Calculations about the risky business of climate change
'Insurance is often misunderstood. Many people feel like they are paying into a bank account and one day they get to draw out what they put in. But insurance is about dealing with uncertainties and sharing risk, rather than putting away money for a rainy day. You should actually pay the premium in the hope that you never have to claim and on the understanding that your premium may be used to help others who suffer misfortune,' says Bob Ward who manages policy and communication issues for the ESRC Centre for Climate Change, Economics and Policy, a joint venture between LSE and the University of Leeds.
Clearly the kinds of things that we insure ourselves against such as loss of property, livelihood, life and flood damage are not incidents that we willingly invite upon ourselves. But invited or not, extreme weather events and the associated disasters that they bring with them will become more likely because of climate change in the coming years.
And this is true however successful we are in cutting emissions of greenhouse gases in the future. Because of lags in the climate system, the climate of the next few decades has been set in train by the emissions we have already pumped into the atmosphere.
While richer nations will be able to weather the impacts to a certain degree, it is the poorer nations – where the effects are expected to be greatest – that will suffer most. This is why one of the issues for the next round of UN climate talks in Copenhagen in December 2009 will be about whether developed nations should fund developing countries to help them adapt to the effects of climate change. Part of these discussions will be around whether money from any such 'adaptation fund' should be used to finance the establishment of insurance in developing countries.
Dr Nicola Ranger works on a programme of research at the ESRC Centre that is funded by Munich Re, one of the world's largest reinsurance companies, providing insurance to insurers. The programme is focused on evaluating the economics of climate risks and opportunities for the insurance sector. A major theme of this programme in the run-up to Copenhagen considers how insurance and risk reduction measures could work together in developing countries to help manage risks from climate change, by looking at the experience of, and learning from, the lessons of the developed world.
Dr Ranger says: 'We have very well-established insurance systems in the developed world which tend to cover 40 per cent of the costs of catastrophes. Government and individuals reduce risks but it is not cost-effective to try to eliminate them entirely. Insurance companies cover the remaining risks. In contrast, in the developing world it is individuals – usually poor people – who bear the largest portion of the risk they are exposed to.'
Insurance to spread these risks in the developing world could be introduced at a number of different levels. At the governmental level the Caribbean Catastrophe Risk Insurance Facility (CCRIF) is one viable model. It is one of the world's most successful regional insurance funds and insures Caribbean governments against financial losses caused by catastrophic hurricanes and earthquakes.
'The advantages of insurance over, for example, a country receiving international disaster assistance is that you know how much you are going to get and when,' explains Bob Ward. 'Extreme weather events, such as hurricanes, can have massive economic impacts and it's very difficult for small countries to recover from them, particularly if they don't know how much disaster relief they might receive, or when it will arrive.'
At the individual level, micro insurance schemes provide insurance for poor people against, for example, crop damage. These schemes use a trigger, such as a certain wind speed or level of drought, to determine when farmers get a pre-determined pay-out. The key thing is that no one has to check a claim and this saves what would be a considerable administrative cost.
In spite of these benefits there are limitations to insurance, not least the tension it can create with encouraging action to reduce risks from disasters – such as improving building codes or putting in place evacuation procedures.
Ranger says: 'One of the concerns is that insurance, by transferring the risk away from the person who is exposed, can actually disincentivise them from doing anything to reduce their risk. So, on an individual level, if as a homeowner you know that you are going to get a payment if you get flooded, you might not take any action to prevent that, and that's a problem, particularly in a world of possible increases in risks due to climate change.
'The thing about insurance is that it can only financially compensate you for a loss. So your house is still destroyed and, more seriously, there are still injuries and loss of life. This is particularly a problem in developing countries. In the developed world, governments have enough money to protect our lives through, for example, implementing certain safety standards. But in the developing world and particularly the least developed countries, this is not necessary the case. Any system which discouraged risk reduction measures would be very bad.'
One example from the developed world where insurance actually works to incentivize risk reduction is the UK where flood insurance is usually available as part of most home-owners' policies. This is maintained through an agreement between the government and flood insurance companies. Insurance companies agree to provide insurance if the government invests in flood defences thereby encouraging the government to do its part.
Ranger says: 'At the moment we're trying to work out how insurance mechanisms in the developing world can help people to manage current and future climate risks. There's lots of questions coming up about how much it will cost, who should be running it and the roles of the public and private sectors. As part of our work we will be running a symposium in October that will bring together academics, insurers and policy makers to discuss some of these issues with the aim of feeding outcomes into the Copenhagen conference.'
Is this all just cynical move by insurance companies to move into new markets? Bob Ward counters: 'Insurance only works because people feel that it benefits them – that it helps them deal with adversity and disaster in their lives. You may be uncomfortable that insurance companies profit from that but that's like complaining that doctors make money because we get sick.'
Centre for Climate Change, Economics and Policy