Food, Agriculture and Natural Resources Policy Analysis Network (FANRPAN) Food, Agriculture and Natural Resources Policy Analysis Network (FANRPAN)
Site map|Contact us  

 


Investigating the Impact of climate change on the robustness of index-based microinsurance in Malawi
May 2008
S Hochrainer, R Mechler, G Pflug, A Lotsch
The World Bank

Acknowledgements: FANRPAN acknowledges The World Bank as the source of this report: www.worldbank.org


Abstract

This analysis explores the potential impact of climate change on the viability of the Malawi weather insurance program making use of scenarios of climate changeinduced variations in rainfall patterns. The analysis is important from a methodological and policy perspective. By combining catastrophe insurance modeling with climate modeling, the methodology demonstrates the feasibility, albeit with large uncertainties, of estimating the effects of climate change on the near and long-term future of microinsurance schemes serving the poor. By providing a model-based estimate of the incremental role of climate change, along with the associated uncertainties, this methodology can quantitatively demonstrate the need for financial assistance to protect micro-insurance pools against climate-change induced insolvency. This is of major concern to donors, nongovernmental organizations, and others supporting these innovative systems; those actually at-risk; and insurers. A quantitative estimate of the additional burden that climate change imposes on weather insurance for poor regions is of interest to organizations funding adaptation.

Introduction

Adaptation to climate change has emerged on the climate agenda alongside the reduction of atmospheric greenhouse gas concentrations as an essential part of the response to climate change risks. The call for intensified support for adaptation in the developing world has been reinforced by the recent report from the International Panel on Climate Change (IPCC), which reports evidence of current climate impacts in the form of longterm and widespread changes in wind patterns and aspects of extreme weather including droughts, heavy precipitation, heat waves and the intensity of tropical cyclones (Solomon et al., 2007). Insurance-related instruments that spread and pool risks may be important candidates for supporting adaptation to climate-related disasters in developing countries (Linnerooth-Bayer, et al, 2002). International financial institutions, as well as some bilateral donor organizations, are already providing assistance for catastrophe insurance schemes that serve low-income clients in Latin America, Asia and Africa, and the World Bank is exploring the idea of a global facility for hedging developing country risk (World Bank, 2005a). As one important item, the Bali Action Plan, which should ultimately lead to a follow-up treaty to the Kyoto Protocol under the United Nations Framework Convention on Climate Change, calls for “…Enhanced action on adaptation, including, inter alia, consideration of risk management and risk reduction strategies, including risk sharing and transfer mechanisms such as insurance” (UNFCCC, 2007). To date, however, there is little understanding or agreement within the climate community on the role that insurance and other forms of risk sharing can play in assisting developing countries adapt to climate change.

Both development organizations and agencies responsible for climate-change adaptation are thus closely observing recent experience with micro-insurance schemes to ascertain their potential for reducing vulnerability to climate-related weather variability and extremes. Of particular interest is the pilot weather insurance scheme in Malawi, which offers index-based drought insurance to smallholder groundnut farmers. Although there is mounting evidence that climate change is and will continue to affect adverse weather extremes throughout Southern Africa (Solomon et al., 2007), to date, neither the Malawi scheme nor (to our knowledge) other disaster insurance schemes operating in developing countries have taken account of information from climate-change models.

This paper integrates climate-change modeling with insurance modeling in order to assess the effects of climate change on the viability of the Malawi insurance scheme. The research addresses the following questions:

  • Does climate change significantly increase the risk of insolvency of the Malawi microinsurance program (assuming farmers cannot pay higher premiums)?
  • What additional capital input would be necessary to reduce the risk of insolvency to an acceptable level?
  • What are the key uncertainties and how can they be expressed given the current state of climate and meteorological modeling and impacts assessment?

These questions are not only of interest to the Malawi program, but the development of methodologies to quantitatively estimate the additional risks of climate change to insurance programs is of interest to development institutions, as well as organizations supporting adaptation to climate change. Both communities could benefit from estimates of the burden that climate change will impose on the viability of the systems, as well as information on the additional capital needed to ensure their survival. For instance, if insurance programs are to qualify for funding from the Global Environment Facility (GEF), it is necessary to identify the extent to which climate change is adding to their costs or increasing the risks of their failure. This issue is not only of interest for disbursing climate adaptation funds, but generally for assessing the robustness of insurance and other mechanisms for managing climate risks in light of mounting evidence that climate change is and will continue to contribute to increasing losses from weather extremes.

Research in this field is only just emerging. Work on risk financing options for adaptation to climate variability and change is increasingly receiving attention (Müller, 2002; Linnerooth-Bayer et al., 2003; Bouwer and Vellinga, 2005; World Bank, 2005a; Bals et al., 2006; Linnerooth-Bayer and Mechler, 2006). Also, assessments of climate change impacts and vulnerability have changed in focus from an initial analysis of the problem to the assessment of potential impacts to a consideration of specific risk management methods (Carter et al., 2007). The implementation, analysis and donor support of risktransfer programs in developing countries has become feasible largely as a result of advances in modeling that make it possible to better estimate and price low-probability extreme event risks for which there are limited historical data. Catastrophe models typically generate probabilistic losses by simulating stochastic events based on the geophysical characteristics of the hazard and combining the hazard data with analyses of exposure in terms of values at risk and vulnerability of assets. In addition, there has been important progress in the mathematics of extreme value theory, and in the convergence of the theories of finance and insurance, rendering possible the pricing of more exotic risktransfer instruments, such as weather derivatives and catastrophe bonds (Embrechts et al., 1997; Geman, 1999). Furthermore, the modelling of the climate system has experienced substantial improvements. Global circulation models (GCM) have been improved from only accounting for land surface and cryosphere effects to capturing biosphere, carbon cycle and atmospheric chemistry as well. Also, regional climate models with a higher resolution (typically 50 km) have been developed in order to study local effects such as from mountains on climate. For example, the Hadley Centre has developed a PC version of such a model for any world region, the Precis model (Met Office, 2007). Such model development has led to new types of vulnerability and impact studies and is effectively being followed here.

Yet, insurance modeling (also called dynamic financial analysis1) and climate change modelling have rarely been brought together and operate in isolation. As Mills (2005) points out, insurance modelling has essentially been backward-looking with a focus on historical trends in order to price and offer short-term contracts; on the other hand, modelling by the climate change community is looking into longer time horizons in the future and has not been directly amenable to decision-support input for the insurance industry. Our paper should be understood as an attempt to link modelling in those two domains, advance the understanding of the potential of such analyses and outline crucial gaps to be filled by further research.

This paper provides a quantitative estimate of the potential impact of climate change on the viability of the Malawi weather insurance program, and assesses the uncertainties of this estimate. Insurance modeling and climate change modeling are integrated, and by combining the two, the methodology demonstrates the feasibility of estimating the effects of climate change on the near- and long-term future of microinsurance schemes serving the poor. By providing a model-based estimate of the incremental role of climate change, along with the associated uncertainties, this methodology can quantitatively demonstrate the need for financial assistance to protect insurance pools against climate-change induced insolvency.

The paper is organized as follows: Section 2 describes the Malawi scheme and its insurance characteristics and conditions in the context of microinsurance; Section 3 outlines the methodology used. Section 4 discusses data input, modeling details and the financial analysis conducted. Section 5 focuses on results, followed by conclusions.


Footnote:
  1. More detail on dynamic financial analysis can be found in section 3.

Top of page   -   Home   -   Contact us   -   Disclaimer
Food, Agriculture and Natural Resources Policy Analysis Network
FANRPAN Remote Access FANRPAN Webmail
Octoplus Information Solutions