Monday, May 23, 2005

Weather Derivative Payout if Drought Hits Ethiopia

The World Food Programme is set to launch a form of insurance based on Ethiopian weather data that will pay out when drought strikes, the first time a scheme of this sort has been used in the developing world.

The weather derivative will offer reinsurers the chance to diversify their portfolio away from the northern hemisphere and developed countries, said Richard Wilcox, director of business planning at the WFP.

Presenting the proposal to a World Bank development conference, Wilcox said the scheme would enable Ethiopian authorities to plan for emergencies with a clear idea of what funds would be available.

It would also give farmers more security, helping them early when rains fail, getting aid to them sooner, and avoiding a sell-off of the assets on which they depend for their income.

"If people sell off their assets, they may never recover," said Wilcox.

More than 40 percent of farmers in developing countries face weather-related threats to their crops, and floods, drought, and other weather conditions cause crop losses of up to $429 billion per year, according to the World Bank.

A drought-induced famine killed nearly one million people in Ethiopia in 1984.

The derivative will be based on a weighted index constructed from the data of 40 Ethiopian weather stations. If the index crosses a certain threshold, a payout of up to $100 million will be triggered, depending on the severity of the drought.

The WFP board has yet to approve the plan, but interest from insurance companies is fierce, Wilcox said.

"They might not have ever thought of doing business with Ethiopia, much less dealing with small-scale farmers -- people who don't have shoes -- but we've put together a financial product they can recognise," Wilcox said.

The derivative will for the first time put a price on the risk of bad weather in Ethiopia, which could help donors to focus their development efforts more efficiently by offering a basis on which to evaluate the cost of other projects.

Reuters AlertNet

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