Insurance, an innovative instrument for managing climate risk?
Start Network's Emily Jones discusses in her in-depth piece how we have the ability to predict climate crises and we should be using this climate and forecasting information to prepare financing in advance of a crisis, but there is a disconnect between the knowledge that acting earlier is better and the practice of civil society and key stakeholders in the way they plan for and respond to these crises.
There is widespread consensus among the international community that acting earlier in the face of climate crises is better than waiting for damages to ensue and responding only once the traditional ‘late’ funding for humanitarian response is made available. Today, given we also have the ability to predict climate crises in most cases, we should be using this climate data and forecasting information to arrange financing in advance of a crisis, so that it is available for best placed civil society organisations to respond as quick as possible.
That said, there is a disconnect between the knowledge that acting earlier is better and the practice of civil society, national governments, and institutional donors in the way they plan for and respond to these crises.
The humanitarian system at present is often reactive and slow, driven by political will and media attention. Therefore, it only acts once humanitarian impacts have been fully and visibly realised. Even when it is clear that a humanitarian crisis is unfolding, sufficient funds usually do not arrive to enable intervention until it is too late.
In early July, the International Insurance Society dedicated a day of its annual Global Insurance Forum in Berlin to bring together civil society, donors/governments with the private sector to look at how insurance can be used to tackle climate risk. They also discussed how insurance instruments can be directed towards the poorest and most vulnerable people. The day was sponsored by the InsuResilience Global Partnership, and it provided a forum for discussion and collaboration between these diverse stakeholders. Despite the positive conversations of the day, many challenges remain.
In context: Madagascar
As one of the poorest and most vulnerable states to climate risks, the Minister of Agriculture and Livestock in Madagascar called for support to create solutions that are innovative against climate risks, with synergies at the global level. He acknowledged that insurance is part of the comprehensive approach to manage disaster risk and called on all countries, the private sector and civil society to find innovative solutions as a matter of urgency.
So how can we, as the humanitarian sector, contribute to the search for and implementation of innovative solutions for climate risk?
“Those who are new to insurance won’t feel able to mainstream [the instrument] unless they feel that the community involved in insurance is practically working together.”
Rowan Douglas, CEO at Willis Towers Watson’s Capital, Science and Policy Practice, during his introduction speech at the Annual Global Insurance Forum.
Insurance is not well known or understood concept by the majority of people in many developing countries. This means that introducing the concept of using parametric (index based) insurance for climate hazards is even more challenging to integrate, as the existing insurance penetration rate is low.
A country’s hazard risks vary in type, magnitude and frequency, therefore appropriate risk management strategies should be considered for different levels of risk. To make use of risk financing mechanisms (including but not limited to insurance), a multitude of stakeholders must work collaboratively in the design process to ensure the risks are managed appropriately.
Governments, academics, civil society, and the private sector each have a role to play to ensure the risks of a country are managed in the most appropriate way.
2. Involving communities
Parametric insurance schemes at present are mainly set up for Sovereign Governments in mind (ARC, CCRIF, Pacific Disaster Risk Financing and Insurance Program). These can be good tools to ensure governments are informing themselves of their climate risks and enhancing their management of these risks by transferring some of them away to the private sector through insurance.
Parametric insurance is like other types of insurance, where in return for a yearly premium the policyholder receives a specified payment if the insured event (e.g a drought) takes place. The key difference is that instead of making payments on the basis of losses measured after an event, it makes the payments automatically based on pre-agreed risk triggers.
One of the key benefits of parametric insurance is speed of payment. This is particularly important where the insurance payment will fund costs of intervention after a catastrophe.
Civil society has slowly begun to carve out a space within this field through initiatives such as the African Risk Capacity Replica (ARC Replica). One benefit from having a stronger involvement of civil society within the disaster risk financing and insurance field is their strong link to the communities in which they work, which ultimately are comprised of the people we seek to protect with this insurance schemes. As civil society’s involvement increases, it is hoped that they can act as the link to embrace community input into policy and response design processes; effectively making them more suited to address the needs of those communities affected by climate hazards.
3. Innovation in response activities
While we would have funds available earlier when if we know a climate hazard will occur, it is not always clear what these early funds should be used on. In sudden onset crises like floods, it is easier to simply move up the timelines of traditional response activities. However, for slow onset crises such as drought, there is a lack of knowledge of what activities we should carry out when we receive money earlier than we ever have; this is unchartered territory. Ultimately, it is an area where communities can add real value in the design of a risk financing mechanism. In the case of drought, communities should be asked how they would react if their harvests had failed and they were given an injection of funds right at that moment.
4. Building resilience through the use of insurance markets
The insurance sector can also help create resilience through the signals we can derive from its pricing. At the Global Insurance Forum, Joan Lamm-Tennant, CEO and Founder of Blue Marble Microinsurance said that for insurance to be used in the most appropriate way, we need to look at the whole value chain. We should be asking, where in the value chain can insurance create efficiencies and network effect somewhere else?
Signalling in the pricing of a risk can encourage us to take risk mitigating measures. For example, if both maize and quinoa are grown in the same area, and we decide to create a model and price insurance product for each crop, the prices of premiums can help us make some conclusions about the practicalities and sustainability of growing one crop versus the other. If premiums for maize are fairly reasonable, but those for quinoa are too high, and therefore unsustainable, this is an indication that that crop should not be grown in that area or environment. This could help farmers think practically about their agricultural practices and make better decisions for their business , climate and their family.
5. Changing attitudes
“The only time insurance doesn’t look expensive is after the incident"
Denis Duverne, Deputy Chair of the Insurance Development Forum (IDF).
So how do we begin changing perceptions of insurance from being perceived as an added expense or a “gamble” to an instrument to manage risk. Some obstacles lie with governments and donors.
There are several reasons why developing countries cannot or do not pay premiums:
- They cannot afford to respond to disaster through a traditional response or through insurance premiums.
- Even if it could respond, all governments have short term planning cycles (due to short political terms).
- Suffer from model-hazard problem: If the international system is going to bail you out, why would you spend your own money to buy insurance?
- Facing increasing risks because of climate change, and don't see why they should cover the costs of this when they are not the countries that are contributing to the effects.
To date, the majority of donors have also been reluctant to fund premiums because:
- Accept responsibility in advance for who is going to pay when something goes wrong - no mechanism for distributing this across donors.
- Might lose opportunity to decide how this money will be spent, and no control over branding the response.
- Have same short-term time horizons as developing countries - more credit for responding to a disaster than to proactively dealing with them.
- Suspicion about working with the private sector.
The disaster risk financing community needs to work together to create changes in how the international community perceives, understands, and utilises insurance to manage climate risk.
Admittedly, insurance is not the only solution, but when natural disasters strike it can help save lives by making funds immediately available. It does not replace traditional humanitarian assistance, but it can get support in quickly with an injection of capital in the immediate aftermath.
Countries need a basket of options to help them manage their risks. A forum like the London Centre, which brings together a multitude of stakeholders working in disaster risk financing to explore the right type of financing for the appropriate risk is a good step in the right direction.
Finally, we shouldn’t look at insurance solely as a product, but also as a process to help build community resilience.