Irrational Economist_ Making Decisions in a Dangerous World - Erwann Michel-Kerjan [117]
Development organizations, international financial institutions, and NGOs are already providing support to make insurance affordable in the developing world. The aforementioned insurance programs in Mongolia, Ethiopia, Mexico, and the Caribbean have all received outside backing in the form of technical assistance, reinsurance facilitation, and, in some cases, direct subsidies. The efficiency and equity issues raised by this kind of assistance are discussed in the next section.
Another challenge is that badly designed insurance contracts can discourage investments in loss prevention or even encourage negligent behavior (“If I know I’m protected anyway, I can take more risk”), commonly referred to in economics as moral hazard or in the climate community as maladaptation. As a remedy, index-based contracts, by decoupling losses and claims, avoid moral hazard and can provide strong incentives for risk-reducing interventions and lifestyle changes. Two of my earlier examples illustrate this: In Mongolia, insured herders will face increasing premiums as climate change worsens weather conditions, giving them an added incentive to change their livelihood if animal husbandry becomes unproductive; and in Mexico, government officials will face higher interest on their catastrophe bonds by not taking measures to reduce risks to public infrastructure. This is the power of risk-based insurance premiums.
INTERNATIONAL SUPPORT FOR INSURANCE: EFFICIENCY AND EQUITY
A central challenge in economics is to find the “right” balance between a policy or a program that is not only efficient from an economic point of view but also equitable. This challenge applies especially to insuring the poor in developing countries.
Efficiency
Incentives provided by risk-based premiums, which price risk and thus couple prevention with price reduction, can be weakened by outside support, especially if such support takes the form of premium subsidies. If the premiums do not fully reflect risks, they may perpetuate vulnerability by discouraging investments in disaster prevention and making it possible for people to remain in high-risk livelihoods or locations. This concern is voiced in the present book by Wharton’s economist Howard Kunreuther, who calls for risk-based pricing, although he is aware, especially given the devastation caused by Hurricane Katrina in 2005, that risk-based premiums may not be affordable to the poor in high-risk areas. In their new book At War with the Weather, Kunreuther and Erwann Michel-Kerjan suggest that vouchers (which are similar to food stamps) would enable the poor to purchase insurance.7 Indeed, vouchers might serve as an alternative to subsidizing insurance systems in the developing world. Already direct cash transfers to the poor are replacing donor-financed projects in some countries; perhaps in those that also provide post-disaster assistance, these transfers could be made conditional on purchasing insurance. As a case in point, cash transfers to women in Mexico are conditional on their provision of child education and health care, and it would be a small step to make these transfers conditional on their uptake of insurance against disasters and other threats to their lives and livelihoods.
Even without insurance vouchers, subsidies and other forms of premium support may be justified by the failure of the market to provide the right price signals. In Mongolia, for example, government support for the syndicate pooling arrangement takes the form of absorbing losses from very infrequent extreme events (e.g., more than 30 percent animal mortality), and the government can call upon a World Bank contingent debt arrangement to back this commitment. The designers of this program argue that subsidizing the “upper layer” is less price distorting than subsidizing lower layers of risk because the market