69976

          Insurance Instruments for Adaptation to Climate Risks:
                         Linking Policy Agendas
               Joanne Bayer, Peter Hoeppe, Eugene Gurenko and Lorenz Petersen


This paper springs from a recent expert workshop on Insurance Instruments for
Adaptation to Climate Risks: Linking Policy Agendas, which took place at the
International Institute for Applied Systems Analysis (IIASA) in Laxenburg, Austria, Sept.
24-5, 2007. The workshop was organized jointly by IIASA, Munich Re, the German
Agency for Technical Cooperation (GTZ) and the World Bank.* It provided a forum for
participants from the climate-change, development and donor communities, including the
private sector, to share ideas and experiences on supporting insurance-related instruments
as a strategy for adapting to climate change. Participants were asked to address three
issues, namely (1) the viability of public/private insurance systems that genuinely serve
the poor and that contribute to the reduction of vulnerability to losses, often called
climate adaptation; (2) the role of private, public and international institutions in
providing insurance instruments within and outside the post-Kyoto adaptation regime,
and (3) the potential for linking climate-change and development agendas. The meeting
identified opportunities and constraints for supporting insurance instruments in the
developing world, including risk pooling and transfer, through public/private partnerships.
The workshop was organized as part of the activities of the Munich Climate Insurance
Initiative (MCII) and the EU integrated project on Adaptation and Mitigation (ADAM).

This document is based on the motivation, discussion and ideas stemming from this
workshop. There is no attempt to comprehensively summarize all the participants’ views
on the issues discussed, and the authors take full responsibility for the content of this
discussion. It is hoped that a continued dialogue will contribute to designing options for
enhancing insurance as an adaptation strategy within and outside the UN post-Kyoto
regime.




*
    Full financial support for the workshop was provided by Munich Re and GTZ.


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1. Introduction
Adaptation to climate change, alongside the requisite reduction of atmospheric
greenhouse gas emissions, is now recognized as an essential part of the climate-change
response. Postponing serious mitigation will exacerbate the need for adaptation, and in
many cases make adaptation impossible. At the same time, significant climate change
impacts are inevitable, not only if current international commitments on mitigation are
realized, but also under more ambitious post-2012 mitigation targets. Adaptation is thus a
concern for all countries, and particularly to highly vulnerable countries in the developing
world, many of which are already experiencing impacts, particularly from increased
climate variability and extremes.

The impacts of weather variability and climate extremes on economic well-being and
human suffering have increased alarmingly. Developing countries suffer the most: In the
past quarter century over 95% of disaster deaths occurred in developing countries, and
direct economic losses (averaging US$54 billion per annum.) as a share of national
income were more than double in low-income versus high-income countries. The indirect
losses can be equally devastating. Due to limited tax bases, high indebtedness and low
uptake of insurance, many highly exposed developing countries cannot fully recover from
slow- and sudden-onset disasters by simply relying on limited external donor aid. The
prevention of losses, and financial instruments that expedite recovery, are viewed as
essential to eradicating poverty and achieving the Millennium Development Goals. Pro-
active disaster risk management, what is increasingly viewed as climate adaptation, is
thus high on the agendas of governments, international financial institutions,
development organizations, NGOs and other stakeholders.

With the advent of novel mechanisms for pricing and transferring catastrophe risks to the
global financial markets, insurance instruments have emerged as a promising opportunity
for developing countries in their concurrent efforts to reduce poverty and adapt to climate
change. Recognizing the critical role that private insurance, as well as public/private
social insurance systems, have played in Europe, the US and throughout the developed
world, and recognizing the responsibility of developed countries to support climate-
change adaptation in the developing world, there is a pressing need to examine climate-
risk insurance as an adaptation strategy.

In what follows, we discuss recent initiatives for providing catastrophe insurance to
farmers, households and governments in highly exposed developing countries. As an
alternative to providing aid after disasters, we show how insurance – by pricing risks –
can be a powerful instrument for promoting adaptation. Being careful not to distort price
signals, nor to crowd out private insurance initiatives, we argue that public/private
partnerships backed by international capital can be instrumental, even essential, in
enabling insurance in developing countries. Finally, as a practical way forward, we
suggest the creation of regional insurance and adaptation facilities (beginning with an
African facility). The purpose of these facilities is not to provide insurance to farmers,
households or governments, but rather to channel international capital to support private
and public/private initiatives by providing, among other services, technical support,


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hardware (such as weather stations), facilitation of pooling and accessing reinsurance,
and absorbing upper layers of risk.

