Insurance is a standard and effective method of sharing risk. Individuals and organisations buy it so that they can be compensated when hazards lead to death, injury or ill-health, or loss of property or income. This gives policy-holders the promise of some financial stability, and hence the confidence to invest (e.g. in home improvements) or expand (e.g. a business enterprise). Insurance companies protect themselves against major catastrophes by basing their insurance premiums on sophisticated mathematical calculations, spreading their own exposure across many different areas and types of risk and buying their own insurance cover (reinsurance).
Insurance is predominantly commercial. Decisions about whether to buy and sell insurance, what kinds of cover to provide and what premiums to set are determined by market forces. Governments do sometimes intervene, either through state schemes (to protect farmers against crop losses, for example), providing subsidies or by making some kinds of insurance cover compulsory (such as employers’ liability or motor insurance). In Japan private insurers are obliged by law to offer earthquake insurance, but are protected by a government-backed scheme, the Japanese Earthquake Reinsurance Programme: this enabled insurers to pay out quickly after the 2011 earthquake and tsunami.+O. Mahul and E. White, Knowledge Note 6-2: Earthquake Risk Insurance (Washington DC: World Bank Institute, undated), https://openknowledge.worldbank.org/handle/10986/16149. Governments also have a key role in policy-making and regulation for the financial sector generally, and can take on more active roles regarding risk-related financing. Other institutions can also force people to take out insurance: companies making loans to people to buy houses usually insist that they are insured.
Insurance can stimulate further risk reduction actions. Insurers may only provide cover in high-risk areas if governments provide adequate mitigation measures and emergency management systems. State crop insurance schemes allow farmers to take the risk of planting different crops, leading to greater diversification and security against individual hazards. In the United States, the National Flood Insurance Program, started in 1968, is a partnership between communities and the public and private sector that links the premiums paid to the level of protection. It offers flood insurance to home owners, renters and business owners if their community takes part in the programme. Once government emergency management specialists have certified that communities and households have put particular flood management and mitigation plans and measures in place, they are eligible for lower rates from the many commercial insurers involved in the scheme.+See https://www.floodsmart.gov/floodsmart/pages/about/nfip_overview.jsp. Many companies offer reduced premiums to individual clients who undertake mitigation measures, such as retrofitting houses against hurricanes or floods.
Because of the size of the global insurance industry and its obvious value in reducing risk through risk sharing and stimulating mitigation, DRR agencies have become interested in its potential for protecting the most vulnerable. However, because the industry is market-driven its success is based on confining its coverage to places where the risks can be calculated with some accuracy and certain minimum standards, such as building codes, can be enforced, and to people who can afford to pay. In effect, this means that coverage is largely limited to higher-income countries, and to wealthy people and larger businesses in middle- and low-income countries; the poorest and most vulnerable find it hardest to obtain insurance, and insurance companies have shown little interest in extending their coverage to such groups. Major disasters may cause companies to raise premiums substantially or even withdraw cover in high-risk areas. State insurance is available in many low-income countries, but premium levels still tend to be high and policies are aimed at the professional classes in urban areas. Even in wealthy societies, many people do not take out insurance. In such circumstances, the burden of financing recovery is often passed on to governments (which have access to risk transfer mechanisms such as insurance, regional risk pools and insurance-linked securities such as catastrophe bonds). Many people who do not take out insurance cover calculate that, in the event of a disaster, their national government will be obliged to compensate them for their losses anyway. All insurance schemes have to face up to the problem of ‘moral hazard’: where the sense of security and confidence of having insurance cover leads to people failing to take steps to reduce risk, or even to take greater risks.
Where insurance schemes for poor groups and individuals have been successful, they have generally originated in development programmes that have aimed at financial sustainability rather than profit. Such schemes are run mainly by MFIs but also by NGOs, cooperatives, governments and even some companies. Business involvement is often in partnership with non-profit organisations, where the business – usually an insurance company – typically provides technical expertise (e.g. actuarial calculations regarding risks and their likely costs), assistance with marketing, or underwriting. Some schemes have an outreach of a few hundred families but they can reach large numbers of people – millions, in a few cases. Terms and conditions vary widely, as do the administrative and financial structures used, but life insurance, which is one of the main forms of insurance on offer, is often compulsory: people who wish to borrow money or open a savings account have to take out an insurance policy. The other main kinds of coverage are health and property insurance.
