Development finance, blended finance and insurance

Jung, Hongjoo Article Development finance, blended finance and insurance International Trade, Politics and Development (ITPD) Provided in Cooperation with: Department of International Commerce, Finance, and Investment, Kyung Hee University Suggested Citation: Jung, Hongjoo (2020) : Development finance, blended finance and insurance, International Trade, Politics and Development (ITPD), ISSN 2632-122X, Emerald, Leeds, Vol. 4, Iss. 1, pp. 47-60, https://doi.org/10.1108/ITPD-12-2019-0011 This Version is available at: https://hdl.handle.net/10419/319550 Standard-Nutzungsbedingungen: Die Dokumente auf EconStor dürfen zu eigenen wissenschaftlichen Zwecken und zum Privatgebrauch gespeichert und kopiert werden. Sie dürfen die Dokumente nicht für öffentliche oder kommerzielle Zwecke vervielfältigen, öffentlich ausstellen, öffentlich zugänglich machen, vertreiben oder anderweitig nutzen. Sofern die Verfasser die Dokumente unter Open-Content-Lizenzen (insbesondere CC-Lizenzen) zur Verfügung gestellt haben sollten, gelten abweichend von diesen Nutzungsbedingungen die in der dort genannten Lizenz gewährten Nutzungsrechte. Terms of use: Documents in EconStor may be saved and copied for your personal and scholarly purposes. You are not to copy documents for public or commercial purposes, to exhibit the documents publicly, to make them publicly available on the internet, or to distribute or otherwise use the documents in public. If the documents have been made available under an Open Content Licence (especially Creative Commons Licences), you may exercise further usage rights as specified in the indicated licence. https://creativecommons.org/licenses/by/4.0/ Development finance, blended finance and insurance Hongjoo Jung Business School, Sungkyunkwan University, Seoul, Republic of Korea Abstract Purpose –This research aims to review literature on development finance and its challenge and to examine blended learning and insurance as a catalysts of development finance. In particular, this paper provides new insights and practical examples of blended finance and insurance. Design/methodology/approach –This research basically relies on literature review and case study to show the value of the emerging methods of blended learning in development finance and insurance system. Findings –Basic finding in this paper includes new insight of blended finance and insurance as a partnership between public and private sector, which offers new arena for academic research and practice. Originality/value –As the research relies on literature review and authors’insight, originality may not be valued so much, but if may be introducing or creating new ideas or thinking about development finance or international development cooperation where relevant data or experience is still lacking. Keywords Blended finance, Millennium development goal, Sustainable development goal, Official development assistance Paper type Research paper 1. Introduction Since the end of the Second World War with the largest mortality loss ever, the United Nations has devoted to enhance world peace in various ways including direct or indirect means. Initially established as war-deterring multinational institution, nevertheless, the UN entered into a historic scale of global project, the Millennium Development Goal (MDG) as a way to strengthen global peace by reducing income gap between developed countries and undeveloped countries. Integrating more group intelligence and financial resources, the 15-year project seemed to be more successful than any other development projects conducted in the 20th century. As a result of success, the MDG project was followed by another 15 years and much larger UN project, the Sustainable Development Goal (SDG) project, from the year 2016. The new project is more ambitious, gigantic and resource-requiring as it involves not only underdeveloped countries but also developed countries and also as it calls not only for public resources but also private resources. As such, financial resource in the SDG stage appears to be much larger and more crucial than that in the MDG period. According to the OECD, total financial resource required to perform the SDG will be US$3.9 trillion (see as follows), which is effectively more than ten times of the MDG resources. And that is why development finance came to attract serious attentions of policymakers, academicians and practitioners along with various issues to resolve. They have their own goals, ideas and experiences, given the knowledge that private financing has its own risk and return concept that public financing including the Official Development Assistance (ODA) Development finance 47 © Hongjoo Jung. Published in International Trade, Politics and Development. Published by Emerald Publishing Limited. This article is published under the Creative Commons Attribution (CC BY 4.0) license. Anyone may reproduce, distribute, translate and create derivative works of this article (for both commercial and non-commercial purposes), subject to full attribution to the original publication and authors. The full terms of this license may be seen at http://creativecommons.org/licences/by/4.0/ legalcode The current issue and full text archive of this journal is available on Emerald