2. Insurance instruments
In addition to the well-known risk financing instruments of insurance and reinsurance,
Many additional instruments have recently emerged making use of rural, domestic and
international financial markets. There are important examples of securitizing disaster risk
in the financial markets by issuing catastrophe bonds, issuing weather derivatives for
flood and drought exposure and using contingent credit arrangements for financing a
government’s post-disaster liabilities.

Financial arrangements that spread disaster losses among those most at risk, and
including support from those not at risk, can make a difference in the lives of vulnerable
people in developing and emerging-economy countries. For example, many Mexican
farmers face double exposure to fluctuations in crop prices and natural catastrophes that
in a very bad year or consecutive years can force them to migrate to the slums of Mexico
City, where they face even higher risks. Pre-disaster or ex ante financial arrangements
that spread crop losses, temporally and spatially, have the potential to smooth and secure
their livelihoods. Likewise, financial arrangements that transfer and spread catastrophe
risks facing governments can make a huge difference in the economic development of
vulnerable countries. If governments do not have the necessary infusion of capital after a
disaster to rebuild critical infrastructure and assist households and businesses with their
recovery, the indirect costs can greatly exceed the direct losses from the disaster. Such
delays can also lead to secondary economic and social effects, such as deterioration in
trade, budget imbalances and increased incidence of poverty.

While market instruments for financing risks have great potential for developing
countries, there are also associated costs. Keeping in mind the huge burden in terms of
lives, livelihoods and asset losses that disasters impose on developing country victims,
the return on preventive investments must be weighed against the return on investing in
financial instruments. This point cannot be overemphasized. In low-income countries, the
opportunity costs of risk-financing instruments can be prohibitively high in terms of
meeting other human needs, and there may be less costly informal alternatives, like
relying on kinship networks. Moreover, it is important to examine the incentive effects
that any financing approach has on preventing disaster losses.

In sum, insurance and other financial instruments have great potential for reducing the
burdens of weather and other disasters in developing countries, but the benefits and costs
– and their distribution - must be weighed against those accruing from preventive and
other risk-management measures. In other words, it is important to view insurance
instruments as part of the portfolio of risk-management measures that reduce
vulnerability to weather and other shocks.

3. Emerging insurance schemes in developing countries
Insurance plays an increasing role in developing countries. Novel and imaginative
programs are already demonstrating their potential to pool economic losses and smooth



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incomes of the poor facing weather variability and climate extremes. These schemes
provide insurance to farmers, property owners and small businesses (micro scale), as well
as transfer the risks facing governments to the global capital markets (macro scale). A
few examples serve to illustrate:

ï‚·   In Malawi, smallholder farmers can now purchase affordable weather derivatives
    based on a rainfall index. By making farmers more creditworthy, this pilot
    loan/insurance scheme enables farmers to purchase hybrid seeds, and thus greatly
    increase their productivity, even lifting them out of the poverty trap;
ï‚·   Similarly, herders in Mongolia can purchase an index-based insurance policy to
    protect them against livestock loss due to winter dzuds and other causes. A recent
    pilot program combines self-insurance, market-based insurance and social insurance.
    Herders retain small losses that do not affect the viability of their business, while
    larger losses are transferred to the private insurance industry and only the final layer
    of catastrophic losses is borne by the government with backing from the World Bank.
   In the past, the World Bank has also financed layers of Turkey’s earthquake risk to
    enable the TCIP – a specialized catastrophe insurer – accumulate reserves and ensure
    stability of premium rates. This is the first time ever that the international
    development community has provided pro-active risk-financing support to a
    developing country.

