The New Frontier of Adaptive Finance for Disaster Recovery

Submitted by Julia Barrott | published 4th Dec 2017 | last updated 13th May 2019
Adapting financial product development processes to user needs

Figure 1 from page 7 of the report: Example of Adaptive Financing Loan-Product Development. A loan or other product designed intentionally in an adaptive manner can quickly adjust to the needs of the market in the event of a disaster scenario. 

Introduction: The Need For Adaptive Post-Disaster Financing

According to Munich RE, a German reinsurance firm, disasters in 2016 caused $175 billion dollars of damage. Only 30% of that damage is covered by insurance, and governments, non-profits and NGOs struggle to make up the difference during recovery and reconstruction. This means that there is a $122 billion opportunity for the financial sector to assist, if they can develop products sufficient to meet post-disaster financing needs.

The case for why the financial sector should focus on financing post-disaster reconstruction hinges on the fact that financial systems rely on healthy markets. After a disaster, damaged and uninsured companies and businesses are unable to sell their products and services. This in turn presents a huge risk to the financial industry that backs their operations, and/or the operations of other companies that rely on such businesses in their supply chain or distribution networks. Likewise, uninsured households must rebuild, and this process requires products and services that are customized to their needs as disaster survivors.

However, financing post-disaster reconstruction is not easy and happens in an environment that is chaotic and changing continuously. To meet the needs of damaged markets and survivors in post-disaster contexts, the financial sector will have to adapt its methods of developing and delivering products and services.

How to Apply Adaptive Financing to Support Long-term, Sustainable Disaster Reconstruction

In many post-disaster circumstances, the financial products available to consumers and businesses are unable to meet their needs, because the customers’ circumstances have changed so much after the disaster. If individuals and companies are forced to pick from standard loan products and other financing mechanisms, they can easily find themselves adopting a greater burden in that the size of the loan, terms and tenor may not be realistic given their new situation. Thus, the decision to desperately take out an ill-fitting loan can not only increase the vulnerability of a customer, it can also also create additional risk for the financial institution.

In this report (download available here and from the right-hand column) we explore how the private sector can be creative and create flexible products that can adapt to the needs of post disaster survivors, enabling them to reconstruct and alleviating the challenges posed by risks to capital investments in times of uncertainty.

What is adaptive financing? Adaptive financing is a type of financial product that is flexible enough to adapt to the needs of specific locations in the wake of disasters. Changing conditions demand flexibility.

Some product-development processes create fixed products. For example, a mortgage is a product that a client can buy. However, if a client wants to change the fixed terms of their contract, they generally have to refinance. In contrast, adaptive financing offers flexible products that can adapt to changes in customer situations. This adaptability depends on flexible underlying processes that allow for finance providers to make ongoing adjustments to products in response to changing client needs. This requires a redesigned product-development process and a new conception that a financial product is a service instead of a commodity.

One example of an adaptive financing instrument is displayed in figure 1. In this framework, the private insurers have a pre-determined suite of insurance options, linked to a variety of disaster scenarios. This way, when disasters occur, the insurer is prepared to select the appropriate scenario and provide a suitable product to the market, as opposed to relying upon business-as-usual financial tools for addressing an un-usual situation.

Report Methodology

To understand how the private sector could create such flexible and adaptive financial products, we facilitated a workshop at Yale University with experts from the humanitarian-response and private-finance worlds, ranging from The World Bank’s Global Facility for Disaster Reconstruction to Citibank. Conclusions and recommendations included in the resultant report (presented here) were based on workshop outcomes, background interviews, and additional research.

Barriers to Adaptive Financing

We identified the following major challenges associated with designing adaptive products for post-disaster relief:

  • The complexity of post-disaster scenarios
  • Damage to markets and disruption of supply chains
  • Challenges associated with balancing risk and return in uncertain environments
  • Slow and cumbersome product-development processes
  • The difficulty of coordinating the deployment of public and private capital
  • The lack of trust between financiers, agencies, and recipients after disasters

These challenges and others keep adaptive financing mechanisms from being sponsored by product development teams at financial institutions that are seeking to maximize value and minimize risk.

