There were not many quantifiable positives when the delegates to the Climate Change Conference left Madrid last December. A large number of participants regarded the conference as having been a failure, in particular representatives from non-governmental organisations. However, in the midst of all the tussles between the various countries, Hannover Rück SE achieved a real coup. On the fringes of this climate summit with few tangible events, the reinsurer joined forces with German and British partners to present the “Natural Disaster Fund”. This fund worth millions is intended to mitigate the damage caused by climate change in emerging and developing countries. Set up in conjunction with Germany and the United Kingdom, the fund starts off with a total of 100 million US dollars. The two countries have contributed capital to the fund, while Hannover Re has provided 50 million US dollars of additional capacity by way of an insurance solution. The fund will be administered by the British partner Global Parametrics, a specialist provider for creating resilience to climate risks in developing countries.
Droughts represent an existential threat
The fund is intended to benefit the poorest regions in the world. This is because the people there suffer the most from climate change. Extreme weather events like droughts or floods pose a threat to their existence. Moreover, they start off with very limited financial means for purchasing insurance to protect themselves against risks such as losing their harvest. While around half of all damage caused by disasters is insured in high-income countries, this proportion is less than five percent in lower-income countries. The “Natural Disaster Fund” is intended to help redress this balance.
“We regard this fund as pioneering work,” commented Henning Ludolphs, Head of the Central Division for Retrocessions & Capital Markets at Hannover Re. He and his interdisciplinary team from Hannover Re have been working together with Global Parametrics for two years towards getting the collaborative project between German and English partners successfully off the ground. “Our target was to give the ‘Natural Disaster Fund’ greater power with the assistance of an insurance solution.”
Special insurance solution
However, the fund differs enormously from a traditional insurance policy. The “Natural Disaster Fund” is a fund that invests in parametric insurance solutions. This type of policy pays out if a weather event hits trigger points agreed in advance. For example, the Natural Disaster Fund might cover a scenario like this: A development bank, aid organisation or non- governmental organisation (NGO) extends mircroloans to small farmers in Africa. The organisation can only afford to do this if it can insure its loan portfolio against natural disasters. This is because if there is no rain, the harvest dries out on the farmers’ fields and they have problems in repaying their loans.
Interview with Henning Ludolphs and Dr Leif Heimfarth
The NGO enters into an agreement with the fund that it will receive a specified insurance sum if, for example, a level of precipitation agreed in advance is not reached in a region from 1 June to 30 September – this is a key indicator for a drought. The data is provided by a local weather station or a satellite. The special aspect of this policy: If the rain fails to fall, the money flows – and payment is not dependent on whether the farmer has actually sustained a loss. This allows the aid organisation to protect its loan portfolio against volatility, for example, and it can continue to extend more loans to the farmers in the region. “Over time, this leads to the creation of a certain level of income stability for the farmers,” said Henning Ludolphs. “This is the first step in the direction of more stable living conditions.”
Hannover Re has a long track record of experience with risk transfer through parametric products. The reinsurer is giving the “Natural Disaster Fund” the benefit of this experience. “Policies like this are ideal for use in emerging and developing countries,” said Dr Leif Heimfarth, expert for parametric covers at Hannover Re. “We are dealing with a large number of insureds although they each tend to have limited cover. The usual procedure applied in industrial countries where a loss adjuster reviews the claims is simply not appropriate in this situation.
Furthermore, there is often a lack of the necessary data and infrastructure to permit traditional insurance solutions to be offered.” The “Natural Disaster Fund” is a pilot project for Hannover Re that it intends to extend further in future. “We are using our experience to invest in this programme in order to create solutions that people in the poorest regions of the world need as a matter of urgency,” said Henning Ludolphs. “We are making our know-how available to society and sending out a strong signal to industrialised countries and policymakers that complex solutions like this actually work.”