When it comes to the impacts of climate change, Africa is bearing the brunt. Although the continent contributes the least to global warming, Africa is the most vulnerable to climate risks.

Climate change is also a multiplier threat in Africa exacerbating social and economic issues. From droughts to storms and tropical cyclones, extreme weather-related events are increasing in Africa. And the continent is facing increased threats of more frequent and severe climate change-induced disasters.

As African nations remain vulnerable to the growing risks of climate change, building the continent’s resilience should be of top importance to policymakers across the continent. Innovative financing mechanisms can help the continent better prepare for and respond to natural disasters.

Using innovative finance to address climate shocks

Africa’s current climate finance levels are falling short and the climate financing gap is getting bigger. Between now and 2030, it’s estimated that Africa will need up to $2.8 trillion to fulfil its National Determined Contributions under the Paris Agreement.

To close the growing climate finance gap, Africa should explore the use of innovative disaster risk financing mechanisms such as parametric insurance.

Parametric insurance, also called index-based insurance, differs from traditional insurance as it’s based on the probability of a pre-defined event occurring rather than indemnifying for actual loss incurred. It offers pre-determined coverage for extreme weather-related events such as cyclones, droughts or floods.

A parametric insurance plan is based on two elements first, a triggering event and second, a payout mechanism that’s pre-determined and custom created in order to ensure that there’s equity between the cost and payout.

In principle, parametric insurance is based on the analysis of loss events. Insurers are able to be innovative in designing novel types of protections against risks that wouldn’t meet the criteria for the indemnity insurance sector. And compared to traditional insurance mechanisms, parametric insurance differs as payouts are not based on an assessment ex-post instead, payouts are triggered when certain pre-defined parameters are met.

In the event of an extreme weather-related, governments are usually forced to reallocate funds from their national budgets in order to respond to a disaster. And for most developing countries, by the time relief reaches those that are impacted by the disaster, it’s often too late.

The biggest advantage of parametric insurance is that after a natural disaster occurs, it enables a rapid payment. This in turn can help governments react to climate shocks more swiftly.

Take Madagascar. It was the first country to adopt the African Risk Capacity’s (ARC) parametric cyclone insurance policy. After the extreme weather-related event that was tropical cyclone Batsirai hit Madagascar in 2022, it triggered the country’s parametric tropical cyclone insurance policy and the ARC paid out $10.7 million to the Government of Madagascar. In turn, Madagascar was able to use the funds to direct emergency aid to the most critical areas in a quick and efficient manner.

Malawi is another case in point. When Malawi was experiencing a drought during the 2021/2022 agricultural season, the government received a payout of $14.2 million to help the country recover from the impact of the drought.

Mitigating Africa’s climate change risks

The recent Intergovernmental Panel on Climate Change (IPCC) report has revealed a disturbing forecast for Africa in regards to the increased frequency of severe extreme weather-related events such as droughts, floods and heatwaves. The report states that “with every increment of global warming, regional changes in mean climate and extremes become more widespread and pronounced”.

Innovative disaster risk financing instruments such as parametric insurance are in no way a panacea to Africa’s climate finance woes. But they offer the continent an opportunity to help mitigate it’s growing climate change risks and can help build resilience against future climate change shocks.