With rigorous economic research and practical policy solutions, we focus on the issues and institutions that are critical to global development. Explore our core themes and topics to learn more about our work.
In timely and incisive analysis, our experts parse the latest development news and devise practical solutions to new and emerging challenges. Our events convene the top thinkers and doers in global development.
Payouts for Perils: Insurance Contracts for Better Emergency and Humanitarian Aid
The Payouts for Perils Working Group is examining how vulnerable countries and frontline humanitarian agencies can use insurance and index-linked securities to save lives, money, and time by financing emergency response much more effectively and creating healthy incentives to invest in disaster risk reduction. The Group brings together multilateral humanitarian and donor agencies, the insurance industry, academia, and senior government policymakers. It is jointly chaired by Owen Barder, Center for Global Development, and Professor Dr. Stefan Dercon, of the Department for International Development and the University of Oxford.
Many people living in countries with weak or cash-strapped government services live with the daily risk of natural disaster. Conflicts compound these risks; scarcity and natural hazards can also ignite conflicts. A UN report examining twenty years of data concluded that nine in ten emergencies have been due to natural hazards.
Providing assistance quickly and reliably after hazards hit saves lives and money. For example, a drought that would cause harvests to fail in Ethiopia can be predicted in advance: cash transfers or food aid could be delivered early enough to prevent starvation or forced sales of livestock. The consequences can be tragic when assistance arrives late. For example, careful statistical evidence collected by Stefan Dercon, the Co-Chair of our Working Group, points to a permanent loss of income amongst families affected by drought in Ethiopia. When aid is late, people do not recover.
Unfortunately, international aid financing typically waits until a crisis has developed to collect money from donors, and donors are reluctant to pay out in advance of perceived need. Stefan Dercon and Daniel Clarke in their book ‘Dull Disasters’ correctly point out that this is a medieval approach to paying for emergencies, forcing governments and frontline agencies to pass around a bowl in order to save people’s lives.
Relying on disaster aid may fail to create (and might even undermine) incentives for planning and risk management. Since it is not clear how much funding will arrive (or when), governments have little incentive to develop disaster preparedness strategies. And because risks are large and in the future, there is systematic underinvestment in things that reduce the cost of disasters. According to DAC figures, just 40 cents of every $100 in international development aid over the last two decades has been spent on Disaster Risk Reduction (DRR).
Can the problem be solved?
Experience of how we tackle problems in industrialised countries suggests that insurance has a key role to play. Insurance contracts pay out quickly and in response to clearly articulated risks. When the risks are too large for households to bear, governments step in to provide additional support, and both national and sub-national governments also insure themselves.
However, the average level of insurance penetration in developing countries remains stubbornly low. At the same time, governments in these countries struggle to provide enough money themselves to tackle emergencies. Though public and private insurance are complements, lower income countries lack sufficient levels of both. As a result, a commonly reported data point is that only 100 million people in developing countries are covered from weather-related risks (this figure is lower when we account for other hazards, like earthquakes). There is plainly a deficit in protection.
There are two innovations that could help to dramatically lower this insurance gap:
First, there has been a technical innovation in insurance contracts that cover relatively large risks by paying out based on scientific data like the violence of an earthquake, temperatures and rainfall linked to drought, or the wind speed of cyclones. Such parametric contracts do not rely on expensive investigations to assess the scale of damage. As a result, they pay out transparently and quickly.
Secondly, financial instruments (index-linked securities in general and catastrophe bonds in particular) that connect these contracts to capital from global markets enable insurance and reinsurance firms to underwrite very large losses.
These two features— paying out quickly and reliably, and for sufficiently large disasters— suggest that insurance contracts can now play a unique role in tackling humanitarian emergencies. Promising examples of these programmes are already in place, notably in the Pacific (PCRAFI), the Caribbean (CCRIF), and several countries of Sub-Saharan Africa (ARC). However these sovereign risk pools cover a relatively narrow range of perils for relatively modest levels of coverage, have only begun to experiment with offsetting risks to capital markets through index-linked securities, do not generally target frontline agencies or others which would benefit from access to fast liquidity, and do not explicitly create incentives to reduce future losses.
