Service Design | 2008-2011

Designing Viable Earthquake Insurance for Rural China

How can we apply international insurance examples to mitigate catastrophic weather risks on Chinese agriculture?

Client

Joint project by the World Bank, China's Meteorological Administration, and Germany's Gesellschaft für Internationale Zusammenarbeit and the Wharton Risk Management Center

The Challenge

In the face of climate change and increasingly catastrophic weather, understanding the steps that public and private actors can take to mitigate and manage these risks will be a matter of survival. Traditional insurance models are poorly equipped for these high-impact, low-probability events. When catastrophes occur, both governments and private insurance markets are overwhelmed. This research project surveys international programs for novel ways alternative weather index-linked insurance schemes were designed, and seeks to apply these models to China's agricultural areas.

Involvement

This was my undergraduate independent study project for 3 years with 2 other teammates under the guidance of Dr. Howard Kunreuther of the Wharton Risk Management Center.

The Outcome

I conducted research on Chinese insurance needs to co-write and present reports on:

  • A policy introduction to Chinese society's current attitudes toward insurance, government framework, insurance penetration, and exposed economic risks to catastrophic natural disasters
  • Models of sustainable risk transfer schemes suited to China's insurance needs
  • A comparison of international models of weather-index linked insurance as an analysis of its viability in China's agricultural areas

How do we design a catastrophe insurance system that suits China's social, economic, and political needs?

The 7.9 magnitude earthquake that devastated Sichuan in 2008 was record-setting in the catastrophic death toll and overwhelming economic impact it wrought. In a country that did not adapt earthquake building codes until after the deadly 1970s Tangshan earthquake, China faced a massive economic burden of financing the rebuilding of Wenchuan county, which had only a 0.8% property insurance penetration. To build a comprehensive risk mitigation plan for China’s rural regions, I worked alongside two other Wharton students to assist the World Bank and China Meteorological Association in writing a series of reports and proposals analyzing how to adapt and prepare for low probability, high impact natural catastrophes like earthquakes and floods. The final topics covered weather-index linked insurance vouchers, alternative financial instruments and reinsurance markets, and public-private partnerships to support risk mitigation of low-probability events.


Cross-cultural Models: Lessons learned from Malawi

To validate future proposals for China, I studied other international weather-index based models to examine what worked and what didn't when setting up a similar pilot for Fujian, specifically focusing on Malawi's groundnut and maize crop insurance program.

In Malawi, there was little demand for a stand-alone insurance product, but an insurance product linked with loan credit for more productive crops and with inputs like seeds and fertilizer was successful in drawing in potential policy holders. The program started with 900 farmers in the first 2005- 2006 season, more than doubled its uptake to 1910 in the next season, and insured as many as 2600 farmers (with a portfolio size of 3 million) by the time the program was discontinued to do non-insurance related defaults. The farmer education requirements, strength of local distributor channels, infrastructure of regional weather systems to measure weather indexes, and potential for reinsurance made this pilot program an attractive model for what China was hoping to implement in Fujian.

As next steps from this research, the organizations that we worked with (GTZ, CMA and World Bank) have expressed interest in funding pilot programs in China as a part of a broader effort on managing disaster risk.

Cover of the final report presented to the World Economic Forum in April 2011

During the 3 years we worked on this research topic, we met with many Chinese stakeholders to deliver a joint public-private catastrophe management plan that served the needs of Chinese meteorological of officials, local governments, insurers and global reinsurers, and residents of earthquake-prone areas.

In addition to the completed 60+ page report from this project, the ultimate findings and recommendations were included in the 2011 World Economic Forum's "A Vision for Managing Natural Disaster Risk", a report dedicated to reviewing strategies for mitigating catastrophic risk through public and private sectors.

We primarily focused on policy modeling, particularly the social assessment of Chinese society's appetite for insurance schemes and researching the institutional design of Chinese partnerships and potential funding sources.

Pilot survey for earthquake insurance demand in Yao’an (姚安)

I assisted in planning a pilot survey to empathize and learn of the needs of stakeholders in Yao’an county, a place commonly hit by earthquakes. The survey included 2000 households distributed throughout the 9 small towns and 77 villages in Yao’an. 80 questionnaires were assigned randomly to households in each village, asking basic information about the respondent, and about their awareness and interest in earthquake insurance.

The goal of this survey was to provide insight into:

  • How much awareness or demand for earthquake insurance there was in Yao'an
  • Willingness-to-pay figures, to calculate the remaining gap between individual purchase thresholds and required policy premium amounts
  • Insight into suggestions for governmental insurance voucher subsidy amounts
Mock of a Chinese voucher based on the Malawi program, which would pay holders if the temperature (or some other weather index) exceeded a specified harmful level.

Proposed program: two-tiered index-based insurance vouchers combined with government subsidies

In the final report, my co-authors and I detailed an weather insurance policy proposal that draws heavily from our in-depth study of the first pilot index-based international programs in developing countries. I focused on Malawi’s groundnut and maize pilot program in particular. The report discusses the context of the program’s history and development, stakeholders involved, and distribution/ payout mechanisms that are relevant to Chinese contexts.

The two tiers would include a single high-loss, low-probability event and several low-loss, high probability events to prevent policyholders from stemming payment due to myopia. The low-loss, high-probability event payments would not generate the most profit for the product; instead, it is simply there to sustain current policyholders.