IPCC_Managing Risks of Extreme Events.pdf - Climate Access

Case StudiesChapter 9countries. Three examples at the local, national, and international scalesare briefly discussed below.9.2.13.4.1. Covering local risks: index-based micro-insurancefor crop risks in IndiaMicro-insurance to cover, for example, life and health is widespread indeveloping countries, but applications for catastrophic risks to cropsand property are in the beginning phases (see Morelli et al., 2010 for areview, and Loster and Reinhard, 2010 for a focus on micro-insuranceand climate change). Typically a micro-insurance company, oftenoperating on a not-for-profit basis, evolves from an organization thathas developed insurance products for a community. Most are based onthe expectation that the pool of participants will provide payments thatcover the costs incurred, including expected damage claims (which aregenerally low because of infrequent and small claims), administrativecosts (which are reduced through group contracts or linking contractsto loans), taxes, and regulatory fees. Many depend on the support ofgovernment subsidies and international development organizations andparticipation of NGOs (Mechler et al., 2006).An innovative insurance program set up in India in 2003 covers nonirrigatedcrops in the state of Andhra Pradesh against the risk ofinsufficient rainfall during key times during the cropping season. Theindex-based policies are offered by a commercial insurer and marketedto growers through microfinance banks. In contrast to conventionalinsurance, which is written against actual losses, this index-based(parametric) insurance is written against a physical or economic trigger,in this case rainfall measured by a local rain gauge. The scheme owes itsexistence to technical assistance provided by the World Bank (Hess andSyroka, 2005). Schemes replicating this approach are currently targeting700,000 exposed farmers in India (Cummins and Mahul, 2009).One advantage of index-based insurance is the substantial decrease intransaction costs due to eliminating the need for expensive post-eventclaims handling, which has impeded the development of insurancemechanisms in developing countries (Varangis et al., 2002). A disadvantageis basis risk, which is the lack of correlation of the trigger with the lossincurred. If the rainfall measured at the weather station is sufficient, butfor isolated farmers insufficient, they will not receive compensation forcrop losses. Similar schemes are implemented or underway, for instance,in Malawi, Ukraine, Peru, Thailand, and Ethiopia (Hellmuth et al., 2009). Ablueprint for insuring farmers in developing countries who face threats totheir livelihoods from adverse weather has been developed (World Bank,2005d). Overcoming major institutional and other barriers must be donein order for these programs to achieve this target (Hellmuth et al., 2009).Weather insurance and especially index-based contracts contribute, in atleast two ways, to climate change adaptation and disaster risk reduction.Since farmers will receive payment based on rainfall and thus have anincentive to plant weather-resistant crops, indexed contracts eliminatemoral hazard, which is defined as the disincentive for risk preventionprovided by the false perception of security when purchasing insurancecoverage. Second, an insurance contract renders high-risk farmers morecreditworthy, which enables them to access loans for agricultural inputs.This was illustrated in the pilot program in Malawi, where farmerspurchased index-based drought insurance linked to loans to cover costsof hybrid seed, with the result that their productivity was doubled(Linnerooth-Bayer et al., 2009). Increased productivity decreasesvulnerability to weather extremes, thus contributing to climate changeadaptation (to the extent that risks of weather extremes are increasedby climate change). In another innovative micro-insurance project inEthiopia, farmers can pay their premiums by providing labor on riskreducingprojects (Suarez and Linnerooth-Bayer, 2010).9.2.13.4.2. Covering national risks:the Ethiopian weather derivativeThe World Food Programme (WFP), to supplement and partly replace itstraditional food-aid approach to famine, has recently supported theEthiopian government-sponsored Productive Safety Net Programme(PSNP). The WFP is now insuring it against extreme drought (World Bank,2006b). When there is a food emergency, the PSNP is able to provideimmediate cash payments that may be sufficient to save lives even inthe case of very severe droughts (Hess et al., 2006). However, thesepayments may not be sufficient to restore livelihoods (World Bank, 2006b).To provide extra capital in the case of extreme drought, an index-basedcontract, sometimes referred to as a weather derivative, was designedby the WFP. The amount of capital is based on contractually specifiedcatastrophic shortfalls in precipitation based on the Ethiopia DroughtIndex (EDI). The EDI depends on rainfall amounts that were measured at26 weather stations that represent the various agricultural areas ofEthiopia. In 2006, the WFP successfully obtained an insurance contractbased on the EDI through an international reinsurer (Hess et al., 2006).A drawback of this arrangement, in contrast to the micro-insuranceprograms in India and Malawi, is that it perpetuates dependence onpost-drought government assistance with accompanying moral hazard.9.2.13.4.3. Intergovernmental risk sharing: the CaribbeanCatastrophe Risk Insurance Facility (CCRIF)The world’s first regional catastrophe insurance pool was launched in2007 in the Caribbean region; this is the Caribbean Catastrophe RiskInsurance Facility (discussed in Section 7.4.4). Sixteen participatinggovernments secured insurance protection against costs associatedwith catastrophes such as hurricanes and earthquakes (Ghesquiere etal., 2006; World Bank, 2007). Several of the participating countriesrepresent the countries experiencing the greatest economic losses fromdisasters in the last few decades, when measured as a share of GDP(CCRIF, 2010).The aim of the Caribbean facility is to provide immediate liquidity tocover part of the costs that participating governments expect to incur524