What are some questions that the working group will try to answer?
During the first meeting on July 1st, 2016 in CGD’s London office, the working group articulated the set of problems to be solved. Some initial questions to be answered through the working group process are:
What are the innovations or policy changes needed to tackle the problem of slow, insufficient, unpredictable, or ineffective financing for both slow - (like drought) and rapid - (like cyclones) onset disasters?
Why is the use of insurance (insurance penetration) so low amongst frontline agencies? Amongst governments?
What is the right format for a solution: bespoke deals for each organisation or government, or building a market of options?
How can donors increase access by paying for premiums without distorting incentives to invest in DRR?
What is the role for a trusted intermediary or broker between frontline agencies, vulnerable sovereigns, and the insurance sector? What kind of institutional framework might be useful to support these functions?
How can incentives be built into contracts so that governments also play a role in reducing their exposures to future losses?
During the second and third meetings, the working group will clarify and articulate a concrete set of problems identified during the first and second meetings, and agree recommendations that will make it possible for policymakers, donors, governments, and frontline agencies to take these solutions to action. The working group expects to report during the fourth quarter of 2016.
Disaster aid is often too little, too late. Pressure on aid budgets is prompting donors to find ways to handle more crises with less funding. But the current model of discretionary, ex-post disaster aid is increasingly insufficient for these growing needs, and does little to create incentives for governments in affected countries and donors to invest in risk reduction and resilience. This framing paper sets out how the global community can do better.
Millions of people live with the risk of rapid-onset disasters like cyclones, slow-onset disasters like drought, or the threat of conflict. We often wait for these crises to develop to collect money from donors, a delay that costs lives and dramatically raises the costs of responding. As a result, there was an $8 billion gap between what frontline agencies requested to tackle crises last year and what they received.
Australia’s recent election has ended in a stalemate, with neither party scraping together enough seats to form a majority government. But amidst the flurry of election promises, one topic was conspicuous by its absence from both major parties’ platforms: the expensive, embarrassing problem of the country’s offshore detention centres for migrants and refugees. The centres made headlines again recently when Omid Masoumali died after setting himself on fire, reportedly protesting his detention.
While the policy of detaining migrants offshore is controversial, it has endured in various forms since 2001. But there is a way to make it better for everyone involved: the Humanitarian Investment Fund, or HIF, is a simple piece of financial engineering that can turn the costs of detention into productive investments in resettlement. It would leave detainees, taxpayers, and the government all better off.
Various governments have built on elements of the ‘Pacific Solution’ that calls for detaining migrants and asylum seekers in centers on Papua New Guinea and elsewhere before returning them or resettling them, sometimes in third countries like Cambodia. More than 1,500 potential refugees were housed offshore last year. Overall, more than 40 percent of detainees are held for a year or more, and the average time in detention has increased to over a year.
It’s all eye-wateringly expensive. Costs per person are hard to pin down, but calculations based on Parliamentary reports suggest that it cost an average of $440,000 AUD to keep a single person on Nauru over the 2014 fiscal year. What could that money have bought if it were spent differently? The Netherlands reports the highest first-year costs in the OECD for integrating refugees, at $31,933 USD a head (about $39,300 in 2014). So a single year’s detention on Nauru cost more than 11 years of support in the OECD’s most expensive resettlement regime. Put differently, we could have resettled 11 people in the Netherlands for the price of detaining just one on Nauru for a year.
That’s what the Humanitarian Investment Fund (HIF) would do, reorienting sunk costs towards investments in refugees’ futures. (You can read a detailed write-up here.) Rather than paying to keep people in detention, the HIF’s financial model shifts these expenses to an endowment that can be traded to give refugees asylum in any country they want to settle in, and which will accept them. Detainees would represent capital to help a willing third country offset any perceived short-run costs of providing public services, or temporary support like language classes.
