Risk Transfer & Private Sector

Risk transfer

Risk transfer, defined as shifting the responsibility or burden for disaster loss to another party through legislation, contract, insurance or other means, can play a key role in helping to manage natural hazard risk and mitigate or minimise disaster losses. As the international community places increasing emphasis on disaster risk reduction, there is growing interest in the potential of risk financing solutions, of which risk transfer is a major component, as part of an overall disaster risk management strategy. Recent developments in this field include the use of a range of risk transfer mechanisms such as catastrophe bonds, catastrophe pools, index-based insurance and micro-insurance schemes. Social protection programmes such as safety nets and calamity funds can also provide effective financial instruments for managing risk and dealing with natural disaster shocks.

ProVention promotes the use of risk transfer as an effective element of disaster risk management. Currently, whereas in high-income countries about a third of natural disaster losses are insured, less than 3% of households and businesses have catastrophe insurance in developing countries (Munich Re, 2005). A key concern for ProVention, therefore, remains whether and how the poor in developing countries can have access to affordable and viable risk transfer mechanisms, such as insurance. It is also important to examine to what extent such risk transfer mechanisms provide incentives for risk reduction measures.

This section is intended to provide links to useful resources on the subject of risk transfer for disaster reduction in developing countries including tools, methodologies and mechanisms being developed by ProVention partners and others.

Resources (by type of scheme):

Micro-insurance

Micro-insurance is defined by CGAP as “the protection of low-income people against specific perils in exchange for regular monetary payments (premiums) proportionate to the likelihood and cost of the risk involved.” As with all insurance, risk pooling allows many individuals or groups to share the costs of a risky event. To serve poor people, micro-insurance must respond to their priority needs for risk protection (depending on the market, they may seek health, car, or life insurance), be easy to understand, and affordable.

Micro-insurance has grown out of the micro-finance movement, where savings, credit and other services have proven successful in helping low-income communities better manage their resources and create their own opportunities. While standard micro-finance products can provide some risk management, the subject of micro-insurance is attracting wide interest as a growing body of evidence demonstrates the potential benefits of micro-insurance for low-income houses and businesses that are traditionally excluded from conventional insurance services.

The intent of micro-insurance is to provide easily accessible insurance cover for small-scale assets at affordable premiums by keeping transaction costs low. The first micro-insurance programmes generally focused on health care and funeral cost products, with new developments and innovations not only improving existing products but also expanding to cover new risks like natural disasters.


In Guatemala, the only company that provides insurance to workers in the informal economy is Columna, with more than half a million clients. Based on the number of people covered, Columna is by far the largest insurer in Guatemala. Unlike traditional insurers that focus on the easy-to-reach urban market, Columna is serving rural populations that never had insurance protection. Columna offers a variety of group insurance schemes for cooperatives and micro-insurance schemes targeting micro-enterprises.

The process of offering both micro and traditional insurance has both advantages and disadvantages for Columna. On the plus side, Columna’s target market—cooperatives and their members—request both types of coverage. By providing a range of products, Columna can more cost-effectively meet the needs of its market while generating additional premiums for itself. On the other hand, the microinsurance operations are different from other insurance products, especially marketing. Some of the expected efficiency is lost because it is not always appropriate for one employee to handle different types of insurance.

Some of the general micro-insurance lessons learned from Columna’s experience include:

  • The most cost-effective way to reach the low-income market is through organisations that already reach large numbers of the target market.
  • The distribution of micro-insurance should therefore be implemented through microfinance institutions (MFIs), cooperatives, trade unions and the like.
  • Insurance company shareholders should implement a policy on surplus that allows the company to grow and maintain good solvency levels.
  • Benefits can be reaped from collaborations with international organisations that provide support, training and market information.
  • A micro-insurance product must be simple and the premiums should be affordable.
  • There should be a range of premium and benefit levels to make the product relevant to a higher percentage of the targeted market.
  • Sales personnel must receive adequate training to promote micro-insurance products; printed promotional material should be simple to understand.
  • An insurance company must establish a mutually beneficial relationship with its marketing and distribution channels.

Source: Columna Guatemala (CGAP Working Group on Microinsurance Good and Bad Practices Case Study No.5)

Specific Projects and Programmes

Micro-insurance is being implemented in a variety of structures that fall under different risk transfer categories. Therefore, micro-insurance example projects and programmes are included on ProVention’s categorised risk transfer resource pages, highlighted with *:

Informational Overviews

Organisations and Centres

Conferences and Events

Traditional hazard insurance

Traditional insurance products covering natural hazards are written on what is often termed an “indemnity” basis, where the policyholder insures a defined property, economic activity or other entity, such as a building or a business, against specific hazards such as earthquake, wind or flood. In the event of the insured item being lost or damaged as a result of a covered hazard, the policyholder is compensated for their financial loss. Therefore, insurers pay claims based on actual losses.

For many traditional insurance schemes, for instance covering automobiles for accidents and thefts, assessing risk is relatively straightforward due to a large volume of data and experience yielding sound probabilities for losses. Risk assessment for natural hazards, however, is more difficult, due to challenges in assessing both the hazard as well as the insured item’s vulnerability to a specific hazard.