Similarly, at the macro scale:

ï‚·   The World Food Programme has issued a novel parametric weather derivative to
    assure sufficient funds to the Ethiopian government to protect the livelihoods of
    Ethiopia’s vulnerable populations who are at risk to severe and catastrophic drought.
    This insurance instrument holds large promise for supporting institutions that have
    traditionally provided humanitarian assistance;
ï‚·   The Mexican government is the first to issue a catastrophe bond to partly insure its
    catastrophe fund and thus reduce its risk of large fiscal deficits following disasters.
    This is another novel instrument making it possible to transfer sovereign catastrophe
    risk directly to the world’s capital markets;
   The Caribbean island states have recently formed the world’s first ever multi-country
    catastrophe insurance pool, to provide governments with immediate liquidity in the
    aftermath of hurricanes or earthquakes. There is a largely untapped potential for
    pooling uncorrelated country risks of country governments ill prepared to respond to
    disasters with their own means.

For the most part, these risk-pooling and risk-transfer programs directly or indirectly
target the poor and vulnerable, and without exception they have received technical
and/or financial support from international development and donor organizations,
making them a viable alternative to post-event aid.

In many cases it is also valuable to support systems serving mainly the middle class, like
the Turkish Catastrophe Insurance Pool (TCIP) that target property owners and the
Caribbean insurance pool that provides capital to governments to finance immediate


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liquidity needs. The provision of start-up expertise and capital can greatly facilitate the
launch of these programs.

Experience is too short to determine if these internationally backed public/private
systems are viable in the long haul, but as pioneering “test balloons� (and some are
beyond the testing phase) they may radically change the way the “North� provides
disaster aid and supports adaptation to climate change. Despite their promise, insurance
reaches only a small fraction of vulnerable communities and governments; for instance,
over 40% of farmers in the developing world face weather-related food scarcity, and yet
those benefiting directly from micro-insurance systems number in the thousands.
Similarly, many highly exposed developing country governments do not have the means
to finance the recovery costs of catastrophic disasters, and could greatly benefit from
transactions, like those in Ethiopia and Mexico. Least-developed countries can hardly
afford the technical analyses and other start-up costs for insurance systems. Scaling up
will prove costly, especially since disaster risks, unlike health or accident, affect whole
regions at the same time and thus require spatial diversification, reinsurance and/or large
capital reserves.

International reinsurers are absorbing the low-probability/high-consequence layers of
many recent public/private programs, for example, in Turkey, Ethiopia and Mexico. They
have been reluctant, however, to commit significant capital and underwriting expertise to
developing micro-insurance programs, but this is changing. For instance, Swiss Re in
partnership with an NGO and academic research institute, has insured about 150,000
smallholder farmers in Kenya, Mali and Ethiopia against drought through a parametric
product. The indices are based on a mix of satellite and weather data. The insurance is
purchased by the internationally backed NGO, and other partners are being solicited to
provide further financial support.

There are scattered examples of micro-nsurance schemes that offer catastrophe cover
without outside support. These schemes are viable due mainly to very low cover. For
example, a large MFI, Proshika, offers compulsory group-based disaster insurance to its
clients in Bangladesh. Under this program 2% of the savings balance is annually
transferred to a fund that will pay twice the amount of the savings deposit in the case of
property damage due to disasters, while savings stay intact. The scheme operates without
reinsurance or donor support. With more than two million clients in 20,000 villages and
2,000 slums, this insurance fund has wide geographic diversification. As another example,
the WINCROP (Windward Islands Crop Insurance) program offers insurance against
windstorms affecting banana crops for 13,000 smallholder banana growers in four
Caribbean countries. For a premium payment of 5% of sales, cover amounts to 20% of
deliveries. his program, however, is operating with a large deficit and has unsuccessfully
requested government support.

4. Insurance and adaptation
Insurance can be a powerful instrument for promoting adaptation to climate-related risks,
but only with well- designed products and systems.




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In the context of weather variability and extremes, adaptation can be thought of as
reducing vulnerability of households, businesses, farms and governments. This can take
many forms, including:
    ï‚· physical interventions, e.g., flood defenses;
    ï‚· lifestyle changes, e.g., relocating or changing livelihoods; or
    ï‚· strategies for recovery, e.g., formal and informal pooling or hedging arrangements.

