Insurance and adaptation

The rationale for including insurance in a climate adaptation regime rests not only on the failure of the market to serve the most vulnerable, but also on the prospect that insurance mechanisms that help countries and affected households recover from extreme weather events can at the same time help reduce the impacts of these events.

This is referred to in the climate community as adaptation, and can be defined as reducing risks to property, assets, livelihoods and lives. Adaptation can take many forms, including:

improvements in physical systems, for example flood defences or early warning systems;
shifts in social systems, for example relocating or changing livelihoods; training for early warning systems;
mitigating underlying vulnerabilities, for example improving productivity and thus enabling savings as a cushion for future disasters.

Insurance can promote these risk-reduction activities by (i) offering premium reductions and other incentives for decreasing risks; (ii) coupling insurance support with requirements for risk reduction; and (iii) promoting productivity that enables the long-term reduction in losses.

Risk reduction through incentives

Insurance can reduce direct and immediate disaster losses by providing incentives for pre-disaster mitigation measures. Researchers have shown, for example, how the drought micro-insurance scheme in Malawi (described above) can be redesigned to provide farmers an incentive to reduce their droughtrelated crop losses.

This is possible by incorporating seasonal rainfall forecasts, which are strongly related to El Nin˜o – Southern Oscillation, into insurance pricing.

If a seasonal precipitation forecast indicates that a drought is likely or unlikely to strike a certain area, this information can help farmers choose a drought-resistant crop variety or engage in high-yield (and high-risk) farming practices, respectively.

This information can be even more powerful if seasonal forecasting is combined with risk transfer schemes that adjust premiums upwards in El Nin˜o years when bad rains are expected and adjust them downwards in La Nin˜a years to reflect the reduced risk of drought.

Premium adjustments can lead to substantial increases in gross revenues for farmers during La Nin˜a years, and substantially reduce losses during El Nin˜a years. By smoothing their incomes, farmers are thus more able to withstand the negative impact of future droughts on agricultural production.

Coupling insurance with risk reduction

As a more direct route to promoting adaptation, the provision of insurance can be made conditional on risk-reduction measures.

This is the idea underlying the U.S. National Flood Insurance Programme, where communities are required to put land-use and other mitigation measures in place in order for their residents to be eligible for subsidised insurance policies.

This same principle can be applied to donor assistance, which in some cases is switching from project-oriented aid to direct cash transfers to the poor. These transfers might be made conditional on the recipients purchasing insurance.

In Mexico, as a case in point, cash transfers to female heads of poor households are conditional on them providing their children with education and health care, and it would be a small step to make these transfers conditional on their uptake of insurance against disasters and other threats to their livelihoods.

Oxfam America and Swiss Re are experimenting with a similar concept of coupling donor-supported insurance with risk reduction. In the Ethiopian village of Adi Ha, farmers can purchase a micro-insurance product to protect them against drought loss to their teff crop.

Farmers not able to afford insurance can join a programme that allows them to pay for part of their insurance premium with labour in the off-season. Oxfam is considering orienting the work programme to projects that mitigate drought risk.

Thus, the donor-funded ‘‘food for work’’ and disaster aid programme is re-designed to a donor-funded ‘‘insurance for risk reduction work’’ programme.

Insurance for enhancing productivity and adaptation

Finally, well-designed insurance can encourage investments that enhance productivity and in this way promote adaptation. Continuing the example of drought micro-insurance in Malawi, the pilot scheme bundles insurance with credit that enables farmers to purchase more productive seeds.

With a doubling of their cash crop in good seasons, farmers are better able to save money for those years characterised by drought and lower productivity. As discussed earlier, the Malawi scheme eliminates moral hazard since claims are not based on crop losses. Thus, farmers have an incentive to adapt cultivation practices to become more resistant to drought.

Location: Indonesia