Insight at: https://www.emerald.com/insight/2586-3932.htm Received 12 December 2019 Revised 15 April 2020 Accepted 18 April 2020 International Trade, Politics and Development Vol. 4 No. 1, 2020 pp. 47-60 Emerald Publishing Limited e-ISSN: 2632-122X p-ISSN: 2586-3932 DOI 10.1108/ITPD-12-2019-0011 may not have. How to integrate those differing concepts of finance into the huge SDG project can be an exciting challenge for those parties concerned enough to give birth to new research area and experiments. As both public finance and private finance play different roles given their own raison d’^ etre , they should be strategically or technically managed to fulfill their own goals and constraints, in such a new way of blended finance or combined way of private– public partnership financing, if the financing method should survive. Blended finance is a strategic development finance for mobilization of additional finance towards sustainable development in developing countries. Understanding the indispensable role of ODA in financing the SDGs, the international community acknowledged the need for significant additional development finance –and accorded a prominent place to private sector participation. The vision underpinning the 2030 Agenda is broad and ambitious, calling for an equally broad and ambitious financing strategy. Although little academic research has been done, policymakers have recently shown considerable interest in a class of development financing opportunities called “blended finance”that pools public and private resources and expertise. Blended finance incorporates a large portfolio of potential instruments, including instruments provided by development finance institutions to leverage private finance (e.g. loans, equity investments, guarantees, etc.), as well as traditional public–private partnerships (PPPs). This paper aims to review issues and challenges regarding development finance, using literature survey and case study, to show what has been done so far on the development finance, particularly on the blended financing including blended insurance. This paper is structured as follows. The first part will be devoted to general description of development finance and basic issues regarding the finance. And next part will cover blended finance in its concept, usages, cases and challenges. The third part may be a major contribution of this paper in filling the niche of existing research on blended insurance. The last section summarizes this paper and presents future direction for research. 2. Development finance 2.1 Concept of development finance Literally speaking, “development finance”is finance for development. As development has a variety of meaning, however, including general disclosure, growth of human bodies, poverty alleviation, improvement of human rights, advancement of national system, economic growth, social advancement, enhancement of freedom [1] and so on, finance is also diverse in its nature. Highlighting the aspect of freedom in development, for example, Sen (1999) notes that “development can be seen, it is argued here, as a process of expanding the real freedoms that people enjoy. Focusing on human freedoms contrasts with narrower views of development, such as identifying development with the growth of gross national product, or with the rise in personal incomes, or with industrialization, or with technological advance or with social modernization. Growth of GNP or of individual incomes can, of course, be very important as means to expanding the freedoms enjoyed by the members of the society”. Development in this article is operationally defined as the project of international organizations such as the United Nations to help underdeveloped countries in various ways. The United Nations’MDG or the SDG shows what can be done with the development projects in real world as follows (see Figure 1). As every project requires both financial resources and human resources, so does the development project. In fact, the SDG project may be the largest global project to develop the whole world for 15 years, requiring more financial resources than any other projects, approximately US$3.9 trillion per year (see Figure 2). And general observation is that US$2.5 trillion should be financed from other sources than regular ODA, mostly from private sector (see Figure 3), which nevertheless functions with its own profit incentive and risk and return ITPD 4,1 48 The Millennium Development Goals (MDGs) Goal 1 Eradicate extreme poverty and hunger Goal 2 Achieve universal primary education Goal 3 Promote gender equality and empower women Goal 4 Reduce child mortality Goal 5 Improve maternal health Goal 6 Combating HIV/AIDs, malaria, and other diseases Goal 7 Ensure environmental sustainability Goal 8 Develop a global partnership for development Sustainable Development Goa ls (SDGs) Goal 1 End poverty in all its forms everywhere Goal 2 End hunger, achieve food security and improved nutrition, and promote sustainable agriculture Goal 3 Ensure healthy lives and promote well -being for all at all ages Goal 4 Ensure inclusive and equitable quality education and promote life -long learning opportunities for all Goal 5 Achieve gender equality and empower all women and girls Goal 6 Ensure availability and sustainable management of water