Promoting Risk Insurance in the Asia-Pacific Region: Lessons from the Ground for the Future Climate Regime under UNFCCC

Abstract

Climate change has brought an additional dimension to disaster risks in the Asia-Pacific Region as it is projected to exacerbate the intensity and magnitude of various natural hazards such as storms, high-intensity rainfall events, heat waves, floods and droughts. Risk transfer has been widely advocated as one of the best means of risk mitigation across the world. In order to address additional risks brought by the impact of climate change, there is a need to reassess and re-frame the current risk reduction strategies especially in terms of development and utilization of risk-spreading instruments within the Asia-Pacific Region. Keeping this in mind, this chapter reviews the current status of risk insurance and identifies emerging issues and experiences.

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22 Promoting Risk Insurance in the
Asia-Pacific Region: Lessons from
the Ground for the Future Climate
Regime under UNFCCC
S.V.R.K. Prabhakar1, Gattineni Srinivasa Rao2,
Koji Fukuda1& Shinano Hayashi1
1Institute for Global Environmental Strategies, Japan
2Niruthi Climate and Ecosystem Services, India
22.1 Introduction
An increase in the number of catastrophic disasters
and related insured and uninsured losses has been
reported (Munich Re, 2010) undermining the devel-
opmental gains across the world. The Asia-Pacific
Region is one of the regions most vulnerable to a
range of primary hydro-meteorological and geological
natural hazards such as earthquakes, storms, floods,
tsunamis, landslides and droughts. The Emergency
Events Database (EM-DAT) of the Center for Research
on the Epidemiology of Disasters (CRED) suggests that
specifically the number of hydro-meteorological dis-
asters over the 2000–09 period was 10 times more
than the number of disasters reported during 1947–
56 (CRED, 2010). In the Asia-Pacific Region, the
hydro-meteorological disasters have claimed the lives
of 0.22 million people with estimated total economic
damage costs of 285 million US$during 2001–12
(CRED, 2012).
The region’s high vulnerability to natural hazards
compared to other regions in the world, is primarily
caused by a range of geophysical, socioeconomic and
developmental conditions. These include a long coast-
line of 187 193 km, a highly variable monsoon sys-
tem, high volcanic and tectonic activity, high poverty
both within and outside of urban areas, high popu-
lation densities associated with massive immigration
to cities, poorly planned urban development, absence
of proper disaster risk mitigation mechanisms and
institutional/regulatory frameworks including preva-
lence and enforcement of structural standards such as
building- and land-use planning regulations, as well
as the poor development of risk spreading instruments
such as risk insurance systems. The data available since
1900 show a steady increase in economic losses and a
plateauing trend in loss of lives from disasters caused
by natural hazards in the Asia-Pacific Region (CRED,
2012). During 1960 and 2010, the average per capita
deaths and average per capita economic losses were
significantly higher in developing countries than in
developed countries in the Asia-Pacific Region (CRED,
2012). A disaster of the same intensity can lead to
a greater number of deaths and higher economic
damage in developing countries (e.g. Bangladesh and
Climate Change Adaptation in Practice: From Strategy Development to Implementation, First Edition.
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Philippines) than in developed countries (e.g. Japan)
(Mechler, 2004). This clearly indicates differences in
exposure and vulnerability between developed and
developing countries of the Asia-Pacific Region. What
is noteworthy as well is that the loss of assets and
related livelihoods significantly limit returning the
affected population to their normal life irrespective
of the developmental state of a country and hence,
the protection of assets deserves greater attention
(Vatsa, 2004).
Climate change has brought an additional dimen-
sion to disaster risks in the Asia-Pacific Region as it is
projected to exacerbate the intensity and magnitude of
various natural hazards such as storms, high-intensity
rainfall events, heat waves, floods and droughts (IPCC,
2007; Kunreuther and Michel-Kerjan, 2007). Espe-
cially, the projections suggest high probability for an
increasing trend in the high-intensity and low prob-
ability events. These increased catastrophic risks will
further undermine the developmental gains already
made in the Asia-Pacific Region.
Take, for example, the case of the agricultural sec-
tor which is one of the sectors in the region that is
highly vulnerable to climate change. Farming com-
munities in particular are at greater risk to weather-
related crop failures. Often, farmers borrow loans from
local banks prior to the cropping season. However,
farmers, banks and governments are exposed to higher
financial risks due to an increasing frequency of crop
failures, and in many cases the governments are forced
to waive the loans. In the case of India, estimates sug-
gest that the government waived crop loans totaling
14.4 billion US$in 2008 (Kanz & Robert, 2011). Sim-
ilar incidences are observed across other countries in
the Asia-Pacific Region (e.g. bailout of Thai farmers
in 2010) (Sompo Japan Insurance Inc., 2010; Kanz &
Robert, 2011).
Hence, in order to address additional risks brought
by the impact of climate change, there is a need to
reassess and reframe the current risk reduction strate-
gies especially in terms of development and utilization
of risk-spreading instruments within the Asia-Pacific
Region. Keeping this in mind, this chapter reviews the
current status of risk insurance and identifies emerg-
ing issues and experiences. Those are compared with
various risk insurance proposals made by the COP to
the UNFCCC for assessing the extent to which they
can promote the risk insurance.
22.2 Risk Insurance and Climate
Change Adaptation
The concept of risk transfer or risk spreading entails
that the individual (the insured) risks are reduced by
spreading or transferring the risks from the insured
to the insurance provider (the insurer) since the
insurer is in a stronger financial position than the
insured (Njegomir & Maksimovic, 2009). The insur-
ance provider is able to insure the risks of the insured
to a great extent due to the fact that the insurer obtains
premiums from a large number of insured who are
at different levels of risks and by making sure that
the total amount of premiums collected exceeds the
underwriting of risks (termed as the law of large num-
bers). Insurance agencies in turn underwrite some of
these risks with reinsurance firms that provide the
needed buffer against losses related to catastrophic
events. In sum, the risk insurance scheme functions as
part of the social safety net through risk transfer mech-
anisms and thereby contribute to an enhancement of
the resilience of societies.
Risk transfer has been widely advocated as one of
the best means of risk mitigation across the world
(Siamwalla & Valdes, 1986; Arnold, 2008; Swiss Re,
2010a) and as a result of several advantages it:
rPromotes emphasis on risk mitigation compared to
the current response-driven mechanisms.
rProvides a cost-effective way of coping financial
impacts of climate- and weather-induced hazards.
rSupports the climate change adaptation by cov-
ering the residual risks uncovered by other risk
reduction mechanisms such as building regulations,
land-use planning and disaster risk management
plans.
rStabilizes rural incomes and hence reduces the
adverse effects on income fluctuation and socio-
economic development.
rProvides opportunities for public-private partner-
ships.
rReduces burden on government resources for post-
disaster relief and reconstruction.
rHelps communities and individuals to quickly renew
and restore the livelihood activity.
rAddresses a wide variety of risks emanating from cli-
matic and non-climatic origin, depending on the way
the insurance products are designed.
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CHAPTER 22 Promoting Risk Insurance in the Asia-Pacific Region
22.3 Current state of risk insurance in
the Asia-Pacific Region
The prevailing insurance widely observed in the Asia-
Pacific Region could be broadly classified into health-
and non-health-based insurances which are offered
both by the governmental insurance programmes and
by private insurers. The most popular form of insur-
ance is the life insurance where the insurance com-
panies pay for the insured party’s death or other risks
such as critical terminal illness. Other forms of insur-
ances cover for health, vehicles, properties, liability,
credit, housing and crop among others. Though both
life and non-life insurances have a stake in disaster
risk reduction, promoting the non-life insurances is of
paramount importance in the region due to its poor
spread compared to the life insurance.
