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Risk management approaches to address adverse effects of climate change - Insurance
According to the Fourth Assessment Report of the Intergovernmental Panel on Climate Change (IPCC), there was a rapid increase in weather related disasters worldwide between 1980–- 2003.  The report estimates the economic losses due to damage caused by natural disasters totaled USD 1 trillion during that period.  While natural disasters rose sharply worldwide over the last two decades, the hardest impacted were low income developing countries, where over 95% of deaths occurred due to natural disasters. 

Many Developing countries, particularly SIDS and LDCs, are unable to afford the economic cost of disasters due to their difficult socio-economic situation.  Impacts are often exacerbated by poor emergency response capabilities and unsystematic disaster management programs.  Socio-economic baseline trends indicate that major challenges can already be expected in developing countries that will be exacerbated by climate change.

The role of insurance in climate change adaptation and disaster risk reduction
Due to the rapid increase in frequency and intensity of natural disasters that have occurred in both developing and developed countries, greater emphasis is being placed on disaster risk management strategies.  Interest is rising for designing disaster risk reduction and risk transfer tools which facilitate adaptation to climate change.
Insurance schemes are increasingly playing a visible role as a means of providing economic security by pooling  economic risks against weather-related disasters. Insurance and other kinds of disaster risk management can facilitate public-private partnerships for dealing with extreme weather related calamities. Transferring risk through insurance could play a useful role in adaptation to climate change and disaster risk management.

Forms of insurance schemes

flodding imageToday, insurance for weather-related risks is available at micro, meso, and macro levels.

A.  Sovereign insurance
Sovereign insurance schemes are efforts taken by country governments or a private insurer to pool losses on a sovereign level.

B.  Micro-insurance
Micro-insurnace is a form of insurance that is aimed at providing easier accessibility and affordability for low income households with  insurance against natural disasters.

C.  Index based insurance
Many new schemes utilize parametric, or index-based, approaches which do not require indemnification (verification of losses in order to pay an insurance claim) because a contract is written against a weather proxy or index, such as: rainfall, sunlight or temperature.  If a chosen weather proxy exceeds a certain threshold, a payment is triggered.  Parametric approaches have the potential to lower the costs of insurance, increase coverage, and reduce moral hazard. They can be applied at the micro-, meso-, or macro level.

Micro-index based insurance
Meso-index based insurance
Macro-index based insurance

A.  Sovereign insurance provided at national level

Developed countries such as Japan, France, the United States, Canada, Sweden Norway and New Zealand have established public-private national insurance systems against natural disasters.   Examples of  such initiatives include the Turkish Catastrophe Insurance Pool (TCIP), which is described as a case study below.  The TCIP is modeled after the United States California Earthquake Authority, the French and the New Zealand earthquake commission programs, which were set up to provide earthquake coverage for homeowners and relied mainly on international reinsurance and capital markets for their risk capital capacity.

Turkey: Turkish Catastrophe Insurance Pool (TCIP)
Organizations involved: World Bank, Government of Turkey, private sector insurers
Background: Two years after the devastating Marmara earthquake claimed over 18,000 lives and resulted in multi-billion economic damages, the World Bank provided financial and technical assistance to the government of Turkey to establish the TCIP, in order to provide reconstruction assistance for damages to houses, disaster mitigation and risk management.  The TCIP is the first national insurance pool of its kind, and involves the public and private sector in different layers of risk coverage to help make insurance affordable in an emerging economy.
Success so far:  Almost 1.8 million earthquake insurance policies have been underwritten since 2000, making the TCIP the second largest catastrophe pool in the world, the first being the regional Caribbean Catastrophe Reinsurance Facility (CCRIF) which is elaborated further in the chapter.
Lessons learnt:  In a Risk Management Workshop held in Washington, 2005, the World Bank has highlighted some issues regarding its role in being the sole emergency lender for the TCIP.  These concerns include:
  1. The World Bank would not be able to provide all liquidity needed to cover the affected  population in the case of a very large event;
  2. The World Bank suggested that in the case of the 2000 Marmara earthquake, it was ill equipped to provide instant liquidity after earthquake disaster and it took over a year for liquidy to become available;
  3. Reliance on the World Bank retroactive lending and emergency donor relief is unsustainable due to frequency of catastrophes.

