by Siddhartha Jha
Climate change has been a growing concern globally with high profile droughts and wildfires in the news from California to Australia. Even if there are debates in some sectors as to the causes of climate change, the melting ice caps and the march north of warm climate plants and animals points to major changes happening to climate patterns we have grown up with. The conversation around climate change often focuses on arguments about the cause or how we can reverse it but a large part of dealing with climate change will be building resilience to more volatile or unexpected weather.
Building resilience to climate change needs to happen in many forms. In the physical realm, our cities and countryside need more resilient structures along with more widespread growth of natural flood protection zones such as mangroves. In conjunction, resilience needs to increase in the financial realm with effective means to protect against losses from an increasingly variable climate. One key route is to improve access to insurance for the agriculture sector, which tends to be the most exposed to natural disasters in terms of financial costs. The deleterious effects on agriculture lead to higher food prices and local economic recessions elongating the period of recovery. Such effects are most felt in developing countries but developed countries are increasingly vulnerable as well.
Many examples of such climate losses have occurred in the last couple of years. Last year’s extreme heat waves in Germany, this year Australia’s extreme drought, and this year’s extensive flooding in the US Midwest are such examples just in the past couple years in the developed world. Further examples of natural disasters affecting the developing world abound from the droughts in South Africa and India to recent cyclone-related flooding in Mozambique. It is often assumed that financial security would be well established in developed countries and that broadening financial security is primarily a focus for developing countries. However, the problem of ineffective protection from financial losses to farmers extends across geographies. After natural disasters, farmers end up waiting long periods for disaster relief and other reactive solutions. In the midst of the Australian drought this year, farms have had to be repossessed or retroactive adjustments to farm loan terms have been altered after the fact in the midst of hardship. In India, loan forgiveness for farmers in the aftermath of drought or floods is a distressingly familiar cycle, which does little to build resilience to stress but instead curtails the future flow of credit to the agriculture sector.
Providing rapid insurance payments is one of the keys to building financial resilience to natural disasters. For the farming sector, rapid and unambiguous payments in the face of disaster allow for a more robust recovery for the next season. Removing the need to wait for relief payments from Governments reduces uncertainty enabling a rapid recovery and also ends up being cheaper in the long run. The US has the most extensive system of crop insurance and the growing availability of insurance has led to a considerably reduced need for ad-hoc disaster relief payments over the past 20 years, as the chart below shows.
US-style crop insurance has the downside of being too expensive in terms of subsidies for most countries to adopt. Even in the USA, many crops outside of the major crops have inadequate coverage. Parametric insurance, driven by data rather than extensive networks of adjusters, holds the promise of covering the gap left by traditional crop insurance as we have discussed in previous posts. Such data-driven insurance has already grown in usage for disasters such as hurricanes in developed markets such as the USA. The payments are paid based on data rather than the laborious process of sending adjusters to the ground to determine losses subjectively. Such processes are plagued with delays and disputes; a glaring example is the California wildfires from 2018 where months later many property owners were still negotiating payments that were either not forthcoming or too low. Parametric insurance holds the promise to remove such issues by making payments linked to data, which in the case of agriculture could be linked to droughts, floods, pests, or other setbacks. Such policies require higher resolution and more accurate datasets to ensure that the datasets match reality. With the rapid growth of better weather sensors, satellites, and drones, such data collection has greatly improved over the past decades making the promise of widespread parametric insurance adoption a closer reality. Such adoption will be necessary to build a resilient financial infrastructure for climate change that moves us towards anticipating volatility rather than being reactive to it.
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