Financing Transitions to Climate Neutrality and Increased Resilience in Cities

This year-long study, conducted by the ARC3.3 Finance team, revealed that:

• Sufficient investment capital exists in world markets to finance needed climate change mitigation and adaptation efforts by cities (and nation-states). However, most of that money is in private hands, is locked in corporate investments and real estate, and is not available to support climate responses.      
• The political will to change that picture and raise the funds needed to support climate response (ten times the money currently available) is undermined by existing models of the economic impacts of climate change. Those models understate potential costs by failing to include the cumulative effects of direct losses from heat, fires, floods, and storms. Investors, governments, and multinational financial institutions thus underestimate the public and private costs that could be avoided by reducing climate change impacts.
• Including environmental and social impacts, not just financial returns, in investment calculations could increase willingness to fund climate change responses. As a result, there is movement in the EU, China and the US, towards new requirements for private climate finance mobilization or disclosure of non-financial information on the impact of business operations. Impending formalization of a non-financial disclosure standard under the global Taskforce on Climate-Related Financial Disclosures (TCFD) (a standard that the International Sustainability Standards Board, ISSB now maintains) bodes well for expanded climate response expenditures.
• Risk reduction measures are needed to attract the required substantial investment of private capital in the climate change fight. The public sector could address risks by providing guarantees, insuring potential losses, and participating in blended finance projects (public-private partnerships) to reduce investors’ fears of losses.  
• The Global North not only controls climate finance but also attracts most of the climate response funds due to lower real and perceived risk. An urgent need thus exists to increase financing for developing countries, especially for climate adaptation efforts which are starved relative to mitigation investments.
• As recipients, not sources, of funding, cities have little capacity to shape financing mechanisms that could better serve their needs in confronting climate change.  As a result, while they can – and do – launch climate response programs, they are largely dependent on non-local funding and thus have to shape their programs to appeal to external parties rather than provide the greatest possible support for their citizens.
• The Global South needs additional training and capacity building to ensure efficient and effective utilization of the funds available. This applies to public officials, but also to local financial institution staffs. Domestic lending officers are often unaware of climate finance mechanisms and the potential availability of national and international funds. They all should be supported with training and awareness initiatives.

A variety of potentially useful approaches to the inadequate supply of climate-relevant investments were identified but this article focuses on one in particular: Better engagement with the insurance industry which has not been a primary focus to date. Consider the following:

• The sector includes all the capital reserves that property, automobile, and business insurance providers manage that protect against current risks. It also includes the investment of the retirement or superannuation funds that provide future incomes to current employees and current incomes of retirees as well as life insurance. As a whole, it controls more freely allocable capital than any other sector, including the public sector.
• Insurers and managers of superannuation or retirement funds have far longer time perspectives than any manufacturer or current service provider. Climate response, whether mitigation or adaptation efforts, involves reducing future losses and only incidentally current revenues. Thus, the sector’s time horizon is more closely aligned to that of decision-makers planning climate responses.
• Finally, insurance companies could offer coverage for the uncertainty inherent in climate-response projects. By reducing project risks, they may lower the returns on investment demanded by other sources of capital. To hold down those risks, they would then have an incentive to set up special alliances with cities to provide data, support risk assessment, and finance local adaptation, provided that the firms recognize the benefits of urban climate change risk reduction.

To maximize the potential contributions of insurers, however, it will be necessary for countries and cities globally to derive and employ consistent and complete measures of risk and impact, requiring that actual impacts be scientifically determined rather than just modeled narrowly by economists and planners - a task that can be undertaken in the Global North. But the impact measures will, in turn, need to be disseminated in a form that decision-makers in the Global South and localities anywhere that have limited specialized staffs can utilize in planning actions if they are to attract external capital.