B.  Micro-insurance

The disaster risk management community views micro-insurance as an important emerging tool for disaster management in developing countries.  This form of insurance is also viewed as a means to keep households out of a cycle of poverty as it provides post-disaster liquidity to households and farmers.  Provision of microinsurance in developing countries has attracted the attention of international stakeholders, but insurance coverage for this market segment worldwide is still low (but growing rapidly). Nevertheless, many microinsurance schemes have successfully been implemented to manage weather-related risks.
For example, a scheme in Bangladesh (see below) has been providing insurance against flooding since the early nineties.  The success of the Bangladesh project was the incentive for a similar project established in India which is known as Afat Vimo system.  Details on both case studies can be found in the report, “Micro insurance for natural disaster risk in developing countries: Benefits, limitations and viability” produced for the IIASA in 2006.
Voluntary microinsurance schemes that have become successful in insuring clients against the risks posed by natural disasters include: The Self-employed Women’s Association (SEWA); , the Working Women’s Forum (WWF) in India; and the Centre for Self-Help Development (CSD) in Nepal.

Bangladesh: Proshika

Organizations involved: Proshika (NGO), the Government of Bangladesh
Background: As a response to the 1988 floods in Bangladesh, which affected over 73 million people, a natural disaster management program was established, by Proshika.  Proshika, one of the largest NGOs in Bangladesh, offers a Participatory Livestock Compensation Fund (PLCF) that targets farmers.
Success so far and still on going: Since the scheme was introduced in 1991, it has won over two million clients in over 20,000 villages and 2000 slums in 57 districts of the country.  It covers 10% of the population of Bangladesh for property insurance and 25% for life insurance.  Until 2004, 20.06million taka (Bangladeshi currency) were paid from the compensation fund to the affected families of 4,448 deceased group members, and 20.29 million taka to 14,525 members for property losses due to cyclones, river erosion, and tornadoes.
Limitations: Despite efforts being taken to try and upscale the scheme by Proshika and the government, it still does not cover the entire population and area of Bangladesh, leaving large areas of the country and much of the population vulnerable and uncovered by insurance. 


C.  Index-based insurance

Index-based insurance has been used at different scales: from small-scale farmers and herders, property owners and small businesses to sovereignty level, by governments, for transfering their risks to the international capital markets.  Index-based insurance has proven to be one of the most popular and promising insurance instruments to facilitate improved emergency response to weather-related catastrophes.  As of 2008 over two-dozen weather index-based insurance schemes were successfully piloted in a number of developing countries, including Malawi, Mongolia, Peru, Mexico and in the Caribbean countries.  These case studies are presented below.

Micro index-based insurance

Micro-index based insurance for agriculture can target either farmers (crop index insurance) or herders (livestock index-based insurance).

Crop index-based insurance

Crop index-based insurance to date has been the most popular form of insurance being utilized by both developing and developed countries in order to assist farmers dealing with the risks posed by weather related calamities.  The World Bank and UNDP have so far been the main supporters for developing crop risk management models as well as providing finance, technology and training for country projects.  To date, over a dozen countries most notably in Africa and Central America, have successfully implemented crop index-based insurance.  These countries include Senegal, Mauritius, South Africa, Tanzania, Peru, Nicaragua, the Philippines, Thailand and Ukraine.  
Swiss Re has also piloted projects in Kenya, Mali and Ethiopia.  According to the 2007 ‘Scaling up index insurance’ paper by the Micro Insurance Center, a number of developed countries such as the United States of America and Canada have also developed such insurance schemes.  Box 3 below presents the case study of Malawi that has had considerable success in providing insurance to farmers against the lack of rainfall in various parts of the country.  A similar pilot project in India, BASIX, was developed in 2003 and has expanded its support from an initial umber of 230 farmers to more than 250,000 farmers.

 Malawi: crop insurance
Organizations involved: International Bank of Malawi (OIBM), Malawi Rural Finance Corporation (MRFC) and the World Bank
Background: Malawi is one of the most drought-prone countries in Southern Africa. The livelihoods and food security of various population groups are greatly worsened by drought.
Success so far: In 2005, the Malawian government along with technical assistance and training provided by the World Bank, introduced an innovative pilot drought insurance scheme that was targeted at local groundnut farmers.  The pilot scheme is currently being utilized by over 900 farmers in four different areas.  The scheme has enabled them to purchase hybrid groundnut seeds, thereby  increasing the productivity of groundnuts significantly.
Lessons learnt: Malawi was the first African country to implement such index-based insurance policies which were sold to small-scale farmers.  Despite the benefits of the insurance scheme there still remain a number of concerns.  For example, the instrument presumes that all farmers use the same farming techniques and have the same soil type when considering crop yield production.  Lack of education and knowledge about index insurance among herders remains a major challenge for the development of the insurance scheme. 

Livestock index-based insurance

This form of micro index-based agricultural insurance is targeted at herders, and provides insurance against the loss of livestock caused by such catastrophes and extreme weather events as drought or flooding.  To date only two countries have successfully implemented the scheme. MARSABIT project is based in the arid and semi arid areas in Northern Kenya.   The livestock index based insurance in Mongolia is presented below.

