6 Dec 2023 - by A4ID

Micro-insurance & Climate Change

A4ID recently hosted a discussion on how groups vulnerable to climate change related loss and damage might mitigate such losses by insuring themselves against climate change related harm. We heard from three speakers: Christoph Schwarte of the Legal Response Initiative, Aaron Oxley of Results UK and Dr Swenja Surminski of the LSE.

What is Micro-insurance?

The role of micro insurance can be set against the backdrop of the United Nations Framework Convention on Climate Change (UNFCCC). At the Cancun Climate Change Conference in 2010, a work programme was established to consider approaches to address loss and damage resulting from climate change in developing countries. One of the proffered approaches was micro insurance, which is insurance of any type aimed specifically at low-income persons. More particularly it is:

“…the protection of low-income people against specific perils in exchange for regular premium payments proportional to the likelihood and cost of the risk involved.”[1]

Micro insurance is not a response to the long-term slow-onset changes being wrought by climate change, such as glacier loss and rising sea levels.  Insurance instead responds to the risk of particular events happening rather than long-term changes. Micro insurance can therefore mitigate against the impact of immediate events, to which the developed world is highly vulnerable, and that appear to be occurring with increasing frequency. These include drought, flooding and tropical storms. As with any insurance, a range of risks can be insured from health and life to agriculture.

The Benefits

The predicted impacts of climate change on farming, particularly the uncertainty over yields, make agriculture a prime candidate for micro insurance and the broad benefits of micro insurance are well illustrated by this area. Clearly the primary benefit is to compensate people who have suffered a loss of crops or livestock, but the potential wider benefits are huge. Insurance frees up money otherwise kept aside, which can be invested to generate income both in the short-term (buying seeds or farm equipment) or long term (investing in a child’s education).  Insurance also encourages investment in loss prevention, such as irrigation systems, as well as enabling farmers to secure the loans required to invest in such systems. After a damaging event occurs, rather than selling assets such as livestock or taking a child out of school to work, the policy holder can rely on a payment from their insurance policy.

The Challenges

The challenges faced by micro insurance are also typified by the farming sector.  Policies must be easily understood by populations with limited experience of insurance products and potentially limited literacy. Administrative costs must be minimised; investigating and adjusting the validity and quantum of each claim is prohibitive. One solution to this is index-based insurance: for example a policy can pay if a weather station in the vicinity of the insured’s farm records either insufficient or excessive rainfall. This is turn throws up problems with ‘basis risk’, which is the risk that the data from a weather station does not correlate with the farmer’s actual losses. This goes to the core of one of the micro insurance industry’s biggest challenges: convincing a sceptical public that the money they are handing over every month is well spent. It is therefore crucial that policies are seen to be paying out from the outset. Regulation of micro insurance will be another key area and the recent micro finance crisis in Andhra Pradesh[2] provides a salutary lesson. The potential fallout is particularly acute in micro insurance where the relative lack of understanding of insurance products and basis risk hinder market penetration. The industry will have to balance proper regulation with flexibility.

Micro-insurance Taking Root

As can be seen, if micro insurance is to take root in the farming sector, there will be many challenges. As a final point, one such challenge, which is often held as both a final and necessary end goal for micro insurance, is whether it can exist without contributions from governments or other funders. Given the difficulties outlined above, this ‘goal’ does not currently look achievable. Is this a problem?  It should not be. Farming in the developed world benefits from many government subsidies and to see farming in the developing world as different is a mistake; micro insurance is in reality just the efficient sharing of risk, and this is something in which we should be investing.