Promoting Food Security in a Volatile Climate: The Role of Agricultural Insurance. Insurance for Development

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1 Promoting Food Security in a Volatile Climate: The Role of Agricultural Insurance Preliminary Paper prepared for: Financial Sector Symposium, Berlin, January 19/20, 2012 Insurance for Development Protecting Emerging Markets and their People in a Climate of Change Prepared by: Charles Stutley Abstract This paper reviews the potential role of agricultural crop and livestock insurance as a food security instrument and specifically as a risk transfer tool to stabilise individual farmers, communities or national governments financing of access to food in times of climatic shocks. Traditional indemnity-based agricultural insurance has not been very successful in meeting the food security needs of small and often subsistence farmers in developing countries. Since the early 2000s the introduction of weather index based insurance products both at the individual farmer level (micro level insurance) and particularly at an aggregate regional or national level (macro-level insurance) appears to offer much greater potential for governments to purchase index insurance as an ex-ante food security product in the event of severe drought or other climatic events. The role of governments in developing countries in supporting and promoting agricultural insurance for food security purposes is also examined. Key Words. Agricultural risk management, Agricultural insurance, Weather Index Insurance, Micro-level insurance, Macro-level insurance, Ex-ante risk transfer, catastrophe drought insurance, Disaster relief, Food Security. Introduction The definition of food security adopted by the World Food Summit in November 1996 is: Food security exists when all people at all times have physical or economic access to - 1 -

2 sufficient safe and nutritious food to meet their dietary needs and food preferences for an active and healthy life. This paper examines the role of agricultural insurance in contributing towards food security at individual farmer, community, national government and or regional levels. The Food and Agriculture Organisation, FAO of the United Nations, defines 4 pillars of food security including: Food availability: the availability of sufficient food supplies either through domestic production or imports to meet food demand; Food access: access by individuals to adequate resources to produce or to acquire appropriate foods for a nutritious diet. Stability: to be food secure a population, household or individual must have access to food at all times. They should not risk losing access to food due to sudden shocks (e.g. an economic or climatic crisis) or cyclical events (e.g. seasonal food insecurity). Utilization: of food through adequate diet, clean water, sanitation and health care to reach a state of nutritional well being where all physiological needs are met. There are also two temporal dimensions of food insecurity: chronic which results from a persistent shortage in food supply or transitory, arising out of a crisis (FAO 2011). Agricultural insurance can potentially play a role in stabilising an individual farmer s access to food in the event of major climatic induced crop or livestock losses through compensating these losses. Similarly government can use agricultural insurance as a tool to ensure lines of contingent funding to finance emergency food supplies in the event of a major natural or climatic catastrophe (e.g. due to earthquake, tsunami, flood, drought, hurricane, freeze, major epidemic diseases). This paper explores the roles of agricultural insurance in securitising food in developing countries. To begin with the paper briefly examines some of the key challenges affecting food security, followed by a review of the role of ex-post disaster relief following a major crisis and some of the drawbacks associated with emergency food assistance. The remainder of the paper then reviews the experience with agricultural insurance as a food - 2 -

3 security instrument at individual farmer and national level, and highlights some of the important roles governments can play in promoting agricultural insurance and then draws conclusions. Global Food Security: Definitions, Challenges and Issues Under the 1996 Rome Declaration on Food Security, the World s Heads of Government reaffirmed the basis rights of all people to safe and nutritious food and to be free from hunger and pledged to reduce the number of undernourished people to half its present level of 800 million people by 2015 latest (FAO 1998). This goal to halve extreme hunger and poverty by 2015 was reaffirmed by the United Nations (UN) Millennium Summit in Despite considerable improvements in reducing the numbers of under-nourished people in the world from about 20% of the global population in to about 16% in , progress has subsequently stalled due partly to the increase in food prices and the global economic and financial crisis of (United Nations 2010; FAO 2011). In 2010 there were still about 925 million food insecure people or 14% of the world s population of 6.8 billion living in 77 Low Income Food-Deficit Countries (WFP 2011; FAO 2010). Food insecure people are defined as those consuming less than 2,100 calories per person per day. Under-nourishment is still prevalent in much of Asia and in Sub-Saharan Africa, SSA, together accounting for 90% of undernourished people in the world. In 2010 nearly 390 million people or almost 50% of the population of SSA were classified as being food insecure and by 2020 it is predicted that the total number of food insecure people in SSA will have increased to nearly 500 million out of a total population of 1 billion. In other words that there will be no overall improvement in the percentage of food insecure people in SSA. (USDA 2010). There are a number of major challenges for future global food security including: 1) Population growth rates and demographic changes: It is estimated that the World s population will peak at about 9.15 billion in 2050 representing a 30% increase on the 2010 population (FAO 2011). Most of this growth will come from developing countries and with larger and wealthier urban populations which will demand more and better food including higher consumption of animal protein