Among the world regions compiled by Swiss Re,
the non-life insurance penetration indicated by pre-
mium volumes is highest in North America fol-
lowed by Western Europe and South and East Asia
(Figure 22.1; Swiss Re, 2010b). Within Asia, the non-
life insurance penetration is highest in Japan followed
by China, South Korea, Taiwan and India. In gen-
eral, the spread of health insurances in the region is
much higher than that of the non-health insurances
overlooking the premiums, though the magnitude
varies between developed and emerging economies.
Car insurances and insurances for industrial and com-
mercial establishments are among the dominant forms
of non-life insurances in the region.
It should be noted that most insurance mechanisms
have been conceptualized and developed largely in
the developed country markets and are being adapted
in the developing countries. While most high-income
households in the developing countries pay their own
insurance premiums, most of the premiums of the
low- and middle-income families are often enrolled by
their employers (O’Donnell et al., 2008).
The poor spread of the insurances remains a con-
cern for the Asia-Pacific Region, especially in the
non-health disaster risk insurance sector, and it is
attributed to the following factors:
1. Affordability: The issue of affordability could be
put at the top of all the bottlenecks limiting the
spread of risk insurance in the developing Asia-Pacific.
Though insurance premiums in the majority of those
countries are lower than in the developed coun-
tries, the annual insurance premium costs are still not
affordable for most of the income groups. Part of the
high insurance premium costs emerge from the high
residual risks and the low number of insured persons
(i.e. poor development of the insurance portfolio).
2. Residual risks: High residual risks are one of the
major causes for the poor risk insurance coverage in
the region. The high residual risks exist due to poor
disaster risk mitigation mechanisms as well as the poor
enforcement and inadequacies of laws, respectively,
such as building regulations, structural codes and laws
pertaining to land-use planning.
3. Presence of insurers and reinsurers: One of
the reasons for the poor penetration of insurances
as well as insurance prices above affordability is the
limited presence of private insurers and reinsurers.
Reinsurers play an important role in providing shock-
absorbing capacity to the insurers. To date, very few
national (e.g. General Insurance Corporation in India,
Africa
Central & Eastern Europe
Japan & Industrialized Asia
Latin America & Caribbean
Middle East & Central Asia
North America
Oceania
South & East Asia
Western Europe
75
590
17 67
703
34
161 67 22
Figure 22.1 Penetration of
non-life insurances indicated
by premium volumes in
different world regions (in
billion US$).
Source: Swiss Re, 010b2010b
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China Reinsurance Company in China, Zenkyoren or
Zenkoku Kyousai Seikatsukyoudoukumiai Rengou Kai in
Japan) and international reinsurers (e.g. Munich Re,
Swiss Re, Toa Re, Axis Re) operate in the region.
Hence, there is a high potential for the expansion of
the reinsurance sector. Insurers and reinsurers cannot
afford to operate in the region unless there is a suffi-
cient enabling environment including efforts to reduce
the residual risks.
4. High premium costs: The high residual risks, lack
of optimum number of insurers, low competition, and
low number of insured parties all lead to the premium
costs being higher than what they could be in the Asia-
Pacific Region.
5. Policy environment: Though risk insurance is a
‘market instrument’, its dynamics are determined or
governed by the principles of an open market, gov-
ernment policies and regulatory guidelines which act
as precursors for a flourishing of the sector and ensure
the effectiveness of the instrument. Hence, the role of
the government in promoting the culture of risk mit-
igation through awareness-raising activities, as well
as designing and implementing structural and non-
structural disaster risk mitigation codes/laws, which
include institutional mechanisms and conducive reg-
ulations, is paramount.
Though there has already been a significant
improvement of policy support for the insurance sec-
tor, as apparent from the high growth rates of the
insurance sector in the region, the support is still not
comprehensive enough. For example, currently, most
developing countries in the Asia-Pacific Region are at
the nascent stages of formulating national disaster risk
mitigation plans and policies (GFDRR, 2009) and they
have not fully utilized the potential of risk insurance
in promoting risk reduction. Traditionally, most gov-
ernments propagate disaster response rather than mit-
igation to hinder the public participation in risk insur-
ance schemes (Yucemen, 2008). Limited financing is
the major reason behind the poor emphasis of disaster
risk mitigation in the region.
6. Cultural and perceptional issues: A general lack
of awareness and misplaced perceptions about deal-
ing with risk in general and risk insurance in par-
ticular among the common people and the business
sector is also an obstacle (Yazici, 2007; Yucemen,
2008). Sociological research has indicated the exis-
tence of behavioural patterns that can be characterized
as ‘lethal attitude’, that is, things will happen whatever
is done and things are beyond ones’ control. As a con-
sequence, the individual willingness to mitigate risks
is limited.
7. Lack of data: Infrastructure for collecting and
managing systematic and comparable data on past
risks, vulnerabilities, disasters and the nature of dis-
aster losses provides important information on design-
ing risk insurance schemes. In fact, this infrastructure
is neither fully developed nor readily available and
accessible to the risk insurance industry as well as to
the general public in most of the developing countries
in the Asia-Pacific Region.
Another important challenge, which has not gained
much attention in the region yet and which could
undermine the implementation of an effective insur-
ance facility, is that of liability. Insurers will have
to deal with it when failing to report their climate-
related risks to their shareholders (O’Connor, 2005;
Kunreuther & Michel-Kerjan, 2007). Besides, the
probability of high insurance payouts increases due
to the greater uncertainty and higher frequency of
occurrence of extreme weather events in a chang-
ing climate that could lead, for example, to crop
failures/harvest losses at increasing intervals (Iizumi,
Yokozawa, Hayashi & Kimura, 2008). As a result of
these limitations, most of the initiatives could not be
effectuated and there are still large, sometimes even
important regions as well as socio-economic groups
that could not benefit from insurance-related instru-
ments.
Thus it appears that most of the above factors
are interlinked and that the situation is akin to the
‘chicken and egg’ dilemma. In order to promote the
risk insurance in the Asia-Pacific Region, there is a
need to overcome these limitations. In this regard,
drawing lessons from some of the existing examples of
implementing risk insurance in the Asia-Pacific Region
and elsewhere can provide insights into how to over-
come these limitations.
22.4 Case study of current experiences
At present, several pilot projects exist within and
outside the Asia-Pacific Region that provide practical
knowledge of promoting risk insurance (Table 22.1).
One of the features of existing examples is that most
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CHAPTER 22 Promoting Risk Insurance in the Asia-Pacific Region
Table 22.1 Selected cases of risk insurance mechanisms from the Asia-Pacific Region and elsewhere
S No Case
Geographical
coverage Hazards covered Direct benefactor
Payment
trigger
1 Caribbean Catastrophe
Risk Insurance Facility
Caribbean
(Regional)
Hurricane and
earthquakes
National
governments
Parametric
2 Mexico cat bonds Mexico Earthquakes and
hurricanes
Government Parametric
3 Turkish catastrophic
insurance pool
Turkey Multi-peril (Currently
earthquake only)
Building owners Indemnity
4 BASIX-ICICI Lambard
microinsurance
Andhra Pradesh,
India
Monsoon failures Farmers Index
5 Indian National
Agricultural
Insurance Scheme
All over India Crop failure due to a
range of conditions
Farmers Indemnity
6 Agricultural weather
index insurance
Thailand Crop failure (Maize and
rice)
Farmers Index
7 Crop insurance in Japan Japan Crop failure (Rice) Farmers Indemnity
8 Microinsurance for
cooperatives
Philippines Protect loan portfolio
from typhoons
Cooperatives and
farmers
Parametric
Sources: Abousleiman, Zelenko and Mahul, 2011; Ghesquiere, Mahul, Forni and Gartley, 2006; Manuamorn, 2007; Munich Re, 2011;
Sompo Japan Insurance Inc., 2010; Yazici, 2007.
of these experiences emanate from efforts to promote
disaster risk reduction funded by the multi- and bilat-
eral assistance organizations implemented at the local,
regional and national level.
