Index Insurance in India

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1 Index Insurance in India Kolli N Rao, PhD Aon Benfield, India

2 Indian Agriculture & Risks What s Index Insurance? Why Index Insurance? The Outline Architecture of Indian Crop Insurance Coverage: The Numbers Index Insurance: Challenges Weather Index: Recent Developments & Innovations

3 Indian Agriculture & Monsoon

4 Indian Agriculture Nearly 120 million farm holdings About 145 million hectares of cultivated area (~ 190 million hectares of gross cropped area) Small farm holding size (Average of 1.2 hectares) 80% are small / marginal farmers (with 62% owning less than one hectare) About 50% of area is under cereals and millets 61% of Rural Households are Farming Households Provides 50% of the Employment Sustains 69% of Population Varied agricultural practices Predominantly Rain-fed Agriculture Large number of farmers produce for self consumption

5 Rainfall Variability Rainfall variability is dominant due to the presence of the Monsoon (seasonal winds blowing from the Indian Ocean and Arabian Sea in the southwest bringing heavy rainfall) Monsoons contribute 78% India s annual rainfall - undergoes wide inter annual variations Large variations in rainfall distribution (<10cm in western desert to >1000cm in northeast) Disparity in the rainfall distribution is so great droughts and floods occur at different parts of the country at the same period and in the same place at different periods One - third of the country is mostly under threat of drought One - sixth of the country prone to floods

6 Index Insurance

7 Index Insurance Index (Parametric) insurance is a type of insurance that does not indemnify the pure loss, but ex-ante agrees to make a payment upon the occurrence of a triggering event Homogenous area' approach based insurance envisages that in the absence of reliable data of individual farmers and in view of the moral hazard involved in the 'individual approach', a homogenous area comprising villages that are homogenous from the point of view of crop production and whose annual variability of crop production is similar, would form the basic unit, instead of an individual farmer

8 Index Insurance - Rationale Large number of Small sized Farm-holdings (nearly 120 million / 1.2 hectare) Non availability of past record of Yields, Land surveys, Ownership and Tenancy Low value output per unit Difficulty in collection of small amount of premium from large number of farmers Prohibitive cost of Manpower and Infrastructure Asymmetric Information Systemic nature of Agriculture risks

9 Crop Insurance Architecture

10 Indian Crop Insurance The Architecture Predominantly Index based Credit linkage (presently compulsory, but need not be in future) Credit institutions also finance the premium (in addition to crop loan) Insurance acts as collateral, and lending agencies have the first lien on claim Risk covered is based on production cost (safety-net) Being index, claims process is automated Multi-Agency Platform (administratively convenient, but insurer doesn t have full control) Government provides for about 2/3rd cost of the program Being a instrument with social dimension, the government has a larger say Private insurance providers are allowed for actuarially priced programs, and enjoy same level of support as public insurer

11 How Products Work?

12 NAIS: How it Works?

13 Modified NAIS: How it Works?

14 Weather Index crop Insurance Weather Index crop Insurance

15 Crop Insurance: Market Volume

16 Program Farmers (Millions) Index Insurance: Numbers Hectares (Millions) Sum Insured (US $ Millions) Premium (US $ Millions) Program Nature NAIS Adminstered WBCIS Actuarial MNAIS Actuarial TOTAL Source: Agriculture Insurance Company of India

17 Index Insurance: Challenges

18 Major Challenges Product Basis Risk Spatial Basis Risk Financial Literacy Delivery Channels for Non-Borrowing Farmers Market Standards (vis-à-vis competition) Plethora of Government Support programs

19 S.No Nature of Basis Risk 1 Spatial Basis Risk Index Insurance Basis Risk Yield Index Arises when the Insurance Unit size is too large and is not homogenous in terms of agricultural production level Weather Index Arises when a weather station is referenced for a larger geographical area, covering areas far off from weather station 2 Product Basis Risk 3 Product Design Basis Risk Yield index insurance covers risk from sowing till harvesting. As Yields are estimated at harvest stage, losses if any suffered after harvest are not reflected in the yield index. Trigger yield used in yield index insurance is a function of moving average of past 5 years yield and coverage level, which may range from 60 to 90 percent. In other words, the shortfall between normal yield and trigger yield is not protected Weather index covers risk arising out of deviations in parametric weather exigencies only. Risks outside these parametric weather (like pests, diseases, hailstorm, flooding etc.) are not covered Arises because of imperfect correlation between weather index and the production process (yield) 19

20 Yield Index Insurance Basis Risk Challenges: Insurance Units are administrative (rather than homogenous) Cost and Quality of Yield estimation surveys Solution: Lowering the Insurance Unit Separate irrigated and rain-fed crop Satellite imagery (target sampling, yield modeling etc.)

21 Weather Index Insurance Basis Risk Challenges: Product Basis Risk Spatial Basis Risk Weather Station Infrastructure & maintenance Solution: Agronomic models Low frequency & High Impact events (Catastrophe events) Macro level Product Increased weather station density Technologies to generate weather data at micro level (TOPS etc.)

22 Index Insurance: Developments

23 Index + (fruit crops) Recent Developments & Innovations Loyalty Bonus for Non-Borrowing farmers Value added services (weather forecast etc.) Traditional Insurance at community level (using GPS enabled HHDs) Double Trigger (Weather and Yield) Product (conceptual stage) Weather Secondary and Modeled outputs

24 Thanks!

25 Index Insurance in India Kolli N Rao, PhD Aon Benfield, India

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