4 FAO estimates that by 2050 global food production will need to increase by about 70% to keep pace with population growth rates and changing consumption patterns. These increases in food production will have to be met mainly through increases in productivity and yields per unit area because of the limited supply of new land that can be brought under crop and livestock production. USDA predict that by 2020 the number of food-insecure people will decline in all regions of the world with the exception of SSA where improvements in agricultural performance and productivity 1 will not be high enough to meet the extremely high population growth rates of 2.4% per year: the result is a predicted 32% increase in the total number of the food insecure people or about 123 million persons (USDA 2010). 2) Land and Water Constraints. According to the United Nations Convention to Combat Desertification, some 2.3 billion people live in drylands (semi-arid or dry sub-humid areas) in 100 countries and in these areas more than 12 million hectares of land are lost due to desertification each year, equivalent to an area the size of South Africa every decade (UNCCD 2011). Desertification and erosion of marginal soils in dryland areas is caused by a combination of natural hazards such as droughts and man-made factors including poor soil management, overgrazing, deforestation etc. Water availability is also a serious consideration as the proportion of people living in water-stressed regions is expected to rise 64% in 2025 compared to 38% in The competing demand for water for human consumption and for crop irrigation and livestock production is likely to pose major challenges for food security in future. 3) Competition by Bio Fuel Production. The first generation biofuels have mainly been produced from conventional agricultural crops (maize, sugar cane, cassava, oilseeds, palm oil etc) and compete directly for land with food crops. FAO (2008a) concludes that liquid biofuel production has contributed to weakening the 1 In SSA, average grain yields have only increased by 1% per annum since 1980 and are less than half the average yields in Asia and Latin America and the Caribbean (LAC). Fertiliser is a key input to increasing gain yields, but in SSA average fertiliser use is only 10 Kg/Ha compared to about 95 Kg/Ha in Asia. Irrigation water is another key factor to increasing crop yields, but in SSA only 4.3% of arable land is irrigated compared to 13% in LAC and 38% in Asia. 2 FAO 2011 quoting Rosengrant et al

5 access to adequate food of vulnerable people in developing countries by contributing significantly to increases in food prices 3 and by causing concentration of land for plantation production and evictions or marginalisation of vulnerable groups. In 2008 biofuels accounted for approximately million tons of cereals (4% of global cereal production) and 10 million tons of vegetable oil (7.5% of global vegetable oil production). According to the International Institute for Applied Systems (IIASA) meeting the ambitious biofuel targets for the first generation biofuels may lead to substantially higher food prices and reduced food consumption in developing countries, resulting in an increased number of between million people at risk of hunger by However, IIASA also note that when the second generation biofuels produced from woody or herbaceous non-food plants start to come on stream after 2020 that these crops which can be grown in semi-arid conditions and on infertile soils (e.g. Jatropha) will not compete directly with cultivated land for food production or land for livestock grazing (IIASA 2010). 4) Climate Change. Climate change through increases in average global temperatures, more variable rainfall patterns (more frequent and severe droughts and excess rainfall/floods and hailstorms) and rises in sea levels will have serious impacts on the four dimensions of food security: food availability, food accessibility, food utilisation and food system stability (FAO 2008b; Schmidhuber and Tubiello 2007, IIASA 2010, IFPRI 2011a). The impact of climate change will, however, vary across agro-climatic regions and will vary over time according mainly to the degree of global warming and the impact will depend on the socioeconomic status of the country and its ability to adapt to and mitigate against the adverse effects of climate change. Global warming has the potential to increase food production in temperate climates (e.g. Russia and Canada) by increasing the number of growing degree days, and in other countries short-term production and yield gains in crop such as maize can be expected through the increased CO2 fertilization effect. However, in the drier areas, higher temperatures will increase evapotranspiration and lower soil moisture and this will mean that some 3 In 2008 increased biofuel production in USA, Europe and Brazil led to increases in the prices of maize, soya and sugar by 27%, 21% and 12%