The evidence available to date indicates that insurance programmes for poor people, especially life insurance, can be financially viable. Nevertheless, insurance is a risky business. To maintain financial stability, life policies generally exclude high-risk groups such as the elderly, and certain causes of death such as epidemics. Health insurance may exclude health care costs for AIDS-related treatment or injuries arising from involvement in riots or other civil unrest. All-risk coverage for property is rarely available. Schemes may have to be amended repeatedly to achieve the right balance between broad coverage and financial sustainability. This is particularly true of health insurance services, whose financial performance is much lower than that of life insurance. Another problem is delays in settling claims. This is partly the result of bureaucratic slowness, but partly inevitable where claimants live in remote villages or communications break down because of technical failures, environmental hazards or civil unrest.
Insurers have to put considerable effort into marketing their schemes to people unfamiliar with the concept and workings of insurance. Local-level approaches involving community meetings and regular discussions with field workers tend to be most successful. Once households understand insurance interest seems to be strong. People are also more likely to buy insurance when they see others in their community purchasing it and obtaining financial benefits from having done so. Non-economic factors can be important, especially trust in the product and the organisations selling and managing it. Where there is already a relationship of trust between the insurer and the community – notably where the insurer is an established MFI or NGO – a base of policy-holders can be built up quite quickly. There are also examples of successful mutual benefit societies, where insurance funds are set up by groups to provide cover for their members (see Case Study 12.4: Mutual insurance for farmers).
Fondos are non-profit mutual insurance funds for farmers in Mexico, formed by groups of farmers and growers and providing insurance only to their own members. Each member pays an annual premium, and surplus funds at the end of the year are reinvested in contingency reserves or spent on social projects. Over the years, the sums insured have increased significantly and insurance premiums have fallen. By 2012 there were 388 fondos, and nearly 1.5m hectares and over 16m animals were covered by the insurance programme. Insurance is available for crop failure and loss of livestock, damage to farmers’ property, death and accident or illness. For many years the government provided all of the reinsurance cover needed, but private reinsurers have begun to join. Admission to a fondo depends on its perception of a farmer’s capacity, and the scheme has been criticised in the past for excluding poorer, more vulnerable farmers.
World Bank, Fondos: Mexico’s Unique Agricultural Mutual Insurance Funds (Washington DC: World Bank, 2013), http://documents.worldbank.org/curated/en/2013/10/19538858/fondos-mexicos-unique-agricultural-mutual-insurance-funds; E. Adamsdale, Transferring Risk: Potential Partnerships between the Insurance Industry and the Humanitarian Sector (London: British Red Cross Society, 2002).
Micro-insurance+V. Tan, Microinsurance (London: Advocates for International Development (A4ID), 2012), http://a4id.org/sites/default/files/files/Short%20guide%20to%20Microinsurance.pdf. is specifically aimed at people living on low incomes. It follows accepted insurance practices, but there are significant differences in the way it operates. It charges low premiums and provides limited coverage, usually against specific risks. A variety of institutions provide micro-insurance: they include community savings and credit schemes, women’s associations, NGOs, credit unions, MFIs and commercial insurers. Micro-insurance procedures are adapted to their clients’ needs and capacities, being much simpler than those for conventional insurance and facilitating quick payouts in response to claims. This combines the convenience and flexibility of informal insurance, while retaining the security and reliability of formal programmes. Micro-insurance can play an important role in helping poor households to cope with everyday or extensive risks.
Micro-insurance can also be used to stimulate mitigation activities. Health insurance is sometimes linked to preventive and primary health care programmes run by the insurer concerned (if an NGO) or a partner organisation, and policy-holders may be expected to use such services. Technical support can be given to policy-holders to help them protect their property against common hazards. Non-profit and community organisations can also play a part in lobbying governments and others to establish non-profit insurance schemes or to encourage the spread of commercial insurance cover – if not for the poor, then at least for lifeline facilities such as hospitals, schools, power plants and bridges.
Micro-finance and micro-insurance can complement one another: while insurance can be effective for covering less frequent, larger shocks, other forms of financing such as savings and credit may be more flexible and efficient in addressing smaller shocks that occur on a more frequent and regular basis. Many MFIs have begun to offer insurance on micro-credit loans so that borrowers (and the MFIs themselves) will not be stuck with debt if their business is damaged by a disaster. There are also examples of linking micro-insurance to savings programmes, by allowing members of savings and credit groups to save for insurance through fixed deposits in savings accounts.