Insurance has the potential to promote each of these adaptation measures. Most directly,
insurance actually reduces long-term losses from disasters by providing ex post liquidity
that enables governments and households to invest in reconstruction and recovery. This
indirect effect – which ultimately can save livelihoods and lives - can be as significant as
physical measures in reducing losses and vulnerability. More indirectly, but importantly,
insurers provide information – and build local capacity - on the risks necessary for each
of the above adaptation strategies.

The verdict is still out whether insurance leads to cost-effective physical interventions or
lifestyle changes that reduce vulnerability. However, there is no doubt that if an insurance
contract incorporates incentives to reduce risks, then it is an improvement over the
current ad hoc model of financial post-disaster assistance, which discourages investments
in adaptation: governments and individuals, expecting support, have little incentive to
invest in precautionary measures. In comparison, insurance products impose a “price� on
their clients, which if designed properly (i.e. flexibly to account for preventive actions)
can create incentives to engage in loss-reduction activities, or adaptation.

Critics rightly point out that insurance can also discourage investments in loss prevention
or adaptation. Poorly designed insurance contracts (for example, not risk based and
without deductibles) can weaken (rather than strengthen) the price signal, and the insured
may take less preventive measures or even negligent actions (moral hazard). Moreover,
the strength of the insurance price signal will depend on the extent of outside aid or
subsidies. Finally, many insurers are reluctant to adjust premiums to reflect loss-
reduction measures. Thus, moral hazard, external assistance and insurer behavior may
weaken the incentive effect of insurance.

Many examples both pro and con can serve to illustrate: Many insurance systems do not
reward preventive behavior at all. The Proshika scheme, as a case in point, provides
incentives to increase savings, but disincentives to reduce risk. Such schemes may
perpetuate vulnerability because they make it possible to remain in high-risk occupations
or locations. Alternatively, apartment owners in Istanbul, who choose to disaster-proof
their properties pay (in principle) less insurance premium, although the system is not
fully risk based. Mongolian farmers can only gain by taking measures to protect their
herds against adverse winter weather since insurance claims are based on average
livestock loss in designated regions. In Thailand, designers of the parametric flood
insurance system anticipate that middle-class property owners will relocate out of the
high-risk areas (Alex, is this right?). As these examples show, moral hazard is absent
altogether with parametric, index-based systems that do not base claims on actual losses.




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While index insurance discourages “bad risks�, it can paradoxically encourage “good
risks�. In Malawi, for example, the insurance contract has enabled farmers to plant riskier
but higher yield crop varieties. Not only does insurance smooth the incomes of farmers
facing weather variability, but it actually provides them the safety net necessary for
riskier and more productive activities - ultimately reducing vulnerability to weather
shocks and thus contributing to adaptation. This point cannot be overemphasized. One
participant at the Laxenburg meeting has this to say about the Malawi index insurance
project:
       We want farmers to adopt high return technologies that allow them finally to make the
       leap and accumulate earnings over time. Systemic risk is the factor impeding this and so
       far banks cannot handle the risk and the high transaction costs in rural areas. The Malawi
       transaction shows that there is a sustainable way to take the big rocks out of the way—
       drought risk—and clear the path to development.

This same “investment effect� operates at the national level. Insured governments can
reassure outside investors that disasters will only temporarily disrupt critical
infrastructure, thus creating a more secure environment for attracting international capital.

In sum, insurance internalizes the risk of taking risky behavior and, in relation to ex post
disaster aid, it encourages more preventive behavior. However, moral hazard, external
assistance and insurer behavior may reduce this incentive effect. Because of the absence
of moral hazard, index-based systems are particularly promising as instruments for
adaptation. Moreover, by providing ex post liquidity that enables governments and
households to invest in reconstruction and recovery, insurance directly contributes to
vulnerability reduction, or adaptation.

5. Public/private partnerships
There is a large potential for private insurance for climate-related risks in developing
countries; yet, the private market alone cannot fulfill the needs of many of the poor and
vulnerable in highly exposed regions.

