The World Food Programme (WFP) is expanding "the first humanitarian insurance policy" in Ethiopia. Officials are hoping to raise US$230 million in insurance and contingency funds to cover 6.7 million people if there is a drought comparable to the one in 2002/2003. 
 
In 2006, WFP partnered with French firm Axa Re to pilot a programme to provide cash payouts to farmers in the event of a severe drought. Now, they are working with the Ethiopian government to expand the programme for three years from 2009. 
 
For the next phase, the partners are creating a more thorough approach to risk management by including clearer contingency planning, capacity building and more robust early warning systems. "Rather than a single transaction demonstrating that this all can be done, we are putting together a comprehensive risk management framework for droughts and for floods in the future," says Ulrich Hess, chief of business risk planning for WFP.
 
Even though there was enough rainfall during the 2006 pilot so that no payout was given, the programme was deemed a success by WFP for its innovative approach to risk management. In the event of a drought, Axa Re would have paid US$7.1 million to WFP, which would then have transferred the funds to the Ethiopian government to be disbursed as cash assistance to households. One study estimated the likelihood of a drought in Ethiopia as once in 20 years. 
 
WFP is also linking with the International Fund for Agricultural Development to assess doing similar work in China.
 
Index-based risk financing heralds a new way that donors are looking at helping the poor cope with extreme weather conditions and natural disasters. While it is not entirely new, according to Christopher Barrett, co-director of Cornell University's African Food Security and Natural Resources Management programmes, "[t]hey have not become widespread in their use at all. There have been a few pilots [and] the pilots are beginning to accumulate enough history that people can assess whether they're working. And the early indications are that these are proving pretty successful for both investors and the insured."  

Index-based instruments collect data over a historic period, and measure deviations against the norm. When these "triggers" are reached, investors pay out. As they do not have to be settled on a case-by-case basis, index-based mechanisms have fewer transaction costs. Additionally, since everyone is paid when reaching the same trigger point, false claims are unlikely. Commercial payouts can also be much more expedient than traditional humanitarian appeals when there is a disaster.   
 
Hess estimates that covering 1.5 million people over 2009-2011 will cost about $5 million for a possible $60 million payout. He says that although the issue has been raised by donors, "I think the principle of using the private markets for this is not disputed any longer. I think it's the 'how' rather than the 'if'."

Climate factors
 
While risk transfers are not necessarily based on weather conditions, the past few decades have seen a sharp rise in weather-related catastrophes, which may affect investment. According to a recent report by Oxfam International, the world is experiencing more than four times the number of natural disasters than two decades ago. Some analysts see this as an opportunity. "It appears that increased climate variability and especially increased asset losses associated with extreme climate events are stimulating rapid growth in the market for weather-related financial instruments," says Barrett.
 
Hess points out that more disasters will mean premiums will also go up. "The cost of coverage premiums might go up as well. It's not so clear if that is the case in all areas for all types of risks, but generally premiums will go up as well." However, he also notes that the increase in cost may be offset by more funds marked for climate adaptation. "The OECD countries, rich countries, are responsible for the climate change. Now OECD countries have to help the poor countries adapt to climate change. Why not pay for some of the insurance premiums that would help them adapt to climate change?"
 
The drought insurance initiative complements the Productive Safety Net Programme (PSNP) started in 2005, which targets those suffering from chronic food insecurity, as opposed to those hit by temporary weather shocks, by providing mostly cash transfers in exchange for work.
 
In September, Swiss Re partnered with Millennium Promise, an NGO working on rural poverty in Africa, and the International Research Institute for Climate and Society to launch the Climate Adaptation Development Programme. This is designed to provide financial protection against drought conditions for up to 400,000 people in 10 African countries. A spokesperson for Swiss Re estimates that an $18 million payout would cover 12 village clusters if the weather trigger was hit. Swiss Re, which also began similar work in India in 2004, declined to disclose the cost of the premium paid by donors to Millennium Promise.
   
According to Swiss Re's head of sustainability and emerging risk management, Ivo Menzinger, "Climate change is a fact and some of its consequences have become inevitable. Parallel to efforts that aim at reducing emissions we have to improve resilience against changing weather conditions, particularly in emerging markets."