MFIs should proceed carefully if they wish to enter the micro-insurance business. They may lack the skills for assessing risk and computing appropriate premiums and contributions. They should have sufficient reserves and reinsurance for large as well as smaller disasters, bearing in mind that large events will also affect clients’ ability to pay their regular insurance premiums. There are concerns that micro-insurance may not be economically viable for the MFIs or NGOs that support them without subsidies (many micro-insurance schemes are subsidised). Schemes with large numbers of policies and clients are usually more secure in terms of exposure to risk and ability to obtain reinsurance. However, all micro-insurers need to be able to adapt to rapidly changing conditions in the financial services market and the regulatory environment. They cannot afford to stick to a fixed model, and they will inevitably have to balance their social goals against financial viability. Even the low costs of micro-insurance programmes may still be too high for very poor households.
Informal insurance and social security systems are already widespread among the poor in disaster-prone societies, especially in rural areas where communities and social structures are well established. Borrowing and sharing of goods, cash and labour are part of the social fabric in good times and bad. They comprise an important coping strategy during crises when those who are suffering can call on neighbours or kinsfolk for food, materials or other support. Exchanges of food form an important part of famine mitigation strategies in Sub-Saharan Africa. Funeral or burial societies are found throughout the world, their members pooling funds to cover expenses related to the death of another member. Traders and artisans may lend small amounts of money to one another to cover short-term cash flow problems.
In recent years, governments, financial institutions and international development agencies have become interested in using index-based insurance to protect assets, particularly in the agricultural sector. Index insurance is linked to an index, such as rainfall, temperature, humidity or crop yields and revenues, or to a combination of these, rather than to actual losses from droughts, floods or other hazards. Thresholds for these indices are set in advance, based on analysis of historical scientific, production and economic data: when the thresholds are exceeded, insurance payouts to farmers are triggered automatically, regardless of their actual losses. This makes the approach much simpler administratively, quicker, cheaper to operate and less expensive to purchase than conventional insurance, where each individual claim has to be assessed. It is therefore more affordable for small-scale and poor farmers.
Index insurance schemes have been piloted and promoted in a number of countries, including the Philippines (with programmes supported by Germany’s international development agency GIZ and the global reinsurance company Munich Re),+S. Prabhakar et al., Promoting Risk Financing in the Asia Pacific Region: Lessons from Agricultural Insurance in Malaysia, Philippines and Vietnam (Hayama: Institute for Global Environmental Strategy, 2013), http://www.asiapacificadapt.net. Malawi, Vietnam, India, Ethiopia, Brazil, Mongolia and Mexico (see Case Study 12.5: Index insurance for farmers). Index insurance requires certain conditions to be met. The indices and thresholds must be calculated objectively and reliably, and the process of calculation and premium setting must be transparent and public, in order to give farmers and others who purchase the insurance confidence in the system. Relevant data must be available and the data collection systems must be reliable: in the case of meteorological data, this can often be collected remotely from automatic measuring stations. However, in many places the quality and quantity of relevant data are limited, and this remains the main constraint on expanding the outreach of index insurance.
A flood and drought index insurance programme by Mexico’s state reinsurance company Agroasemex is designed to improve the distribution of government assistance to farmers in the event of climate-related crop failure. The scheme targets poor farmers, giving assistance for up to 5 hectares of land per farmer. It uses a rainfall index, with different payment thresholds according to the type of crop, stage in crop growth and geographical region. These indices are adjusted each year. The programme’s coverage grew from 75,000 hectares and five weather stations in 2002 to 1.9m hectares and 251 weather stations in 2008. By 2008, 800,000 low-income farmers had insurance cover and the total sum insured was $132m. Take-up was constrained by the limited number of weather stations producing usable data and by limited technical capacity. Rainfall and temperature simulations were used to replace missing historical data and develop projections of future rainfall.
M. Helmuth et al. (eds), Index Insurance and Climate Risk: Prospects for Development and Disaster Management (New York: Columbia University, 2009), http://iri.columbia.edu/wp-content/uploads/2013/07/Climate-and-Society-Issue-Number-2.pdf.