Seduced by disaster insurance? Don’t dive in
by Tom Mitchell, Head of Climate Change, Environment and Forests, Overseas Development Institute, and Senior Advisor, CDKN
Under the leadership of the Mexican Presidency, disaster risk management featured on the ‘financing track’ of the G-20 discussions this week in Los Cabos, Mexico for the first time. Worries about record economic disaster losses in 2011, combined with Mexico’s long standing experience of disaster risk financing, have helped move the issue up the G20 policy agenda.
Informed by a 287-page edited volume from the World Bank-Mexican Government titled ‘Improving the Assessment of Disaster Risks to Strengthen Financial Resilience’, G-20 discussions considered the relationship between risk assessments and the options provided by risk financing measures, including insurance products at all scales. This focus serves to highlight a high level of interest globally in the opportunities provided by insurance markets and public-private risk financing approaches as a way to transfer disaster risk, even in developing countries. For example:
• Getting natural catastrophe insurance markets to work in Africa is a priority area for the ‘Political Champions for Resilience’ group
• Risk transfer mechanisms, including insurance, are a key part of ‘loss and damage’ negotiations currently being held by the UN Framework Convention on Climate Change.
Why all the interest in disaster insurance?
The mechanism is seemingly rather simple. If a disaster strikes and you have the right insurance, whether a government, business or an individual, you receive some level of payout to help with recovery and reconstruction efforts. This helps to reduce the long term impact of the disaster financially, and potentially to mitigate its impact on levels of poverty. The security of having insurance in place allows for more risks to be taken, which may lead to greater profits and more innovation.
In some cases, the costs of insurance premiums can vary depending on whether or not you have measures in place to reduce risks – for example your premium is cheaper if your roof is connected to your walls with the right roof ties or a country has a strong regulatory environment around building codes. This creates an incentive structure that promotes investments in reducing risks to reduce premium costs. Sounds great.
Why then does the IPCC Special Report on Extreme Events and Disasters conclude that there is only medium confidence that disaster insurance mechanisms can increase resilience? While highlighting that insurance can help to finance relief, recovery and construction, reduce vulnerability and provide knowledge and incentives for reducing risk, the IPCC Report also says that under certain condition such mechanisms can provide disincentives for reducing risk.
There are a number of problems with an over reliance on insurance:
1) Evidence presented in the IPCC report suggests that insurance is an effective disaster risk management tool when it is combined with other risk management measures (e.g. early warning, provision of risk information, preparedness and measures to reduce vulnerability). Where insurance is applied without adequate risk reduction, insurance can convey a feeling of security while actually leaving people overly exposed to impacts.
2) Insurance products never cover the full extent of disaster losses. Intangible losses such a long-term impacts on mental health, lifelong loss of earnings related to missed schooling or malnutrition in drought years, or cultural heritage and identity are almost uninsurable.
3) While there is considerable evidence to suggest that insurance products help with absorbing the financial burden of disasters, there are questions over how long such products will be affordable or even offered by the private sector given increasing disaster risks and uncertainties, particularly in developing countries. A recent case of a cap on the reinsurance liability in Bangladesh is a case in point. How sustainable then is an insurance dependent approach to risk management for a developing country with rising risks?
4) The highest quality risk assessments are those used by the insurance industry and are commonly only available to governments at a price and as part of a conversation oriented toward the purchase of an insurance product. A concerted effort is required to maximise the quality of risk assessments available in the public domain. Assessments can then be used to inform a well thought through risk management approach that looks to risk transfer approaches only after implementing a strategy focused on risk reduction.
5) There has been lots of work looking at how insurance products can be tailored to those who cannot usually afford to buy insurance, including by farmers offering labour to pay premiums or some sort of collective approach to purchasing. However, farmers need to be able to increase their productivity in order to pay the premiums, as offering additional labour time does not come without trade-offs. Even if in-kind payments are accepted, many vulnerable groups or chronically poor are unable to offer their labour, such as the young, elderly and ill. There has been some interest in the role of social protection and safety nets as a way to proactively manage shocks and stresses faced by vulnerable populations and to provide a foundation for risk financing approaches, such as in the case of WFP’s relationship to Productive Safety Net Programme in Ethiopia. While promising, the link between social protection and micro-insurance requires further exploration.
6) There is insufficient evidence of the medium and long-term outcomes of the relationships between developing countries, individuals and insurers. Does micro-insurance genuinely smooth out the impacts of disasters on poverty? What happens to trust and risk management approaches when insurers do not deliver as expected? Does insurance lead to increases in risky behaviour and greater exposure? Do insurance schemes perpetuate dependency of post-event pay outs?
My intention with this blog is not to downplay the role of insurance and risk transfer, just to recalibrate the view that insurance offers some kind of panacea for managing disaster risk. It does not. Insurance has an important place in a comprehensive risk management strategy, which must focus on assessing and then reducing risk as a first priority. Insurance should then be considered as one component of a strategy designed to minimise the losses associated with the residual risks left after measures to reduce risks are in place. This is a point that we made in our recent CDKN guide to ‘Tackling Exposure: Placing Disaster Risk Management at the Heart of National Economic and Fiscal Policy’. At the moment insurance is simply too prominent, seen by too many governments and agencies as a first move rather than a later consideration. Let’s get insurance in perspective and not be seduced, at least not too quickly, when the sophisticated risk modellers and insurance sales people knock at the door.
Photo courtesy of Arenamontanus