Risky business: Three exam questions from the Risk Pool Summit
by Theo Talbot, Chief Economist & Associate Director – Sustainable Finance and Sophie Evans, Associate Director - Advisory
Credit: Shutterstock. Vehicles try to drive through a flooded street in Dhaka, Bangladesh. Encroachment of canals is contributing to the continual water logging in the Capital Dhaka.
The Centre for Disaster Protection works on how the international system can better protect people when disasters strike. With years of experimentation and iteration behind them, risk pools are an essential piece of the answer, offering predictable pay-outs for pre-agreed risks like earthquakes and droughts.
CCRIF SPC (formerly The Caribbean Catastrophe Risk Financing Facility) has 22 Caribbean and Central American countries as members. Since 2007 it has paid out USD $245 million in claims for earthquakes, hurricanes, and excess rainfall. The Pacific Catastrophe Risk Insurance Company (PCRIC) now has six members, three of which pay regular premiums for coverage. The African Risk Capacity (ARC) Group has so far paid out USD $124 million in claims for droughts and cyclones, with all 55 members of the African Union eligible to access capacity building support and ultimately join the risk pool. The Southeast Asia Disaster Risk Insurance Facility Insurance Company, set up and owned by the ASEAN+3 countries, helps cover flood risks in Lao PDR.
Last month, the Centre hosted the executive leadership and technical experts running these risk pools. Our summit was the pools’ first gathering focused on peer-to-peer learning, taking lessons from one region and cross-pollinating it to others.
We organised discussions under the Chatham House rule, but over the course of a two-day event and various side meetings, three open challenges stood out:
Selling umbrellas, not tents.
The pools trade off competing pressures: to maintain financial viability as insurance organisations, to help governments cover losses they face from specific hazards, and to charge the lowest premiums possible.
Why are there trade-offs? First, because of basis risk, the mismatch between the policies that the pools offer and the losses they seek to protect against. For example, a country may experience financial losses due to a drought even when the indicators in the underlying contract aren’t triggered. That means that governments might expect pay-outs that aren’t forthcoming.
Second, because the pools are insurers, not donors. They stay solvent by underwriting insurance policies at prices that won’t bankrupt them. If they tried to cover all risks or cherrypicked which risks to cover (and to what extent) after disasters happened, they would replicate the problem of unpredictable and incomplete emergency aid they set out to fix.
So, the pools walk a thin line – relying on the governments that own (and, in some cases, govern) them for support, political buy-in, and sustainable premiums, while retaining the independence to make pay-outs based on agreed policies.
When governments feel that the models that determine their pay-outs don’t reflect the size of losses on the ground, it can effectively pit the pools against their customers. To work well, the pools sometimes have to say no because conditions for a pay-out haven’t been met, even when politicians might feel like the pools should be saying yes. The challenge is for pools to market themselves as umbrellas – focused protection for circumscribed risks – rather than tents that provide broader shelter on demand.
Securing repeat, predictable business.
Five countries were initially part of the scheme that evolved into PCRIC. The Cook Islands joined in the second year, but the Solomon Islands declined to take policies in the third. Participation stayed steady until 2019, when Vanuatu did not renew its policies. And so on.
Volatile membership matters because the underlying mechanics require a steady drip of premiums to offset lumpy pay-outs. Socialising governments to pay consistently for protection isn’t incidental to the business model – it is the business model.
Donor subsidies often mean the premiums cost less than they would at market prices or that countries pay part of the cost of coverage. But developing countries have tight budget constraints. Overspending forces hard choices between borrowing or printing money. That raises the spectres of high debt burdens or faster inflation (or both).
In this environment, even modest spending needs a vocal defender in budget meetings. There is a constant worry that governments will trade the long-run protection against big and unforeseen expenditures that pools offer for a bit of short-term slack in their budgets.
We can make this easier for at-risk countries by pivoting resources focused on concessional loans into windows for concessional insurance that, after all, protect the investments that loans help to fund. Initiatives like the GRiF and InsuResilience Solutions Fund show cautious but welcome progress in this direction.
But we want the pools to become financially sustainable without (or with less, or more targeted) subsidy, so the challenge is ultimately to build political commitment, turning buying cover into a dull, predictable, repeatable procurement decision.
Evolving from regular insurance to development insurance.
There is growing recognition that risk pools can evolve from providing the financial engineering that provides pay-outs to supporting the planning that gets triggered (and funded) when pay-outs arrive – turning early funding into early action.
How the pools navigate this transition from regular insurance to development insurance is an important open challenge.
We’re learning from experiments in this direction. ARC asks participating countries to set out audited preparedness plans for how pay-outs will be spent when disasters strike. Its parallel Replica policy pushes NGOs and governments to coordinate, helping to seal gaps between national and humanitarian response.
But there’s a lot of white space to fill in. Governments may commit to use pay-outs for emergency assistance, but without publicly available response plans and healthy transparency (like audits) after spending, it is difficult to evaluate how it was used or whether humanitarian aid dovetailed effectively with the government’s response.
The pools’ product offers could evolve to help with these dull-but-important things, like public financial management systems to process funds quickly and trickle them out transparently. Or they might borrow more from ARC’s playbook, helping to articulate prior actions that governments and their development partners put in place as a precondition of being insurable.
Helping countries tackle disaster risk and lock-in gains from economic growth – especially for their poorest citizens, who don’t have buffering assets like savings and often lack political visibility – lies in the sweet spot of what governments prioritise and the funding they need to do it.
That makes it the kind of problem risk pools, owned and operated by their members and offering clear contracts instead of unpredictable fundraising, are well-positioned to help solve. Instead of throwing our hands up at the scale of the challenge, working collectively on these exam questions will help turn disaster risk into the kind of problem governments start to get their arms around.
We’re excited to keep learning from our friends operating these institutions, and to help them learn from each other.