The Caribbean Catastrophic Risk Insurance Facil-
ity (CCRIF) is probably the epitome. It is the only
insurance facility implemented and with premiums
pooled on the regional level in which national gov-
ernments pay the premiums for the insurable risks
assessed at the national level. There are a num-
ber of examples for national level insurance facilities
(e.g. Mexico cat bonds, Turkish catastrophic insur-
ance pool, and Indian national agricultural insur-
ance scheme, Japanese rice insurance) and numer-
ous examples at the local level mostly implemented
by non-governmental organizations (e.g. BASIX-ICICI
Lambard microinsurance in India). Among the local
level experiences, India and Mexico are reported to
have well developed weather-based insurance pro-
grammes (Barnett & Mahul, 2007).
22.4.1 Weather index insurance is the way:
Experiences from India
National policy environment
Around 70% of Indian agriculture is susceptible to
the vagaries of the monsoon and other factors beyond
the control of farmers. As a result, Indian agriculture
has always been affected by nature’s caprices. Each
agro-climatic region requires different cropping plans
as well as a distinct policy regime. With this in mind,
the government of India has initiated several policy
initiatives to address various risks faced by farmers in
the country:
(i) Programme based on ‘individual’ approach (1972–
78): The first-ever crop insurance programme was
introduced in 1972 to cover H-4 cotton in Gujarat
and was later extended to a few other crops and
states.
(ii) Pilot Crop Insurance Scheme – PCIS (1979–1984):
PCIS was introduced on the basis of a report by
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Prof. V. M. Dandekar (Dandekar, 1976) presenting the
‘Homogeneous Area’ approach. The scheme covered
food crops (cereals, millets and pulses), oilseeds, cot-
ton and potato and was confined to borrowing farmers
on a voluntary basis.
(iii) Comprehensive Crop Insurance Scheme – CCIS
(1985–99): The scheme was an expansion of PCIS
and has made insurance compulsory for borrowing
farmers.
(iv) National Agriculture Insurance Scheme – NAIS
(1999): NAIS (i.e. area yield index based crop insur-
ance programme) replaced CCIS in the year 2000.
Despite it being ideally suited for Indian conditions,
the scheme has some shortcomings. The most impor-
tant one is ‘basis risk’ as the area (insurance unit) is
rarely homogenous. As the index is based on yield,
the insurance covers primarily the processes between
sowing and harvesting, but pre-sowing and post-
harvest losses are not reflected in the yield index.
Another challenge is the infrastructure and manpower
required to conduct millions of crop cutting experi-
ments (CCEs) across the country to estimate the yield
of crops. The process also contributes to a delay in the
settlement of indemnities as the CCEs can take several
months. Moreover, yield index based insurances can
be designed only for those crops for which historical
yield data for at least 10 years (at insurance unit level)
exist. Despite these shortcomings, the area yield index
crop insurance operational in India is still regarded as
one of the most illustrious crop insurance programmes
in the world.
(v) Modified National Agricultural Insurance
Scheme (MNAIS): The government announced a
pilot project on an experimental basis in selected
states and districts which is an improved version of
NAIS titled ‘Modified NAIS’ (MNAIS). The new ver-
sion bridges to a large extent the gaps of the existing
NAIS.
The following are a few salient features of MNAIS:
a) Insurance unit for major crops is the village Pan-
chayat or other equivalent units.
b) In case of prevented / failed sowing, claims up to
25% of the sum insured are payable, while insurance
cover for subsequent periods gets terminated.
c) Post-harvest losses caused by cyclonic rains are
assessed at farm level for the crop harvested and left
in ‘cut and spread’ condition up to a period of two
weeks.
d) Individual farm level assessment of losses in the
case of localized calamities like hailstorm and land-
slide.
e) Payment on account of up to 25% of likely claim
in advance, for providing immediate relief to farmers
in the case of severe calamities; and
f) Threshold yield based on average yield of past seven
years excluding up to two years of declared natural
calamities.
One of the major issues in implementing MNAIS is
that the insurance unit for major crops has been low-
ered to village Panchayat which is good for the farm-
ers but increases exponentially the work load of CCEs.
Many states are moving away from the pilot because
of the enormity of the work load. Some states are
requesting that the federal government shares parts of
the costs of CCEs. From the insurer’s point of view,
accurate and timely data are needed to price the prod-
uct accurately and to make timely payouts.
Risk insurance experiences in India
Significant experimentation and pilot projects have
been taken up since 2003 in various states by all
the major insurance service providers (Table 22.2). To
provide risk cover to farmers, weather index insur-
ances are better placed. Advocates of index-based
insurances argue that it is transparent, inexpensive to
administer, enables quick payouts and it minimizes
moral hazard and adverse selection problems associ-
ated with other risk-coping mechanisms and insur-
ance programmes (Gin´
e, Townsend & Vickery, 2007;
Hellmuth et al., 2009). Most importantly there are
many low-income countries for which no historical
data are available, except for weather data, afford-
ing an opportunity to try out index insurances of
some kind. As a result, weather index-based insur-
ances caught the imagination of policy makers at the
beginning of the 21st century. Development institu-
tions like the World Bank initiated pilot projects of
this form of crop insurance in low-income countries
where traditional crop insurances could not take off
for various reasons that include unavailability of his-
torical yield and/or loss data. The underlying principle
for weather index insurances is the quantitative rela-
tionship between weather parameters and crop yields.
There are various crop modeling and statistical tech-
niques to estimate the impact of deviations in weather
parameters on the crop yields (Rao, 2011).
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CHAPTER 22 Promoting Risk Insurance in the Asia-Pacific Region
Table 22.2 Comparison of various local initiatives of risk insurance in India
S
No Case
Geographical
coverage
Hazards
covered
Direct
benefactor
Payment
trigger
Benefits
accrued
1 Weather Insurance
by ICICI Lombard
General Insurance
Company (BASIX
as local partner)
Mahabubnagar
District, Andhra
Pradesh during
kharif 2003
Rainfall Farmers Excess and deficit
rainfall
Claim amount to be
adjusted against the
crop loan
2 Mausam Bima
Yogana by IFFCO
Tokio General
Insurance
Company
Coimbatore
District, Tamil
Nadu during rabi
2008
Rainfall Farmers and State
Cooperatives
Excess Rainfall
3 VarshaBimaby
Agriculture
Insurance
Company of India
Limited (AIC)
Selected districts
in 15 states in the
Country
Rainfall Farmers Sowing failure and
deficit rainfall
during various
phenophases
Partial payments as
per the case during
the crop cycle
4 Weather Based
Crop Insurance
Scheme (WBCIS)
by AIC
Whole Rajasthan
along with various
other states
Rainfall,
temperature, frost,
heat wave and
relative humidity
Farmers Excess and deficit
rainfall, deviation
from the normal
temperature and
relative humidity
i. Trigger events can
be verified
independently; ii.
Quick settlements
of indemnities; iii.
Covered all ranges
of farmers
5 Weather Insurance
by ICICI Lombard
General Insurance
Company
Nagapattinam,
Tamil Nadu
Rainfall Gujarat Heavy
Water Chemicals
Limited for Salt
Industry
Rainfall disruption
for salt
preparation
Hedging against
rainfall
6 Weather Based
Crop Insurance
Scheme (WBCIS)
by AIC
Nashik,
Maharashtra
Rainfall,
temperature and
Relative Humidity
Vine Making
Industry
Disease and pest
incidences
considering
weather as proxy
Hedging against
weather for selected
period of risk
7 Bajaj Allianz
microinsurance
All over India Life, asset
damage, accidents
etc
Rural communities On maturity or
damage
Accidental death
benefit & accidental
permanent total /
partial disability
benefit
The first pilot project of weather index insurance
in India was carried out in 2003 by ICICI Lombard
General Insurance Company Limited which was fol-
lowed by projects of Agriculture Insurance Company
of India Limited and IFFCO-Tokio General Insurance
Company Limited, both during 2004. An impressive
repository of historical weather data, high dependence
on rain fed agriculture and a huge pool of scientific
resources place India at the forefront in piloting dif-
ferent models of weather index insurance. The gov-
ernment’s realizing of the need for encouraging pilot
projects of this risk management tool has supported
weather index insurance programmes from 2007
onwards by providing financial support in the form of
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premium subsidy paid up-front. The weather param-
eters that have been incorporated so far in weather
index insurance include rainfall (deficit, excess, num-
ber of rainy days, consecutive dry days and wet days),
temperature (minimum for frost, hourly chilling units,
maximum for heat wave, mean etc.), humidity and
wind speed.
