Insurance can trigger a more stable, more humane world. Here's why

Deep underground in September 2023, the African and Eurasian plates scraped across one another and triggered Morocco’s deadliest earthquake in more than 60 years.

Their movement also triggered something else: an insurance payout. In 2020, Morrocco’s government took out a policy that insured against any quake beyond 5.0 on the Modified Mercalli Index of earth shakiness. September’s quake was 6.8 on the scale and Morocco’s government is believed to have received many millions of dollars to fund reconstruction.

The concept of insurance isn’t exactly new; most of us who can afford it insure our houses, cars and health. Governments use so-called parametric insurance to insure against specific named events. Sometimes it works well. It’s been used to insure against bad weather destroying crops in Africa, to insure property across the hurricane-prone Caribbean and even to insure against a drop in milk production when cows get too hot in India.

But parametric insurance has limits. By definition, insuring against a specific parameter or trigger event means leaving out everything not specified or not – quite – severe enough. Whatever the losses, if the ground doesn’t quite shake enough, if a storm’s wind doesn’t quite hit a certain speed or if cows don’t get quite hot enough then a policy won’t pay out.

More typically governments and the global donor community fund responses and recoveries directly, or through aid agencies. For more than four decades, for example, the International Federation of Red Cross and Red Crescent Societies (IFRC) has helped communities through our Disaster Response Emergency Fund. Known as DREF, the fund has been invaluable for crisis-hit communities. It’s helped fund humanitarian efforts for decades, reaching more than 220 million people. Donors pay in and we pay out when emergency needs demand it.

The DREF is not a bottomless pit and it’s often stretched. A growing number of global conflicts and climate-related events mean the number of humanitarian crises – disasters – is getting worse.

The DREF is also vulnerable to runs of bad luck. Large-scale disasters can be like buses: there might not be one for ages, then, suddenly, three or four come at once. If the pot has already been depleted by prior emergencies, there may not be enough left to go around.

Another danger is that we hold too much back in anticipation of hazards that don’t materialize. That’s economically inefficient and can mean unnecessarily restricting help for some who desperately need it.

The IFRC’s solution to this problem is a first in the humanitarian sector. It’s an innovative, indemnity insurance policy that insures the pot itself, (the DREF), rather than specific events. If, in any year, demands on the DREF reach a set threshold, the policy kicks in. The trigger is not a natural hazard but an aggregate financial loss.

We can think of that as the excess common to most insurance policies. For now, it’s an excess of CHF 33 million (Swiss francs) or approximately $38.3 million. If this ‘deductible amount’ is spent, insurance will fund a further CHF 20 million worth of DREF allocations (approximately $23.2 million).

With a policy premium of CHF 5 million (or $5.8 million) a year, when needed a donor’s funding could be effectively quadrupled by insurance. That’s one donor franc in, four francs out in a particularly calamitous year.

The benefit is stability: the intensity and frequency of disasters are unpredictable; the financing of responses need not be. Donors to DREF – often governments – can contribute a set amount knowing they won’t be asked for more at short notice if a year becomes particularly busy. That stability may encourage greater generosity if a donor knows their contribution to DREF can be multiplied if there’s acute or unanticipated need.

Increased predictability was a motivating factor for the British government, which has contributed to the policy. Likewise, Germany’s InsuResilience Fund (ISF), the British and Danish Red Cross Societies and private sector donors have all financially backed it. The British government has been explicit about making insurance a pillar of its international development strategy.

If ours can be a model for other humanitarian actors to follow, an important insurance market will open up. To insurance companies this isn’t charity, which means it’s sustainable long-term. In quiet years, insurers will make money – they’ll pocket premiums without having to pay out – but, of course, they’ll carry risk.

There’s further work to do. Insurers need to be persuaded that, at scale, moral hazard won’t be an issue: just as an insured driver could behave recklessly knowing they’ll get a new car if they crash, so a disaster fund with insurance might spend its money faster than one without, knowing shortfalls will be covered.

The evidence, however, suggests the opposite: insurance improves risk management through greater transparency, accountability and clearer accounting of costs. The DREF has a long track record, with decades of statistics on disasters and how we’ve spent in response. The brokers and insurers who’ve backed our policy have used their own tech-enabled algorithms to look over our data. They’ll keep doing so to check that our future spending matches past criteria.

As hazards worsen, we want to encourage donors. We’re aiming to grow the DREF’s potential to CHF 100 million (approximately $116.2 million) by 2025, with a fifth covered by an insurance payout if it’s required.

The DREF has already been one of the fastest and most effective ways for donors to support emergency humanitarian responses. The backstop of insurance means we’ll have greater capacity to respond not only to events after they happen but also in anticipation of and immediately before expected hazards hit. Preparedness spending is always the best bang for buck.

Hazards will happen. The ground will shake, winds will blow, fires will rage. The climate crisis will make hazards worse, but hazards only become disasters through their impacts and reliable funding can stop those impacts from being too awful.

Just as bad events can trigger insurance, so insurance can trigger a more stable, more humane world.