and sanitation for all Goal 7 Ensure access to affordable, reliable, sustainable, and modern energy for all Goal 8 Promote sustained, inclusive and sustainable economic growth, full and productive employment, and decent work for all Goal 9 Build resilient infrastructure, promote inclusive and sustainable industrialization, and foster innovation Goal 10 Reduce inequality within and among countries Goal 11 Make cities and human settlements inclusive, safe, resilient and sustainable Goal 12 Ensure sustainable consumption and production patterns Goal 13 Take urgent action to combat climate change and its impacts Goal 14 Conserve and sustainably use the oceans, seas, and mari ne resources for sustainable development Goal 15 Protect, restore and promote sustainable use of terrestrial ecosystems, sustainably manage forests, combat desertification, halt and reverse land degradation, and halt biodiversity loss Goal 16 Promote peaceful and inclusive societies for sustainable development, provide access to justice for all, and build effective, accountable and inclusive institutions at all levels Goal 17 Strengthen the means of implementation and revitalize the global partnership for sustainable development Source(s) : sdgfund.org/mdgs-sdgs Figure 1. Various goals of the MDG –and the SDG projects Development finance 49 principle. Although ODA is important for developing countries, but it is so limited in size that it may be strategically used to attract more financial resources [2]. Although public financing had contributed significantly to the MDG project targeting developing countries or their governments, for instance, private financing will be expected to play a dominant role in the SDG stage as it involves further development of both underdeveloped and developed countries. That is, a strong private sector is a driver for economic development. Businesses need funding to grow and contribute to their local environment and communities [3]. 2.2 Classification of development finance Development finance can be classified into private finance and public Finance, domestic finance and international finance, direct finance (market-based finance) and indirect finance (institution-based finance), intentional finance and unintentional finance. Among those Source(s): IMF (2019) 0 100 200 300 400 500 600 Total needs Increased tax revenue Extra financing required Total needs, increased tax revenue, and Extra funding required for low income developing countries in 2030, billion US$ Source(s): UNCTAD (2014), World Investment Report 2014 0 0.5 1 1.5 2 2.5 3 3.5 4 4.5 Annual Investment Needs Current Annual Investment Investment Gap Estimated Investment Gap in Key SDG sectors, 2015-2030 (Trillion US$, annual averge) Figure 3. Financial gap between total needs and tax revenue in low-income countries Figure 2. Estimated investment gap in key SDG sectors, 2015–2030, per annum ITPD 4,1 50 classifications, which can be explained later, noticeably unintentional finance means foreign trade or investment without any original altruistic intention to help developing countries but leading to outcome of developing those countries. There are several different options for development finance –domestic or foreign, private or public and combined. The following Table 1 shows and explains what are the specific ways of development financing (see Table 1). As described earlier, blended finance is a leverage of private finance through public finance, an innovative partnership between private and public financing, which is explored in more detail in next section. Options Primary roles Strategies 1. Domestic public financing (1) Increasing equity through poverty reduction (2) Providing public goods and services to change incentives of private actors (3) Managing macroeconomic stability (1) Promote tax reform, tax compliance and deeper international cooperation (2) Ensure good financial governance and public financial management (3) Internalize externalities and mainstream environmental sustainability (4) Address inequality and the social protection imperative (5) Effectively manage public debt (6) Explore the potential contributions of national development banks 2. Domestic private financing (1) From households to multinational corporations (2) Profit-oriented, suitable for productive investment (1) Provide access to financial services for household and microenterprises (2) Promote lending to small and mediumsized enterprises (3) Develop financial markets for long-term investment and enhance regulations to balance access and stability (4) Strengthen the enabling environment (5) Strengthen economic, environmental, social and governance and sustainability considerations in the financial system 3. International public financing (similar to domestic public finance) (1) Meet existing commitments (2) Make use of all international public financing sources and instruments (3) Use international public resources efficiently and effectively 4. International private financing (similar to domestic private finance) Including FDI, portfolio flows and cross-border bank loans (1) Channel international funds towards long-term investment in sustainable development (2) Manage volatility of risk associated with short-term cross-border capital flows (3) Facilitate the flow of remittances and private