Rao (2011) reported that, from 2007 onwards,
both borrowed and non-borrowed farmers are covered
under this scheme. Between 2010 and 2011 as many
as 15 states have implemented the project Weather
Based Crop Insurance Scheme (WBCIS) in over
100 districts covering more than 800 blocks/tehsils
(administrative subdivision of a district). As per esti-
mates, it insured nearly eight million farmers consti-
tuting acreage of more than 12 million hectares for a
sum insured of approximately Rs. 96 350 million at a
premium of Rs. 8830 million. The cumulative num-
ber of Indian farmers covered under WBCIS during
2010 and 2011 is estimated to have reached 9.27 mil-
lion, in 13.23 million hectares and risk exposure of
Rs. 143 000 million at a premium of Rs. 12 900
million.
Lessons from the ground
Despite several risk insurance experiences in India, the
farmers’ loyalty has not been won completely (Singh
& Jogi, 2011). There are various reasons for it and
the most important are basis risk, either no or delay
in payment of claims, lack of knowledge and aware-
ness of various contracts, lack of historical weather
data and hence high premiums.
The two major challenges of the present weather
risk index-based insurance product are (i) designing
a proxy weather risk index with predictive capability
to measure crop losses realistically and (ii) basis risk.
Basis risk results if the actual experience of weather
risk (rainfall) in the neighbourhood significantly dif-
fers from the data recorded at the weather station. The
two aspects lead to compounding of the problem for
all parametric triggered insurance products: both may
not trigger a payout despite the occurrence of damages
at an individual farm, or these may trigger a payout
when loss did not occur.
The State of Knowledge Report by the Global
AgRisk (2010) has brought out a few important obser-
vations on using a weather index for small, mod-
erate and large losses. When rainfall is around the
optimal level for a crop, many other important fac-
tors affect crop yields (e.g., soil quality, fertilizer use,
pesticide use, crop husbandry practices, etc.). Around
this level, the correlation between rainfall and crop
yields is likely to be not very strong. When rainfall
is extremely low, however, the relationship between
rainfall and yields is expressed more strongly. Other
variables such as use of fertilizers and pesticides have
very little effect on yields at low levels of rainfall.
Due to high transaction costs, insurance is perceived
to be rather an expensive financial instrument and
is mostly designed to protect against low probabil-
ity and extreme loss events. However with increasing
awareness, penetration and efficiency, the unit cost is
going down rapidly. The schemes like WBCIS are in
fact more desirable as they have the ability to miti-
gate even small to moderate losses and also provide
extended coverage for pre-sowing periods and qual-
ity of output which are difficult to cover under other
schemes.
On the other hand, catastrophic events affect not
just yields but assets and long-term income. A ‘generic’
insurance product (in place of a sophisticated prod-
uct), therefore, can do well for mitigating such losses
(Rao, 2011). Compared with a weather index insur-
ance a catastrophic coverage could be an alternative as
it is designed to cover the insured party in case of a fire,
flood, earthquake, tornado, or other major accidents.
The data requirements for designing catastrophic cov-
erage insurance products are relatively low and hence
the basis risk is lower. The cost of administration is also
lower for catastrophic coverage. Premiums for cover-
ing catastrophic risks through catastrophic coverage
are generally affordable which leads to availing insur-
ance for almost all important assets, which in turn can
lead to increased demand for insurance and ultimately
a high level of insurance penetration.
Insurers have to find a way to offer a technically
sound product that is simple and easily accessible
to farmers. Farmers must be able to understand the
products sufficiently in order to calculate claims and
expect realistic payouts. The lack of benchmarking for
weather index insurance products erodes the value of
financial support provided by the state under WBCIS.
By their very nature, weather index insurance
products are difficult to comprehend, especially by a
typical Indian farmer who has limited capacities and
experience. The multitude of weather index insurance
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products offered by various insurance providers neces-
sitates the need for benchmarking the various prod-
ucts to enable the farmer to make an informed choice.
Through benchmarking it may be ascertained whether
the products offered by the different insurance com-
panies carry at least comparable benefits (Protection
vis-a-vis Premium). The complex weather index insur-
ance products may be disintegrated into the con-
stituent covers for different perils.
The opinion of WBCIS beneficiaries on 16 different
aspects of weather index insurance was assessed by
the Government of India (2010). Eighty per cent of
the respondents highlighted high basis risk (location
of weather station), 57% were not satisfied with the
grievance redress mechanism, an equal number have
reported inconvenience in enrolment, 17% were not
satisfied with the transparency, 19% were not satis-
fied with the reliability of weather data and 25% were
not satisfied with a weather index as a substitute for
yield index insurance. From this exercise, it is clear
that weather risk index-based insurance is rated well
on data accuracy, transparency and quick claims set-
tlement, which are very attractive to both farmers and
the reinsurance market.
Though the WBCIS programme is perceived by
states as a good alternative to NAIS, there are some
key challenges to be overcome for the scaling up of
the scheme (Rao, 2011).
1. Scope of WBCIS is limited to parametric weather
exigencies like rainfall, temperature, humidity and so
on. In addition to weather-related impacts, often crops
suffer due to hailstorm, floods, pests and diseases,
which to a large extent are difficult to cover under
the scheme. However, over the years with increas-
ing understanding between weather parameters and
effects on crops, indices have been designed which
provide cover against pests and diseases by consider-
ing weather as a proxy.
2. Product design under WBCIS is challenging as crop
yield and weather relationship is not only complex,
but also influenced by various factors such as cultural
practices, date of sowing, soil type and crop variety. It
requires focused research by agricultural scientists to
fine-tune the weather-yield relationship.
3. The growth of WBCIS demands that every village
has a weather station so that basis risk in weather
index insurance is minimized. Nevertheless, with con-
sistent increase in coverage under WBCIS the penetra-
tion of weather stations is also increasing. The weather
stations are now available at about a radius of 15 km
for locations where they were available at more than
30 km earlier. The acceptable radius for insuring rain-
fall is about 5 km and for other parameters is 10 km.
For achieving these levels, nearly 50 000 weather sta-
tions are required as against about 5000 stations which
are presently available including both public and pri-
vate stations in the country (Milesi et al., 2011).
4. Calibration of sensors and data at weather sta-
tions is another challenge as presently weather data
providers are using stations of different make and
quality. This would require third party accreditation
and calibration services to vouch for reliability and
accuracy of the data.
5. There is a need to develop location specific and crop
specific insurance contracts by making use of local his-
torical weather data.
Recognizing the problems being faced in creating
and delivering weather index based insurance prod-
ucts around the world, systems such as Terrestrial
Observation and Prediction System (TOPS) have been
developed to organize disparate streams of informa-
tion into a cohesive framework to serve a variety of
societal needs (Nemani et al., 2009). The need for
data synthesis for producing actionable information is
greatest in rural India where nearly 70% of the popu-
lation lives and works.
