Financial instruments for disaster risk management and climate change adaptation

The International Panel on Climate Change (IPCC) has called for a new balance between reducing the risks from climate extremes and transferring them (for example, through insurance) as means for effectively preparing for and managing disaster impacts in a changing climate. This paper elaborates on this balance with an overview of disaster risk financing mechanisms and how they contribute to disaster risk reduction and climate change adaptation in developing countries. We suggest a risk management approach that targets risk reduction and risk financing to different layers of risk, including a layer that represents a possible limit to adaptation. By reviewing traditional post-disaster financial arrangements, such as government compensation, and non-traditional pre-disaster instruments, such as index-based insurance, we show how risk financing can complement and stimulate risk reduction. We discuss the benefits of financial instruments, including the provision of post-disaster finances for recovery and pre-disaster security necessary for climate adaptation and poverty reduction. These benefits come at a cost, and we discuss the risks, challenges, and future prospects of risk financing in developing countries.