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 Osgood deo@iri.columbia.edu Megan McLaurin mmclaurin@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

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) • 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/

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)

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

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