TOPS is a modeling software system designed to
produce ecological forecasts. TOPS brings together
advances in information technology, weather/climate
forecasting, ecosystem modeling and satellite remote
sensing to enhance management decisions related to
floods, droughts, crop condition, human health, for-
est fires, forest production and so on. TOPS provides
a suite of ecosystem ‘nowcasts’ (measures of current
conditions) and forecasts. These data products include
measures of vegetation condition and productivity,
snow dynamics, soil moisture and meteorological con-
ditions and forecasts (Milesi et al., 2011). Another key
feature of TOPS is an automated system for ingesting
climate observations from local, regional and global
networks of meteorological stations in real-time to
produce spatially continuous gridded meteorological
fields. This capability allows TOPS to provide continu-
ous estimates of ecosystem conditions for any location
in the country, including remote and sparsely instru-
mented regions.
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Information from TOPS can benefit the risk insur-
ance society in a number of ways. By blending data
from a few weather stations with satellite data avail-
able for over 30 years, TOPS creates high-quality infor-
mation at village level. Similarly the integrated infor-
mation from TOPS allows one to verify fraudulent
claims, in a way acting as third party verification.
Using TOPS capabilities for long-term simulations of
vulnerabilities, key insights about the potential conse-
quences of climate change in a variety of sectors can be
generated and disseminated. The weather stations are
not totally tamper-proof and their maintenance costs
are high. The concept of a ‘virtual weather station net-
work’ based on TOPS platform can produce the daily
weather data at a scale of one kilometre grid for the
past 10 years which is valuable for agriculture meteo-
rological risk reduction.
22.4.2 Financial markets play a vital role:
Experiences from Japan
Although Japan has made large investments in infras-
tructure, agriculture, fisheries and allied sectors, the
great Tohoku earthquake in 2011 has revealed that
these sectors are still vulnerable to natural hazards.
The damage caused by the Tohoku earthquake reaf-
firms that Japan is potentially one of the countries
in the world that holds the highest liability to natu-
ral hazards. According to UNU-EHS’s and Munich Re’s
(2007) Natural Hazard Risk Index (Table 22.3) poten-
tial disaster losses in Japan’s megacities are significant.
Based on statistics issued by the Government of
Japan, both direct and indirect social and economic
damages caused by Hanshin-Awaji earthquake (also
known as the Great Hanshin or the Kobe Earthquake)
was approximately 2.6% of national GDP in 1995
(Kato, 2009). This quake also had surprisingly low
insured losses compared to the very high economic
losses (see also Figure 22.1). The recent Tohoku earth-
quake has affected wider areas leading to significant
economic and financial damage to the Japanese econ-
omy. It was estimated that the damage could be to
the tune of 16.9 trillion Japanese Yen, 1.7 times of
Hanshin-Awaji earthquake in 1995 (Cabinet Bureau
of Japan, 2011). The earthquake has worsened the
nation’s fiscal balance.
Having passed a depression era in the 1990s, the
so-called ‘lost decade’, Japan issued deficit-covering
government bonds in large proportions (OECD, 2011).
Due to Japan’s economic situation, which includes fis-
cal imbalance, it is not easy for the national and pre-
fectural governments to issue bonds for disaster recon-
struction, since this could affect fiscal consolidation
and fiscal deficit. Hence, the Tohoku disaster dam-
age cannot be covered by the reconstruction bonds
issued by the national and prefectural governments
and it is essential to consider other financial instru-
ments (OECD, 2011).
Though Japan’s individual financial asset is the
biggest in the world (1 450 trillion Yen) (Bank of
Japan, 2012) consisting of bonds and bank deposits
(nearly 80%), only a small contribution comes from
risk assets such as equities and mutual funds. This
shows a huge potential for the growth of market
oriented risk management schemes such as equities
and mutual funds, replacing public financing assumes
importance in Japan.
Table 22.3 Natural Hazard Risk Index for Megacities
City
Natural Hazard
Risk Index City
Natural Hazard
Risk Index
Tokyo/Yokohama 710.0 Hong Kong 41.0
San Francisco 167.0 London 30.0
Los Angeles 100.0 Beijing 15.0
Osaka/Kobe/Kyoto 92.0 Dhaka 7.3
New York 42.0 Mumbai 5.1
Source: UNU-EHS and Munich Re, 2007.
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CHAPTER 22 Promoting Risk Insurance in the Asia-Pacific Region
National policy environment
In Japan, the risk insurance is mainly represented in
the form of earthquake insurance. Earthquake insur-
ance issued by private insurance companies is desig-
nated to financially support lives of earthquake victims
and hence is limited to cover residential houses and
personal properties. Until Niigata Earthquake in 1964,
damages on assets caused by earthquakes in Japan
were not covered by fire insurance since the fire insur-
ance schemes in place have regarded the earthquake
damages as legally immune to compensatation even
though fire could have led to secondary disaster in
the wake of an earthquake. The Government of Japan
has decided to support the earthquake insurance as
an exclusive reinsurer since private insurance com-
panies could not fully afford to compensate without
government support. As a result, the Government of
Japan has established Japan Earthquake Reinsurance
Co. Ltd. as a Special Purpose Vehicle through ‘The
Law Related to Earthquake Insurance, 1966’ to give
impetus to the earthquake insurance in Japan (Min-
istry of Internal Affairs and Communications of Japan,
1966). Despite this, the earthquake insurance could
not become popular and the major spread of insurance
has limited to fire insurance with coverage of 30–50%
in the present value of the asset (with an upper limit
of 50 million Yen). Due to the high premium costs and
low compensation levels, the earthquake insurance
has not been popular until Japan experienced Hanshin
Earthquake in 1995. After 1995, the number of earth-
quake insured has steadily increased up to 23.7% of
entire households in 2010. Such an inadequate spread
of earthquake insurance could be a financial burden
in the wake of a major earthquake (General Insurance
Association of Japan, 2011).
Due to limited demand for risk insurance products
and limited volume of Japan’s reinsurance market,
only very few other forms of risk insurance, other
than the government supported earthquake insur-
ance, could be observed in Japan (Financial Cen-
tre Futures, 2011). During recent years, big corpo-
rations have started using alternative risk transfer
products such as captive, finite risk insurance and
cat bonds. For these firms, risk hedging using the
financial schemes helps to get higher evaluation by
credit rating agencies. However, these practices are
hardly contributing to risk insurance for vulnerable
citizens.
In early 2008, the Government of Japan has
introduced Japanese Sarbanes-Oxley Act (J-SOX) to
strengthen corporate internal control (Kato, 2009).
The act stresses firms’ risk management and ensures
risk mitigation against physical and financial damages.
Since then, Japanese businesses, from small to large
scale, have found encouragement to minimize the
disaster risks and realized that the government rein-
sured earthquake insurance is inadequate to address
the range of risks these firms face.
The Government of Japan has begun amending Pri-
vate Finance Initiative Act (PFI Act) to diverge risks on
public infrastructure between public and private sec-
tors (Kato, 2011). J-SOX require companies to disclose
various risks that companies face in their financial
reporting. With this amendment, private corporations
can also get involved in large scale public infrastruc-
ture projects such as agricultural community sewerage
projects with government subsidies. This requires cor-
porations to invest in weather derivatives to deal with
unexpected hydro-meteorological extreme events.
Although the Government of Japan has recog-
nized the importance of aggressively promoting the
risk financing, the related processes are still in their
infancy. The current rigid financial law does not allow
captive insurance firms in Japan to be established and
this needs to be addressed at the policy level. The
direction of Government of Japan’s policy is to empha-
size various risk mitigation provisions for both public
and private sectors. With this, the application of risk
insurance and alternative risk transfer is being increas-
ingly recognized in Japan.
Risk insurance experiences in Japan
Currently, a major part of alternative risk transfers
in Japanese market is through cat bonds,1captive,2
finite risk insurance,3and weather derivatives4(METI,
2006). These form the greater part of risk transfer
1A debt instrument that is usually insurance linked and
planned to raise money in case of a catastrophe such as a
typhoon or earthquake.
2A subsidiary that is designed to provide financing to cus-
tomers by purchasing the parent company’s product.
3An insurance contract that shifts the risk of loss from an
insured to an insurer during a given years.