In Malawi, for example, the premium for the loan/insurance package can easily be paid
by the five-fold foreseen productivity increase; however, extending cover to provide
security against drought-induced food scarcity (livelihood insurance) would be largely
unaffordable for Malawi’s smallholder farmers. This risk cannot be covered by the
private market acting alone, and is currently absorbed by post-disaster emergency food
programs on the part of the World Food Programme, FAO and other donors. Emergency
food assistance, while currently indispensable for humanitarian reasons, not only disrupts
local food markets, but gives farmers little incentive to diversify crops or even their
livelihoods, activities that render them less vulnerable to droughts.

The reluctance of the private market to commit its capital and expertise to serve the poor
and vulnerable (those who cannot pay for the unavoidable risks to which they are
exposed) can be overcome by forming internationally backed public/private partnerships
(partnerships with insurers, governments and NGOs, with support from bi-lateral and
multi-lateral development/donor organizations).



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In Mongolia, the under-developed insurance industry is protected against extreme losses
by a syndicate pooling arrangement backed by the government, which, in turn, can call
upon the World Bank contingent debt to pay for really catastrophic losses. In other words,
the government and World Bank absorb a portion of the risk, protecting insurers and
ultimately reducing premiums to affordable levels. As other examples, international
experts have provided valuable technical assistance for estimating risks and setting up
micro-insurance programs in Malawi and Thailand. The new initiative by Swiss Re
(Climate Adaptation Development Programme) relies on a partnership with an
internationally funded NGOs and academic institutions. The reinsurance and catastrophe
bonds that transfer risks from Mexico and Ethiopia to the international capital and
reinsurance markets were made possible by outside technical support from IFIs and other
types of start-up assistance. The same is true for the largely self-financing Caribbean
Catastrophe Risk Insurance Facility (CCRIF), although, here too, donors have pledged
significant capital to the reserve fund.

Advantages of public/private insurance systems
There are many advantages to reorienting from providing post-disaster aid to enabling
public/private insurance systems. As a start, by sharing responsibility with individuals
and the state, donors leverage their limited budgets and substitute a calculable annual
commitment to a risk-transfer system for the unpredictable granting of post-disaster aid.
With donor-supported risk-transfer programs, developing country governments will rely
less on debt financing and international donations, and assured funds for repairing critical
infrastructure will attract foreign investment. For many, an insurance contract is a more
dignified and secure means of coping with disasters than dependency on the ad hoc
generosity of donors. According to a participant at the Laxenburg meeting:

Most importantly, by making this assistance contingent on requirements or incentives for
prevention as part of a comprehensive risk management program, pre-disaster assistance
can ultimately reduce the human and economic toll disasters take on the poor. This means
that switching to pre-disaster donor aid, even at extra cost, can be an efficient long-term
strategy because of its potential to reduce the need for humanitarian assistance.

Challenges of public/private insurance systems
Despite compelling arguments for public/private partnerships, there are legitimate
concerns that excessive public and international support can distort market prices and
greatly jeopardize the incentive effects of insurance, crowd out private initiatives, and
create unstable systems due to the inability of donor institutions to make long-term
commitments.

Critics rightly point out that subsidized premiums in the US farm insurance program have
weakened incentives to plant more robust crop varieties, or to move away from farming
in high drought or flood risk areas. If the intent is to provide transfers to the poor, it is
argued, it is far better to compensate them directly rather than subsidize insurance
premium.




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Tempering this argument, however, is the fact that even donor-supported insurance has a
greater incentive effect than the current practice of free public assistance to disaster
victims. While there is a great deal of concern about distorting prices and thus giving the
wrong signals for adaptation, it is also important to keep in mind that risk markets may
not be operating optimally and thus prices may already have distortions. Donors can
compensate for price distortions by linking their support with vulnerability reducing
measures (note, however, that DFID and other donor agencies are moving away from
contingent aid). The challenge is thus to design incentive compatible public/private
programs.

Incentive compatible subsidies
Subsidies (in a broad sense) can take many forms, including assistance for developing the
insurance products, absorbing layers of risk, and directly paying or reducing premiums.
One creative idea is to provide support for public/private systems only to the point that
premiums do not fall below the “real risk� price, or expected loss. Insurance premiums
are often significantly higher than expected loss for many reasons, including high
administrative and capital costs incurred by insurers to provide the cover. These
“frictional costs� can be several multiples of the actuarially fair value or real risk price.
Donors could subsidize premiums and provide other means of support to eliminate the
frictional costs but maintain the real risk price, which arguably is the proper signal for the
insured to reduce their vulnerability or adapt. This idea, however, will not address the
issue that many poor households are exposed to unavoidable risks to which they cannot
pay even the real-risk price.

