New report: Reducing climate risks with index insurance

by |June 23, 2009

We know climate has always presented a challenge to farmers, herders, fishermen and others whose livelihoods are closely linked to their environment–particularly in developing countries. A type of insurance called index insurance shows some promise as a climate-risk management tool, according to the latest Climate and Society publication from Columbia’s International Research Institute for Climate and Society.

The IRI published the report in partnership with the United Nations Development Programme, the International Fund for Agricultural Development, Oxfam America, Swiss Re, the US National Oceanic and Atmospheric Administration and the World Food Programme.

For poor people, a variable and unpredictable climate can critically restrict options and limit economic development. For example, banks are unlikely to lend to farmers if they think a drought will cause widespread defaults, even if the farmers could easily pay back loans in most years. The farmers’ lack of access to credit limits their access to improved seeds, fertilizers and other necessities.

Now, if the farmers could insure their crops against loss, then they could persuade the banks to give them loans. But traditional insurance is generally too expensive to implement in rural parts of developing countries. Enter index insurance: it uses a weather index, such as rainfall, to determine payouts, and this resolves a number of problems that makes traditional insurance unworkable in many poor rural areas. For example, with index insurance contracts, an insurance company doesn’t need to visit a farmer’s fields to determine premiums or to assess damages in the case of crop loss. Instead, if the rainfall recorded by gauges is below an earlier, agreed-upon threshold, the insurance pays out. Simple as that. Such a system significantly lowers transaction costs and allows insurance companies to sell to small farmers, which means they can then apply for bank loans and other types of credit previously unavailable to them.

To be sure, institutions need to overcome some major challenges before they can scale up the use of index insurance to cover significant percentages of an at-risk population. The new report, called Index Insurance and Climate Risk: Prospects for development and disaster management, discusses all these technical and operational hurdles, and presents a number of case studies on the use of index insurance around world thus far. You can read more here, or watch the embedded video above.

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dan
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dan

this is a great slideshow. i’m also interested, however, about the mechanisms to scale up index insurance in the the developing world.

specifically, how can index insurance be designed to cover the wide-range of risks it must address in any one setting? also, what role is there for government and NGOs in scaling up index insurance? is this primarily an act of charity or is it a full-fledged business venture?

anyway, thanks for keeping us updated — looking forward to more on this topic.

Dan Osgood
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Hi Dan, Glad you enjoyed the slideshow. Im one of the editors on the report mentioned by Francesco. The question of how and if index insurance can be scaled up is one that people are grappling with right now. There are efforts to find index insurance products that can cover a wide range of risks. An alternate strategy is to focus the index insurance on the risks it can best target, using it as a tool to begin to reduce risks as effectively as possible as opposed to attempting to address everything. The hope is that index insurance can become… Read more »