4A financial commodity used by companies is designed to
hedge against the risk of weather-related losses.
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strategy for big companies and large associations such
as Zenkyoren, the National Mutual Insurance Feder-
ation of Agricultural Cooperatives. Zenkyoren in turn
will compensate the financial losses faced by its mem-
bers. After the Hanshin-Awaji earthquake in 1995,
Oriental Land, which runs Tokyo Disney Land, issued
two different cat bonds to cover reconstruction costs.
Big corporate bodies can create Special Purpose
Vehicle (SPV) for captive insurance and they can
afford to accumulate sufficient funds for finite risk
insurance. Small businesses and households can
purchase risk insurance issued by associations like
Zenkyoren. However, these forms of insurance are
inadequately covered by reinsurance and hence pose
financial threat to the insurer in the wake of a large
disaster (Froot, 1999). In addition, it is extremely
unlikely for small businesses to utilize these financial
risk transfer mechanisms due to the need for a large
portfolio for these instruments to work effectively.
Munich Re issued a cat bond called ‘Muteki’, which
covers Zenkyoren’s earthquake risk and transfer to
the capital market (Munich Re Group Risk Trading
Unit, 2011) (Table 22.4). The bond is well recognized
in the market since it is independent of the stock-
market and practical to put in theportfolio. According
to Steve Evans (2011a), Muteki was triggered during
the Tohoku earthquake and made a loss to the tune
of 300 million US$. However, despite these losses,
the investors may not have lost their confidence in
Japanese cat bonds (Evans, 2011b). The earthquake
also took a toll on the Zenkyoren which faced a
reported loss of US$11.2 billion (Evans, 2012a). If the
insurer (Zenkyoren) cannot bear the financial dam-
age, small businesses and households that are insured
cannot expect to receive full compensation.
The Midori bonds are designated for the JR East,
the largest railway company in Japan since 2007. This
five-year bond is expected to cover loss of public trans-
portation services and the infrastructure when a sig-
nificant earthquake hits within a 70 km radius of
Tokyo.
Despite rising reinsurance costs, Kibou, another cat
bond, has been issued on behalf of Zenkyoren (Evans,
2012b). According to Swiss Re Global Cat Bond Per-
formance Index, Index Exposure by Peril (shown in
Evans, 2011b), the global cat bond market is still dom-
inated by the US hurricane risk bonds and the share
of typhoon/earthquake risk related bonds in Japan are
on the decline. Since capital markets welcome diversi-
fication of the investable, there is enough room for cat
bonds in Japan.
Initiatives 3 to 5 in Table 22.4 are examples of
weather derivatives in Japan which are emerging as
a significant financial tool for farmers and small busi-
nesses (Yokouchi, 2007). The weather derivative sales
have increased significantly recently (Yamada, 2010;
Table 22.4 Comparison of various local initiatives in risk insurance in Japan
No Case
Geographical
coverage
Hazards
covered
Direct
benefactor
Payment
trigger
Benefits
accrued
1 Muteki Ltd (cat bond) Japan Earthquake Zenkyoren Richter scale Investors
2 Midori Ltd (cat bond) Japan Earthquake JR East Richter scale Investors
3 Typhoon Derivative
(Tokio Marine Co.)
Japan Typhoon Farmers Union, Hotels,
Leisure industry,
Number of
typhoon passed
None
4 Warm Winter Derivative
(Sompo Japan)
Japan Climate Change Farmers Union, Energy
retailers, Fashion
Industry
Temperature None
5 Winter Preparation aka
Fuyu no Sonae
(Aioi Insurance)
Japan Climate Change Farmers Union, Energy
retailers, Fashion
Industry, Hotels
Temperature,
Rainfall, Snowfall
None
Sources: Aioi Nissey Dowa Insurance Co. Ltd., 2011; Sompo Japan Insurance Inc., 2010b; Munich Re Group – Risk Trading Unit, 2011;
Tokio Marine and Nichido Fire Insurance Co. Ltd., 2011.
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CHAPTER 22 Promoting Risk Insurance in the Asia-Pacific Region
0
100
200
300
400
500
600
700
2001 2002 2003 2004 2005 2006 2007 2008
Million USD
Year
Figure 22.2 Growing market volume of
weather derivatives (million USD) in Japan.
Source: Compiled by the author, based on
Yamada, 2010
Figure 22.2) as local small banks and credit unions
played an intermediate role in selling weather deriva-
tives for agriculture and allied sectors (Figure 22.3).
Weather derivatives in Japan are designated for spe-
cific clients since the derivatives are not publicly
offered. Therefore, the premium is usually over one
million Yen (approximately US$1250 at an exchange
rate of 80 JPY per US$) and this is too expensive for
individuals and small businesses. However, the local
financial institutions (FIs) such as local banks and
credit unions with a strong local network played a
significant role in selling weather derivatives benefit-
ing commission from insurance companies. FIs know
Insurance
Companies
Small Businesses
Far mers
Developing
Market
Commission
Payment
Weather Derivative
Contracts
Local Banks
Credit Unions
Figure 22.3 Weather derivative sales scheme using local
financial institutions.
Source: Ono, 2004
the need for weather derivatives and how to access
the potential market. These FIs can even accommo-
date farmers and business owners with a loan for
the derivative since FIs have a strong local network
through which to sell financial commodities unlike
insurance companies.
The strong ties of farmers and business owners with
FIs have helped them to get familiar with the sophis-
ticated financial products such as weather derivatives.
As a result, this has emerged as a key model in dis-
seminating alternative risk transfer. The mediation by
the local FIs has stimulated their sales and has drasti-
cally reduced the cost of designing the financial instru-
ment. The growing number of weather derivative sales
helped to reduce the premium costs (0.3 million Yen,
approximately US$3750) and helped in their spread.
No significant impact of the financial crisis could be
seen on the derivatives market in Japan since people
are sensitive enough and aware of weather risks.
Although the weather derivatives market is grow-
ing, their volume in Japan is much smaller than in
the US (Bank for International Settlements, 2010).
To avoid holding domestic risk insurance within the
country, it is necessary to transfer the risk abroad
by increasing trade volume and risk transfer will be
accelerated if foreign investors hold more Japan issued
derivatives. Weather derivatives in Japan are only
negotiated over-the-counter and are not traded on
exchanges. This is due to the Commodity Exchange
Act (METI, 1950) that allows only trading of ‘tangible
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objects’. Without a provision in the law, the weather
derivatives in Japan cannot be traded in domestic and
international markets. However, exchanges such as
Chicago Mercantile Exchange, London International
Financial Futures and Options Exchange (LIFFE),
Intercontinental Exchange (ICE) and the Catastrophe
Risk Exchange Inc. (CATEX) are listing standardized
weather derivatives (Amazaki et al., 2003). Such trad-
ing of weather derivatives will have a positive impact
on price discovery, volume and market liquidity.
The weather derivatives sold by Japanese insurance
companies are only intended for corporate bodies and
unions, since selling the financial products to an indi-
vidual can be a violation of the Consumer Contract
Act in Japan (Itabashi, Iwazawa & Watanabe, 2007).
Individuals, mostly farmers, purchase the derivatives
through local agricultural associations. Each derivative
has a different trigger for the payment and hence it is
not rare to purchase multiple financial products. The
strong demand from businesses and industries affected
by weather change has stimulated the insurance com-
panies to develop numbers of weather derivatives, and
expansion of the market has reduced the premium
prices. With this trend, the insurance companies are
now able to provide various weather derivatives on a
small to big scale.
Lessons for scaling up
It is clear that Japan needs multiple sources to finance
disaster risk reduction in the future. As described in
the previous section, financial risk transfer in Japan is
mostly used by small businesses and big corporations
leaving individuals out of the risk insurance market.
