IPCC_Managing Risks of Extreme Events.pdf - Climate Access

Chapter 9Case StudiesTable 9-3 | Examples of risk financing mechanisms (shaded cells) at different scales. Source: adapted from Linnerooth-Bayer and Mechler, 2009.NationalGovernmentsInternationalDevelopment organizations, donors, NGOsSolidarityInformal risk transfer (sharing)Savings, credit, and storage(inter-temporal risk spreading)Insurance instrumentsAlternative risk transferLocalHouseholds, Farmers, SMEsHelp from neighbors and local organizationsKinship and other reciprocity obligations,semi-formal micro-finance, rotating savings andcredit arrangements, remittancesSavings; micro-savings; fungible assets; foodstorage; money lenders; micro-creditProperty insurance; crop and livestock insurance;micro-insuranceWeather derivativesGovernment post-disaster assistance;government guarantees/bailoutsReserve funds; domestic bondsNational insurance programs; sovereign risktransferCatastrophe bondsBilateral and multilateral assistance, regionalsolidarity fundsContingent credit; emergency liquidity fundsRe-insurance; regional catastrophe insurancepoolsCatastrophe bonds; risk swaps, options, and losswarrantiesin Table 9-3), which is defined by UNISDR as “the process of formally orinformally shifting the financial consequences of particular risks fromone party to another whereby a household, community, enterprise orstate authority will obtain resources from the other party after a disasteroccurs, in exchange for ongoing or compensatory social or financialbenefits provided to that other party” (UNISDR, 2009b). Risk sharingcan be considered synonymous with risk transfer, although the latter isoften used to connote more informal forms of shifting risk withoutexplicit compensation or payment, for example, mutual non-marketarrangements among family or community. Insurance is the best knownform of market risk transfer; yet, risks can be transferred with manyformal and informal instruments as described in the following section.Traditional channels for financing disaster relief and recovery, althoughin many cases less costly than risk transfer, have in the past proved tobe inadequate for managing large-scale weather-related events in highlyvulnerable countries (Cohen and Sebstad, 2003; Cardenas et al., 2007;Barnett et al., 2008). In poor countries, households and businesses usuallydo not have the resources to purchase commercial insurance to covertheir risks with the additional difficulty that in many developing countriesthe commercial insurance providers do not exist. If there is no supportfrom family or government, disasters can lead to a worsening of povertyin the absence of insurance. The victims then must either obtain highinterestloans (or default on existing loans), sell their important and valuedassets and livestock, or engage in low-risk, low-yield farming to lessentheir exposure to extreme events (Varangis et al., 2002). In recognition ofthese issues and to reduce the overall costs of disasters, investments indisaster risk reduction and proactive risk transfer are strongly encouragedby governments, the insurance sector, and the donor community (Kreimerand Arnold, 2000; Gurenko, 2004; Linnerooth-Bayer et al., 2005).9.2.13.3. Description of Strategy – Catastrophe Risk TransferMechanisms and InstrumentsAs shown by the shaded cells in Table 9-3, risk transfer includes a rangeof pre-disaster mechanisms and instruments (Cummins and Mahul,2009), the most important of which are briefly described below:• Informal mutual arrangements involve pre-agreed non-marketexchanges of post-disaster support (informal risk sharing).• Insurance is a “well-known form of risk transfer, where coverage ofa risk is obtained from an insurer in exchange for ongoing premiumspaid to the insurer” (UNISDR, 2009b). A contractual transactionbased on a premium is used to guarantee financial protectionagainst potentially large loss; contracts typically cover losses toproperty, productive assets, commercial facilities, crops andlivestock, public infrastructure (sovereign insurance), and businessinterruption.• Micro-insurance, based on the same principles as insurance, isaimed, most often, at lower-income individuals who cannot affordtraditional insurance and hence the premiums are lower but alsothe coverage may be restricted. In some cases, the individuals areunable to access more traditional insurance (Mechler et al., 2006).Often it is provided in innovative partnerships involvingcommunities, NGOs, self-help groups, rural development banks,insurers, government authorities, and donors.• Alternative risk transfer denotes a range of arrangements thathedge risk (Mechler et al., 2006). These include catastrophe bonds,which are instruments where the investor receives an abovemarketreturn when a pre-specified catastrophe does not occurwithin a specified time interval. However, the investor sacrificesinterest or part of the principal following the event.• Weather derivatives typically take the form of a parametric(indexed-based) transaction, where payment is made if a chosenweather index, such as 5-day rainfall amounts, exceeds somepredetermined threshold.• Contingent credit (also called deferred drawdown option) is aprearranged loan contingent on a specified event; it can be providedby the insurance industry to other insurers, or by internationalfinancial institutions to governments.• Risk pools aggregate risks regionally (or nationally) allowingindividual risk holders to spread their risk geographically.9.2.13.4. Interventions – Examples of Local, National, andInternational Risk Transfer for Developing CountriesDevelopment organizations working together with communities,governments, insurers, and NGOs have initiated or supported manyrecent pilot programs offering risk transfer solutions in developing523