A global review of the impact of basis risk on index insurance

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Abstract

Climate change is increasing the risks of weather-related disasters in many regions around the world. This has an adverse socio-economic impact on households, farmers and small businesses. Some strategies for effectively managing climate related disasters include index based insurance products, which are increasingly offered as alternatives to traditional insurance, particularly in low-income countries. However, the uptake of index insurance remains low, which can be partially attributed to the inherent problem of basis risk. This review assesses the problem of basis risk that occurs when insurance payouts depend on an index that is imperfectly related with actual losses experienced by the insurance policyholder. Special attention is paid to the design of the index, quality and sampling data, the estimation of basis risk and its influence on insurance demand, and index-insurance supply. The paper concludes with several policy recommendations including the need for a systematic approach to quantify the magnitude of basis risk, to inform index design with participatory approaches, to offer index insurance through existing risk sharing networks. Moreover, we recommend to improve policyholders access to information about their risk and measures they can take to limit risk, create an enabling environment for a well-functioning insurance market, and lastly to have an integrated approach that incorporates insurance with other mechanisms that reduce basis risk.
LanguageEnglish
Pages845-853
JournalInternational Journal of Disaster Risk Reduction
Volume28
DOIs
StatePublished - 2018

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Insurance
insurance
insured person
Disasters
disaster
index
participatory approach
small business
economic impact
integrated approach
Climate change
low income
farmer
climate change
climate
income
supply
Sampling
weather
Economics

Cite this

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title = "A global review of the impact of basis risk on index insurance",
abstract = "Climate change is increasing the risks of weather-related disasters in many regions around the world. This has an adverse socio-economic impact on households, farmers and small businesses. Some strategies for effectively managing climate related disasters include index based insurance products, which are increasingly offered as alternatives to traditional insurance, particularly in low-income countries. However, the uptake of index insurance remains low, which can be partially attributed to the inherent problem of basis risk. This review assesses the problem of basis risk that occurs when insurance payouts depend on an index that is imperfectly related with actual losses experienced by the insurance policyholder. Special attention is paid to the design of the index, quality and sampling data, the estimation of basis risk and its influence on insurance demand, and index-insurance supply. The paper concludes with several policy recommendations including the need for a systematic approach to quantify the magnitude of basis risk, to inform index design with participatory approaches, to offer index insurance through existing risk sharing networks. Moreover, we recommend to improve policyholders access to information about their risk and measures they can take to limit risk, create an enabling environment for a well-functioning insurance market, and lastly to have an integrated approach that incorporates insurance with other mechanisms that reduce basis risk.",
author = "K. Yuzva and W.J.W. Botzen and R. Brouwer and J.C.J.H. Aerts",
year = "2018",
doi = "10.1016/j.ijdrr.2018.01.001",
language = "English",
volume = "28",
pages = "845--853",
journal = "International Journal of Disaster Risk Reduction",
issn = "2212-4209",
publisher = "Elsevier",

}

TY - JOUR

T1 - A global review of the impact of basis risk on index insurance

AU - Yuzva,K.

AU - Botzen,W.J.W.

AU - Brouwer,R.

AU - Aerts,J.C.J.H.

PY - 2018

Y1 - 2018

N2 - Climate change is increasing the risks of weather-related disasters in many regions around the world. This has an adverse socio-economic impact on households, farmers and small businesses. Some strategies for effectively managing climate related disasters include index based insurance products, which are increasingly offered as alternatives to traditional insurance, particularly in low-income countries. However, the uptake of index insurance remains low, which can be partially attributed to the inherent problem of basis risk. This review assesses the problem of basis risk that occurs when insurance payouts depend on an index that is imperfectly related with actual losses experienced by the insurance policyholder. Special attention is paid to the design of the index, quality and sampling data, the estimation of basis risk and its influence on insurance demand, and index-insurance supply. The paper concludes with several policy recommendations including the need for a systematic approach to quantify the magnitude of basis risk, to inform index design with participatory approaches, to offer index insurance through existing risk sharing networks. Moreover, we recommend to improve policyholders access to information about their risk and measures they can take to limit risk, create an enabling environment for a well-functioning insurance market, and lastly to have an integrated approach that incorporates insurance with other mechanisms that reduce basis risk.

AB - Climate change is increasing the risks of weather-related disasters in many regions around the world. This has an adverse socio-economic impact on households, farmers and small businesses. Some strategies for effectively managing climate related disasters include index based insurance products, which are increasingly offered as alternatives to traditional insurance, particularly in low-income countries. However, the uptake of index insurance remains low, which can be partially attributed to the inherent problem of basis risk. This review assesses the problem of basis risk that occurs when insurance payouts depend on an index that is imperfectly related with actual losses experienced by the insurance policyholder. Special attention is paid to the design of the index, quality and sampling data, the estimation of basis risk and its influence on insurance demand, and index-insurance supply. The paper concludes with several policy recommendations including the need for a systematic approach to quantify the magnitude of basis risk, to inform index design with participatory approaches, to offer index insurance through existing risk sharing networks. Moreover, we recommend to improve policyholders access to information about their risk and measures they can take to limit risk, create an enabling environment for a well-functioning insurance market, and lastly to have an integrated approach that incorporates insurance with other mechanisms that reduce basis risk.

U2 - 10.1016/j.ijdrr.2018.01.001

DO - 10.1016/j.ijdrr.2018.01.001

M3 - Article

VL - 28

SP - 845

EP - 853

JO - International Journal of Disaster Risk Reduction

T2 - International Journal of Disaster Risk Reduction

JF - International Journal of Disaster Risk Reduction

SN - 2212-4209

ER -