Insuring Against Climate Change

The Emergence of Regional Catastrophe Risk Pools

Nikolas Scherer

• Publisher: Routledge
• Year: 2020
• ISBN:
  9781000033540
• Edition: 1
• Topic: Biological Sciences
• Subtopic: Global Warming & Climate Change
• Index: Biological Sciences

This book provides one of the first systematic in-depth studies on regional catastrophe risk pools. It explores the various goals of these new financial instruments, illustrating how they function on a conceptual, technical and practical level, and reconstructs their political genesis.

With climate-related disasters increasing in frequency and severity, Insuring Against Climate Change explores how affected countries, especially those in the Global South, have increasingly turned to innovative index insurance instruments, as demonstrated by the creation of the Caribbean Catastrophic Risk Insurance Facility (CCRIF), the African Risk Capacity (ARC) and the Pacific Catastrophe Risk Assessment and Financing Initiative Facility (PCRAFI Facility). Scherer scrutinizes the formation of this trend, exploring comparatively the goals, characteristics and histories of these tools, and argues that their attractiveness rests more on political than economic benefits and is, in fact, more supply than demand-driven.

Making a significant contribution to current debates on the opportunities and limitations of what are sometimes described as indirect 'climate risk insurance', this book will be of great interest to political scientists with an interest in insurance instruments and climate-related disaster management politics as well as to practitioners working in the insurance, finance and the development sectors.

1 Introduction

The puzzle

Climate change is altering weather extremes around the globe. The years 2014–2018 have not only been the warmest on record (Climate Central, 2019) but have also seen a major increase in the frequency and severity of natural disasters across the globe (Swiss Re Institute, 2018). In particular, the year 2017 stands out: Natural disasters created estimated economic losses of US$ 340 billion—the second highest figure ever (Munich Re, 2018). The hurricane season in the Atlantic basin was thereby one of the busiest in history and characterized by an unusual phenomenon: Three powerful hurricanes—Harvey, Irma and Maria struck the United States (US) and the Caribbean within the space of just a few weeks. Drought conditions in Southern and Eastern Africa related to El Niño and La Niña and extreme rainfall events in China, Bangladesh and India as well as in Western Africa have cost life in the thousands, especially among the poorest segments of society. Late frosts in May 2017 destroyed much of the fruit and wine crops in large parts of Europe. But also 2018 saw major natural catastrophes, leading to overall economic losses of US$ 160 billion and more than 10,000 fatalities. In particular, hurricanes Michael and Florence in the Atlantic basin, typhoons Jebi, Mangkhut and Trami in Asia and wildfires in the US left their mark. What was a more moderate year vis-à-vis 2017 ranks among the ten deadliest and costliest disaster years (Munich Re, 2019). 2019 seem to continue the overall trend of increasing temperature and weather extremes with heat waves across Europe in July, setting all-time temperature records in Belgium, Germany, Luxembourg, the Netherlands and the United Kingdom (UK) (World Meteorological Organization, 2019), a severe drought in Somalia (The Guardian, 2019), the landfall of Tropical Cyclone Idai in Mozambique and hurricane Dorian in the Bahamas. In short: The impacts of climate change are becoming more and more visible.

Accordingly, over the recent years dealing with the consequences of climate change has become a top priority in global policymaking. For years, states have put emphasis on mitigation. Under the umbrella of the United Nations Framework Convention on Climate Change (UNFCCC), the prime global governance goal has been addressing the causes of climate change. In recent years, however, the global focus has shifted from mitigation to adaptation and, thus, to coping with the consequences of climate change. The Bali Action Plan (2007) was arguably the historical turning point: It identified adaptation as a key building block for a strengthened future response to climate change and claims that adaptation policies should gain ‘equal importance’ to those of mitigation. In 2010 states adopted the Cancun Adaptation Framework (CAF) with the objective of enhancing global actions on adaption. In 2012, the Doha Conference called the more ‘developed states’ to support ‘developing countries’ that are vulnerable to the adverse effects of climate change with more financial and technical resources. In 2014, following two years of deliberations, the 19th session of the Conference of Parties (COP) finally institutionalized goals and policies by establishing the Warsaw Mechanism for Loss and Damage. The Warsaw Mechanism for Loss and Damage implemented policies to support ‘developing countries’ that are particularly vulnerable to the adverse effects of climate change. The Paris Agreement formalized this support. It establishes adaptation as an equal global policy goal next to mitigation (Article 7), highlights the importance of averting, minimizing and addressing loss and damage associated with the adverse effects of climate change (Article 8), calls on ‘developing countries’ to specify their needs and ‘developing countries’ to provide regular information on their support (Article 9,10, 11). There is no doubt that adaptation is currently at the forefront in global climate policymaking, in particular in Global North-South relations.

Adaptation can be understood as “measures which enable [persons] to cope with the ill-effects of climate change” (Caney, 2005, p. 752). The unitary label masks, however, different adaptation actions. On a very general level adaptation compromises 扠 preventive and reactive measures (Duus-Otterström & Jagers, 2011, p. 323). Preventive measures include, for example, the strengthening of a flood defense, the diversification of economic activities and improvements in water irrigation systems, and revolve around mitigating the impact of climate change. Reactive measures, by contrast, center around the access to funding “to rebuild society after already experienced harm” (2011, p. 323), including the compensation for hazard-related loss and damage. They manifest in a number of ‘disaster financing’ instruments such as contingency credits, catastrophe funds and (index-)insurance instruments (see Table 1.1).

