Insurance Post

Index-based insurance: Protecting the vulnerable against weather uncertainty

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There is growing recognition that extreme weather events are not just an environmental problem but an economic one as well.

They undermine business competitiveness and long-term economic sustainability. With the current levels of interconnectivity of the world economy, local disasters are no longer ‘local' and have devastating ripple effects throughout global supply chains, causing indirect losses to production, businesses and agriculture around the world.

According to a recent UN Office for Disaster Risk Reduction report, natural disasters have cost the global economy $2.5trn since 2000, driving millions of people further into poverty.

Those who live in rural areas and depend on subsistence farming for their livelihoods are especially vulnerable to natural catastrophes. Understanding and managing the risk of weather-related disasters is critical to reducing their economic losses. Innovative solutions are crucial.

One such innovation is index-based insurance. The Global Index Insurance Facility, a programme managed by the International Finance Corporation and implemented by the World Bank, is financed by the European Union, Japan and the Netherlands. Its objective is to expand the use of index insurance as a risk management tool in agriculture, food security and disaster risk reduction, especially in Africa, Latin America and Asia.

GIIF's implementing partners have already insured more than 400,000 farmers, pastoralists and micro-entrepreneurs, and have reached nearly one million people, sharing information and access to index insurance.

Index insurance is a relatively new but innovative approach to insurance provision that pays out benefits on the basis of a pre-determined index -- such as rainfall level, seismic activity, or livestock mortality rate -- for losses stemming from weather and catastrophic events, without requiring the services of insurance claims assessors. It also makes the claims settlement process quicker and more objective.

Index-based insurance has gained significant importance in regions like East Asia and the Pacific which have been especially prone to weather-linked disasters recently. 60% of the global losses from disasters were sustained by this region over the past 20 years. In 2011 alone, economic losses from natural disasters here were over $250bn.

For example, in the Philippines, which has an average of 20 typhoons a year, losses have surpassed $2.5 billion since 2009, making it the third most disaster-prone country in the world. As in many other parts of the world, farmers are hardest hit.

Since agriculture accounts for 11%of GDP and one-third of all jobs in the Philippines, risk mitigation has become an economic necessity and a major development objective. Typhoon Haiyan, which in 2013 killed more than 6,000 people and destroyed or damaged 1.5m homes - as well as causing economic losses of around $13bn - is still fresh in people's minds.

IFC, through GIIF, has been working in the Philippines to offer insurance products that can safeguard farmers' assets and also cover bank risks so they can increase lending to farmers. Most recently, IFC started a partnership with the Center for Agriculture and Rural Development Insurance Agency to support the development of typhoon index insurance for hundreds of thousands of its farmer clients in the Philippines.

The indemnity insurance is complemented by index-based insurance products relying on predetermined triggers such as wind speed and rainfall levels to strengthen the existing insurance coverage options. As a result of the new products, agricultural lending should be significantly expanded while helping farmers protect their assets.

Indonesia is another country vulnerable to weather-inflicted disasters. More than 12m Indonesians live and work in earthquake-prone zones, with economic exposure reaching an estimated $7bn. These risks are especially high in areas such as Yogyakarta and Padang, where banks lost between 15 and 35% of income following recent earthquakes. So the GIIF partnered with reinsurer PT Asuransi Maipark Indonesia to develop an index insurance product for banks and microfinance institutions to provide loans to individuals and micro, small and medium enterprises for losses following earthquakes and other disasters.

Such insurance, which hedges banks against losses from non-performing loans and from mass savings withdrawals after disasters, improves their risk management. This, in turn, improves financial performance, lowers interest rates, reduces volatility in access to credit, and expands banking services. The project expects to facilitate $50m in additional financing for the working poor and micro and SMEs by 2019.

In summary, the number of people affected by climate-related disasters is on the rise globally, and the poorest households are the ones left without the means to deal with the economic effects. Index insurance is a great vehicle to take risk mitigation to the next level, protecting the most vulnerable from the unknown.

With natural disasters increasing in frequency and severity due to climate change, adaption and proper risk mitigation are crucial for assuring that development gains achieved today will benefit future generations and that economic growth will be sustainable.

Giles Galludec is principal of global insurance advisory at IFC 

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