The Payouts for Perils Working Group is examining how vulnerable countries and frontline humanitarian agencies can use insurance and index-linked securities to save lives, money, and time by financing emergency response much more effectively and creating healthy incentives to invest in disaster risk reduction. The Group brings together multilateral humanitarian and donor agencies, the insurance industry, academia, and senior government policymakers. It is jointly chaired by Owen Barder, Center for Global Development, and Professor Dr. Stefan Dercon, of the Department for International Development and the University of Oxford.
Theodore Talbot leads the working group secretariat.
What’s the problem?
Many people living in countries with weak or cash-strapped government services live with the daily risk of natural disaster. Conflicts compound these risks; scarcity and natural hazards can also ignite conflicts. A UN report examining twenty years of data concluded that nine in ten emergencies have been due to natural hazards.
Providing assistance quickly and reliably after hazards hit saves lives and money. For example, a drought that would cause harvests to fail in Ethiopia can be predicted in advance: cash transfers or food aid could be delivered early enough to prevent starvation or forced sales of livestock. The consequences can be tragic when assistance arrives late. For example, careful statistical evidence collected by Stefan Dercon, the Co-Chair of our Working Group, points to a permanent loss of income amongst families affected by drought in Ethiopia. When aid is late, people do not recover.
Unfortunately, international aid financing typically waits until a crisis has developed to collect money from donors, and donors are reluctant to pay out in advance of perceived need. Stefan Dercon and Daniel Clarke in their book ‘Dull Disasters’ correctly point out that this is a medieval approach to paying for emergencies, forcing governments and frontline agencies to pass around a bowl in order to save people’s lives.
Relying on disaster aid may fail to create (and might even undermine) incentives for planning and risk management. Since it is not clear how much funding will arrive (or when), governments have little incentive to develop disaster preparedness strategies. And because risks are large and in the future, there is systematic underinvestment in things that reduce the cost of disasters. According to DAC figures, just 40 cents of every $100 in international development aid over the last two decades has been spent on Disaster Risk Reduction (DRR).
Can the problem be solved?
Experience of how we tackle problems in industrialised countries suggests that insurance has a key role to play. Insurance contracts pay out quickly and in response to clearly articulated risks. When the risks are too large for households to bear, governments step in to provide additional support, and both national and sub-national governments also insure themselves.
However, the average level of insurance penetration in developing countries remains stubbornly low. At the same time, governments in these countries struggle to provide enough money themselves to tackle emergencies. Though public and private insurance are complements, lower income countries lack sufficient levels of both. As a result, a commonly reported data point is that only 100 million people in developing countries are covered from weather-related risks (this figure is lower when we account for other hazards, like earthquakes). There is plainly a deficit in protection.
There are two innovations that could help to dramatically lower this insurance gap:
- First, there has been a technical innovation in insurance contracts that cover relatively large risks by paying out based on scientific data like the violence of an earthquake, temperatures and rainfall linked to drought, or the wind speed of cyclones. Such parametric contracts do not rely on expensive investigations to assess the scale of damage. As a result, they pay out transparently and quickly.
- Secondly, financial instruments (index-linked securities in general and catastrophe bonds in particular) that connect these contracts to capital from global markets enable insurance and reinsurance firms to underwrite very large losses.
These two features— paying out quickly and reliably, and for sufficiently large disasters— suggest that insurance contracts can now play a unique role in tackling humanitarian emergencies. Promising examples of these programmes are already in place, notably in the Pacific (PCRAFI), the Caribbean (CCRIF), and several countries of Sub-Saharan Africa (ARC). However these sovereign risk pools cover a relatively narrow range of perils for relatively modest levels of coverage, have only begun to experiment with offsetting risks to capital markets through index-linked securities, do not generally target frontline agencies or others which would benefit from access to fast liquidity, and do not explicitly create incentives to reduce future losses.
What are some questions that the working group will try to answer?
During the first meeting on July 1st, 2016 in CGD’s London office, the working group articulated the set of problems to be solved. Some initial questions to be answered through the working group process are:
- What are the innovations or policy changes needed to tackle the problem of slow, insufficient, unpredictable, or ineffective financing for both slow - (like drought) and rapid - (like cyclones) onset disasters?
- Why is the use of insurance (insurance penetration) so low amongst frontline agencies? Amongst governments?
- What is the right format for a solution: bespoke deals for each organisation or government, or building a market of options?
- How can donors increase access by paying for premiums without distorting incentives to invest in DRR?
- What is the role for a trusted intermediary or broker between frontline agencies, vulnerable sovereigns, and the insurance sector? What kind of institutional framework might be useful to support these functions?
- How can incentives be built into contracts so that governments also play a role in reducing their exposures to future losses?
During the second and third meetings, the working group will clarify and articulate a concrete set of problems identified during the first and second meetings, and agree recommendations that will make it possible for policymakers, donors, governments, and frontline agencies to take these solutions to action. The working group expects to report during the fourth quarter of 2016.
Owen Barder, Vice President, Director of CGD Europe, and Senior Fellow at the Center for Global Development
Professor Dr. Stefan Dercon, Professor of Economic Policy and Chief Economist, University of Oxford and DFID
Working Group Members
Professor Dr. Alex De Waal, Research Professor and Executive Director of the World Peace Foundation, Tufts University
Alice Albright, CEO, Global Partnership for Education
Aniket Shah, Program Lead– Financing for Sustainable Development Initiative, Sustainable Development Solutions Network
Dr. Cindy Huang, Visiting Fellow, CGD
Dan Preston, Assistant Professor and Deputy Director for Global Initiatives, University of Indiana
Dr. Daniel Clarke, Senior Disaster Risk Financing and Insurance (DRFI) Specialist, World Bank
Debbie Hillier, Senior Humanitarian Policy Adviser, Oxfam
Dr. Ginger Turner, Senior Economist and Vice President, Swiss Re
Dr. Gordon Woo, Catastrophist, Risk Management Solutions
Dr. Joanna Macrae, Previously: Head, Humanitarian Policy Team, and Head of Humanitarian Evidence and Innovation Programme, DFID
Rachel Turner, Director, International Finance Division, DFID
Ravi Gurumurthy, Vice-President, Strategy and Innovation, International Rescue Committee
Rowan Douglas CBE, CEO, Capital, Science & Policy Practice and Chairman, Willis Research Network, Willis Towers Watson
Sean Lowrie, Director, The Start Network
Dr. Simon Young, CEO, African Risk Capacity Insurance Company
His Excellency Ato Sufian Ahmed, Advisor to the Prime Minister and former Minister of Finance, Government of Ethiopia, Government of Ethiopia
William Dalziel, Partner and Head, Institutional Division, London & Capital
Claire Horton, Special Assistant to the Chief Executive Officer, Global Partnership for Education
Deirdre O'Sullivan-Winks, Programme Director of ACRE and Inclusive Business, Christian Aid
Emma Williams, Joint Deputy Head of the Private Sector Division, UK Department for International Development
Ian Clark, Head of Unit for Disaster Risk Management, Joint Research Centre of the European Commission
Sophie Evans, Programme Director for the Capital, Science, & Policy Practice, Willis Towers Watson