7 Pages Posted:
Date Written: January 1, 2021
Relative to its importance, climate adaptation (reducing vulnerability to future climate change) is one of the least funded global issues. Promising technological and policy solutions exist for reducing greenhouse gas emissions, and that’s ultimately a global collective action problem. Climate adaptation is more of a planning and financing problem, with fewer existing solutions. Although adaptation could yield significant benefits under future climate scenarios, the uncertainty of those scenarios decreases the feasibility of proactively adapting, especially where local political consensus is required. However, projects could be underwritten by benefits paid for in climate scenarios they’re designed to address because other entities would like to hedge the financial risk of those scenarios and support climate resilience.
Infrastructure projects can be built to defend against more extreme climate change through upfront spending. These expenditures generate more climate resilience benefit under more extreme climate outcomes. The return on investment of the adaptation is a function of the level of climate change, so it's optimal for the adapting entity to finance adaptation with repayment also a function of the climate. It's also optimal for entities with financial downside under a more extreme climate to serve as an investing counter-party because they can obtain higher than market rates of return when they need it most.
In this way, entities proactively adapting could reduce the risk they over-prepare and their investors could reduce the risk they under-prepare. This is superior to typical insurance because by investing in climate-contingent financial mechanisms the investors are not merely financially hedging but also outright helping prevent damage, and therefore creating value. Instead of buying insurance, they’re paying for defense. Both sides of the positive-sum transaction — physical and financial hedgers — can be made better off. This coordinates capital through time according to parties’ climate risk reduction capabilities and financial profiles.
Keywords: Climate change, Climate adaptation
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