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Famine Insurance: Using derivatives to fight famine in poor countries
From "Hedging against the horsemen" in the Dec 9th 2004 print edition of The Economist
A recent article in The Economist argues that derivatives markets could be used to hedge against famine in places like the Sudan. According to the article, the World Food Programme (WFP) -- a UN body that combats hunger -- is looking into the application of catastrophe-based instruments as a way to fund humanitarian efforts in famine-stricken regions. There are two ways such a system might work:
- CATASTROPHE INSURANCE:
WFP would buy insurance against bad weather. The insurance policy would pay out when the rainfall in a specific area was below a certain threshhold. WFP would use the proceeds to fund food programs.
- CATASTROPHE BONDS:
WFP would issue catastrophe bonds that paid interest (out of income from donors) to investors in years with adequate rainfall, but could be redeemed when drought came. WFP woulf use the investor's principal to fund food programs.
In either case, WFP would have funds when drought struck. The Economist points out that likely investors in such a system might be "big reinsurance firms in rich countries ... because they currently have very little exposure to weather in the southern hemisphere, and its always wise to diversify one's portfolio."
The article adds, "Richard Wilcox, the man at the WFP assessing the scheme's feasibility, says he thinks it could be up and running by 2007."
The full article can be found in The Economist
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