Climate risk insurances are effective, but need reform

Extreme weather events are on the rise. Exacerbated by population growth, urbanisation, overexploitation of natural resources and environmental degradation, these events can quickly become disasters that put lives, livelihoods and development gains at risk. Regional climate risk insurances help countries in the developing world limit the impact of disasters. While this is good news, these valuable tools need reform to be more effective. The G20 can do much to advance them by developing an action plan to address their weakness.

Regional, public-private insurance facilities (CCRIF, ARC, PCRAFI) were created by development experts to give countries in Africa, the Caribbean and the Pacific financial resources to respond and adapt to disasters. They have made 28 payouts to 16 countries, amounting to around US$ 106 million since their inception. Moreover, they increasingly act as intra-regional hubs for disaster management. Simply put: they work.

While this is certainly an achievement, a closer look reveals a number of pressing problems. Premiums must become more affordable; countries need disaster planning to reduce risks and better data collection, monitoring and evaluation systems; and insurance facilities need disaster risk management specialists. If properly reformed, climate risk insurances can benefit countries facing fiscal constraints, as well as the international community.

When disaster strikes, developing countries must often reallocate budgets and rely on the generosity of the international community to rebuild. These ad-hoc responses strain government resources and delay public relief and recovery efforts.

Climate risk insurance is a way to expedite funding for those in need. Underpinning these facilities is an innovative payout mechanism. In contrast to ‘traditional’ insurance, payouts are not made on the basis of real losses, but on the performance of a model. The model processes real-time weather data (e.g. wind-speed, amount of rainfall) and combines it with geophysical, economic and population data to estimate losses as the event happens. This enables a payout within 14 days of a disaster. Once a certain loss level is breached, a country gets a pre-agreed payout – whether or not the estimate was accurate.

At the moment, premiums are too high. Just as with private health insurance, the poorest countries – those most in need – may be left with no or inadequate coverage. Climate risk insurances should principally benefit the poor. But premiums are currently funded by those least responsible for climate change and least able to pay. To address this problem, the G20 should provide full premium support or at least facilitate premium funding through multilateral climate finance funds such as the Green Climate Fund.

Some insurance facilities, like CCRIF and PCRAFI, have no rules for how payouts are spent. While this laissez-faire philosophy may have its merits, international experience from the fields of disaster management indicates that an emergency plan stating objectives, responsibilities and procedures is the key to saving lives and livelihoods. The G20 should encourage countries to develop plans that clarify how payouts are used. Premium support could, for example, be conditional on such plans.

ARC, CCRIF and the PCRAFI are also hubs for regional disaster management. But disaster management specialists are often sidelined, as the facilities are largely run by finance and insurance specialists. Financial interests naturally play a large role in shaping their strategic direction, but finance experts are not disaster experts. The G20 should encourage the systematic integration of disaster risk management specialists into governance structures. This would help embed insurances more firmly into national and global efforts and give them greater legitimacy.

The G20 should support regional insurance facilities in data collection and analysis efforts. Experience indicates a slight tendency towards ‘underpayment’. This is a serious issue for cash-strapped countries. Payouts are only as accurate as the models and their data. Moreover, is not clear whether payouts have been adequate or reached those who needed them most, as there is no comprehensive monitoring or evaluation system.