Insurance is not always the most suitable solution, writes Swenja Surminsk

Surminski, Swenja

LSE Research Online

6/7/2016When disaster strikes, who pays for the impacts of climatechange?blogs.lse.ac.uk /businessreview/2016/06/07/when-disaster-strikes-who-pays-for-the-impacts-of-climate-change/The Paris Agreement on Climate Change calls for further emission reductions, more efforts to increase ourresilience to climate impacts, and support for those who are affected by a changing climate. Under the heading‘Loss and Damage’ this third pillar of the international climate architecture has gained prominence over the last fewyears and is now an official element of the narrative of the United Nations Framework Convention on ClimateChange (UNFCCC). While scope and scale of ‘Loss and Damage’ remains unclear, there appears to be a growingconsensus that we need a mechanism to help pay for those negative impacts that can’t be avoided throughmitigation or adaptation. This includes losses of and damages to people’s livelihoods, assets, land, culture andecosystems.Measuring these impacts and attributing them to climate change is technically complex. It also raises several moraland legal questions around fairness and liability: who to pay for islands lost and income streams stopped?1/4Politically the term ‘compensation’ remains taboo in the UN climate negotiations– instead the focus is on ‘finance mechanisms’ that can support thoseexperiencing losses. One instrument that receives particular attention in thiscontext is insurance. This mechanism has been used for centuries to addressuncertain losses including those from disasters but can it help to address ‘Lossand Damage’ from climate change as discussed under the UNFCCC?In many countries insurance is used to protect against financial losses fromclimate-related disasters, such as floods, droughts, and windstorms. Penetrationrates, types of products and operational mechanics of insurance schemes varyfrom country to country, depending on several factors including risk drivers,cultures, regulatory demands, and the economic environment. Estimates indicatethat in developing countries only 5 per cent of direct natural hazard disasterlosses are insured as compared with 40 per cent in developed countries (DfiD,2013). To address this insurance gap there have been a range of new initiativesand pilots introducing insurance against climate-related risks in emerging anddeveloping countries. (See Vivid Economics 2015 for an overview of the challenges for climate insurance indeveloping countries).Lessons from those existing insurance schemes teach us to be cautious, particularly when it comes to supportingthose most vulnerable to current and future climate change.Overall there is evidence that insurance, if correctly applied, can support climate resilience and keep individuals,communities and countries from falling into poverty traps after a disaster occurs. Insurance offers risk spreadingover space and time, gives certainty of support should a loss occur, and delivers fast and efficient reconstruction.The experience to date suggests that insurance can help address extreme events and sudden disasters, protectingthe financial needs of governments (sovereign insurance), businesses (property and business insurance, includingliability), farmers (agricultural insurance) and individuals (property and micro-insurance).However, even in the context of extreme events, insurance is not always the most suitable solution – in fact there isalso evidence that if incorrectly applied it can create a false sense of security, encourage unwise risk-taking andlead to mal-adaptation. Therefore it is important to see insurance not as a stand-alone solution, but as a package,closely linked to wider risk management and adaptation efforts. This is easier said than done, as recent researchshows (Surminski and Oramas-Dorta 2013 Surminski 2014).To avoid mistakes from the past, any efforts to design and fund new insurance schemes should consider thefollowing questions before pursuing this route (see Vivid Economics 2015):How does the insurance proposal fit within a broader integrated risk management package?How has climate change been included in the underlying risk assessment and analysis?How will the scheme incentivise risk reduction and stronger adaptive behaviour?Many policy makers are attracted by insurance solutions as this may allow the engagement of the private sector,usually via international reinsurers and insurers. But if and how private insurance can be used in the context of ‘Lossand Damage’ is not just a question of insurability. It would also depend on how affordable and equitable anyproposed solutions are. In Europe and the US flood insurance is already under heavy pressure from rising risklevels due to misguided building and land use practices, as well as environmental and climatic changes. Recentfigures emerging from the UK, highlighted by the Bank of England (PRA and BoE 2015), show