A related concern is that public or international involvement in the provision of insurance
will impede the development of the private market. Although private insurers and re-
insurers are constrained in their ability to offer world-wide catastrophe risk coverage,
there is still concern that public assistance will crowd out private operations. In the words
of a participant at the Laxenburg meeting:

       Providing support for the high layers of risk, like in the case of the TCIP or Mongolian
       insurance systems, can greatly jeopardize markets. Pouring aid in at the top has a
       “sausage effect�: it will come out at the bottom with strong distortions of market prices.
       Although my business stands to gain by climate-related aid, I’m terrified of it! (Richard,
       I’m sure I put words in your mouth. Please change in any way to reflect what you meant)

Of more immediate concern is public/private partnerships that unfairly advantage some
private companies over others, or crowd out competing private companies altogether.
While partnerships, like the TCIP, actually create an opportunity for the private market to
carry out business, there is danger that by offering deep premium subsidies ill-conceived
public-private partnerships may prevent private companies from entering the market.
This issue underlines the importance of recognizing three distinctly different market
opportunities: (i) targeting those who can afford sufficient cover for the risks to which
they are exposed, (ii) targeting those who can afford a small contribution (in some cases,
very small) but cannot pay the full risk-based market price (pure risk premium plus
frictional costs), and are unable to “move out of harms way� or otherwise reduce their
risks to an affordable level. A third category, namely (iii) those with no assets or


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livelihoods, or who cannot pay even a small premium. It is clear that this last category is
not eligible for insurance and will remain fully dependent on post-disaster humanitarian
assistance.


Insuring those who can and cannot afford the full cost of cover
The Malawi loan/insurance package, the Turkish Catastrophe Insurance Pool and the
Caribbean Catastrophe Risk Insurance Facility are good examples of insurance systems
that target those who can afford the risk-based premium. In all cases, the product is kept
affordable partly by limiting cover: in Malawi, the insurer will reimburse only the cost of
the seeds; in Turkey, the TCIP will cover up to $60,000 of damage that accrues to mainly
middle-income property owners; and expected cover in the Caribbean is sufficient to
address the liquidity needs of the government in the first few months following a natural
catastrophe. International organizations have a role to play in this market, but it should be
limited to providing access and ensuring competition, for example, by providing
assistance for establishing the product (the most difficult aspect of setting up the CCRIF..
was negotiating an agreement among governments), enabling access and setting up
regulatory structures. In other words, internationally backed public/private partnerships
should take utmost care to ensure unimpeded competitive market conditions.

Examples of insuring those who can afford a small premium but cannot pay the full risk-
based market price include the Mongolian Index-Based Livestock Insurance Program and
the Indian weather risk derivatives crop insurance program.. Herders in Mongolia can
afford only very limited premium (or interest) payments, insufficient to attract private
insurance capital. Only outside support (donors or others “buying� part of the product)
can create an attractive market for private insurers in the first several years of the
program.


In sum, we can identify two principles to guide the formation of public/private
partnerships that provide weather and other hazard insurance in developing countries:

   ï‚·   Targeting those who can afford the price of insurance, internationally supported
       partnerships should be limited to ensuring conditions for private insurance
       provision through competitive markets;
   ï‚·   Targeting those who cannot afford sufficient insurance cover, internationally
       supported partnerships can legitimately intervene with financial and other support,
       but care should be taken not to significantly distort prices or competition. This can
       be achieved by designing highly socially targeted insurance products that serve
       only the designated segments of the population.

6. Linking insurance and climate-change agendas
The above discussion suggests a qualified case for internationally backed public/private
partnerships that enable the provision of catastrophe insurance in the developing world.
The case may be strengthened by climate change, which is now recognized as a
potentially significant driver of weather variability and extremes.


