The insurance industry has become a participant in a new and unusual initiative sponsored by the United Nations World Food Program, which aims to have funds available to meet the needs of disaster victims as soon as they occur.
AXA Re, the reinsurance division of France’s AXA Group, has been selected by the UN to underwrite an innovative weather derivative transaction, which would provide up to $7.1 million to Ethiopian farmers, if rainfall levels fall below certain parameters, indicating that a drought and famine are likely to occur.
Weil, Gotshal & Manges, a New York law firm, which acted as pro bono counsel to the UN in establishing the program, noted in a press bulletin that the new initiative creates “a novel way to transfer humanitarian risk to the financial markets.”
In insurance terms, for a $930,000 premium, the policy partially shifts the risk of crop failures from the Ethiopian farmers to the financial markets. One of the biggest problems humanitarian agencies, both government and private, face is the lag time between the eruption of a crisis, such as famine, and the time it takes to gather and allocate funds to combat it.
By establishing rainfall parameters indicative of an incipient drought in the region, the funds would be available before the threat of starvation becomes a reality. It gives the World Food Program immediate access to emergency relief funds, and provides additional time to raise more funds, if necessary.
Conrad G. Bahlke, a partner in Weil, Gotshal & Manges Structured Finance and Derivatives practice group, who played an integral role in structuring the deal, observed: “This is an incredible application of sophisticated financial and legal concepts, which have the potential to do so much good for so many. I am honored to have played a part in the project.”
The policy calls for rainfall data to be collected from 26 stations throughout Ethiopia. Weil Gotshal’s bulletin said: “Payment in this experimental pilot project will be triggered if data gathered over a period from March to October 2006 indicates that rainfall has been significantly below historic averages, pointing to the likelihood of widespread crop failure. While the pilot transaction only provides a small amount of contingency funding, the model has been designed on the basis of the potential losses that 17 million poor Ethiopian farmers risk should an extreme drought arise.”