Smart investments instead of sunk costs
The current policy misses a trick or three, and the Humanitarian Investment Fund model could turn these losses into smart investments.
Better value for money for taxpayers. The offshore programmes in Nauru and PNG cost a reported $1.2 billion AUD last year (more than $900 million USD). Enabling people to resettle in third countries in exchange for a small share of those costs would leave a lot of money on the table to spend on Australia’s aid programme, or on public services at home.
Better for people being detained, some of whom are children. People are held in camps for long periods, sometimes under conditions that are hard for Australia’s watchdog agencies to monitor, leading to risks of abuse or neglect. Australia’s Human Rights Commission found that “children detained...on Nauru are suffering from extreme levels of physical, emotional, psychological, and developmental distress.” The HIF model would move people off this caseload much more efficiently.
Better for Australia’s relationships with other countries. The current policy resettles some detainees in third countries with which the government has struck aid-for-migrants deals, including in Cambodia and PNG. Australian filmmaker David Fedele summarises the situation in an op-ed: “Papua New Guinea is currently struggling to look after its own people…There is no true social security system for its population, and excruciatingly high living costs, unemployment and crime.” As a result, there’s mounting frustration and even uncertainty about the system’s legality. And the deals cost even more in aid, such as the $55 million AUD paid to Cambodia.
Reasonable people have strong opinions about whether Australia should house and support more refugees, and facilitate their arrival on-shore. But it seems unreasonable to argue that pouring money into detention, restricting choices for refugees, and damaging the country’s relationships with other nations is the right public policy for Australians.
From offshore to opportunity
There are some reasons why Australia’s political leaders might not want to pivot from the detention model. One argument is that the current strategy acts as a deterrent, preventing many more people from making the risky crossing to Australia. To the extent that’s accurate, the strategy is not working: asylum applications went from 4,300 in 2003 to an average of over than 12,000 a year between 2012 and 2014. Another argument is that countries like PNG and Nauru depend on the aid that Australia is providing in exchange for hosting detainees. But switching from detention to investment through a model like the HIF would be efficient, generating large savings that could also be spent on more effective aid for these countries.
Deterrence is not working, detention is bad for detainees, and the camps are ruinously expensive for taxpayers. So reallocating funding to a HIF model makes sense: it would dramatically increase the number and quality of resettlement options. It would reduce the costs that current policy inflicts on people fleeing conflict overseas. It would help refugees transition out of camps quickly, saving time and money. And it would further establish Australia as a humanitarian leader, capable of using its diplomacy, resources, and stature to give those escaping hardship a fair chance at safe, productive lives.
Thanks to Forrest Rilling, Hannah Postel, and, particularly, Rajesh Mirchandani for helpful comments.
Nine thousand delegates gathered last week in Istanbul for the first World Humanitarian Summit. There was no shortage of great commentary in advance, all of which pointed to the pivotal role that the WHS could play in the future of humanitarian aid. And there was widespread consensus that we must do better: emergency aid is overstretched; delivery systems are often poorly matched to people's needs; refugee crises are overwhelming international organisations’ ability to respond; and lack of security for humanitarian workers signals a worrying trend of blurred battle lines that imperils both humanitarians and civilians.
How could the Summit have tackled these mounting problems? Depending on who you ask, the humanitarian system is either broke or broken.
If the system is simply broke, then the problem is that donors are simply not providing enough money. Last year, humanitarian agencies appealed for $15 billion more in funding than they received, a deficit which is set to grow larger this year. Donors currently spend about $25 billion a year on humanitarian aid—less than a quarter of all aid—and on this view, a relatively affordable increase in humanitarian aid would go a long way towards meeting the world’s obligations.