Furthermore, natural hazards tend to impact large areas, thus affecting large portions of the population or risk pool at the same time. This can challenge the resources of a local insurance provider who may only do business in the affected area. Reinsurance helps reduce these risks by providing geographic and hazard diversification.

Traditional insurance requires extensive networks of claims adjusters who assess individual losses following an event. At the same time, the possibilities of insurance fraud (called “moral hazard”), as well as only people or organisations at high risk purchasing insurance (called “anti-selection” or “adverse selection”), are relatively high. These factors contribute to the cost of traditional insurance.


The Gujarat State Disaster Management Authority (GSDMA), India, was the main agency for the provision of government relief and reconstruction assistance after the 2001 earthquake disaster. GSDMA established a compulsory group-based housing insurance scheme for those households that had been completely destroyed and rebuilt with government assistance.

For a mandatory payment deducted from the final installment of housing assistance, the policy provides protection for 10 years for 14 types of natural and human-induced disasters. GSDMA undertook promotional activities to raise client awareness and understanding about the contents of the insurance policy and how to file a claim.

Lessons learned from this experience include:

  • standardised, non-voluntary group policies can substantially reduce transaction costs;
  • at the same time, such a standard insurance package can fail to respond to individual requirements;
  • awareness of active and potential clients needs to be continually raised;
  • with the premium being paid only once every 10 years, there is no potential for providing incentives for risk reduction.

Source: Disaster Insurance for the Poor? A Review of Microinsurance for Natural Disaster Risks in Developing Countries)

Specific Projects and Programmes

Informational Overviews

Organisations and Centres

Conferences and Events

Index-based insurance

Index-based insurance (also called parametric insurance) is distinguished from traditional indemnity-based insurance in that it features contracts based on a physical measurement of a hazard, such as rainfall, temperature or wind speed. Index-insurance is often used for crop risks, where farmers collect insurance compensation if the index reaches a certain measure or “trigger” regardless of actual losses. These schemes may offer a viable alternative to traditional crop insurance, which has failed in many countries, mainly because of the high costs associated with settling claims on a case-by-case basis.

Index-based crop-insurance contracts are sold in standard units by rural development banks, farm cooperatives, or microfinance organisations, and the “premium” varies from crop to crop. As payouts are not coupled with individual loss experience, farmers have an incentive to engage in loss-reduction measures, for example, by switching to a more robust crop variant. A physical trigger also means that claims are not always fully correlated with actual losses, but this “basis risk” may be offset by the reduction of moral hazard and the elimination of long and expensive claims settling. As the claim is a pre-fixed amount per unit of protection, transactions are greatly simplified.

The major advantages of index-based insurance are therefore the reduction of moral hazard and transaction costs. Index-based mechanisms are also more transparent, as they are based on a physical trigger and the payout is fixed in advance. The major downside of index insurance is the basis risk: if the trigger is insufficiently correlated with the losses experienced then no payout may occur, even if the losses are substantial.


The World Food Programme (WFP), together with the World Bank Commodity Risk Management Group (CRMG), piloted an index-based insurance scheme to cover farmers against severe drought during the 2006 agricultural season in Ethiopia. Payment was to be triggered if rainfall was significantly below historic averages, pointing to the likelihood of widespread crop failure. The contract was awarded to Axa Re.

Rainfall in 2006 turned out to be above average, so no payout was triggered. If the contract had been triggered, Axa Re would have paid out to WFP, who would then have transferred the funds to the Ethiopian Government for distribution as cash assistance to individual households through their Productive Safety Net Programme.

Valuable lessons were still however learned from this experience:

  • it is feasible to use market mechanisms to finance drought risk in Ethiopia;
  • it is possible to develop objective, timely and accurate indicators for triggering drought assistance;
  • ex-ante resources can give governments and donors the incentive to put contingency plans in place, allowing earlier response to shocks;
  • in terms of humanitarian funding for Ethiopian drought, risk transfer is optimal only for major catastrophes, as for smaller events insurance becomes disproportionately expensive.

For the continuation of this project, WFP plans to develop an Early Livelihood Protection Facility (ELPF). The ELPF will again be index-based, but smaller losses will be covered by a contingency fund, medium losses financed by contingent grant or debt, and only major catastrophes covered by weather index-based insurance. If an extreme drought surpasses even the insurance coverage, a traditional flash appeal for funding will be required.


Specific Projects and Programmes

Informational Overviews

Organisations and Centres

Conferences and Events

Catastrophe pools and bonds

In a catastrophe pool, different but similar entities such as national governments or insurance companies combine resources to form a fund which provides financial protection against catastrophic risks. The amount paid into the pool by participating entities depends on their individual exposure to the covered hazards.

In some cases the fund itself pays out to the individual pool members when claims are made (risk sharing); in others the fund is used to purchase insurance or reinsurance for all involved (risk transfer). In the case of risk sharing, if there are no claims no capital is lost such that the capacity of catastrophe protection increases. For risk transfer, pooling helps lower the cost of (re)insurance, such that the coverage acquired is greater than could have been attained separately by each individual member.