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With the emergence of climate change on political agendas, the discourse on disaster
assistance and food security has also changed. In addition to land-use and other local
practices, weather disasters are increasingly viewed as intensified by the emissions of
greenhouse gases on the part of northern-hemisphere countries. The Intergovernmental
Panel on Climate Change (IPCC) has predicted that climate change will increase weather
variability as well as the intensity and frequency of climate-related extremes. There is
even some evidence of a current “climate signal� with the IPCC (2007) reporting
observations of long-term and widespread changes in wind patterns and aspects of
extreme weather including droughts, heavy precipitation, heat waves and the intensity of
tropical cyclones.

In accordance with the climate convention’s principle of common but differentiated
responsibilities, there is a legitimate, and growing, claim for Northern support of risk
management practices, including insurance, aimed at reducing vulnerability to climate
variability and extremes in the developing world. According to a participant at the
Laxenburg meeting:

       Northern-hemisphere countries have a moral obligation to support climate-related
       insurance systems in the “South�. By analogy, consider a downstream community that
       faces higher insurance premiums because an upstream community is cutting trees and
       thus increasing the intensity of floods. Would it not be fair for the upstream community
       to bear some portion of the increased premiums?

The question is not so much the apportionment of responsibility, but how to compensate
those who bear the burdens? From a market perspective, it is more efficient (less price
distorting) to compensate the victims via direct financial transfers. However, in the
climate debate there is little political will for compensatory mechanisms, which means
that providing financial and other forms of support for insurance systems may be the only
approach receiving consensus from the convention delegates. Article 4.8 of the United
Nations Framework Convention on Climate Change (UNFCCC) requires Parties to
consider actions, including insurance, to meet the specific needs and concerns of
developing countries arising from the adverse impacts of climate change (United Nations,
1992, emphasis added).

An issue (among many) hampering implementation of Article 4.8 is the unresolved issue
linking climate change to weather risks in the developing world.

Climate change: loading the odds
Scientists cannot attribute any particular storm or other event to a changing climate, but
they can present evidence on the contribution of climate change to the risk of climate
variability and extremes. By way of analogy, if we throw a “loaded� die and “six�
appears, we cannot ascertain whether the “six� is due to loading, or not. We can only say
that the probability of throwing a “six� is increased. If we throw the die a thousand times,
we can estimate with great confidence how much the load is changing the odds. We don’t
have a thousand years to make this same estimate for climate change. Scenario models
can help, but until we can attach probabilities to scenarios, we cannot make good


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estimates. Some evidence is emerging, however. Recent analyses show that the effects of
human-induced climate change could account for up to 30% of the expected future
increase in cyclone losses, but this estimate is based on many assumptions behind
scenario modeling (Pielke, 2007). I think he is from some US University

       How much human-induced climate change increases losses from weather
       variability and extremes, today and in the future, remains highly inexact. While
       this scientific impasse can daunt efforts at compensating for climate-change losses,
       it should not discourage efforts at supporting insurance and other risk
       management efforts. More important than the exact estimation of “additionality�
       is the growing consensus that greenhouse gas emissions will contribute, and
       possibly significantly, to weather-related risks in the developing world. Because
       adaptation to “normal� climate is, at the same time, adaptation to climate change,
       the current dialogue on adaptation increasingly refers to climate risks as opposed
       to climate-change risks.

7. Moving ahead
With the advent of novel mechanisms for pricing and transferring the risks of floods,
droughts, typhoons and other weather extremes to the global financial markets, insurance
instruments are emerging as a promising opportunity for developing countries in their
concurrent efforts to reduce poverty and adapt to climate change. Yet, they will serve the
poorest and most vulnerable only with an infusion of outside expertise and capital. This
is both an opportunity and challenge for the post-2012 adaptation regime, and outside the
UN convention process.

Parties to the climate convention, as well as many other stakeholders, should address this
opportunity and challenge with a global strategy for making affordable insurance
instruments available to farmers, small businesses, households and governments of highly
exposed developing countries. This strategy would be developed and implemented
collaboratively with governments, the private insurance industry, international
development institutions, NGOs and other partners. There are convincing reasons for
putting such a strategy into place, and quickly.

