Can insurance break Ethiopia’s vicious cycle of hunger?

Ethiopia is in the news again, with the World Food Programme warning earlier this month that millions of people are once more at risk of hunger.

After the massive droughts of 1984, 1987 and 2002 and the fundraising drives that followed them, this kind of warning can spark frustration and a feeling that perhaps Ethiopia is a hopeless case; for many, it’s difficult to understand why a country that has received so much aid over the past 20 years is still incapable of feeding itself.

The fact is, Ethiopia has been receiving the wrong kind of aid. Per capita it receives more emergency aid than any other country, but the least amount of development aid. There is a need to explore new ways to help Ethiopia with its chronic food shortages.

The problem lies, at least partly, in a lack of insurance to help poor people cope with economic shocks. In sub-Saharan Africa, around 140m people live with the ever-present threat of natural disasters such as drought and floods. Without insurance, these people face losing not just their income but their assets when disaster strikes; without productive assets they have no livelihood, and they become locked in a vicious cycle of deepening destitution, reliant on aid for years to come.

INSURING AGAINST DISASTER

So why shouldn’t Africa’s subsistence farmers protect themselves from the weather in the same way as an energy company, which takes out insurance against mild winters when demand for heating falls?

In India, smallholder farmers in some districts of Andhra Pradesh have been able to buy weather insurance against drought since 2002, through Hyderabad-based microfinance institution Basix and Mumbai-based insurance company ICICI Lombard. The project, initiated with support from the World Bank’s Commodity Risk Management Group, has spread rapidly from the initial pilot; this year Basix intends to offer weather insurance for the monsoon season to 10,000 farmers across seven Indian states.

In Africa, many farmers don’t have access to insurance or can’t afford it. But why shouldn’t a humanitarian agency pay for a policy on their behalf, thereby pre-empting the need to provide emergency food aid further down the line?

That’s exactly what WFP is planning to do for the farmers of Ethiopia, where we will launch the prototype of a “weather insurance” scheme at the beginning of 2006 with technical support from the World Bank, which is just beginning a number of small-scale weather insurance pilot projects in Africa.

If successful, the scheme could help in devising effective financial solutions to address natural disasters throughout the world, enabling faster interventions to prevent the sale of crucial assets and finally breaking the cycle of dependency in which millions of vulnerable people find themselves.

THE NEED FOR INSURANCE

When the rains in a country like Ethiopia fail to arrive, subsistence farmers act fast, selling their tools and livestock within four to six weeks. They do this firstly because they know that everyone else will be selling their assets too, driving down prices, and secondly because they need cash to buy food at harvest time, when it is cheapest.

Appeals to donors by agencies such as WFP for funds or donations in kind are traditionally based on the failure of the harvest, which does not occur until several months after the failure of the rains.

This means that by the time donors have come up with the aid and it has been passed on to the farmers and their families, four or five months have passed since the rains failed to show and those families have long since sold their assets, leaving them unable to benefit from better weather the following year and therefore trapped in a state of dependency.

So while we can stop people starving, we often fail to protect their livelihoods. Studies show that it takes a decade to recover from a severe drought. It accounts for huge numbers of destitute people; once they lose their productive assets, they become semi-permanent beneficiaries, so it’s important to reach them during the two to six weeks following the failure of the rains, when they would normally sell those assets.

HOW THE SCHEME WILL WORK

The solution proposed by WFP in its pilot project in Ethiopia is to write insurance contracts based on a rainfall index, which correlates with historic, drought-induced food needs.

In other words, the amount of rainfall will be measured and if the index falls below the trigger line on the graph, suggesting a drought severe enough to warrant food aid to the region, the insurance company will issue a payout which will be used to fund relief.

Because it’s based on objective data, we can take this index to insurers and private finance companies. We will give them a premium each year if they give us a payout as soon as the index crosses the trigger point.

Premiums will be met by donors, who will direct funds to commercial risk-taking entities such as reinsurance companies to cover the cost of the policies, as well as giving directly in the traditional way.

THE ADVANTAGES OF INSURANCE

With an insurance company paying out as soon as rainfall dips below the index, WFP can get aid to the vulnerable much faster – an estimated four to five months earlier than with the traditional appeals-based system, and in time to prevent the sale of those crucial productive assets.

Another advantage is what I would callthe developmental impact of certainty: the fact that subsistence farmers who have the safety net of insurance in place will feel secure enough to make higher risk, higher return investments in land, seed, fertiliser and so on, bolstering their livelihoods and triggering economic development.

The insurance approach will also be helpful to donors, because it will prevent them having to find funds quickly when catastrophe strikes. Assuming a traditional, appeals-based approach, a drought such as the one sub-Saharan Africa suffered in 1984 would require around US$1.6 billion of food aid for Ethiopia alone at today’s prices; a huge amount of money for donors to come up with in a hurry.

With the risk transferred to reinsurance companies and/or the capital markets, funds will be available on a predictable and timely basis, providing an effective insurance function against the loss of income and assets for vulnerable populations.

THE SCHEME IN PRACTICE

In the first quarter of next year, WFP plans to go to the international markets and appeal for funding to insure the 2006 harvest in Ethiopia, offering to pay an attractive premium in order to have several hundred million dollars on standby in case of drought.

To satisfy the needs of reinsurance companies and the capital markets, over 30 rainfall-measuring stations across Ethiopia will provide reliable, objective data, to be measured against an index based on rigorous, comprehensive records of the past correlation between the lack of rainfall and the need for food aid, includingresearch on the depletion of household assets in response to droughts.

The index is designed specifically for the crops grown in Ethiopia and measures rainfall as a national average; regional droughts within the country and crop failures that are not caused by a lack of rain but by, for example, a locust invasion, will have to be dealt with in the traditional way.

Aside from providing tightly controlled data, WFP is willing to pay commercial prices for its insurance in order to make the proposal attractive to the providers. We must hope that droughts do not occur too frequently, as if the insurance is regularly claimed, no one will be interested in underwriting the risk.

I estimate that there is only a one in ten chance of an event triggering a payout, but the effectiveness of the weather insurance contracts can only really be tested in practice; all WFP can do is show that it is feasible to write them. We need to prove that we can build something that’s acceptable to the market at favourable rates.

THE BOTTOM LINE

The bottom line is that to have large amounts of cash available on a contingency basis costs money, and WFP will have to pay. In order to justify using donors’ money in this way, we need to demonstrate that by doing so we will increase the value of those funds to the people who need them: those vulnerable to hunger.

I believe the insurance approach will increase that value many times over, because if we can reach someone before they sell their assets, it means we don’t have to feed them for the next two, three, four, five years; they have a chance of becoming self-sufficient with the next harvest.

To suggest that famines are simply a result of drought, ignoring factors such as corrupt government or civil war, is obviously misleading. But by isolating systemic risks in key areas – a lack of rainfall in Ethiopia, for instance – agencies such as WFP can spend more time focusing on the other causes of hunger.

Essentially, it’s all a matter of how you look at what a humanitarian organisation does.

WFP’s fundamental function is as an insurance provider of last resort for vulnerable populations. When a vulnerable population is hit by bad weather or a man-made shock, its insurance protection is WFP’s food. The premise of the weather insurance project is that by looking at the agency’s work in this way, we can make it more efficient. And that should encourage donors to increase their contributions.