New Insurance Against Extreme Droughts Takes Off
New Insurance Against Extreme Droughts Takes Off

New Insurance Against Extreme Droughts Takes Off

Severe droughts, often leading to famine, have been some of the greatest catastrophes in Africa. Countries where they occur find themselves unable to deal with the crisis in time. Now, a new insurance scheme, in conjunction with the African Union, will seek to mitigate this calamity. Dominique Magada reports.

Managing severe droughts is one of the pressing challenges African governments have to face. With the change in weather patterns, droughts are more likely to happen in an unpredictable way on the continent, leaving thousands of people resourceless.

The international insurance market, which until now had limited involvement in Africa, could provide a lasting solution to help governments manage this type of risk while minimising the cost of doing so.

In a groundbreaking move, the African Union (AU) recently adopted an innovative project which will combine national contingency plans with international weather insurance coverage to better manage drought and food security emergencies on the continent.

The project, known as the African Risk Capacity (ARC) and soon to be established as a specialised agency of the Addis Ababa-based AU, will use weather risk insurance to cover against drought. “The idea is to move from managing crises to managing risks, and transfer the burden away from African governments to international markets who have the expertise in handling this type of risks,” explained Richard Wilcox, managing director of the ARC.

The project, still in its design phase and managed by the UN World Food Programme, aims to create an insurance pool to spread the financial risk across the continent for countries threatened by severe drought. “The idea is to spread the coverage thin and wide,” said Wilcox.

According to the ARC, the international system, as currently structured for responding to natural disasters, is not as equitable and timely as it could be. Affected countries have to wait until funding is secured, which is done on an ad hoc basis, to mobilise relief towards the people who need it the most.

In the meantime, lives are lost and assets depleted, forcing more people into chronic destitution. It is hoped that a mechanism such as the ARC will be able to redress the balance by using an insurance pool to better prepare for likely disasters.

The project was formally approved at the African Union Summit in July 2012, and is currently being finalised as a new AU Agency. It should become operational in the second half of 2013. “A Treaty has been agreed, we are now going through the formal adoption process within the African Union,” he added. “So far, we are on track with our schedule.”

Insurance pool

The insurance pool will be based on a weather data index which will estimate and trigger quick-disbursing funds, up to a maximum of $30m per country per season, for droughts that occur with a frequency of one in five years or less. Such funds would give African countries hit by severe drought the immediate resources to implement effective and timely responses.

Reliable weather data will be gathered daily to create a common index for all the participating countries. This will be used to assess risks, calculate premiums and disburse funds. For example, if rainfall goes below a set level over a period of time and a serious drought occurs, a pre-agreed amount will be paid out to the affected country.

Participating countries will pay an annual premium based on the number of countries involved and a risk analysis of the situation. The base capital for the insurance pool will initially amount to $180m and be provided by international donors. A number of UN agencies are participating but funds are still being collected. The index itself is being developed using African RiskView (ARV), the software developed by the ARC, which uses information from ground base stations as well as satellite systems.

“Each country has to develop its own weather index, which will feed into the system and amalgamate into a single index through the ARV software,” explained Wilcox.

The index will be based on different sets of meteorological data providing actual rainfall estimates, cumulative rainfall, and historical rainfall data for the continent. It will be further strengthened with other indicators such as a water requirement satisfaction index, which monitors shortage of water throughout a cropping season, as well as country specific data on vegetation and dryness.

“We believe data provided by satellite systems are sufficient because they include the different sets of data needed for the index, and the information is reliable,” he said.

The idea of weather-risk coverage is not new. A pilot contract of the same kind was implemented in Ethiopia in 2006; however, because it was a good year for rain and crops, no payout was released. “It was a one-off annual contract, and in that frequency it is less likely that there may be a payout. However, the contract was a great example and a good basis on which to expand and develop a sovereign insurance scheme like the ARC for the whole continent,” said Wilcox.

Mitigating extreme risk

In fact, the ARC is designed to be a tool for African governments to manage extreme drought risk and crises, not recurrent droughts which occur more regularly. Most countries in sub-Saharan Africa already have national mechanisms to prepare and cope with smaller shocks, which are better managed through national reserves or other investments.

So far, four African countries – Kenya, Lesotho, Malawi and Niger – have signed a pre-participating agreement which means that they will engage in a six-month capacity-building exercise with the ARC in view of deciding whether the insurance pool will work for them. “Other countries are very close to signing a participation agreement,” said Fatima Kassam, Chief of Government Affairs and Policy at the ARC. “The ARC wants to make sure the participants make an informed decision on whether or not to participate.”

According to the ARC, the value of the system is based on the fact that droughts never happen in the same place at the same time, so the likelihood of several droughts hitting the continent in the same season of the same year is extremely low. “We did a risk simulation and found that emergency situations can be better managed at continental rather than national level and the more countries participate, the more money can be saved,” said Fatima Kassam. “We estimate that costs can be cut by half.”

Compared to other mechanisms already in place elsewhere, such as the Caribbean Catastrophe Risk Insurance Facility (CCRIF), which covers against hurricane and earthquake risks, the ARC brings another innovation by requiring participating countries to have a contingency plan already in place.

“We are linking the pan-African insurance pool to national contingency plans,” explained Kassam. In other words, to be able to participate in the ARC, a country will have to show that it has a sound contingency plan in place to respond effectively to an emergency situation, using the ARC funds. “We want to avoid potential cases where the funds disbursed under the ARC are not immediately used for the emergency situation,” added Wilcox.

In his view, the strong solidarity among African Union member countries is another positive factor likely to make the ARC work for the continent. “In the meetings we had, countries were openly discussing their respective contingency plans and were keen to learn from each others without competing,” said Wilcox, “they trust each other, something we don’t necessarily see in other large regional organisations.”

Furthermore, the purpose of the ARC is not only to provide an insurance pool to cover against drought, but work towards the food security of the African continent in the long run. By linking contingency funding to effective response plans, the ARC aims to help African governments reduce their reliance on external aid.

“We view it as a vehicle for countries to get together and develop sound risk management practices against drought, and also to get the private financial sector more involved in Africa,” explained Wilcox. “Our philosophy is that insurance is not the end goal, but it can be used as a valuable tool for the long-term food security of the African continent,” he concluded.

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Written by African Business Magazine

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