development assistance 5. Blended financing (1) Leverage private finance and traditional public private partnership (2) nnovative implementing partnership (1) Strategically assess the use of blended financing and innovative partnership (2) Explore the potential contributions of development finance institutions in support of blended finance (3) Strengthen capacity development efforts Source(s):United Nations (2014), Report of the Intergovernmental Committee of Experts on Sustainable Development Financing, New York. pp. 15–37 (summarized) Table 1. Options, roles and strategies of development finance Development finance 51 3. Blended finance As to definition of blended finance, many institutions, more specifically, development actors and researchers have developed a variety of the definitions that may differ in approach and emphasis. The following is a sampling of these definitions (italics added). The following is various definitions of blended finance collected by the OECD [4]. “In general,blendedfinance connotes acombinationof publicand private finance,which mayor may not involve a form of subsidy”(Klein, 2016). Blended finance refers to “the strategic use of development finance and philanthropic funds to mobilise private capital flows to emerging and frontier markets”(OECD/World Economic Forum, 2015). “Blended finance is an approach that can be used to enable the private sector to invest where it would not otherwise be possible. The idea is to mix concessional funds typically from donor partners with those of commercial development institutions and private investors in a risk-sharing arrangement, with aligned incentives to make sure official assistance can be leveraged as much as possible with private capital”(IFC, 2016). “Blending is an instrument for achieving [European Union] external policy objectives, complementary to other aid modalities and pursuing the relevant regional national and overarching policy priorities. Theprinciple of the mechanism is tocombine EU grants with loans or equity from public and private financiers.”(European Commission, 2015). “Blended finance is defined as the complementary use of grants (or grant-equivalent instruments) and non-grant financing from private and/or public sources to provide financing on terms that would make projects financially viable and/or financially sustainable”(Mustapha et al., 2014). “Blending as carried out by the EU facilities mixes loans and grants. It entails a combination of market (or concessional) loans with grant (or grant equivalent) components which may be in various forms” (European Think Tanks Group, 2011). “Blending’is a mechanism that links a grant element, provided by official development assistance (ODA), with loansfrom publicly owned institutions or commercial lenders”(Eurodad, 2013). Blended finance “combines concessional public finance with non-concessional private finance and expertise from the public and private sector”(UN, 2015). In blended finance, “the public aid agencies invest alongside private institutional investors in commercially sustainable private sector projects in developing countries” (Commons Consultants, 2015). Blended finance “refers to a combination of resources, either from official public sources (governments and/or DFIs) or philanthropic actors with capital from other sources (either official public or private actors)”(Development Initiatives, 2016). Blended finance transactions can include the use of financial instruments to crowd in commercial investments as well as mechanisms to structure or intermediate instruments with the same purpose. According to the DAC Creditor Reporting System, official development finance is provided using five main groups of instruments [5]: (1) Grants: transfers in cash and in kind where no legal debt is incurred. (2) Debt instruments: transfers in cash and in kind where legal debt is incurred (e.g. loans, bonds and other securities) or could be incurred when certain events occur (e.g. reimbursable grants). •Equity: a share in the ownership of a company or a collective investment scheme. (3) Mezzanine finance: hybrid instruments, such as subordinated loans and preferred equity that present risk profiles between senior loans and equity. (4) Guarantees/insurance: risk-sharing agreements under which the guarantor agrees to pay to the lender/investor part of or the entire amount due on a loan, equity or other instrument in the event of non-payment by the borrower or loss of value in case of investment. These can be still structured into more complicated mechanisms to mobilize private capital such as funds, syndication, securitization or PPPs [6]. Blended finance should pursue both ITPD 4,1 52 development and commercial objectives, underlining its hybrid character, operating between public and private spheres. Similarly, blending may be justified as a response to different types of problems. For example, it may be proposed as a means of addressing market failures (perceived or not) and to improve the risk–return relationship of investment projects (OECD, 2018, p. 1). The variety of actors, forms of financing and objectives associated with blending present a challenge in terms of generating an evidence base on its effectiveness, both in relation to the goals associated with blending itself and in identifying