Climate risk insurance: New approaches and schemes

Finding solutions for how to deal with the impacts of climate change is one of the most pressing issues of our time. It is the least and less developed countries which are the most affected by increasing frequency and severity of extreme weather events such as droughts or floods, while being the least capable of coping with them. Relying on ad hoc donor support creates uncertainties concerning the timing, size, and frequency of the payout which is desperately needed for mitigating the negative repercussions of weather extremes. Consequently, new viable and sustainable pre-disaster arrangements for transferring financial risks need to be found and implemented. Various general problems arise when setting up formal disaster risk transfer schemes in developing countries, which are mainly related to the concentration of risk, lack of data, low resilience of infrastructure, and potential for moral hazard.

On the one hand, classic insurance schemes on the micro, meso, and macro level, covering individuals, intermediaries, and countries, respectively, serve as a way to sharing weather-related risks and losses.  Microinsurance is designed to directly meet policyholders’ specific needs. Microinsurance schemes hedging against losses caused by extreme weather events have already been implemented in numerous African, Asian, and Middle-American countries. Meso-level insurance enhances investment potential by reducing losses caused by credit default and currently exists in regions in Central- and South America as well as South East Asian island states. Insurance on the macro-level allows both insured and uninsured individuals to be compensated for damage caused by extreme weather events. Two macro-level pooling facilities cover Caribbean island states and Sub-Saharan African countries. 

On the other hand, alternative formal approaches to transferring weather-related risks may be pursued. Catastrophe bonds transfer risks to the capital market, thereby spreading them widely. They have mainly been issued by macro-level risk pooling facilities for reinsurance, but are increasingly being taken into consideration by public entities as a risk-sharing mechanism. Weather derivatives are another way of transferring risks to the capital market. A limited amount of projects have been piloting them in developing countries, mainly in Africa. Sovereign insurance enables highly exposed governments with a low tax base and a vulnerable infrastructure to hedge their liabilities against weather-related risks. Macro-level risk pooling facilities may be regarded as providers of sovereign insurance.

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