Enabling Factors and Solutions

However, through actions like development of partnerships, use of creative design and research techniques, and adequate consideration of planning, innovation can help private financiers reduce the challenges of post-disaster financing. Additionally, many of these actions can help accelerate the product development timeline so that provide timely, effective relief to people in need. 

A full list of recommendations and suggested methods for enabling more adaptive financing products and processes is available in the report (download available from the right-hand column).

Outcomes and Impacts

What were the key findings of this project and their associated impact?

If banks can help restart markets, not only can they they help prevent their clients from facing default, they can also enjoy additional benefits like strengthened customer/supplier loyalty, enhanced brand reputation, and valuable experience that can push the capabilities of the organization, spurring new internal innovation.

Lessons Learnt

From this investigation, we identified the following challenges and proposed the following solutions. These are the key takeaways for those working in private capital or disaster recovery and response seeking to become more nimble and climate sensitive in their financial product development processes. See the full text for much more detail.

Challenges of Post-Disaster Financing Example Recommended Adaptive Approaches
Financing after Disasters Requires New Models of Product Development
  • Research primary financial needs and non-financial needs of clients after disasters.
  • Preapprove a set of solutions or financial products that can be adapted quickly after a disaster.
  • Use scenario-based planning models during product development. Include climate change projections and associated risk intensification in scenario models. 
  • Create products that have several investors participating at various levels of risk.
  • Optimize the non-monetary benefits of post-disaster financial deals for investors.
The Case for Private Investment in Disaster Reconstruction Is Underdeveloped
  • Calculate all of the benefits of participation for your financial institution.
  • Ensure that benefits are realized.
  • Create solutions to reduce risk in uncertain scenarios.
  • Foster strategic partnerships to diversify risk.
  • Make the formal business case for market entry into post-disaster recovery world.
  • Track accrued value by participating in post-disaster financing over time.
Disasters Disrupt Supply Chains and Complicate Recovery Logistics
  • Create redundant access to customers along supply chain. 
  • Utilize mobile and flexible technologies.
  • Prepare for disaster events and run scenarios across supply chain network. Include climate change projections in this scenario planning.
  • Plan supply-chain responses and have a business continuity plan.
  • Perform risk and sensitivity analysis of supply chains before disasters occur.
Larger Markets Can Be Damaged by Disasters
  • Map and activate networks and diagram supply chains.
  • Understand community needs and create community associations and other mechanisms to strengthen community response and supporting local markets in wake of disasters.
  • Partner with other financial services providers to scale adaptive financial product solutions. 
Slow and Cumbersome Financial-ProductDevelopment Processes Lead to a Mismatch in Timing Between Need and Available Financing
  • Take preventative steps that inform future financing and create new processes for adaption of products after disasters.
  • Use scenario analysis to understand potential situations.
  • Map out the post-disaster funding opportunities and connect with alternative funding sources.
  • Pre-structure adaptive products before a disaster event and establish a new approvals process to facilitate this kind of approach.
Complexity Can Pose Obstacles during Disaster Recovery
  • Use collaborative research and innovation methods during the product-development process.
  • Map all known vulnerabilities in communities served by your products and quantify associated changes to existing disaster and associated risks, including climate change projections. 
  • Create strategic partnerships with other organizations.
  • Map existing resources in communities served before a disaster hits.
Exploitative Behavior Can Affect Community Trust
  • Gather feedback from survivors of past disasters on what constitutes exploitative behavior.
  • Create partnerships and establish relationships with clients before a disaster.
  • Create public ethics policies and standards surrounding this issue.
Lack of Preparation for a Disaster Increases the Magnitude of Impacts
  • Develop risk education programs to accompany products.
  • Incentivize vulnerability-reduction efforts within supply chain and client communities.
  • Partner with programs and organizations that are already established to support disaster-risk mitigation.

This is a framework that is intended to kick-start the conversation about what role the private sector can play in disaster reconstruction finance. However, more work needs to be done at the organization level to pilot adaptive products that are viable and contribute to a community's needs. We suspect that many additional challenges will arise during such processes that will also be worth sharing with the field.

Further resources