the added value of blending in comparison to other development instruments Blended finance can help bridge the investment gap for the SDGs, but requires a common framework. Delivering the 2030 Agenda and the Paris Agreement will require all sources of finance –development and commercial –to be scaled up. ODA continues to play an indispensable role in financing the SDGs. We need to move from “billions to trillions”to meet the volume of resources needed, well beyond the US$149.3bn provided as ODA in 2018. Development finance helps unlocking and channelling finance from other sources towards development uses. The OECD Development Assistance Committee (DAC) in February 2016 agreed to develop “an inclusive, targeted, results-oriented work programme”on blended finance with the following principles: (1) evidence-based:collate evidence and lessons learned on blendedfinance with a focus on targeting private finance andtheuse of blendedfinance across different regions; (2) best practices: develop best practices for deploying blended finance in key economic systems and sectors, such as sustainable infrastructure, and to address specific issues such as climate change. These mechanisms will provide the much needed recommendations to bring together public and private investors for the use and deployment of blended finance to achieve the SDGs. Mobilizing additional capital that would not otherwise support development outcomes is increasinglyrequired inthedeploymentofdevelopmentfinance.Inthiscontext,blended finance attracts commercial capital towards projects that benefit society while providing financial return to investors. Ensuring that blended finance delivers on its promise. The OECD DAC Blended Finance Principles for Unlocking Commercial Finance for the Sustainable Development Goals are a policy tool for all providers of development finance –donor governments, development cooperation agencies, philanthropies and other concerned stakeholders. They build upon already established commitments on ODA targets, leaving no one behind, development effectiveness and aid untying. (1) Anchor blended finance used to a development rationale (2) Design blended finance to increase the mobilization of commercial finance (3) Tailor blended finance to local context (4) Focus on effective partnering for blended finance (5) Monitor blended finance for transparency and results Those principles include and imply potential benefit and cost of blende financing which will be explained later in this paper. 4. Development insurance 4.1 Insurance for development Insurance is a financial agreement that transfers risk of the insured loss to a risk pool administered by an insurer [7]. Traditional insurance, specializing in risk transfer, differs from the other risk management methods such as risk retention, risk control or risk avoidance in that insurance focusses on risk pooling and sharing among insurance system. Insurance Development finance 53 requires multiple participants to exercise the law of large numbers in order to stabilize average loss or loss ratio among the members. Having gradually developed with global economy, insurance, the most popular risk management tool, is classified into private and public insurance, lifeand non-life insurance, individual and group insurance and so on, depending upon who to manage, what to insure, whom to cover and so on. Originated from ocean marine insurance in the 15th century, insurance has been developed into fire insurance in 17th century, life insurance in 18th century, automobile insurance in 19th century and many other insurances in 20th century. Insurance has developed with economic growth together. Economic growth has stimulated growth of insurance, and vice versa. Causality of insurance growth and economic development has been addressed among many economists to find in general that insurance also determines economic growth, although the latter influences the former more heavily. And insurance also influences income disparity. Insurance may be linked to growth theory through input factors. Insurance products or systems can increase factor productivities of labour, capital or technology according to the socalled diamond model of insurance as follows (see Figure 4). Labour productivity, value of human life or household can be protected or enhanced by life insurance including education insurance or personal non-life insurance. That is, economic value of human resources can be maintained by the personal insurance system. And financial system or productivity of capital can be enhanced by credit life insurance, fire insurance or deposit insurance which allows to banking system work, as they are precondition for loan contracts of banks. And technology development or industry structure can be upgraded by corporate non-life insurance, commercial property or liability insurance which have more developed in such tech-savvy countries as the United States or Germany than life insurance in terms of size. Commercial insurance can pave the way of new technology or business development. Unlike finance in general that helps economic growth rather than income equality, insurance can also support social safety net by providing minimum wealth or health support Figure 4. Role of insurance in economic and social development ITPD 4,1 54