To begin, in light of Northern countries’ contribution to climate risks in the South,
supporting insurance instruments may be a practical way to apply the climate
convention’s principle of common but differentiated responsibilities. Providing ex post
liquidity that enables governments, households and businesses to invest in reconstruction
and recovery – and quickly get back on their feet - insurance reduces long-term losses
from disasters. It also smoothes income streams thus enabling poor farmers, herders and
others to invest in higher productive, but riskier, activities. In some poor countries,
insurance is often the only way to ensure that the payments are made to the real victims
of natural disasters. These are just a few of the ways that insurance reduces poverty,
vulnerability and, at the same time, contributes to adaptation. Insurance instruments can
also provide incentives to actually reduce immediate and direct losses with physical
interventions and lifestyle changes, but only if they do not themselves encourage
negligent behavior.


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Many difficulties, however, confront the development of a global strategy for insurance
in the developing world. There are legitimate concerns that excessive public and
international support will distort market prices and greatly jeopardize the incentive
effects of insurance, crowd out private initiatives, and create unstable systems due to the
inability of donor institutions to make long-term commitments. The challenge is thus to
design sustainable, incentive-compatible programs that provide products to clients who
cannot be served by the private market, and to support the private sector in providing
affordable products.

Another difficulty within the climate adaptation debate, is determining the contribution of
climate change to risks of weather variability and extremes, today and in the future.
Although some evidence is emerging, estimates remain highly inexact. This scientific
impasse can daunt efforts at compensating for climate-change losses, but it should not
discourage efforts at supporting insurance and other risk management efforts.

As one concrete proposal, regional climate insurance and adaptation facilities could be
created to meet these challenges. Regional facilities would not directly provide insurance
to households, farmers or governments, but as multi-donor operations they would offer
capacity building and financial support to nascent micro- and macro- disaster insurance
systems, like those now operating in Malawi, Mongolia and the Caribbean. Other
proposals include a global facility to insure public infrastructure losses of highly exposed,
least-developed countries. This insurance would be contingent on the government
implementing a risk management program. Still another proposal would pool country
risks at the global level, and claims would be settled through debt forgiveness.

There are many pros and cons to these proposals; yet, it is important to move ahead with
concrete ideas, and these ideas should be fully aired in a dialogue among stakeholders. It
is hoped that this document, based on discussions in Laxenburg, September, 2007, will
contribute to this dialogue and to tackling the challenges of providing security against
severe weather in the developing world. Linking the agendas of development and climate
adaptation for this purpose has the potential to bring the needed capital and expertise to
this challenge. It is hoped that a continued dialogue will contribute to designing options
for enhancing insurance as an adaptation strategy within and outside the UN post-Kyoto
regime.




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    Selected literature (incomplete, participants please add relevant publications to this
    list)


Bals, C., S. Butzengeiger and K. Werner, forthcoming, “Insuring the Uninsurable: Design
    Options for a Climate Change Funding Mechanism�, in Climate Policy, E. Gurenko, ed.
    Special Issue on Insurance and Climate Change.

Gurenko, E., 2004, Catastrophe Risk and Reinsurance: A Country Risk Management
      Perspective, London, Risk Books.

Hess, U. and J. Syroka, 2005. Weather-based Insurance in Southern Africa: The Case of
       Malawi, Agriculture and Rural Development Discussion Paper 13, Washington DC,
       The World Bank.

Höppe, P. and E. Gurenko, forthcoming, “Scientific and Economic Rationales for Innovative
   Climate Insurance Solutions�, in Climate Policy, E. Gurenko, Ed. Special Issue on
   Insurance and Climate Change.

Linnerooth-Bayer, J., M. J. Mace, and R. Verheyen, "Insurance-Related Actions and Risk
       Assessment in the Context of the UNFCCC," Bonn: UNFCCC Secretariat (2003).

Linnerooth-Bayer, J. and R. Mechler. "Insurance for Assisting Adaptation to Climate Change
       in Developing Countries: A Proposed Strategy." in Climate Policy, E. Gurenko, Ed.
       Special Issue on Insurance and Climate Change (forthcoming).

Pielke, Roger

World Food Programme, 2005, Pilot Development Project – Ethiopia Drought Insurance
      10486.0, Projects for Executive Board approval, WFP/EB.2/2005/8-A, Rome.




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