Global Development: Views from the Center
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March 10, 2006
Insurance against disaster: public or private?
Posted by Owen Barder at 07:21 AM
In the last two days we've had the announcement of a program to buy commercial insurance against drought in Ethiopia, and the launch of the new UN emergency fund.
New York Times: Aid Group Takes Out Insurance on Drought in Ethiopia
In a pilot project that could someday transform the world's approach to disaster emergencies, the World Food Program has taken out an insurance policy that will pay it should Ethiopia's notoriously fickle rains fail this year. The policy's creators are calling it the first natural disaster insurance coverage for an international aid agency .BBC NEWS: UN launches $500m emergency fund
The UN has launched a $500m (£288m) emergency fund to speed up the handout of money for humanitarian disasters. ... But worldwide responses to the fund have been muted - with only a quarter of the amount needed raised so far, of which a third has come from the UK.Analysis and comment
UK International Development Secretary Hilary Benn described the world's reaction to disasters as similar to that of a fire brigade having to go round with a collecting tin to raise funds before it can put out fires.
In many circumstances, proposals to harness private sector energy, expertise and resources to solve problems of global poverty would be welcome (see, for example, our work on creating incentives for pharmaceutical companies to invest in vaccines). But we should not have knee-jerk ideological preferences for either the public or the private sector.
In the case of insurance against natural catastrophes, economics theory points towards maintaining a single, large, international fund. Most Governments self-insure because they face a large and diverse set of risks, and so makes sense for them to deal with the costs as they arise themselves, rather than pay private investors to bear those risks instead. The private sector has to be compensated for taking individual risks, and for the cost consequences of both adverse selection and moral hazard. On the same logic, the international community faces a large and diverse set of risks from the consequences of natural disasters, and should self-insure rather than pay to transfer individual risks to the private sector.
But as we see from the story of the UN Fund so far, there are considerable bureaucratic obstacles to international cooperation that this requires. As UK Development Secretary Hillary Benn rightly points out, when the disaster occurs, there is no time to raise funds to pay for a response. But it is very difficult to persuade donors to agree burden sharing arrangements and to make contributions to a fund for theoretical future disasters. As a result, the proposed disaster fund is having difficulty raising the funds it needs.
The decision to establish a fund to insure Ethiopia against famine is not, as it may first appear, a welcome sign of new entrepreneurial thinking among aid agencies. It is a measure of how the international system is failing. The market will do it, at a price. This insurance is going to work out quite expensive, though it is hoped that it will lead the way for a bigger and cheaper market. But the international system could self insure much more cheaply. That it is unable to do so, and will have to pay more to the private sector, is a failure of international coordination and a bureaucracy. The price that will be paid for private insurance is a measure of the cost of those failures of international coordination; and it will be paid for with money that would otherwise be used to help the poor.
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Comments
Very good points.
I also wonder about the transaction costs. Bc while the WFP is taking out the contract, I think they plan to distribute funds directly to farmers - not themselves use the funds to purchase and distribute funds, seeds etc... And who is to say what the farmers will use these funds for?
Simliar ideas have been done in Malawi and India. But in these cases donors have arranged wetaher insurance contracts for large Banks. The banks in turn have used these contracts as a security blanket to lend to small farmers. Small farmers where given loans to buy new strains of resilient seeds. And to hedge their risk they were told that if there was a drought that year their loans would be forgiven. (The donor arranged insurance contract paying off their loans instead.) Still not perfect - but seems better aligned in terms of incentives than the above program.
Posted by: Pablo at March 10, 2006 11:12 AM
I agree that this "insurance policy" is symptomatic of a broken international humanitarian aid system, but in the absence of a more thoroughgoing reform of that system, it seems like a useful way to make sure that assistance gets to people who need it on a timely basis. Also, the Times's description of this as an "insurance policy" isn't really correct. If the Ethiopian government is self-insuring, then WFP is providing one level of reinsurance and AXA Re another. Given the unreliability of U.N. consolidated appeals for humanitarian assistance and donors' slow filling of the new U.N. central emergency relief fund, this may not be such a bad approach. Fewer people will starve as a result.
Posted by: Marc Cohen at March 10, 2006 11:49 AM
Private insurance: A necessary evil?
The recent initiative to overcome the adverse effects of drought in Ethiopia through a private insurance scheme is a classic case of proverbial problem of coordination in political economy. International political economy is full of cases of problems of collective action as in lack of collective security to stop genocide in Darfur(Sudan)or ensuring African governments adhere to international norms on good governance.So, if delegating a task to a private entity means a quicker and more effective access to millions of vulnerable people in Ethiopia then the insurance scheme is not bad at all. However, we need to be wary of its long term effects on the country, particularly with regard to incentives for government to reform. There exist a very clear possibility for moral hazard on the part of government in that because it knows it will be bailed out whether the disaster is truly natural or human-error and, hence, may be tempted not to work hard on preventive reforms particularly along governance lines. We, Ethiopians, have been so highly dependent on foreign aid over the past decade that the political accountability of our leaders continually shifted to western donors. In general, we will be unable to put into effect political institutions that reward effort because the West is always there to do what we otherwise would have liked to get from our own government.
Posted by: Michael Seifu at March 12, 2006 07:00 AM
UN $500M?
In the existing economic system it is hardly possible to see improvement in humanitarian disaster.We need a new economic system that the UN should be involved in.
Posted by: michael at January 22, 2008 09:29 AM