Catastrophe bonds (also known as cat bonds) are risk-linked securities that transfer a specified set of risks from the insured to the global financial markets (investors). Although much discussed, cat bonds are not yet common in developing countries, partly because they are relatively new and generally more expensive than traditional reinsurance.

Cat bonds are usually offered through the creation of a special intermediary entity. If a bond is not triggered, meaning no covered hazard occurs during the predefined period, investors make a healthy return. But if the bond is triggered, then the principal initially paid by the investors and/or the interest is used to pay claims to the insured. Investors find cat bonds attractive because for the same level of risk, cat bonds offer higher interest relative to alternative investments, and they are not correlated with the ups and downs of the financial markets.


The majority of the population of Turkey lives in earthquake-prone areas, such that the persistent potential for large-scale natural disasters has become a fiscal and social issue for the government. Combined with a desire to increase catastrophe insurance penetration, this led to the establishment of the Turkish Catastrophe Insurance Pool (TCIP) in 1999.

Since the programme began, insurance penetration for catastrophe coverage has more than tripled. Providing coverage to approximately 2 million Turkish homeowners, TCIP is now the largest insurance programme in the country. In only five years, the programme built approximately $200 million in its own reserves and secured nearly $1 billion in total claims-paying capacity, primarily from the international reinsurance market on competitive terms.

The programme has significantly reduced the government’s fiscal exposure to earthquake risk. In the wake of several small and medium-scale earthquakes over the last few years, the TCIP demonstrated its ability to pay claims quickly and fairly. It has promptly settled 6,000 claims amounting to $6 million. Because of its low cost structure and well-managed reinsurance costs, the TCIP can provide affordable catastrophe insurance for low-income urban homeowners.

However, despite it being officially mandatory for homeowners, only 16% of the insurable housing stock is currently covered by the TCIP. Attainment of a higher level of earthquake insurance penetration will depend on:

  • limiting government’s future bailouts of uninsured homeowners to the provision of structured relief;
  • securing the insurance industry’s cooperation through appropriate incentives;
  • ensuring adequate claims-paying capacity;
  • developing a regulatory framework consistent with a genuine public-private partnership;
  • finding additional distribution channels to reach the underserved.

Source: Earthquake Insurance in Turkey - History of the Turkish Catastrophe Insurance Pool

Specific Projects and Programmes

Informational Overviews

Organisations and Centres

Conferences and Events

Risk financing

Catastrophe risk financing refers to the combination of all methods used to pay for financial losses incurred during a disaster. This has in the past in developing countries focused on post-disaster aid and lending. It is clear, however, that such “ex-post” strategies are not efficient or sufficient. Risk financing now stresses “ex-ante” (before the disaster) measures such as risk transfer and sharing. While use of ex-ante risk financing methods is increasing, during most disasters in developing countries some degree of ex-post support will always be needed.

A truly integrated risk financing strategy should utilise all appropriate and effective methods, in combination as appropriate. Just as risk financing should form an integral part of a general disaster reduction strategy, risk transfer should form an integral part of a risk financing strategy. Aiming to strengthen the flow of resources for effective disaster risk management both “ex-post” and “ex-ante”, risk financing in this sense is relevant at macro-levels for countries as well as at micro-levels for individuals, households, and communities.


Experience has shown that to best help the poor manage risk, an integrated approach combining savings, credit and insurance provides the alternatives needed to address individual situations. Such a suite of products can be managed and offered by a single organisation, or individuals themselves tend to access the mix of services (when available) they need for their own personal risk management and growth.

The Indian microfinance institution Sanghamithra, which was developed as a separate organisation by the NGO Myrada, has found that credit, savings, insurance and capacity building are equally important components for sustaining livelihoods. Beneficiaries are organised in self-help affinity groups (SAGs), which manage their own savings, often employing diversification strategies such as keeping savings in both a common SAG fund and local banks. While Sanghamithra provides credit, Myrada and other NGOs provide infrastructure, business linkages and training to the SAGs.

Birla Sun Life has developed an insurance product appealing to SAG members, and the company relates directly with the projects where Sanghamithra is lending. Insurance policy administrative support is provided for a commission by Community Managed Resource Centres. In this manner and through a collaborative strategy, beneficiaries have access to a mix of products and can thus choose what they need for their own risk management.

Based on the experiences of Sanghamithra and other organizations during and after the 2004 Indian Ocean tsunami, the following lessons were learned on risk financing at the micro level:

  • some aid will always be necessary;
  • grants can be vital for recovery, but great care is needed;
  • demand management presents a challenge;
  • sensitivity yields appropriate and flexible products;
  • different goals need different products;
  • training and education are as important as financial services;
  • microfinance should be used to support disaster mitigation;
  • microfinance helps foster a culture of prevention;
  • disaster funds should be developed at all levels;
  • more micro-insurance is needed.

Source: Bhatt, M. and Chakrabarti, P.G.D. eds. (2006), Micro-Finance and Disaster Risk Reduction, Knowledge World, Delhi, India.

Specific Projects and Programmes

Informational Overviews

Organisations and Centres

Conferences and Events