Using Index Insurance to Manage Climate Risk Issues
- Slides: 14
Using Index Insurance to Manage Climate Risk: Issues in Scale Up and Capacity Building Daniel Osgood deo@iri. columbia. edu Megan Mc. Laurin mmclaurin@iri. columbia. edu The International Research Institute for 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 (99 th % pay – Ave(Pay)) • New demand for climate services
Micro application • 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, marketer • 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
Example: Malawi Groundnut contract bundle • Farmer gets loan (~4500 Malawi Kwacha or ~$35) – – – • Farmer holds insurance contract, max pay is loansize – – – • Insurance payouts on rainfall index formula Joint liability to farm “Clubs” of ~10 farmers Farmers in 20 km radius around met station At end of season – – – • Groundnut seed cost (~$25, ICRSAT bred, delivered by farm association) Interest (~$7), Insurance premium (~$2), Tax (~$0. 50) Prices vary by site 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/
Insurance index developed with farmers Nicole Peterson, NSF-DMUU
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
Macro Implementation MVP Index • 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…
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
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