From the analysis, it can be said that the risk finance
market is segmented and the market should be con-
solidated to adjust needs from various sectors such as
households, public and industry, if risk transfer is to
be strengthened. The government supported reinsur-
ance is a strong backbone for the earthquake insur-
ance system, but alternative risk transfers also need to
be encouraged.
One of the reasons why the market cannot respond
to the growing need for risk financing is the immatu-
rity of Japan’s capital market infrastructure in terms
of capability of domestic FIs. It is indicated by the
existence of a few Japanese reinsurance companies
with small gross billings compared to top reinsur-
ers elsewhere. Consequently, most of the funds flow
to Europe, the United States and other regions such
as Bermuda as the Japanese market cannot pro-
vide much needed financial services meeting domes-
tic investors’ demand. If Japan and countries in Asia
need to utilize abundant funds in Asia for the region’s
risk reduction, it is necessary to establish sound capital
market and reinsurance market supported by domes-
tic agents. By doing so, disaster risk will be shared not
only in Japan and the region, but also in the world
through a flow of funds.
The following points emerge clearly, considering the
current fiscal condition and discussion above: a) exist-
ing risk mitigation mechanisms such as investments
in infrastructure are not sufficient to mitigate disaster
risks; b) there is a huge potential for increasing the
risk insurance in Japan in terms of insurance from the
individual subscribers as against institutional and cor-
porate insurance and in terms of insurance for spe-
cific natural hazards such as earthquakes, tsunami and
floods; c) the role of financial markets can be further
strengthened by linking the domestic risk insurance
market with that of the regional and international
financial markets; d) there is a diminishing role of gov-
ernments (national or prefectural) in promoting risk
insurance in the country, but it is expected to support
establishing generic risk finance market in the future;
e) consolidating risk insurance and alternative finan-
cial risk transfer markets is not only complementary
of Japan’s current risk mitigation but also provides an
opportunity to disperse various risks to natural haz-
ards in the region; and f) it is highly desired to establish
transparent and openly accessible risk finance mar-
ket in Japan for farmers, small business owners and
investors.
22.5 Proposals to the UNFCCC for the
Future Climate Regime
The future climate regime can facilitate promoting
the climate risk insurance in the Asia-Pacific Region
through providing the additional finances required
which is one of the major limitations in promoting dis-
aster risk mitigation (GFDRR, 2009). Mention of the
risk insurance can be found in the negotiated text of
the UNFCCC and the Conference of Parties. The Arti-
cle 4, paragraph 8 of the UNFCCC text refers to the risk
insurance as a funding mechanism to meet the needs
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CHAPTER 22 Promoting Risk Insurance in the Asia-Pacific Region
of the developing countries arising from the adverse
effects of climate change (UNFCCC, 1992) ‘including
actions related to funding, insurance and the trans-
fer of technology, to meet the specific needs and con-
cerns of developing country Parties arising from the
adverse effects of climate change and/or the impact’
(p.8). The UNFCCC text also characterizes countries
eligible for financing and insurance mechanisms. The
Bali Action Plan goes further and explicitly states that
the risk insurance mechanisms should be used in pro-
moting adaptation (UNFCCC, 2007).
Various proposals have been submitted by the Par-
ties to the Convention as well as by those outside the
Convention for promoting the risk insurance under
the Convention (Table 22.5). The Alliance of Small
Island States (AOSIS), the most rigorous promoter
of such a risk insurance scheme, has proposed that
an International Insurance mechanism and Solidar-
ity Funds addresses catastrophic risk and collective
loss sharing. Cook Islands proposed the International
Insurance Scheme where it emphasized the collec-
tive burden sharing, subsidy elements to maintain
the fund as a compensation for unavoidable impacts,
and funding risk reduction initiatives (Harmeling,
2008). A Swiss proposal to the UNFCCC on promot-
ing risk insurance includes prevention and insurance
pillars with funds coming from global CO2levy with
greater benefit to low income countries (Government
of Switzerland, 2008).
Munich Climate Change Initiative (MCII) made a
proposal consisting of two tracks or pillars, one for
supporting risk reduction through mitigation activities
and the other supporting the insurance (Bals, Burton
& Butzengeiger, 2008). The insurance component was
divided into two tiers with tier I consisting of climate
insurance pool to cover the high level risks in non-
Annex I countries and the tier II consisting of pub-
lic safety nets and insurance systems through public-
private partnerships covering medium level risks.
Recent negotiations have anchored the risk insur-
ance subject in the Paragraph 14 of Decision 1/CP.16
of the Cancun Adaptation Framework (CAF) in Can-
cun Agreements. Under the Cancun Agreements, a
work programme to consider approaches to address
the loss and damage associated with climate change
impacts in vulnerable developing countries was estab-
lished by the COP. These discussions have stressed
the need for a climate risk insurance facility. The
related submissions by Parties display the general
convergence among Parties and relevant organiza-
tions for risk insurance mechanisms to be included
under the work programme (UNFCCC, 2011). How-
ever, divergence of views can also be observed in
terms of its form: for instance, AOSIS envisages estab-
lishment of an international risk insurance mecha-
nism under the UNFCCC framework whereas coun-
tries such as the United States and EU prefer a climate
risk insurance facility at national and regional level,
taking into account country differences and respecting
country-driven approaches. The related discussions in
March 2012 in Tokyo have emphasized the need for
improved knowledge sharing among various UNFCCC
processes; the need to standardize damage assessment
and reporting, and identify entry points and facilitate
the engagement of the finance sector in disaster risk
reduction (UNFCCC, 2012).
22.6 Messages for the future climate
regime
Several lessons and best practices emerge in terms
of what should be the essential design elements for
promoting risk insurance under the future climate
regime.
1. Keep the price of the insurance premium
affordable: The price of the insurance premium is
one of the major determinants for enrolling a maxi-
mum number of insured and hence keeping its price
affordable is an important aspect of the overall design
of the insurance system. In the case of Japan, the
premiums were heavily subsidized (over 50%) to
make the premiums affordable (Tsuji, 1986). Since
the amount of residual risks and premium prices are
directly correlated, other insurance programmes such
as the Turkey catastrophe insurance pool have com-
bined to promote the risk mitigation measures such
as enforcing seismic resistance codes along with the
insurance programme. In the Philippines, the prices
of premiums were able to be kept at an affordable
level by linking microinsurance with the cooperatives
(Munich Re, 2011). However, there is a limit to which
the insurance agencies can reduce the insurance pre-
mium prices since the premium prices would have
to cover capital costs, reinsurance costs and admin
costs and profit margins. Any substantial reduction in
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Table 22.5 Summary of Selected Country/Consortium Proposals on Disaster Risk Insurance Mechanisms at UNFCCC Negotiations
Proposals
Characteristics AOSIS MCII Cook Islands Switzerland
Target group
(governments/
individuals)
National
Governments of SIDS,
LDCs and other
developing countries
Governments and
individuals
National
governments of SIDS
Regional authorities,
governments, and
individuals
Geographical
coverage
(national/local/
regional)
Regional/National National and regional National rRegional and
sub-regional
(insurance pillar);
rNational
(prevention pillar)
Source of funding rConvention
Adaptation Fund
rKyoto Protocol
Adaptation Fund
(existing)
rOther bilateral and
multilateral sources
Financial mechanism
of the Convention
channeled through
CIP, CIAF, and CRMF
Internationally-
sourced pool of funds
(subsidy in
establishing establish-
ing/maintaining
fund)
rGlobal Carbon Tax
rInsurance pillar
funded through
MAF
Promotion of
re-insurance
Yes, through
conventional risk
sharing and transfer
instruments
Yes, through CIP No reference to
re-insurance
Yes, through
public-private
partnership
Targets pr e m i u m
prices
No indication for
premium prices
No indication for
premium prices
No indication for
premium prices
Provides funding for
premiums
Inclusion of risk
mitigation
component
Yes, through
technical and
financial support for
risk reduction efforts
Yes, through the
prevention pillar
Yes, mechanism
funds risk reduction
initiatives
Yes, through the
prevention pillar
Reference to
guidelines for
implementation
No reference to
guideline
Yes, under the
authority and
guidance of COP
No reference to
guideline
Yes, defines eligible
extreme events and
insured damage
Reference to
awareness
No reference to
awareness
No reference to
awareness
No reference to
awareness
Yes, awareness
generation is
financed by NCCF
Addressing the risk
data gaps
Yes, though improved
risk management
tools, collection and
analysis of data
No reference to
addressing data gaps
No reference to
addressing data gaps
Yes, through small
budget under the
insurance pillar
Sustainability
issues if any
No reference to
sustainability
No reference to
sustainability
No reference to
sustainability
No reference to
sustainability
Notes: AOSIS: Alliance of Small Island States; MCII: Munich Climate Insurance Initiative; SIDS: Small island developing states; LDC:
Least developed countries; CIP: Climate Insurance Pool; CIAF: Climate Insurance Assistance Facility; CRMF: Chronic Risk Management
Facility; MAF: Multilateral Adaptation Fund; NCCF: National Climate Change Fund.
