Climate insurance – An opportunity for developing countries
Low-income countries are particularly vulnerable to natural catastrophes, as few of their inhabitants can afford insurance protection. At the 2015 climate summit in Paris, insurance solutions were already adopted as one means of addressing climate risks. Climate insurance makes it possible to help developing and emerging countries adapt to climate change, by cushioning the material impacts and providing a building block for sustainable economic growth. The private sector and national governments need to cooperate in this area.
Developing countries most at risk
Low-income countries are particularly vulnerable. More poor than rich lives are lost, both in absolute terms and as a percentage of population. Moreover, material losses that cannot be repaired or replaced because of insufficient funds lead to a lasting loss of prosperity. According to Munich Re's NatCatSERVICE, approximately 861,000 people lost their lives between 1980 and 2015 as a result of weather-related natural catastrophes worldwide. Of these, 61% (522,000) lived on less than US$ 3 per day (income groups in accordance with the World Bank definition), and therefore counted among the world's poorest people. As a proportion of the world population, however, this group represented only around 12% in 2015. If you consider the next-highest income group (daily income of up to approx. US$ 11), the rate drops considerably but still shows a disproportionately high mortality rate from weather catastrophes among low-income sections of the population. In our assessment, the reasons for this are clear. Poor access to risk information and early-warning systems, and insufficient financial resources needed to protect oneself from natural catastrophes with structural measures, for example, drive up the number of victims.
Adaptation options vary depending on the region and hazards involved, but there are two main categories:
- Ex-ante preventive measures taken ahead of a catastrophe in order to mitigate losses. These include early-warning systems, but also structural precautions and land-use regulations.
- Ex-post measures to deal with the consequences of loss, including humanitarian aid and financing schemes. These help to overcome the economic impact of a disaster and pave the way for repair and reconstruction efforts, thereby developing resilience.
Climate insurance – A crucial adaptation instrument
The objective of InsuResilience is to give an additional 400 million people in emerging and developing countries access to insurance by the year 2020 to protect themselves against weather-related catastrophes. This will either be organised on a macro level with insurance cover for entire countries (indirect insurance of the population), or on a micro level with insurance policies for individual persons (direct insurance of the population). Claims payments are linked to clearly defined weather parameters such as levels of rainfall or wind speed.
Such products are known as parametric or trigger-based covers. In this way, people can insure themselves against drought, windstorm or heavy rainfall, each of which is recorded using objective measurement methods. This mechanism makes terms and conditions transparent, reduces the administrative cost of calculating claims amounts, and thus enables payouts to be made promptly. It should be remembered, however, that besides the above-mentioned advantages of parametric triggers, there is also a basis risk to be taken into account (occurrence of a loss before the defined trigger level has been reached).
However, the simplicity of the payout principle on a parametric basis means that micro and macro solutions already exist in a number of developing countries and, in line with the G7 declaration, should be further built upon. If structured well, insurance solutions not only create incentives to take preventive measures (by way of knowledge transfer and/or deductibles), but also represent an effective tool to finance claims burdens. If the public and private sectors are to overcome the immense financial impact of such disasters, it is imperative to soften their long-term impact on the economy. To this end, the introduction of climate insurance solutions promotes the construction of robust social and economic structures, thereby developing resilience.
Public-private partnerships are required
If the G7 target is to be attained, the affected countries will have to adopt the necessary regulatory measures and participate financially in the project. The additional provision of international aid or ramp-up support from climate funds, such as the Green Climate Fund (GCF), also constitutes a promising solution. This is the only way to develop lasting (i.e. sustainably financed) insurance schemes in developing countries and emerging markets that enable people to better adapt to the new risks resulting from climate change. Climate insurance solutions could become a textbook example for cooperation between the public and private sectors. The roles of the individual cooperation partners are clearly defined based on the competences and resources of each:
- The public sector defines the legal and regulatory framework and the socio-political aims. The establishment of weather databases, the development of publicly accessible risk information systems, and knowledge building among the population can also be supported at both national and international levels.
- The insurance industry is responsible for the development and implementation of climate insurance solutions. To this end, it provides expertise, risk models, best practices from other countries and, most importantly, risk capital. Risk-commensurate premiums need to be charged for the mechanism to function in a lasting and stable manner. Only then will pricing adequately reflect the risk potential and create an incentive for people to take measures that reduce the risk.
In the past, diverging views between the private and public sectors often presented insurmountable obstacles in the realm of risk financing that made it impossible to develop insurance schemes in less developed countries. But there is a growing awareness that it is precisely these countries that have the most urgent need to adapt to the consequences of climate change.
The topic of energy is closely linked to both climate objectives and development policy goals. It is for this reason that the UN brought into being the Sustainable Energy for All (SE4All) initiative. The General Assembly has declared 2014–2024 the "Decade of Sustainable Energy for All", setting out the following goals to be achieved by 2030:
- Ensure universal access to modern energy services
- Double the global rate of improvement in energy efficiency (the ratio of GDP to energy use)
- Double the share of renewable energy in the global energy mix
According to estimates by the World Bank, annual investment in the energy sector of between US$ 600bn and US$ 800bn will be required to develop the low-carbon energy technologies needed. More recent figures from the International Energy Agency (IEA) are even higher. Such amounts pose a formidable challenge. However, if we consider how the annual global inflow of capital into technologies for renewable energies increased fivefold between 2004 and 2015 to US$ 330bn, the target seems feasible. Here too, the insurance industry can make a valuable contribution by safeguarding project risks and thus making energy projects more attractive to investors. Many of these risk-transfer solutions are special products requiring particular expertise. It is up to the political leaders, as with the insurance solutions for adaptation to climate change, to give clear signals and support the energy policy objectives with concrete initiatives. The aim should be to achieve additional cost efficiency through public-private partnerships and standardisation on the financing and risk-transfer side. The insurance industry can also play a major part by itself investing in energy projects. International climate policy has opened a window of opportunity for a fresh approach. With its geoscientific and underwriting expertise, loss data from its NatCatSERVICE database, and by providing risk capital, Munich Re supports the development of insurance systems in the areas of climate change and natural catastrophes.