Page - 493 - in Loss and Damage from Climate Change - Concepts, Methods and Policy Options

21 InsuranceasaResponse toLossandDamage? 493 The ratio of the premiumpaid versus the coverage obtained gives an indication of the insurancecost,particularlywhencomparing insurance toother riskfinancing tools.Using this ratio,GhesquiereandMahul (2010) found that risk transfer isvery costly compared tomost other financial instruments (Ghesquiere andMahul 2010; ClarkeandDercon2016).Asacaseinpoint,intheCaribbeanregionannualinsurance premiums (paidmostly by businesses) were estimated to represent about 1.5%of GDP during the period 1970–1999, while average losses per annum (insured and uninsured)accounted foronlyabout0.5%ofGDP(Auffret2003). If insurancepremiumscost clientsonaveragemore than their anticipated losses, and in the case of co-variant catastrophic events significantly so, why do house- holds, businesses and governments insure? This question is particularly pertinent for resource-poorhouseholdsandgovernments,wherepremiumpaymentscanhave highopportunitycosts.The textbookrationale forpurchasing insurance,verifiedby evidenceon insurancepenetration, isbasedon theconceptof“riskaversion”.Risk- aversepersonsandentities (generallypeoplewhocannotcopewith large losses)are willing topaymore than theyexpect to loseonaverage toavoidcatastrophic losses. Householdsandfarmsindevelopingcountriesarelikelytobehighlyriskaversesince large lossescan threaten livelihoodsand lives (and thushave severecosts andother implications beyond the sheer financial loss). The sameholds for the public sector sincedisasters can significantly affect development if governments donot have the means for rapid reconstructionand relief efforts (Mechler2004). For middle- to high-income earners in developed as well as developing coun- tries an insurancevaluepropositioncanoftenbediscernedas shownbysubstantial insurance demand, yet it is pertinent to ask how insurancemechanisms can serve resource-poorclients facinghigh risk?Ascurrentprogramsdemonstrate, insurance premiums are made affordable by targeting higher income clients, implementing cross subsidies, limiting coverage, providing outside support and forming partner- ships (Linnerooth-Bayer et al. 2010).Whereasmost discussions focus largely on making insurance affordable, it should be recognised that itmay not be advisable from a benefit-cost perspective. Indeed, reliance on alternative financial arrange- ments, likedonorsolidarity,savings,creditandremittances,canbeconsiderablyless costlythaninsurance,andthesearrangementscanworkreasonablywellfor low-loss events(CohenandSebstad2003).However,theycanbeunreliableandinadequatefor covariate and catastrophic shocks that place a significant financial strain onwhole communities, regions and governments. Insurance theory and recent cost-benefit assessments indicate that insuranceandother riskfinancinginstrumentsaremainly advisable,andviable, forlargeandresidualrisksthatcannotbereducedorretained otherwise.