WRI examines current insurance proposals under discussion in the UNFCCC and considers options for a global agreement in promoting insurance as a climate change solution.
The last several decades have seen growth around the world in economic damages from extreme weather events. Most of these losses are attributable to global population growth, the greater concentration of people and economic value in urban areas, and the worldwide migration of populations and industries into areas like coastal regions, which are particularly exposed to natural hazards. However, the increasing severity of climate forces has also contributed to this rising trend. Poor people and poor countries – those least able to cope with such damages – are likely to suffer disproportionately as these trends intensify under a changing climate.
Effective adaptation to climate change will require risk management strategies that can reach vulnerable people in the developing world. Insurance – a financial mechanism through which a policy-holder pays a premium to transfer the risk of future losses to an insurance provider — could be an important component of these strategies. But to provide the adaptation benefits that vulnerable people need, insurance schemes must be designed carefully.
Insuring Against Climate Change: A Challenge for Public and Private Decision-makers
As the climate changes and more people experience weather extremes, the insurance industry will be called upon to provide products and services to a large new set of customers. At the same time, the current supply of insurance could be negatively affected if insurers are unable (or unwilling) to cover climate-related losses under changing risk profiles. Insurance providers will have to develop innovative products and delivery systems if they are to expand coverage to the poor and vulnerable while simultaneously covering growing weather-related losses among those who already have access to insurance.
Private insurers alone are unlikely to succeed in this dual challenge of expanding and deepening insurance coverage in response to climate change. For this reason, a growing number of public entities – including the Parties to the United Nations Framework Convention on Climate Change (UNFCCC) – are considering their own role in helping to make insurance an effective adaptation option.
How Can Insurance Help in a Changing Climate?
Insurance is a form of ex-ante preparedness for economic losses and can help build resilience to shocks such as storms, floods, or drought. If designed and operated well, insurance can provide immediate financial relief when a climate hazard strikes, providing several resilience benefits that are becoming increasingly important as the climate changes:
At the household or business level, insurance can help prevent an extreme climatic event from leading to long-term reduction in assets. This helps to prevent a household from falling into a poverty trap, and enables a business to continue to grow.
At a government level, insurance can help prevent extended gaps in government services after an extreme event, and can speed reconstruction of roads, energy systems, and other important infrastructure. Doing so can help, broadly, to maintain economic, social, and political stability.
Parameterized insurance, where insurance payouts are tied to a physical parameter (or an index) like rainfall – rather than to actual losses – can be especially effective in addressing large weather-induced losses. Parameterization reduces the administrative costs involved in calculating insurance benefits, and speeds delivery of payouts to clients. It is also an important design element in insurance products for small farmers and other low-income consumers. Typical loss-based insurance products rarely reach these customers, due to the high transaction costs involved in providing a large number of very small insurance policies.
Types of Insurance for Negotiators to Consider
The adaptation stream of the post-Bali negotiations has seen extensive discussion of whether and how to address insurance through the UNFCCC. Types of insurance that have been discussed include:
Post-catastrophe Resource Fund:
The global community pays into a fund that directly supports the governments of vulnerable countries in contending with large-scale catastrophic losses caused by climate change. This is not true insurance, as there is no risk-based premium pricing. Solidarity funds (like the EU solidarity fund for disasters) and the proposed compensation mechanism both would function this way.
Subsidized Global Risk Pool:
The international community establishes a global risk pool and pays the premiums on behalf of vulnerable countries to insure them against the large-scale catastrophic losses related from climate change.
Sovereign Risk Pool:
Vulnerable country governments themselves share the
risks of weather-related catastrophic events by paying
into regional or global sovereign risk pools. (The Caribbean
Catastrophic Risk Insurance Facility is
an example of this type of risk pool.)
Commercial Insurance:
Individuals and companies purchase private insurance
to cover extreme weather and climate change related
risks.
Micro-insurance:
Poor and vulnerable individuals purchase specially designed
insurance products that cover small-scale household-
level losses due to weather extremes.
Insurance Proposals Under Discussion
Several proposals have been made regarding possible
insurance programs in the UNFCCC:
AOSIS
The Alliance of Small Island States (AOSIS) has
actively called for the Copenhagen agreement
to include insurance. They have submitted a detailed
proposal for creating a new global insurance
mechanism that would include “windows” for increasing
insurance coverage for climate impacts
and for supporting countries in promoting commercial
and micro-insurance.
AOSIS recognizes that insurance can have limits.
Beyond insuring for weather related damages, they
ask for compensation and rehabilitation funding to
address catastrophic climate losses that insurance
will not be able to cover, such as the inundation of
entire island nations.
MCII
A consortium of organizations called the Munich
Climate Insurance Initiative (MCII), which includes
private insurance companies, NGOs and universities,
has also submitted a detailed proposal for
a UNFCCC-led insurance program. Instead of
asking for compensation, MCII imagines a multilayered
insurance system with a subsidized global
risk pool that pays out to affected countries if they
are hit. Annex 1 countries would be expected to put
money into such a pool.
Like AOSIS, the MCII proposal includes a “pillar”
addressing commercial and micro-insurance.
Risk Reduction Proposals
Parties are also exploring ways through which insurance
can be integrated into larger risk reduction
and management strategies that are vital to adapt
to a changing climate. The AOSIS proposal leaves
the nature of non-insurance risk reduction activities
at the discretion of participating Parties; MCII
makes risk reduction a condition of access to the
insurance mechanism.
Some Parties (mostly Annex I countries) see insurance
as just one element of risk reduction and
have not supported the creation of a special UNFCCC
insurance mechanism.
The Next Step on Insurance: Deciding What Role the UNFCCC Should Play
The costs of insurance programs under discussion have
only been roughly estimated, and the overall pool of
adaptation finance available through the post-2012 regime
remains unknown. The initial level of finance may
constrain options for insurance program design, and
may force some difficult trade-offs between insurance
programs and other adaptation activities that could be
supported through the UNFCCC. This situation calls
for concrete and specific discussions about options for
the roles the UNFCCC should play in the promotion and
provision of insurance, and for the institutional arrangements
needed to support each option.
The role of a global institution like the UNFCCC in supporting
the provision of insurance may vary depending
upon:
- which type(s) of insurance Parties prioritize
- the scale of finance available
- Parties’ decisions about what roles are appropriate
and feasible
- Parties’ expectations regarding the roles of the private
sector and national governments
