Economics of Climate Change: Example from Ethiopia

by |November 9, 2009

A group of farmers in rural Ethiopia meet to discuss drought index insurance for their village.

Experts from Swiss Re, Oxfam America, and the International Research Institute for Climate and Society recently participated in a panel discussion at Columbia recently on weather index insurance for climate change adaptation. The event, organized as part of efforts to support Climate Week in New York, was sponsored by the New York Committee for Oxfam America, and hosted by the M.A. program in Climate and Society at Columbia University.

David Bresch, vice president of sustainability and emerging risk at Swiss Re, led the talks and was followed by Marjorie Victor of Oxfam America, Daniel Osgood, an economist at the IRI, and Tufa Dinku, a climate scientist at the IRI.

The discussion focused on the group’s efforts to implement an innovative microinsurance program in rural Ethiopia, designed to help rain-fed farmers become more resilient to droughts.

“We can’t separate sound development from a sound climate change adaptation strategy any longer,” said Bresch. “But we need economically viable solutions.”

During his comments, Bresch discussed a recently released Swiss Re report titled “Shaping Climate-Resilient Development” in which the authors show that climate change is likely to cost developing countries up to 19% of their GDP by 2030. The report itself outlines a bottom-up microeconomic approach to identify least-cost, best-practice actions for climate adaptation that fit a diversity of geographic and economic scenarios worldwide. By implementing these actions, the authors claim that 40-68% of that loss can be offset.

One of those actions that may reduce climate risk is offering poor farmers the chance to purchase microinsurance policies tied to the amount of rainfall their crops receive. Doing so would provide low-cost assurance to farmers during drought years by eliminating much of the cost associated with traditional insurance, like sending insurance representatives to verify losses and check for fraud. It would also allow farmers to take more productive “good risks”, like using fertilizer, during years where rainfall is likely to be favorable.

The certainty that insurance affords farmers regarding their rainfall allows them to make better use of their productive assets. “When you’re buying insurance, you’re buying certainty,” said Oxfam America’s Victor. “Making better use of assets makes farmers more productive and reduces poverty”.

In Ethiopia, Oxfam America is working with Swiss Re and a vast network of local stakeholders to establish a holistic climate risk management strategy for the village of Adi Ha. The strategy for Adi Ha includes risk reduction through community-led environmental efforts, risk transfer through purchasing weather index insurance, and prudent risk taking by making fertilizer and improved seeds more available through loans from local lending institutions.

So far, the Adi Ha project has enrolled 20% of the local population in the project, which requires participants to purchase the insurance contracts with their own money at a fair market rate. One goal of the project is to prove the financial viability of the microinsurance tool as a way of cost-effectively addressing climate risk.

“The experience in Adi Ha has so far challenged the conventional wisdom of what is possible,” said Osgood. Researchers at the IRI and Columbia University have shown takeup rates in Adi Ha to be significantly higher than in similar previously implemented projects, despite the focus in Adi Ha on insuring the “poorest of the poor”. The Adi Ha project has been able to make this advance by helping farmers tap into an underutilized resource: their own labor.

By allowing farmers to receive a voucher for the rainfall insurance contract by performing environmental tasks that benefit the community, like building check-dams and learning to compost, the Oxfam project has tied together a complete climate risk management strategy.

“Weather insurance on its own is like a wheel without a car,” said Osgood. “You to have all parts working together to have a complete product.” It shouldn’t be treated as a standalone product, he said.

Farmer driven processes, like those being pioneered in Adi Ha, direct the actions of local and international partners.  These processes, like the election of an insurance “design team” of farmers within the local community, help frame the insurance design around the challenge of developing appropriate products that will meet the test of sustainability.

“The task is to build a package of risk management tools, keeping careful track of remaining risks.  These tools include water management, environmental risk reduction activities (like terracing and composting), diversified crop portfolios, and community based risk sharing, with insurance playing a role of addressing the residual risks that remain.

Based on this integrated approach, scientists at the IRI are working to use the latest climate science to improve on earlier weather insurance products while farmers in Adi Ha make plans to train farmers in neighboring villages, working with local partners (including DECSI (a local MFI), REST (a local NGO), and Nyala (a local insurance company)) in focus group meetings to discuss which years in the past had drought problems, among other issues. Meanwhile, Dinku, along with colleagues at the University of Reading, hopes to improve Ethiopia’s available rainfall datasets by recalibrating old satellite data, in order to get a more accurate idea of how frequent droughts were in the past. With both of these pieces of information, the insurance should help farmers better plan for the future.

However, actions undertaken to reduce climate risk–such as the ones Swiss Re and Oxfam America are demonstrating in Ethiopia–shouldn’t be seen as being completely altruistic, Bresch said. He argued that appropriately valuing climate risk will “incentivise people around the world to do their own share of risk mitigation,” thereby limiting the occurrence of climate-related disasters in the future, just like the project in Ethiopia hopes to do.

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“By allowing farmers to receive a voucher for the rainfall insurance contract by performing environmental tasks that benefit the community, like building check-dams and learning to compost, the Oxfam project has tied together a complete climate risk management strategy.”

This is a brilliant idea…creating a win win situation for all stake holders.

Nice post, Eric.