The alternative view is that the humanitarian system is broken—that is, in need of fundamental reform. The majority of humanitarian aid is spent on long-lasting crises rather than short-term emergencies, and the system does a poor job of helping people to move from dependence on humanitarian aid into safer, more productive lives. Large international agencies often fail to work with local governments and civil society partners. There are few independent needs assessments, and little rigorous evidence about what works. Agencies are mandated and organised to distribute supplies rather than give people control over their own lives and building markets by giving people cash. There is little information about what happens to the money: the humanitarian system is far behind the development system on improving aid transparency. We don’t even know how big the funding shortfall really is, since humanitarian agencies have every rational incentive to overstate needs, knowing that donors will only fund a portion of them; nor do we know how much more the humanitarian system could achieve if it were better organised. And conflicts are dangerously changing in character, threatening a greater number of civilians and increasingly targeting humanitarian staff.
In the absence of a consensus on whether the system is broken or merely broke, little progress was made on either issue at the World Humanitarian Summit. The so-called Grand Bargain was an effort to bring these two points of view together, acknowledging the need for systemic reform and for more money. But the overall result was a series of incremental, rather than transformational, improvements—and some absolute setbacks—along three dimensions of humanitarian aid: how to spend it, how to pay for it, and how to fix it.
How to spend it
Locally, transparently, and in cash. That sums up some of key commitments from humanitarian organisations and donors. One of the Grand Bargain’s few hard numerical targets is the shift to spending at least 25% of humanitarian spending through local organisations by 2020—which, if achieved, will be a dramatic increase from the small fraction that goes to them today. There is a clear and welcome call for greater transparency in how aid is spent, leveraging the International Aid Transparency Initiative, a simple electronic format for recording resource flows that many development organisations already use to help them transparently report on what, where, and when they are spending money.
There’s also been a strong endorsement of the need to give more humanitarian aid as cash transfers. We’ve worked with the Overseas Development Institute and others on collating the evidence. Not surprisingly, people are better than bureaucracies at knowing what they need and want. Markets are good at delivering those things (and can often do so much more efficiently than an international logistics system). And cash transfers are not ‘wasted’ on ‘sin goods.’
On this point, the Grand Bargain’s final language doesn’t match the impressive leadership from few forward-thinking organisations, like World Vision and the International Rescue Committee, both of whom pledged substantial targets for the share of their aid to be delivered as cash. Instead, it emphasizes 1) the need to further evaluate the evidence for providing cash transfers (when in fact this cash transfers are one of the most widely and rigorously evaluated modes of delivery in the history of humanitarian aid), 2) using cash alongside in-kind aid (often it should substitute for more expensive in-kind aid), and 3) ensuring that the delivery of cash is coordinated (thus sidestepping the need for a single organisation to deliver a single unrestricted payment to families, rather than dozens of organisations duplicating each other and requiring coordination).
How to pay for it
Reliance on single-year funding through humanitarian response plans for what are multi-year problems is a long-standing frustration in humanitarian aid, a fundamental misalignment of finance and purpose akin to trying to buy a home using a credit card rather than a mortgage. In 2015, only 13 (of 35) response plans had funding lasting more than a year, even though over half the countries that needed a response plan had had one for at least five years, and nearly a quarter of countries had had one for a decade or longer.
The Grand Bargain explicitly tackles this problem, promising to both increase “collaborative” multi-year funding from donors and reduce the number of earmarks that are applied to those funds, so that agencies get the kind of flexible financing they need to respond effectively instead of managing an endless portfolio of grants too small to make a dent in the problem, each of which carrying its own reporting requirements and administrative expenses. Although donors need to have their feet held to the fire to ensure that these promises stick, that feels like progress. (And though it is, in effect, one giant earmark, so did the announcement of a multi-billion dollar special education fund to pay for schooling for children affected by disaster or fleeing violence, a longstanding lacuna in humanitarian budgeting.)