 Mongolia: livestock insurance
Organizations involved: World Bank
Some 11 million animals were lost in Mongolia between 2001–2002 due to severe winter weather (known locally in Mongolia as dzud).  As a result the Mongolian government, aided by the World Bank developed an Index-Based Livestock Insurance (IBLI).  The IBLI protects Mongolian farm herders against livestock loss due to extreme cold winter.

Success so far: The pilot project is the first attempt by a developing country to provide security against livestock losses for farmers due to extreme climate/weather conditions.
Lessons learnt: Despite the success of the project, certain challenges remains.  The index payouts reported sometimes do not match the individual livestock loss.  Another concern with the IBLI is that it does not cover the loss of all types of livestock, which has left some herders uninsured against the loss of other livestock.  The lack of knowledge about the existing index insurance among herders remains a challenge.


Meso-index based insurance

In meso index-based insurance schemes, payouts are made by a reinsurer either to national banks or to NGOs so that they can respond to economic losses that might have resulted from a natural disaster.  An example of such a scheme is being implemented in Peru and is elaborated in the box below, in which the an El Niño–Southern Oscillation (ENSO) related climate indices are used as a proxy for extreme rainfall in Piura district.  Similar projects that have been implemented in Vietnam and Mexico use different climate indices such as sea or river level rise as a proxy to issue insurance payments.

Peru: schemes against natural disasters
Organizations involved: Microfinance institutions (MFIs)
Background: Severe rains and floods associated with El Niño are economically the most significant catastrophic risk in Peru. Extreme rainfall may cause widespread loss to agriculture as well as to infrastructure and often cause landslides which lead to deposits of large amount of sediments in rivers, which undermines the ability to manage droughts.  El Niño and its related climate indices are used as a proxy for extreme rainfall in one of the districts of Peru called Piura.  A strong El Niño can bring rainfall that is more than 40 times the average in Piura.
Initiation: In 2007, a private company began offering a weather-index insurance product in the northern department of Piura.  This insurance scheme was based on the ENSO (El Niño Southern Oscillation) index that measured the sea-surface temperature off the Peruvian coast.  This index is a good predictor of extreme rainfall resulting from El Niño events.


Macro-index based insurance

At a macro level, a government, institution or an international charity might use index insurance for a disaster relief fund or to fund relief activities following a natural disaster as illustrated in Ethiopia, Mexico and the Caribbean Community (CARICOM).

Mexico: Catastrophe Bond

Organizations involved: World Bank, Inter American Development Bank.
Background: The Mexican government in 2006 insured its catastrophe reserve fund, the Fondo de Desastres Naturales (FONDEN), against natural disasters with a mix of reinsurance and a catastrophe bond.  The resulting contract is linked to a parametric trigger in terms of magnitude and depth of seismicity for the three-year period 2007 - 2009.
In 2008, the Mexican government spent $1.2 billion from the reserve fund to cover rescue and rebuilding operations after Hurricanes Stan and Wilma. The government is planning to issue a similar kind of catastrophe bond for insurance against hurricanes.
Limitations: There is no mechanism in place to ensure that the post-disaster bond payments reach those that need the payments most.  Moreover, the catastrophe bond transaction has proved to be of a very high cost.

Caribbean Catastrophe Risk Insurance Facility (CCRIF)
Organisations involved: CARICOM (the Caribbean Community), donors, World Bank
Background: The Caribbean islands are extremely vulnerable to natural disasters.  On average, one major hurricane affects the regions every two years.  The Caribbean Catastrophe Risk Insurance Facility (CCRIF) was set up in 2007.  It is considered as a system in which a number of Caribbean countries combine emergency reserve funds into a common pool, so that there is a regional insurance facility which will trigger payments to tackle the economic losses caused by natural disasters.  The schemes also provide easy access to affected countries to obtain liquidity to implement both long- and short-term recovery efforts.  Claimed payments are based on parametric triggers such as wind speed. The CCRIF is the first multi-country risk pool in the world.
Success so far: In November 2007 an earthquake devastated Dominica and St. Lucia.  The CCRIF paid out approximately US$1 million to the countries to reover their economic losses.  The advantages of this scheme include efficient risk transfer mechanisms, optimal pricing from reinsurance through risk-pooling and economies of scale, and sharing of administrative and operational costs of the insurance business.
Lessons learnt: The scheme has faced some challenges, including:
  1. The CCRIF policy covers a small portion of the risks retained by governments;
  2. The CCRIF  is designed as insurance against large catastrophic events, such as when country-wide impact threatens the entire economy;
  3. Parametrics are difficult to be designed for smaller magnitude events.   
Similar projects: The World Bank is beginning the process of implementing other regional insurance pools in Romania (to cover Eastern Europe)  against harsh winters and in the Pacific against severe weather related disasters.


Related technical papers
Mechanisms to manage financial risks from direct impacts of climate change in developing countries.  Technical Paper.  FCCC/TP/2008/9