Sources: AOSIS, 2008; Cook Islands on behalf of AOSIS, 2008; The Munich Climate Insurance Initiative, 2009; Government of
Switzerland, 2008.
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CHAPTER 22 Promoting Risk Insurance in the Asia-Pacific Region
insurance costs can only be possible by a combination
of approaches such as efficient management by the
insurance firms, reducing basis risks through risk miti-
gation measures such as enforcing structural standards
and land-use planning regulations, and subsidies from
the national governments.
2. Generate public awareness: Apart from the issue
of the price of the premium, the lack of aware-
ness among various stakeholders is a major hur-
dle in spreading the risk insurance. This hurdle was
mostly overcome by incorporating the grassroots level
awareness generation activities. For instance, such an
effort can be seen in agricultural weather index insur-
ance, im Thailand; and in various locally implemented
insurance programmes (e.g. BASIX-ICICI Lambard
microinsurance; Turkey catastrophe risk insurance
pool). Through insurance agencies working closely
with farmer associations, the Japanese example pro-
vides a good case for increasing public awareness and
overcoming other attitudinal barriers.
3. Avoid the moral hazard: One of the major
problems with the traditional insurance programmes
including the crop insurance programmes has been
the moral hazard that is, unfair insurance claims lead-
ing to a higher risk for the insuring agencies (Gin´
e,
2009). This limitation has largely been overcome by
the advent of index based insurance systems where
payment is triggered by factors that are extraneous to
human control, that is, the actual incidence of the par-
ticular intensity level of the hazard (e.g. 60% reduc-
tion in rainfall). One factor that needs to be taken into
consideration, however, is the weather data required
for developing such indexes. The India case provides a
good example of overcoming this barrier.
4. Link with reinsurers and investment in finan-
cial markets: Support by reinsurers is one of the
important considerations for putting in place robust
risk insurance systems as reinsurers provide needed
financial backup to the insurers. In addition, insurance
facilities created may also consider investing, in part or
total, in international financial markets using the sup-
port of the international reinsurance facilities. Such
an example is epitomized by the current agricultural
weather index programme in Thailand (Sompo Japan
Insurance Inc., 2010a) and the Caribbean catastro-
phe risk insurance facility (Ghesquiere, Mahul, Marc
& Ross, 2007). The structure of current financial mar-
kets is only favourable for large corporations and busi-
nesses and does not seem to benefit direct risk reduc-
tion for the individuals. Efforts should be made so as to
ensure that the financial markets provide greater risk
reduction benefits to individuals by giving right price
signals encouraging greater participation in risk insur-
ance.
5. Enhance availability of risk information:
Availability of reliable rainfall data and associated
crop losses is a prerequisite for designing a robust
index-based insurance facility. Similarly, comprehen-
sive information on the physical characteristics of the
infrastructure such as buildings, warehouses and so
on to be insured is needed for estimating the risk
from hazards such as floods, droughts and earth-
quakes. Such a robust information infrastructure is
still not readily available on a large-scale in most of
the countries, including the Asia-Pacific Region, hin-
dering expansion of the risk insurance facilities.
For example, the lack of widespread historical data
to assess the relationship between weather parameters
and crop losses has limited the implementation of risk
insurance facility to the area where historical weather
information is available in Thailand (Sompo Japan
Insurance Inc., 2010a). Risk insurance facilities have
overcome this limitation by investing the resources to
collect and analyse the available information, employ-
ing simulation modelling, interpolation and extrapola-
tion techniques as well as by increasing the risk mar-
gin while calculating the price of the premium (United
Nations, 2007; O’Connor, 2005). Nevertheless, in all
the cases, the availability of risk information deter-
mined the feasibility and success of an insurance facil-
ity.
Comparing these experiences with the issues identi-
fied at the beginning of this section, the insurance ini-
tiatives did not translate in terms of scaling up and sus-
tainability of these initiatives which are areas where
the future climate regime could play an important
role.
22.7 Conclusions and way forward
This chapter has identified existing limitations in pro-
moting risk insurance by drawing lessons from within
and outside of the Asia-Pacific Region and looking into
how the future climate regime could help overcome
these limitations.
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Climate Change Adaptation in Practice
Numerous risk insurance experiences show that risk
spreading is a way forward for dealing with a variety of
climate and non-climate related risks. However, feasi-
bility and sustainability of implementing an insurance
facility at the global, regional, national and local level
could face several barriers, as identified in this chapter,
which include limited knowledge among stakeholders
about the benefits of risk insurance systems, limited
expertise to design and implement insurance products,
challenges in keeping the premium prices sustainable,
lack of good quality data on risks and historical losses
and limited presence of reinsurers. Addressing these
limitations is essential in enhancing readiness to accept
insurance as a risk reduction tool.
While divergent positions are observed between
Annex I and non-Annex I parties on the fundamen-
tal need to support an insurance mechanism, it is cru-
cial for parties to consider and assess the opportunities
that insurance mechanisms provide in reducing risks
at different levels in line with the role of the UNFCCC
as a catalyst to promote collective actions. It is impor-
tant for the Annex I parties to recognize the fact that
any risk reduction promoted in Non-Annex I countries
would benefit the Annex I countries as well due to the
role these countries are playing in terms of production
of goods and services.
To adapt to the future climate, it may be neces-
sary to consider adopting a convergence approach
consisting of the lessons drawn from regional mod-
els such as CCRIF as well as from local models, for
example, numerous microinsurance schemes which
have proven to be suitable in particular for developing
countries. In this regard, further assessment is needed
to identify the best mix or combination of such tools
for each region concerned, including Asia-Pacific. The
proposals to the Convention should aim at promoting
public awareness on risk insurance, putting in place
robust and transparent systems to collect, analyse and
disclose risk information, providing for continuous
evaluation of the performance of the risk insurance
systems, encouraging greater private sector participa-
tion, and most importantly, helping to keep the pre-
mium prices at affordable levels. The latter objective
could be achieved by a combination of approaches,
such as targeted subsidies or enforcing structural and
land-use planning regulations. In addition, the pro-
posals should make clear how the regional and local
insurance mechanisms are to be governed and sus-
tained while improving the existing risk governance
systems at the national level. The ultimate metric for
the real impact of these proposals should be in terms of
the scaling up of insurance leading to substantial risk
reduction on the ground.
Acknowledgements
We thankfully acknowledge the funding support
from the Asia-Pacific Network for Global Change
Research Project No CRP2009-02NMY-Pereira, Min-
istry of Environment Strategic Environment Research
Project (S8) led by Professor Mimura, Ibaraki Uni-
versity, and the Asia Pacific Adaptation Network,
Bangkok.
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JWST287-c22 JWST287-Schimidt Printer: Yet to Come December 19, 2012 7:15 246mm×189mm
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