While the big donors and agencies read prepared speeches to each other in one part of the conference, the side events next door was the venue for some of the most progressive, transformative thinking. Whether or not there’s actually a $15 billion shortfall, there’s no doubt that the system is not keeping up with needs. The result is an urgent push for innovation in how to pay for big parts of the humanitarian caseload, and agencies are increasingly turning towards insurance.
Side events convened by groups like the Insurance Development Forum highlighted an exciting future in which large organisations and vulnerable countries can insure themselves against a growing list of perils like drought and earthquakes. That would make money readily available when things go wrong, protect humanitarian funding for emergencies that can’t be insured, and ensure that vulnerable governments can plan effectively to tackle crises because they know the resources that will be brought to bear.
How to fix it
If the Summit was about finding solutions, then unfortunately it failed to address one of humanitarian aid’s core problems: the incidence of violent conflict. Research published last year found that although there were fewer armed conflicts in 2014 than in 2008, each one caused a death toll that was three times higher on average: in other words, for a complicated set of reasons we’re struggling to understand, conflicts are becoming much more lethal.
Of course, it was never realistic to think that a single summit could achieve real change in the number of protracted conflicts responsible for a large share of the humanitarian caseload. But to the extent that progress could have been made, the absence of even a core group of world leaders meant that real change was probably never in the works. In this sense, the WHS was about treating symptoms, rather than curing the disease. Chancellor Merkel led Germany’s delegation, but the UK was represented by its Secretary of State for International Development, Justine Greening, rather than Prime Minister David Cameron, and the US delegation was led by Gayle Smith, head of USAID, rather than Secretary of State John Kerry.
The absence of senior leaders also meant that real progress on refugees—one of Europe’s most bitter political discussions—was never really on offer. The outcome document from the section of the Summit dedicated to finding a way for countries to provide asylum to refugees and facilitate their integration lapsed into vague promises (“The Summit affirmed more political leadership was required for mediation, peaceful resolution and conflict prevention...”) rather than setting hard targets or measurable commitments.
* * *
The Summit brought global attention to these important issues. Disruption and strong political leadership rather than gradual evolution are needed to create a system that can rise to modern challenges. But a meeting convened by the organisations most in need of reform and without a core group of senior political leaders was always going to struggle to be truly transformational. Political leaders need to confront the realities of paying for and integrating refugees. Donors should use their financing to demand transparency and efficiency from frontline organisations, including the local NGOs now poised to receive a greater share of it. And we must all support efforts to find peaceful solutions to violent conflicts.
Theodore Roosevelt said that good foreign policy should “speak softly and carry a big stick.” The World Humanitarian Summit—and its Grand Bargain—spoke softly. For the many problems addressed at the World Humanitarian Summit, now is the time for the main humanitarian donors to demand reform and delivery by wielding the big stick a little more conspicuously.
The emerging consensus is that the response to Ebola is a test that most richcountries failed. Given that the next public health challenge is a ‘when’, not an ‘if’, what can we do to be more prepared for the next emergency?
Cat bonds might be part of the solution. For the uninitiated, this has nothing to do with securitising housepets: the ‘cat’ stands for ‘catastrophe.’ Cat bonds work like regular bonds, with the twist that if a pre-agreed ‘bad thing’ happens, investors forfeit their cash to the borrower, who can spend it right away — for example to tackle an emergency or pay for recovery.
The World Bank issued its first one in June last year to help cover the insurance costs for earthquake and cyclone risks of 16 Caribbean countries. Now, it wants to scale up and across. The Financial Times reported from Davos that the Bank wants “...to create a global fund that would issue bonds to finance pandemic fighting measures by governments and other bodies.”
It’s not alone. Richard Wilcox, interim director general of African Risk Capacity (ARC) — an underwriter created to help African governments insure themselves against infrequent-but-costly disasters like poor harvests — told reporters that his organisation wanted to offer pandemic insurance to African governments by 2017.
