A New Approach to Africa Drought Insurance for the Third World
The cattle die first -- and the people follow soon afterwards. And after three years of draught in Kenya's Kajiado region, there's hardly anything left to eat for the large herds belonging to the Massai nomads who live in the area. Government trucks are busy hauling away the corpses to prevent contamination of the little water left in the few wells that haven't yet dried up.
For months, international aid organizations have been issuing dire warnings that the relentless drought in East Africa -- the worst in 10 years -- threatens to condemn 6 million Kenyans, Ethiopians and Somalis to death by starvation. The world community is about to face its next humanitarian disaster, says the aid community, and it can only be averted with a rapid infusion of money. "We don't want Kenya to turn into another Niger, where, in 2005, donations didn't start coming in until some of the victims were already dead," says Peter Smerdon, a spokesman for the United Nations World Food Program (WFP).
But donation fatigue has set in internationally, and aid organizations accustomed to collecting millions each time catastrophe strikes have recently found themselves faced with cash shortages. Following a year of tsunamis, hurricanes and earthquakes, it takes truly horrific images to generate enough sympathy to make a difference financially.
Famine insurance for the Third World
But this could soon change. If experts with the World Food Program and the World Bank have their way, future donations for natural disaster victims will no longer depend on the whims of private donors or the political needs of governments, but on agreements with international financial corporations. The plan is to create famine insurance for the Third World.
In other words, the capital markets will jump in where donations tend to be insufficient and an insurance policy will protect against draught-induced malnutrition. High finance instead of alms.
The example of Ethiopia shows the way. In early March, the WFP announced that it had taken out the "world's first insurance policy for humanitarian emergencies" with the French reinsurance company Axa Re. In return for the substantial premium of €772,000, which the UN organization is financing with donations, Axe Re will provide a maximum of €5.8 million in coverage should Ethiopian crops fail. The benefit would only be paid in the event of severe drought.
But what is a drought? A study is currently ongoing in Ethiopia during which 26 weather stations are measuring precipitation in the country from March to October. Actuaries then plug the findings into a formula to develop a precipitation index.
Between March and October, 26 weather stations measure precipitation in Ethiopia. The actuaries then plug the resulting precipitation readings into a formula and develop an index. The farther the index value drops below the limit stipulated in the policy, the larger the payout. If there is sufficient rain, Axa Re is not obligated to pay any benefits and thus turns a profit.
"A bold innovation for a hopeless case"
The potential for attractive earnings, in short, may be high and many in the world of high finance want to be a part of it. "Transferring the risk of drought to international financiers makes sense for insurance companies, because it enables them to expand their portfolios," says Robert Shiller, a professor of finance at Yale University. The two global market leaders, Munich Re and Swiss Re, are now playing catch up.
"A bold innovation for a hopeless case," is how one European official ironically describes the Ethiopia-Axa Re agreement. The desperately poor country, after all, has depended on aid organizations for decades, but true success has thus far eluded the aid community. Indeed, any new potential cure-all is enough to divert attention away from the many failures. "Wonderful, very promising," enthuses Ethiopia's Minister of Agriculture, Abera Deressa. Not only could the policy minimize hunger in his country, but, he hopes, Ethiopia may once again become a grain exporting country.
But it's difficult to overlook the fact that droughts account for only part of the recurring malnutrition and hunger problem in East Africa. Indeed, mismanagement and corruption are far greater culprits than Mother Nature. "We can insure ourselves against the weather," says WFP employee Ulrich Hess, "but not against manmade hunger."
He too believes in the capital markets' ability to at least reduce the risk of catastrophic starvation in the future. "If we have another big drought like the one in 1984," says the economist, "will the donor countries even be capable of responding quickly enough?" But with insurance, local farmers would be guaranteed speedy payment of drought benefits.
Germany's Ministry of Development plans to "review the insurance idea without prejudice." So far, the only statement to have come out of the ministry is a wishy-washy, "What's important is what really helps." Some problems, he adds, would have to be cleared up in advance. After all, he says, it would be "questionable, at the very least, if private earnings in the insurance industry were financed with German tax revenues, and if the money itself never reached the people who needed it most." Besides, an unintended consequence of taking out insurance policies could be a decline in precautions taken against famine.
Micro-loans to combat poverty
The Ethiopia policy is a first in the world. Never before have an entire nation's farmers been insured in this way. But despite its novelty, the idea of a weather policy for food producers in the third world emerged already the late 1990s. Using aid money from the European Union and Switzerland, World Bank experts began devising models that could shift harvest risk to the international capital markets.
In the past three years in India, for example, companies like Icici Lombard have sold more than 140,000 insurance policies, some subsidized by the government, directly to farmers wishing to insure themselves against a weak monsoon season. Capital market giants like Swiss Re, for example, then provide reinsurance for the weather speculation.
"These policies developed out of the discussion surrounding micro-loans," says Hans-Peter Egler of the Swiss State Secretariat for Economic Affairs. By supporting local micro-loan banks, development officials place a premium on local responsibility. Not only do the banks maintain a degree of control, but their creditors too benefit. Women in Bangladesh, for example, are considered especially reliable borrowers and, thanks to micro-loans and other innovative financing options, many have been able to build their own businesses.
Farmers in Malawi, Nicaragua and Ukraine have also recently experienced the World Bank's capitalist insurance concept. The miniature policies are also expected to be introduced in Peru, Mongolia and Ethiopia this year.
In each case, the payment of benefits is determined by the applicable weather index. Just recently, the European Union approved another €25 million in funds intended to provide poor countries with access to the international risk market.
Incidentally, the big insurance companies would have had to pay benefits in the case of Ethiopia's great drought in 1984. At the time, rainfall amounted to only 83 percent of the country's already low average precipitation figures -- the lowest value in 30 years.
Translated from the German by Christopher Sultan