SEATTLE — For so many, life teeters on the brink. A drought or monsoon can dry up or wash away all assets and savings, and a pest problem can lead to starvation. Having access to climate insurance is critical for protecting against these risks.
Unfortunately, the rate of insured in the developing world is far behind that of their richer counterparts. In Africa, 76 percent of people receive no transfer from social protection systems, and in South Asia, social protection system transfers remain out of reach for 67 percent of the population. In Europe, including the poorer region of Central Asia, the number drops to 37 percent.
Compounding the problem, the impacts of natural disasters weigh much heavier on underdeveloped nations because of their already poor infrastructure and limited government expenditures to deal with the problems. In other words, they are more vulnerable to the shocks of natural disasters and a changing climate.
With climate change modeled to bring about more frequent and severe weather catastrophes, a premium should be placed on insurance. A study on the East African drought that ended in 2012 estimated that each dollar spent on insurance “would have saved $4.4 in post-crisis relief.”
Thankfully, a new form of security, called climate-related parametric insurance, is taking the world by storm. In the last 12 years, 43 countries have implemented or begun implementing parametric insurance programs.
By 2020, the Group of 7 aims to “increase by up to 400 million the number of people in the most vulnerable developing countries” with access to insurance coverage against the impacts of climate change. They are focusing almost exclusively on parametric insurance models.
Parametric risk insurance is unique in that its payout is based on independent verification of environmental factors such as wind speed, rainfall, temperatures and magnitude on the Richter scale.
For example, a parametric insurance policy might state that if a certain volume of rainfall is experienced or if wind speed exceeds a predefined level, then the insured receives compensation. Essentially, environmental conditions trigger a payout.
Conventional insurance, which requires an onsite assessment of damages by loss adjusters, can be time-consuming and costly. In the event of a crisis, many governments do not have the luxury of waiting around for a payout, especially when damages may still be accruing. In addition, inspections and reports compiled by loss adjusters can increase insurance premiums.
For example, the Caribbean Catastrophic Risk Insurance Facility, a multi-country parametric risk insurance pool, is able to charge member countries a premium valued at only 26 percent of the cost of traditional insurance for a 1-in-1,500-year risk.
However, these premiums and the instruments required for proper environmental measurements and sophisticated data and modeling technology may prove to be prohibitively costly for some developing nations.
Assistance from international organizations may be necessary to help pay for the initial premium. Also, the data necessary for a parametric insurance program may benefit multiple insurance programs as well as climate researchers, so international institutions can play a vital role in data sharing, technical assistance and funding.
In order to meet the G7 target and fine tune the implementation of a rapidly growing industry, the Center for American Progress proposes five key principles.
First, the need for international support, as previously mentioned, will help countries afford the premiums and technical assistance that will pave the way for insurance markets to take root. Without this initial stimulus, parametric insurance may not get off the ground.
The second principle helps to avoid a common problem throughout insurance markets: moral hazard. By designing a pricing structure that encourages climate-resiliency investments, the long-term costs of the insurance program may be reduced.
Offering lower premiums for climate change mitigation or adaptation measures incentivizes the insured to protect themselves against climate related disasters. One parametric insurance program offers poor farmers insurance in exchange for their labor on projects that “reduce their vulnerability to droughts.”
Diversifying parametric products, the third principle, can help affected countries weather different consequences of a climate-related disaster. For example, one product may insure against agricultural losses while another may protect against infrastructure damage or business interruption.
This diversification not only smoothes the road to recovery for the country, but it also avoids eroding the solvency of the insurance company by receiving payouts from different insurers.
The next principle, data sharing, can provide vital information to climate researchers, emergency services and governments. The amount of rainfall, for instance, may tip off a government about the amount of available drinking water or the expected output from a hydroelectric dam. Data sharing can also facilitate the uptake of best practices by showing what type of data collection works best in certain circumstances.
Finally, according to the Center for American Progress, global risk-sharing will help insurers avoid bankruptcy and will smooth risks and reduce the cost of insurance for developing nations.
If an insurance company focuses on a relatively small region that is struck by a large storm, it may risk going out of business. Spreading the risk globally and coordinating insurance pools are vital for this type of insurance.
Parametric insurance should not be viewed solely as a vehicle for aid. Funding will only partially come from international organizations and grants from developed countries. Individuals, industries and governments will pay for their policies.
In fact, parametric insurance should be viewed as business opportunities for the financial sector. The quick and less complicated payouts are attractive for investors.
The United Nations Framework Convention on Climate Change estimates that by 2040, damages from climate change could cost $1 trillion annually. These damages will be unevenly spread. The historical development pattern of developed nations, by emitting a far greater concentration of greenhouse gases, has created conditions wherein developing countries are both more vulnerable to and less culpable for climate change.
Increasing access to parametric insurance — especially if implemented properly — can incentivize climate mitigation and adaptation, tap into the private sector for dealing with climate change, protect citizens and ecosystems around the world, and provide a cornerstone for successful climate change talks in Paris at the end of this year.
– John Wachter
Sources: Center for American Progress, Inside Quarterly, International Food Policy Research Institute, United Nations Framework Convention on Climate Change, United States Department of Agriculture, The White House, World Bank