Using Index Insurance to Manage Climate Risk: Issues in Scale Up and Capacity Building

Using Index Insurance to Manage Climate Risk: Issues in Scale Up and Capacity Building

Daniel Osgooddeo@iri.columbia.edu

Megan McLaurinmmclaurin@iri.columbia.edu

The International Research Institutefor Climate and Society

Index insurance: background

• Traditional Crop insurance – Undermined by Private Information problems – Almost always subsidized (VERY DANGEROUS)

• The index innovation– Insure weather index (such as seasonal rainfall), not crop– Only partial protection (basis risk), should not oversell– Cheap, easy to implement, good incentives

• Design complex – Only a naive partner would reveal all their cards– All partners must play active role in a cooperative design– Client must know what is not covered

• Price: – Money in = average(Money out) + cost of holding risk

– Ave(Pay) + 0.06 (99th % pay – Ave(Pay))

• New demand for climate services

• Climate Risk Barrier for Green Revolution Technology

• Smallholder farmers– Want hybrid seeds, fertilizers, other inputs– Understand how to increase yields– But face risk, have severe difficulties obtaining inputs

• Production system choice not individual decision– Joint decision negotiated between farmer, relatives, lender,

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• Component Green Revolution ‘seeds’ have been sowed– Quality seeds, inputs, ongoing research; extension expertise;

sophisticated smallholder farmers; potential for markets

• Risk of 1 bad year out of 5 prevents them from being productive in 4 good years

• Use index insurance to allow farmers to utilize technologies

• Farm level example – Development oriented -- NOT famine relief

Micro application

Example: Malawi Groundnut contract bundle

• Farmer gets loan (~4500 Malawi Kwacha or ~$35)– Groundnut seed cost (~$25, ICRSAT bred, delivered by farm

association)– Interest (~$7), Insurance premium (~$2), Tax (~$0.50)– Prices vary by site

• Farmer holds insurance contract, max pay is loansize– Insurance payouts on rainfall index formula– Joint liability to farm “Clubs” of ~10 farmers– Farmers in 20km radius around met station

• At end of season– Farmer provides yields to farm association– Proceeds (and insurance) pay off loan– Remainder retained by farmer

• Farmers pay full financial cost of program (with tax)– Only subsidy is data and contract design assistance– Farmers told us:

Insurance package is how they adapt to climate change.

• Malawi Project Partners: Farmers, NASFAM, OIBM MRFC, ICRSAT, Malawi Insurance Association, the World Bank CRMG, Malawi Met Service, CUCRED, IIASA

• We are involved in additional projects including:– MVP, Central America, Kenya, Tanzania, Ethiopia…

http://iri.columbia.edu/~deo/IRI-CRMG-Africa-Insurance-Report-6-2007/

Nicole Peterson, NSF-DMUU

Insurance index developed with farmers

Sustainability and Scale up

• Products are currently being designed through international research institutions

• Products must– Scale up: new clients, new locations

– Increase in robustness with application experience

– Adapt to changing needs

– Take advantage of local insights

• Design should be local, supported by Global research community

• Need tools to build capacity, educate, communicate, design, provide foundation for discussion/negotiation

Design training tools (under development)

Design training tools (under development)

Design training tools (under development)

Design training tools (under development)

Research/Education Issues and Potential Modules

• Issues:– Pilots are low hanging fruit, for future need to be able

to work with more difficult data– The capacity building process drives research– Research directly available through module education

and tools– Modules can represent academic debate

• Technologies and modules under development– Other types of contracts

• Eg. excess rainfall, dry spell, water balance

– Systematically map uncertainty through products• Rainfall Simulation

• Using short data series appropriately

• Complimenting data with Remote Sensing

• Use of Paleo info

– Forecasts, climate processes and spatial hedging

Insurance and seasonal forecasts

• Index insurance starts exactly where forecast stops– Difficult to take chance using with forecast if livelihood at stake

• Well designed insurance can take risk out of forecast• Maps probabilistic forecast to deterministic outcome

– Insurance can communicate forecasts and risk costs as price signal

– Seasonal forecast makes badly designed insurance insolvent• Well designed insurance robust to forecast

• “Low skill” forecasts/indices – can have high skill for insurance specific decisions

• Not only forecasts, other climate science can be harnessed in portfolios

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Non-Hybrid ENSO shifted Land Allocation Based on Historical District Yields

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Macro Implementation

• Early warning vs early action?

• Policy maker has barriers in using forecasting/monitoring for action

– Takes chance that crisis might not happen– Logistics, coordination, mandate, authority– Large costs of actions during disaster

• Index contract/policy for disaster response – Determine actions that would be worthwhile to take if

index reaches given level– Provide authority, policy, budget for action– Purchase index contract to fund action

• IRI projects: – Index product for Earth Institute MVP– Also exploring: Locust, fire, malaria, livestock disease

and international trade, forage, water management…

MVP Index

Global implications

• With increasing climate risk need to leverage whole world

– Extreme events• Big component of damage from Climate Change?• Negatively correlated across globe?

– Whole world distributes risk • Subsidized index insurance pilot in US• Need to develop global risk markets• Costs to US reduced• Insurance premiums lower• With global markets incentives for optimal global

production diversification given risks

– Eg. US Corporate resilience with international climate sensitive suppliers

• Major new role for climate science, monitoring