Finance for good
FT, 08/05/2006:
"Polite conversation for some, the weather is a matter of survival for others. Ethiopia suffered droughts in 1965, 1984 and 2002. At worst, such events kill millions. At best, emergency aid prevents deaths but does not stop desperate farmers selling productive assets such as tools or livestock. The United Nations World Food Programme has turned to derivatives to address this problem (...) Under the WFP's pilot scheme it will pay Axa a $930,000 annual fee in return for a maximum payout of $7.1m. Unlike insurance, the payout is not related to loss. Axa will stump up if Ethiopian rainfall is below a defined level. Derivatives redistribute risk, for a price. Has the WFP got value for money? Based on 30 years of data it estimates a 10 per cent chance of a payout in any year, compared to a fee equivalent to 13 per cent of the payout value. Superficially that does not look attractive."
How is it possible that the WFP is paying an annual premium of 13% for this 3-year option on Ethiopian rainfall when the probability of a payout each year is only 10%?
And, for a socially oriented conclusion, the FT adds:
"The WFP's pilot is logical. It creates an economic synergy in the form of a risk uncorrelated to insurance companies' existing exposures. The alternative is disastrously slow. The Axa contract should allow the WFP to start disbursements to farmers within six weeks of it identifying that a harvest has failed. Conventional aid might take three-five months to arrive, by when the damage to farmers' livelihoods has occurred."
"Polite conversation for some, the weather is a matter of survival for others. Ethiopia suffered droughts in 1965, 1984 and 2002. At worst, such events kill millions. At best, emergency aid prevents deaths but does not stop desperate farmers selling productive assets such as tools or livestock. The United Nations World Food Programme has turned to derivatives to address this problem (...) Under the WFP's pilot scheme it will pay Axa a $930,000 annual fee in return for a maximum payout of $7.1m. Unlike insurance, the payout is not related to loss. Axa will stump up if Ethiopian rainfall is below a defined level. Derivatives redistribute risk, for a price. Has the WFP got value for money? Based on 30 years of data it estimates a 10 per cent chance of a payout in any year, compared to a fee equivalent to 13 per cent of the payout value. Superficially that does not look attractive."
How is it possible that the WFP is paying an annual premium of 13% for this 3-year option on Ethiopian rainfall when the probability of a payout each year is only 10%?
And, for a socially oriented conclusion, the FT adds:
"The WFP's pilot is logical. It creates an economic synergy in the form of a risk uncorrelated to insurance companies' existing exposures. The alternative is disastrously slow. The Axa contract should allow the WFP to start disbursements to farmers within six weeks of it identifying that a harvest has failed. Conventional aid might take three-five months to arrive, by when the damage to farmers' livelihoods has occurred."
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