Drought Insurance

The NYTimes reports on an innovation in disaster aid, drought insurance taken out by relief agencies.

In a pilot project that could someday transform the world’s
approach to disaster emergencies, the World Food Program has taken out
an insurance policy that will pay it should Ethiopia’s notoriously
fickle rains fail this year…

The policy, which costs $930,000, was devised to create
a new way of financing natural disaster aid. Instead of waiting for
drought to hit, and people to suffer, and then pursuing money from
donors to be able to respond, the World Food Program has crunched the
numbers from past droughts and taken out insurance on the income losses
that Ethiopian farmers would face should the rains fail…

….If it works, the insurance will get emergency money flowing
faster, before the haunting images of dying babies reach television
sets. It would also shift the risk from farmers to financiers.

    Insurance like this could even have benefits in the United States.  Private firms, of course, often do buy disaster insurance but the United States government might want to do the same.  Hurricane insurance, for example, bought by the US government could better spread the costs of disasters to the well-diversified.  In theory, the government could duplicate any insurance program with a tax and spending program (give Bill Gates money now and tax him when the disaster occurs) but in practice it’s going to be much easier to commit to an insurance plan than to an equivalent tax and spend plan.   

More generally, drought insurance on this scale is part of the New Financial Order.  I refer to Robert Shiller’s work on using macro-markets to
offer large-scale insurance.  A market in GDP futures, for example,
could be used to hedge against declines in GDP such as have occured in
Argentina, South Korea or the future United States (yes Tyler, it could happen!). 
Markets in the income of professions as a whole, e.g. the the income of
dentists, could be used by dentists to hedge against the possibility of
a super anti-cavity sealant.  See Entrepreneurial Economics for more on macro markets.

Thanks to Alex Wolman for the pointer and Robin Hanson for discussion.


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