mild shocks without external assistance. Risk management then becomes critical to protect these investments. In order to protect the resilience achieved, countries need to ensure that future shocks — mild or severe — do not erode their gains, and that the number of households falling into poverty or depleting their assets does not grow.

This is where a tool such as ARC can offer the most value. ARC can provide dedicated contingency funds to scale up safety net systems. These systems allow households to remain solvent and sustainable, protecting hard-won gains and reducing the country’s reliance on emergency appeals. In this sense, ARC insurance can be considered a climate change adaptation mechanism in that it helps reduce communities’ vulnerability to natural disasters and other climate-induced shocks.

How can international mechanisms like the climate funds play a role?

Developed nations have committed to provide $100 billion annually by 2020 to help developing nations mitigate and adapt to the impacts of climate change. A significant portion of this finance will likely be distributed to developing nations through the emerging GCF. The ARC—with its focus on adaptation and reducing vulnerability—could be one of the many innovative mechanisms through which the GCF disburses finance to vulnerable African nations. For example, the GCF or the intermediaries it works through could help fund the ARC with capital contributions, or even re-insure or guarantee the ARC’s capital.

We are currently in advanced conversations with the UK, German, and Swedish governments to secure the initial capital contributions ARC requires. While we designed ARC such that the premiums from ARC member states will be sufficient to maintain the solvency and sustainability of the facility in the long term, ARC needs these external capital contributions in the early years before we are able to accumulate sufficient capital from premium payments.

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