CANBERRA — The annual costs of natural disasters in the Pacific can range from a few percent of gross domestic product to more than 100%. This cost has resulted in a range of schemes and efforts to insure public and private assets against natural disasters such as cyclones and earthquakes, and donors investing in research to understand its potential.
But are the Pacific islands insurable?
It is a question that Vijaya Ramachandran, a senior fellow at the Center for Global Development, is seeking to answer as part of new research into the challenges and opportunities for disaster risk finance with colleague Junaid Sadiq Masood.
“The Australian government and other donors are interested to explore different mechanisms for providing assistance to the Pacific Islands, going beyond traditional mechanisms of aid as a result of looking at this question of whether in fact we can provide insurance to minimize or reduce disaster risk,” Ramachandran explained.
At the Australian National University on Sept. 4, Ramachandran presented interim findings that suggest insuring this region is possible — if barriers are removed. And for the Pacific Islands, the greatest barrier to enabling insurance policies with reduced premiums and suitable parametric triggers is data.
The challenge of the Pacific
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Thousands of islands throughout the Pacific Ocean make up the Pacific Island region. They are geographically, demographically, economically and culturally diverse. And the natural disasters they face and its impacts are as diverse as they are.
A critical challenge in responding to disasters is access to short-term, immediate financing for emergency response and maintenance of essential government services — which also limits secondary economic and social effects, including increased incidence of poverty. But the reliance of many countries on aid can limit their borrowing capacity. In Nieu, for example, aid is 42% of GNI. Supporting populations in remote and regional areas of Pacific Island countries can also increase recovery costs and vulnerability.
The hope is that insurance can be a solution to help with the immediate funding needed — and a range of offerings are available. But most of them, Ramachandran said, are “not well-considered,” including credit lines which risk creating debt distress for disaster-affected countries.
Premiums are the biggest barrier including for the Pacific Catastrophe Risk Insurance Company, a World Bank initiative that is supporting four countries in the immediate response to cyclones, earthquakes, and tsunamis.
Its results so far have been “patchy,” Ramachandran explained. While the speed of delivering payouts has worked well, there is concern the models used to predict impacts and the parametric triggers required for the payouts are incorrect.
“There is a big problem with the models insurers are using,” she said. “Something called basis risk is very high … This is risk that essentially arises when the losses predicted by the models are significantly different than the actual losses. And with the Pacific, I will make the argument that basis risk is higher than anywhere else in the world.”
Basis risk combined with the use of parametric triggers, Ramachandran said, has created a set of problems that no one had really anticipated in designing insurance. And it meant countries were becoming distrustful that insurance schemes could support them.
Overcoming the barriers
There are a number of key improvements that Ramachandran recommends to make insuring Pacific Island countries viable. One is linking resilience to the premiums charged — something that is not currently done. Ramachandran sees this as an important opportunity to help Pacific Island countries and their partners to support better investment and additionally reduce premiums as risk lowers.
But this is unlikely to occur immediately. To support this transition, Ramachandran also recommends creating a donor pool of funds to support paying premiums until a blended finance model can be established.
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In considering the triggers for payouts, she also recommends looking at whether parametric triggers should be used all of the time or whether soft triggers — such as governments declaring an emergency — can also play a role. This would support concern from some Pacific nations that triggers being used weren’t suitable for the needs of the region.
Bundling disaster insurance with well-known insurance policies such as fire insurance could increase uptake of policies among households, as well as expanding insurance options to include microinsurance in remote areas that major schemes miss. And building the ecosystem of incentives and regulations to support sustainability of insurance is important.
But investing in improved data, including high-resolution satellite imagery over the Pacific, is critical to improve the awareness and monitoring of risk, and products that are built on strong models.
“My sense from talking to people in this business is that there just needs to be a lot more data to reduce basis risk,” Ramachandran said, explaining that India and Africa have vast amounts of available spatial data in comparison to the Pacific.
A blend of public and private resources to fill this gap is needed — but currently, both are providing limited data coverage for the region.
“There is so much donor activity in this space,” Ramachandran said. “Between all of these donors if we can get some investment in the data side that will attract some private players into this space. And the private players can presumably also invest in data. What I am worried about is that donors want to see tangible results … there is more of an incentive to do some kind of financing rather than to invest in data which is very intangible and sometimes long term.”
Investment in data would likely see increased activity in insurance companies offering products — particularly companies based in New Zealand — based on better models. And with Ramachandran explaining that many donors are currently looking at their schemes, her research is timely to encourage them to invest in areas that would lead to a sustainable insurance market supporting disaster resilience and recovery.