Humanitarian Insurance: Weighing the Options
by Conor Meenan, Lead Risk Finance Specialist
Through the previous blogs in this series, we have started to unpick the role for risk transfer in a humanitarian context, and raised some of the ethical, practical, and principle-based reasons why humanitarian actors might think twice before using risk transfer tools like insurance [1]. The obvious next question for humanitarian actors and donors is simple: "when is risk transfer a good option?".
Whether risk transfer is a good option depends on many factors. And the exercise of weighing the relative benefits of risk transfer and balancing this against its cost can’t be done simply by turning a handle on an excel spreadsheet.
This question takes a human touch. At its core, weighing and balancing the option of risk transfer often relies on a technical analysis of the costs and benefits of risk transfer in relation to a defined value statement. But any decision must also reflect strategic objectives, reviews of practical, logistical, and legal limitations, and a critical evaluation of the reasons why a product might fail, and the failsafe mechanisms that can be used to mitigate this risk.
To help guide decision-making, this blog poses three questions that aim to help humanitarian actors and donors to triage proposals for using risk transfer:
Risk transfer for what future costs?
How does risk transfer compare to other options?
Are we there yet?
These questions set out a streamlined version of the detailed approach set out in the Centre for Disaster Protection Quality Assurance framework.
Risk transfer… for what future costs?
It goes without saying that a person wouldn’t buy car insurance if they couldn’t first answer some basic questions, the main ones being: ‘do I own a car, and if so, how much is it worth?’.
Through this analogy, answering the question of whether or not you own the car, or want to formalise a commitment to be on the hook for somebody else’s car, can prove surprisingly complex - and requires a principled and pragmatic assessment of the possible trade-offs, unintended consequences and ‘duty of care’ implications.
The question ‘what future costs do you intend to cover using risk transfer?’ is also often a surprisingly difficult one for humanitarians to answer.
Part of the problem is that future humanitarian costs are difficult to define accurately ahead of time. This challenge is potentially why event-based fundraising, and preferences for fully flexible funding are the status quo in the humanitarian sector – the responsive and flexible model allows organisations to wait and see how an event unfolds before costing it up. But this wait-and-see approach raises its own challenges.
Where possible, the question ‘risk transfer for what future costs’ should be answered with a description of how funds will be used by the organisation if a payout is made, alongside some evidence to indicate how the size and timing of payouts aligns with the expected humanitarian funding need.
Humanitarian costs are difficult to predict accurately – so clearly any answer to ‘how much and for what’ will fall within a range. Anticipating and quantifying future humanitarian costs is a difficult task, but it is worthwhile – information about funding needs for previous humanitarian crises, technical tools, and scenario planning can help to form a basic picture of the shape of anticipated costs, even for humanitarian costs within the most complex crises.
Parametric triggers offer a powerful tool that help to create clear disbursement rules even in situations where the type, size, and timing of required funds are difficult to anticipate. These parametric rules are often, but not always, necessary for the pricing and transfer of intangible risk to a third party. However, parametric triggers can be a double-edged sword – exactly because they make it possible to build risk transfer policies in the absence of a clearly defined funding need, it is also possible to build financial roads to nowhere. In other words, the situations where parametric trigger design is easy, don’t necessarily align with contexts where humanitarian actors have an obvious responding role or associated funding requirement.
If an organisation can’t convincingly answer ‘risk transfer for what?’, and the ‘what’ doesn’t clearly link to activities that support organisational objectives, this should be a red flag that risk transfer might not be the right approach.
How does risk transfer compare to other options?
The world of risk financing, with its technical predictive tools and use of finance and insurance industry approaches can seem overly complicated. But when it comes down to it, it is simply a financial planning exercise in creating, comparing, and choosing options for how to pay for the costs of tomorrow’s crises.
Risk transfer is one of these payment options, so when asking if it provides the best option for a humanitarian organisation, then it should be properly considered and compared.
Again, on the surface this question appears simple, but the process of answering it can be a little more complicated. So, to break it down:
How does the risk transfer policy support better humanitarian outcomes?
What are the total costs (including fixed setup costs, ongoing premium fees, and additional internal resources)?
Are there other options that deliver the same or better outcomes, at a lower total cost?
Defining the benefits of risk transfer, assessing costs, and comparing against other options is a tricky exercise, but again – the outcome is worth the effort. Having a clearly defined value statement, and a sound justification of the costs against benefits in relation to other options is a good way to make sure that the use of risk transfer is the right option in that situation. These assessments should be documented publicly to enable scrutiny, and support learning across the sector around the use of risk transfer in humanitarian contexts.
Are we there yet?
The use of risk transfer to support costs associated with future humanitarian responses represents a new way of working for humanitarian organisations. There is a good justification for humanitarian organisations to look towards risk transfer. Making response plans and pre-arranging finance before a crisis emerges creates a space to plan and design for better humanitarian outcomes. This includes improved participation of vulnerable communities in design, targeting and accountability and building in incentives and linked activities to promote preparedness, risk reduction and risk ownership.
As with any novel approach, the use of risk transfer comes with new challenges for humanitarian organisations. Some groundwork may be required before an organisation is in the right place to develop and use risk transfer effectively. This could be in terms of working through anticipated future costs, developing organisational strategies for using risk transfer, ensuring there is sufficient access to expertise and advice about risk transfer, designing new processes to ensure seamless flow of payouts through the organisation, or legal review to ensure risk transfer policies fit within requirements.
All of this takes commitment and investment at an organisational level. The commitment to a long-term vision for how the system pays for crises, matched by investment in the skills, roles, and resources needed to implement these new financing approaches. There is also a need for donors to commit to the same vision, in principle and in practice, so that forward-looking financial management can become sustainable in the humanitarian sector.
Before committing to a large purchase of risk transfer, it is worth humanitarian organisations and donors alike looking critically inwards and asking, ‘are we there yet?’.
Read part 1 now: Humanitarian Insurance: Risk Transfer 101
Read part 2 now: Humanitarian Insurance: Ethical tightropes, trade-offs and unintended consequences
[1] Although the term ‘insurance’ is often used as shorthand for risk transfer, insurance policies are in fact a specific subset of risk transfer instruments. While the risk transfer instruments available to humanitarian organisations can reasonably be called ‘insurance-like’, it is not strictly correct to call them insurance. However, for the sake of ease of reading in this series we will use the terms ‘insurance’, ‘insurance policy’, ‘risk transfer’, and ‘risk transfer instruments’ interchangeably. Note also that risk transfer instruments are themselves a subset of risk financing instruments (which are also confusingly referred to as any combination of [pre-arranged/ pre-agreed/ pre-positioned/ event-based/ triggered/ contingent] – [funding/ finance/ financing] – [instruments/tools/ mechanisms/ arrangements]), which also expand to cover risk retention instruments such as contingent loans. This series focuses explicitly on the role for risk transfer – i.e., those instruments that facilitate the transfer of risk from one entity to another.