It is in particular insurance instruments which, under the labels ‘disaster risk insurance’ and ‘climate risk insurance’, have gained increasing support from policymakers, NGOs and private insurers alike.¹ The Compendium of Disaster Risk Transfer Schemes by the London School of Economics and Political Science reports 110 operating insurance schemes associated with natural hazards in low- and middle-income countries in 2018 (LSE, 2019). In the context of the Paris Agreement and the submission of National Determined Contributions (NDCs), over 38 countries expressed their intention to implement or scale-up insurance schemes (Kreft, Schäfer, Behre, & Matias, 2017) related to different kinds of weather extremes such as floods or droughts. In 2017, at the UN climate conference in Bonn (COP23), the G20—the industrial countries—partnered with the V20—an interest group of the most vulnerable countries to climate change—and representatives from development banks, businesses and NGOs to launch the InsuResilience Global Partnership. The G20 equipped the initiative with US$ 550 million to facilitate the expansion of ‘climate risk insurance’ for up to 400 million people by 2020. According to Oxfam this is as much as international donors spend each year on disaster risk reduction (Oxfam, 2018). Also, the Sendai Framework for Disaster Risk Reduction 2015–2030, the guiding global framework that steers the efforts of the humanitarian community to build resilience against disasters, calls its stakeholders to promote the development of disaster risk insurance. There is no doubt: Insurance is en vogue.

Table 1.1Overview of disaster financing instruments

Instrument	Mechanism
Budget contingencies	Government sets aside a certain amount of capital of their overall budget and earmarks it for the unforeseen
Budget reallocations	Government reallocates funds from already planned programs, projects or budget lines
Capital market instruments	Government transfers the financial consequences to the capital market actors by issuing catastrophe bonds and other financial market products (e.g., weather derivatives) While government receives a capital infusion in the case of an adverse event, it pays a certain dividend in the case of a non-event
Contingent credit	Government enters into an agreement with a multilateral development bank (e.g., World Bank) which provides low-cost loans for recovery and reconstruction in the case of an adverse event
Credit	Government enters in a loan agreement or issues bonds on the domestic or international market
Donor assistance	Government receives donations and financial grants from donors and international humanitarian programs
(Indemnity/index-based) insurance	Government transfers the financial consequences to a third party (e.g., an insurance company) in exchange for a periodical premium
Reserve fund	Government creates a fund to which they pay in annually
Taxes	Government increases tax rates or introduces a new tax

Source: based on Ghesquiere & Mahul, 2010; OECD, 2012; Suarez & Linnerooth-Bayer, 2011

Introducing index-based insurances

While there are various types of insurance schemes, the most prominent type discussed and put forward within a variety of climate and disaster-related policy initiatives is ‘index insurance’, sometimes also known as ‘index-based insurance’.²

Simply put, what distinguishes index insurance from conventional indemnity insurance is that it is not the actual financial loss that triggers a payout but the performance of a model. The performance of this model depends on specific variables (such as the wind-speed, rainfall level, wave height and/or economic or population data) and functions as proxy for the actual loss. If the calculated losses reach a pre-specified threshold, a payout is due, irrespective of whether the model’s estimation was accurate or not. The advantage of index insurance is that they allow for quick access to capital since insurers do not need to send a loss adjuster to ‘ground zero’ for checking and verifying claims. This saves also administrative costs, which, in turn, translates into lower premiums for insurance policyholders. The downside is, however, that the payout may not match the actual losses on the ground. It might turn out to be too low or too high and thus not adequate to compensate for incurred loss and damage. This phenomenon is called ‘basis risk’.

Index insurance is typically classified according to the intended beneficiary, that is, the insurance policyholder³:

• Micro index insurance schemes: Insurance policyholders are individuals (such as farmers or market vendors)
• Meso index insurance schemes: Insurance policyholders are societal or financial intermediaries (such as associations, cooperatives, credit unions, banks or NGOs)
• Macro index insurance schemes: Insurance policyholders are states

This book is interested in the third type, macro index insurance schemes—that is, in those schemes where sovereign entities themselves resort to index-based insurance coverage. Those are arguably also the schemes that have received the most attention in policy debates surrounding international climate change adaptation.

Introducing regional catastrophe risk pools

Macro-level index insurance schemes are typically provided via newly created ‘regional catastrophe risk pools’, sometimes also known as ‘sovereign catastrophe risk pools’. Regional catastrophe risk pools are effectively supranational, public-private self-insurance companies. In exchange for annual premium, they offer states from a speci...

Table of contents

• Cover
• Half Title
• Series
• Title
• Copyright
• Dedication
• Contents
• List of figures
• List of tables
• List of abbreviations
• Acknowledgments
• 1 Introduction
• 2 Understanding insurance: a primer
• 3 The Caribbean Catastrophe Risk Insurance Facility (CCRIF)
• 4 The African Risk Capacity (ARC)
• 5 The Pacific Catastrophe Risk Insurance Pilot (PCRAFI Pilot)
• 6 CCRIF, ARC and the PCRAFI Pilot in comparative perspective
• 7 Conclusion and implications
• Index