Lest a useful piece of financial innovation fall prey to the development hype cycle, it’s worth pinning down what these contracts can and can’t do.
Cat bonds’ promise lies in the insurance facility they provide. Governments benefit from assured payouts when hit by bad shocks; unlike donors’ unenforceable pledges, these bonds pay out specific amounts under unambiguous conditions.
Compare and contrast: as Amanda Glassman and Karen Grépin noted, it took the WHO five months to declare the Ebola outbreak an emergency. Even if the organisation had access to fully funded contingency fund, they’re not convinced that it would have been triggered — and certainly not with the predictability and immediacy that is a feature of catastrophe bonds.
The investors themselves still seem keen: if the ‘bad thing’ doesn’t happen, they earn a nice payday. Better yet, as one typically breathless industry briefing puts it, cat bonds “are almost entirely uncorrelated with macroeconomic variables.” This means that cat bonds pay out when other assets don’t, and vice versa, a property much-beloved of portfolio managers.
Live deal tracking shows that, as a result, demand for these has grown at a fast clip, totaling $23 billion today (of which nearly $1 billion was issued in just the first few weeks of 2015). Healthy demand for these products drives down yields, making cat bonds potentially a cheaper way to provide insurance against some types of risks.
Insurance contracts need triggers for payouts that are measurable and transparent: we all have access to the same seismological data, so we can all agree whether or not an earthquake of magnitude 7.3 hit Port Vila.
But many of the problems we’d like to insure against don’t benefit from the same data infrastructure. One of the constraints on mounting an early defense against Ebola, for example, was the lack of monitoring and early warning systems. The “pandemic bonds” proposed for dealing with these risks would need to be priced and triggered based on credible, transparent, and timely data about the spread of diseases— effectively presupposing the existence of institutions that, were they in place, might reduce the need for risk financing in the first place.
Even when we can agree on a so-called “parametric trigger”, it’s not clear that catastrophe bonds are the best way to insure countries against shocks. The Pacific Catastrophe Risk Insurance Pilot, for example, pools risks from five Pacific island countries for total coverage of $43 million against tropical storms, earthquakes and tsunamis. Rather than a catastrophe bond, it is a traditional insurance contract. Structuring the transaction as a catastrophe bond might lower the cost of the insurance, but only if enough investors can be enticed to take the other side of the transaction.
These contracts could also create new risks if they make policymakers spend less on prevention, a problem economists call moral hazard. Imagine an overworked civil servant at the end of long budget meeting with her Minister, faced with a choice between, say, training additional midwives or investing in frontline monitoring for an unknown, future outbreak. I know that I’d pay for the immediate need — especially if I had some type of fiscal cover if I needed it. It might sound deeply uncharitable to claim that insuring against these risks affects our incentives; then again, I would think you uncharitable if you told me offering insurance refunds to drivers for not crashing would reduce accidents or that financial incentives reduced drug use or convinced people to stop smoking– but both do.
Solve some of the problems, some of the time
The excitement about finding new uses for catastrophe bonds is healthy. Cat bonds are perfectly suited for some jobs. And if investors remain enthusiastic about piling into frontier market cat bonds, they could provide a cheaper alternative to traditional insurance contracts.
Where they are appropriate, these instruments can bring market rigour to bear on the longstanding problems of how governments with stretched budgets pay for emergencies, and make sure those funds are mobilised when they’re needed. They also provide a clear framework for donors to choose how and how much to chip in, for example by covering interest payments or by guaranteeing the outstanding debt. Compared to unenforceable pledges to buy unknowable amounts of development impact, that’s progress.
But however sexy financial innovation for development might sound, it shouldn’t distract us from paying for and helping to build boring but essential public goods, including better data for development. Those investments are enabling technologies that would make insurance contracts and catastrophe bonds feasible— and perhaps even reduce the need for them in the first place.