Adaptation to climate change is increasingly falling within the remit of local governments, creating new costs (seawalls and beach nourishment) and increasing the costs of existing responsibilities (roads, drainage and water supply). In the development of adaptation plans, it is critical that emphasis on selecting a course of action considers not only the cost-benefit ratio (Monetary and non-monetary valuation) but also the practicalities of how such initiatives will be funded and the possibilities for financing.

To date, there has been relatively limited attention given to financial mechanisms for adaptation to climate change within developed countries. What discussion there has been tends to conflate similar but differentiated terms such as financing and funding (see Box 1). This suggests a lack of clarity regarding foundation concepts among adaptation professionals, creating a barrier to interaction with finance professionals.

In making a distinction between funding and financing it is important to recognise that financing requires funding. However, financing also impacts on the nature of funding required for a given project. To illustrate this, Figure 1 illustrates the costs (red line), available funding (black line) and repayments for debt financing of the costs (black dash line) for a local government that decides to hold the line against a retreating shoreline and to do this by constructing a seawall. The curve of the red line shows that there is an initial planning cost followed by a steep increase in costs for construction which then drops off into maintenance. For a local government with the level of funding available as indicated by the black line, the project could not move beyond the planning stage without raising a loan. By using debt finance with repayment costs indicated by the dashed line, the project can proceed into construction because the available funding can meet the financing repayments.

Financing Mechanisms

There is a wide range of financing mechanisms provided by both the public and private sectors. Regarding debt financing, there are two main borrowing options for local governments – debt sourced from private banks and debt sourced through government treasuries. The capacity for local governments to borrow as a source of finance is generally regulated by the respective state or territory through the Local Government Act. Restrictions are typically imposed on one or more of the following:

• the amount borrowed
• the purpose for which it is used
• the source of borrowings.

Table 4 introduces the most widely used financing mechanisms and outlines preliminary issues in considering each mechanism within adaptation planning.

Table 4: Financing mechanisms for application to adaptation.

In considering any of the mechanisms identified in Table 4 it is important to recognise the following.

• While revenue and resources are challenges, local governments have solid asset bases, stable revenue and low debt, which are potentially prized customer characteristics for finance providers.
• Many projects within climate change adaptation plans will be unsuitable for application of financing mechanisms due to their public good characteristics. This should not be construed as a basis for avoiding a particular expenditure. Delivery of public goods is the responsibility of governments and a basis for payment of taxation revenues by citizens.

Insurance

Insurance provides financial compensation in the event of damages suffered due to unforeseen circumstances or events. Individuals enter into agreements (policies) with an insurer to forego small certain payments (the premium) spread out across time in return for protection from the financial implications of an instantaneous, large, uncertain event. The Insurance sector is viewed as having the potential to enable and/or facilitate adaptation to climate change for coastal communities. In the development of adaptation plans, it is important to be clear about what role the insurance sector can plan and what barriers might exist (see Role of insurance).

The roles the insurance sector can play in enabling adaptation for coastal communities include:

• Building adaptive capacity: the insurance industry can enhance adaptive capacity through the financing it provides subsequent to an insured event.
• Providing incentives: appropriately designed insurance products can create incentives to engage in adaptive behaviour.
• Influencing policy: in the extreme, the threat of insurance withdrawal can compel risk reduction behaviour.
• Through investment: as the world’s third largest institutional investor (trailing only mutual and pension funds) the industry can strongly influence the propensity to adaptation in institutions.

A range of factors acts to limit the potential for the insurance sector to enable adaptation. These include:

• Standard 12 month contract terms: There is a misalignment between contract terms and projected climate change impacts. Standard insurance contracts are for 12 months, which creates a focus on short-term risk reduction rather than the longer time periods over which climate change impacts will occur. Shifting to longer contract terms will enhance the capacity of insurance to enable adaptation.
• Disaster response and moral hazard: Moral hazard occurs where an assumption of Government disaster recovery funding motivates an individual to avoid costs to mitigate risks from extreme events, such as taking out insurance. Government disaster recovery schemes should be designed so as to avoid contributing to moral hazard by reducing participation in insurance and its potential to support adaptation.
• Appropriate information for consumers: Natural hazards, climate change and insurance are complex subjects and individual consumer’s capacity to undertake appropriate risk reduction is contingent upon dealing with this complexity. By improving information and communication about hazards, climate change and risk reduction strategies such as insurance. Governments can encourage participation in appropriate insurance and other risk reduction actions, which will contribute to adaptation.
• Promoting maladaptation: This occurs when governments and/or insurers unintentionally promote activity that increases or fails to reduce exposure to climate change, e.g. home insurance policies that provide like-for-like replacement can promote maladaptation following a disaster event. Like-for-like replacement of a house destroyed by a natural hazard event would only create another house equally vulnerable to the next hazard event. By changing like-for-like clauses to build-back-better clauses in policies, insurance could contribute to climate change adaptation.

Appropriate use of financial mechanisms

This document introduces a wide range of concepts and approaches that, under certain conditions, may be appropriate to enable the implementation of climate change adaptation plans by local governments. Decisions regarding the selection of a particular strategy require specialist professional advice based on the particular context and circumstances of an individual local council.