Fundamental and Particular Risks

Climate insurance proposals

Introducing the term ‘insurance’ for the first time, the Alliance of Small Island States (AOSIS) suggested in 1991 that an ‘international insurance pool’ funded by industrialized (Annex II) countries be established under the control of the Conference of the Parties (COP) to compensate small-island and low-lying developing nations for the uninsured loss and damage from slow-onset sea-level rise. The pool would compensate developing countries (i) in situations where selecting the least climate sensitive development option involves incurring additional expense and (ii) where insurance is not available for damage resulting from climate change (Intergovernmental Negotiating Committee, 1991).

Mandatory contributions to the fund would be made to an administrating authority, which would also be responsible for handling claims made against the resources of the fund. As a basis for settling claims, the proposal contemplated that assets in developing countries potentially affected by sea-level rise would be valued and registered with the authority. Trigger levels (levels of sealevel rise that would legally require the payment of claims) would be subject to negotiation between individual countries and the authority. Importantly, in assessing claims, the authority was to determine whether and to what extent the loss or damage could have been avoided by measures which might reasonably have been taken at an earlier stage, thus avoiding the moral hazard of not taking appropriate preventive measures. Assets covered by commercial insurance would not be compensated by the scheme.

There are difficult challenges in implementing the AOSIS proposal. Valuing all properties and verifying loss claims in countries with no indigenous insurance structures would impose large transaction costs on the system. Determining ‘reasonable’ loss-reduction measures is also problematic. Nonetheless, the proposal was, and remains, a valuable first step in presenting concrete ideas on how developed countries could take financial responsibility for climate-change impacts accruing to vulnerable developing countries.

Müller proposal

Whereas the AOSIS insurance proposal addressed the gradual onset of sea-level rise, subsequent proposals have turned to sudden-onset weather events such as floods, tropical cyclones and sea surges (worsened by sea-level rise). Müller (2002) advocated a switch from the current international disaster relief system characterized by voluntary, media-driven and uncoordinated donations to a Climate Impact Relief Fund (CIRF), which is regularly funded up-front and centrally administered by the UNFCCC in order to increase efficiency and fairness. No ‘new money’ would be needed, since OECD or Annex II countries would donate to the fund proportionally to their current average post-disaster assistance spending. According to Müller, further options for such a fund could be to provide disaster preparedness support and adopt burden-sharing criteria, such as based on financial ability or a CO2-emission-based system.

Germanwatch proposal

The Germanwatch proposal for a Climate Change Funding Mechanism (Bals et al., 2006) builds strongly on the AOSIS and Müller proposals. The authors propose a global catastrophe insurance programme funded by developed countries and administered by a public/private entity. The scheme would be limited in scope by indemnifying only public infrastructure damage in least-developed countries (LDCs) and offering cover only for rare, high-consequence, climate-related risks. As an interesting innovation, there would be in-kind premium payments in the form of implemented loss-reduction measures by public clients who voluntarily join the scheme: the CCFM would define

minimum risk reduction measures to be undertaken by the country where the annual cost to the country is commensurate with the level of imputed risk-based premium.

Defining risk-reduction measures by an outside authority (for example, requiring squatters to evacuate areas targeted for flood-control dams) may be problematic, especially if not subject to government and stakeholder involvement. Moreover, least-developed countries may find it difficult to finance mitigation measures that cover the imputed risk-based premium. For highly exposed LDCs, this premium can be quite substantial. For example, in the recently introduced drought insurance programme in Malawi, annual premiums amounted to 6–10% of the insured crop value (Opportunity International, 2005). Finally, the strategy can be inefficient if the required measures are not cost-effective or high priority in the country.

The Germanwatch strategy also faces problems in its practical implementation. Besides costly monitoring of adaptation measures, post-disaster losses must be assessed to determine the triggering threshold. This will involve high transaction costs, especially in the less-developed countries lacking insurance infrastructure and claims handling expertise. It will also encourage overestimation of loss figures, which will be difficult to verify. Assessing risks, setting in-kind premiums, monitoring adaptation measures and settling claims will require a large administrative apparatus. Finally, targeting governments for claims payments poses the same problem that donors confront with post-disaster aid – payments in the hands of corrupt officials may not reach their intended purpose. Despite the drawbacks, the Germanwatch proposal and its predecessors have strong merits. They target the most vulnerable and encourage proactive risk management measures in highly exposed countries.