Weeks before the harvest started last summer, Li Ping's rice paddies were hit by extreme weather. Temperatures of 95 degrees Fahrenheit baked Longtan village in north China for over a month, causing leaf yellowing and damaging grain production. As a result, Li's rice yields decreased by 20 percent compared with normal years.
But Li did not struggle to raise money for his next planting, which he did after previous crop failures. Instead, the 51-year-old farmer waited at home for the money to come.
"I have insured my rice production since 2009," Li said. "The compensation I got didn't recover the total losses, but it did remove part of my financial pressure."
Li is one of hundreds of millions of Chinese farmers who are now using insurance as a tool to hedge against the risks of climate change. China is the world's second-largest agricultural insurance market after the United States by premium income, and it is scrambling to spread the use of climate-related insurance into other sectors.
The changing climate has already left many scars on China's society. Data from its first national climate change adaptation strategy issued last year show that extreme weather events have killed more than 2,000 people each year on average since the 1990s. They also cost the Chinese economy more than 200 billion yuan ($32 billion) annually in direct economic damage.
Although China has already poured billions of dollars into preventing that damage, increasingly frequent and intensified natural disasters likely linked to climate change are forcing it to spend more. According to a 2013 study from the Climate Group, a London-headquartered nongovernmental organization, China will need at least $24 billion per year for adaptation actions by 2020; by contrast, the nation's estimated budget is only $13.5 billion based on its current expenditures.
Harnessing market forces
To narrow that gap, the Chinese government has called for expanding climate finance through market forces. Insurance services are among the suggested solutions.
Chinese policymakers in recent years have already persuaded hundreds of millions of farmers there to buy agricultural insurance, forming a capability of covering losses worth 1.4 trillion yuan ($225 billion) in 2013. Climate risks are known as the biggest danger for losses in agriculture.
"Although the government subsidizes the insurance purchase, at least 20 percent of the insurance premiums still come from farmers' own pockets," said Tuo Guozhu, an insurance expert at Capital University of Economics and Business in Beijing.
"So compared with government aid, climate insurance can reduce the government's financial burden. It can also be used more efficiently," Tuo said.
In order to spend less on compensation, insurance companies are eager to protect farmers from adverse changes in the climate. They do so by training farmers how to cope with erratic weather patterns; they also try to mitigate climate risks through paying for artificial hail suppression services, for instance.
For industries that have yet to gain government support while already experiencing the threat of global warming, the importance of climate insurance appears to be more obvious. Southern China's Guangdong Meiyan Hydropower Co. Ltd., for one, in 2012 bought a precipitation insurance policy allowing it to claim up to 80 million yuan ($12.9 million) if unusually low rainfall hampers the output of its five hydroelectric powerhouses.
While such an insurance solution is the first of its kind in China, "we reached an agreement with Meiyan relatively quickly," said Stuart Brown, director at corporate solutions of Swiss Reinsurance Company Ltd., known as Swiss Re, which partnered with a local firm to provide the service.
"The management team of Meiyan has good understanding of the solution," Brown said. "They carried out their own calculation and found out that it would have received an insurance payout of more than 17 million yuan ($2.7 million) if the insurance policy had been in place in 2011."
Uphill climb for a new product
Insurance that the hydropower producer had previously obtained could protect it from damage caused by mudslides and other powerful natural disasters, but it could not help with economic losses associated with slowly mounting dangers, like declining rainfall. Droughts evaporated nearly 30 percent of the company's power production revenue in 2011 alone, and such losses are expected to soar in the future as weather changes become more extreme.
Other energy firms also are starting to look at climate insurance. Late last year, a wind farm developer in northern China's Hebei province signed a deal with Swiss Re to hedge against wind volatility. The insurance company now is working with Chinese insurers to develop a temperature insurance solution for district heating companies whose profits are often being impacted by fixed heating prices and rising costs due to colder winters.
While the demand for climate insurance in China is strong, headwinds against such service might be even stronger. According to Brown of Swiss Re, "many senior managers are aware of their weather exposures. However, few of them have done quantitative analysis on such exposure and its impact on the operation."
China-style budget planning then poses another challenge. As Brown explained, some managers simply don't have the budget to hedge for weather, even if they are convinced it is valuable. "This is especially true for some state-owned companies, which strictly separate income and spending management. The insurance premium, considered as spending, is difficult to get approval even though it has the benefit of bringing in cash flow when it is needed the most," Brown said.
There is also an issue of whom to involve in climate change adaptation. Liu Xinli, associate professor of the Department of Risk Management and Insurance at Beijing's Peking University, said that disaster recovery is traditionally considered the job of the Chinese government; therefore, the role of insurers is largely being ignored -- apparently, it won't be anymore.
Multiple experiments underway
In a press conference hosted last month in Beijing, Xiang Junbo, head of the China Insurance Regulatory Commission, told reporters that the government intends to leverage insurance services in the fight against natural disasters. Pressure is mounting for Chinese policymakers to do so because claims paid out by insurance companies currently help many countries make up 30 to 40 percent of their disaster losses, while that contribution is less than 1 percent in China.
With that in mind, southern China's Shenzhen city recently launched the country's first disaster insurance pilot, taking aim at typhoons, coastal flooding and other threats from the sea. The municipal government already bought the insurance service for every citizen, and residents there are also encouraged to insure their life and property against natural disasters.
There are also plans to innovate insurance design, making it easier for businesses and citizens to handle an increase of climate-related damages. For instance, in heat-stress-prone Anhui province, where rice growers used to wait for months until insurance companies complete damage assessments, a so-called temperature index insurance service was introduced in 2009. It allows the compensation process to start immediately once air temperatures go beyond a set limit.
Experts say those innovations have proved successful on the pilot stage, but how to scale them up is a troublesome question. Although tangerine growers in central China's Jiangxi province welcome a newly developed insurance service, which links compensation rates directly with low temperatures, few of them can afford the insurance premiums. Local authorities have provided financial assistance to some growers but find it challenging to subsidize more.
And for those lucky ones who can access the government subsidies, they too have their own problems. The rice grower Li, for one, complained that with his current insurance policy, he can recover only half of his rice production cost when disasters hit the most often. While having climate insurances in place is good, Li said increasing the compensation rate through government subsidies could make it even better.
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