that climate changeand socio-economic risk drivers are expected to widen the gap between ‘affordable’ flood insurance premiums andpremiums that reflect the technical price of flood insurance. (Jenkins et al 2016) Theory and evidence from existing2/4insurance markets suggests that a ‘riskier and more uncertain world would be associated with an increase ininsurance demand, at least until some local threshold were reached where the affordability of insurance or theinsurability of risk were threatened’ (Ranger and Surminski, 2013).It is therefore important to reflect on the demand side – on the specific needs of those most vulnerable and clarifyhow insurance would be funded:“As the intensity and frequency of climate extremes increase, is it fair to shift responsibility onto those leastresponsible, least able to shoulder the premium, and in many cases least able to reduce the losses?” (Surminski,Bouwer and Linnerooth-Bayer 2016) Subsidies can help to avoid shifting the burden to those most vulnerable,however this also means that insurance may not offer value for money compared to other mechanisms due to hightransaction and capital costs. This suggests that international funds might be better spent on other types of safetynets rather than buying insurance cover from international insurance markets (Suarez and Linnerooth-Bayer 2011).The existing insurance schemes are focusing on current climate risks, rather than future changes. While some pilotschemes explore forecast insurance as well as insurance against gradual changes in rainfall amounts, mostschemes only grant cover over a 12-month period and do not consider any longer term climate change projections.Therefore insuring some of those irreversible losses projected appears outside the usual scope of insurance. Forthis we need to explore alternative means, for example by securing dedicated international funding for vulnerablecommunities that will inevitably be displaced by sea level rise.Finally, before channelling climate funds into new insurance schemes or compensation funds it is essential to reflecton the practical challenges around data, measurability of impacts and facilitation of the pay-outs, as well as theplanned time horizon of any scheme– can we set up mechanisms to deal with current and future impacts, and howwill we judge what type of “Loss and Damage” would qualify under such schemes? Would any “Loss and Damage”instruments only pay for those parts of the losses attributed to climate change? It is hard to imagine how any pay-outfor a flood or a windstorm would be based on differentiating between climate change and socio-economic riskdrivers. This remains scientifically very controversial and would lead to lengthy legal battles. Regardless of theattribution challenge we will need innovative ideas and arrangements, particularly to monitor very closely if and howany scheme would meet the objective of supporting those most vulnerable today and in the future. Insurance cansupport this, however the most important lesson to be learned is that insurance is no silver bullet.♣♣♣Notes:This blog is based on a recent submission by the author to the call for ‘best practices, challenges and lessonslearned from existing financial instruments at all levels that address the risk of loss and damage associatedwith the adverse effects of climate change’ by the UNFCCC’s Executive Committee of the WarsawInternational Mechanism for Loss and Damage.The post gives the views of its author, not the position of LSE Business Review or the London School ofEconomics.Featured image credit: Wikimedia CommonsBefore commenting, please read our Comment Policy3/4Swenja Surminski is a Senior Research Fellow at LSE’s Grantham Research Institute on ClimateChange and the Environment, as well as a member of the Centre for Climate Change Economicsand Policy (CCCEP). She is Programme Leader for the ‘climate risk, insurance and private sector’work-stream at the institute, overseeing research projects from a multi-disciplinary field. Her workfocuses on climate adaptation and disaster risk reduction with a special interest in the role of theprivate sector, particularly insurance.   She was recently appointed lead author for the business andindustry chapter of the UK Climate  Change Risk Assessment. She is a Visiting Academic at theBank of England and a contributing author to the IPCC. Swenja is the lead academic for a World Bank project on theTriple Resilience Dividend of Disaster Risk Management (DRM). She has published widely and works closely withindustry and policy makers at a global level, in a developing country context, across the EU and within the UK. Swenja is a founding member of the new Loss and Damage Network, aiming to foster policy-science exchangesunder the UNFCCC’s Loss and Damage work programme. Copyright © 2015 London School of Economics4/4

When disaster strikes, who pays for the impacts of climate change?

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