6 areas will no longer be viable for cropping or that more drought resistant crops will have to be introduced. According to IIASA 2010 climate change threatens the loss in southern Africa of up to 44%, 43% and 28% respectively of its rainfed wheat, maize and cereal production by 2050, and Central America, North Africa and West Africa will also incur losses in cereal production area. In the semi-arid and sub-humid regions of Sub-Saharan Africa and South Asia, increased precipitation variability is likely to accentuate the negative impact of extreme droughts and floods on food production and supplies, thereby accentuating the problems of food insecurity in these regions. Up to 2050 the impacts of climate change on global food production are likely to be relatively minor, but between 2050 and 2080 the negative impacts of warming will be accelerated causing major reductions in crop production potential in many regions, cereal prices may increase by 20% to 40% and the number of people at risk of hunger may increase by between 5 million and an additional 170 million according to which GCM and SRES models are used (IIASA 2011, Schmidhuber and Tubiello 2007). Disaster Relief Programs and Food Security Many governments both in developed and developing countries have established natural disaster management programs to protect against and to mitigate the consequences of major natural disasters including typhoons, floods and droughts. The traditional approach to a disaster event is for the national government to provide direct disaster assistance up to the point they can afford and to then appeal to the international community (governments, multilateral and bilateral development agencies and NGOs) for emergency relief including clean water, medicines, shelter and food aid. In the mid- 2000s international food aid provided about 10 million tonnes of commodities a year to some 200 million needy people at an estimated cost of about US$ 2 billion (FAO 2007), but this figure has subsequently fallen to a low of only 5.7 million metric tons in 2010 (WFP 2010) 4. In 2010 emergency food aid accounted for 73% of all disbursements, followed by project food aid 22% and program food aid 5%. 4 In 2010 the top eight recipient countries accounted for 65% of total food aid deliveries: Ethiopia (25%), Pakistan (13%), Sudan (8%), Haiti and Kenya (5% each), Bangladesh, The Democratic Republic of Congo and Niger (3% each)

7 While natural disaster relief and food aid programs are well intentioned, they are often hampered by implementation problems which result in unintended consequences which Hazell and Hess (2010) and Skees (2009) summarise as: - The costs of immediate post-disaster emergency relief and medium term recovery and reconstruction costs after a natural disaster are usually very high and in many developing countries the national budget is inadequate to bear these costs. Funding of emergency relief diverts resources from development; - Following a major widespread natural disaster when communications and transport networks are usually disrupted, it is often very difficult to target relief assistance (immediate food aid, replacement seeds, fertilisers and livestock) to the intended beneficiaries (most in need) and major leakage of food aid occurs; - There are often major delays in responding to natural disasters and often the food aid and other forms of assistance arrive too late to be effective and to prevent asset depletion by resource poor farmers and rural households. - Disaster relief, especially in the form of food aid can distort incentives for farmers to replant their crops by depressing prices for locally produced food crops 5. - The provision of disaster assistance may have unintended consequences by increasing farmers dependency on government or donor assistance and this may also encourage farmers to continue poor farm management or cropping practices. A theme of the remainder of this paper is that under a carefully planned sovereign risk financing strategy involving the ex-ante purchase of a suitable catastrophe climatic index insurance cover may in part overcome some of the problems associated with conventional ex-post disaster relief programs. 5 Ethiopia and Somalia are countries where food aid has often lead to a collapse in prices of locally produced food crops and this has delayed post drought recovery as farmers have little incentive to replant their crops

8 Agricultural Insurance Markets and Types of Products The Global Agricultural Insurance Market Today it is estimated that about 50 percent (104 nations) of all countries have some form of agricultural insurance: of these 86 countries have mature programmes and 18 countries were piloting new crop or livestock insurance schemes (Mahul and Stutley, 2010). In 2009 the global agricultural insurance premium volume was estimated at about US$19.4 billion: North America was the largest agricultural insurance market accounting for US$10.7 billion of agricultural premium (55 percent of total premium), followed by Asia and the Pacific region with premium of US $4.0 billion (21 percent), then Europe with premium of US$ 3.9 billion (19 percent), Latin America and the Caribbean, premium of US$ 0.7 billion (4.0 percent) and finally Africa with a very small share of only US$100 million (0.5 percent) (World Bank 2010). Agricultural Insurance has a lengthy history and is widely available in most of the developed group of high income countries which have an agricultural base. Agricultural insurance is also relatively well developed and available in about 50% of the 44 countries in the Asia-Pacific Region and in Latin America agricultural insurance is available in 72% of the 25 countries with an agricultural base. Agricultural insurance, is however, very poorly represented in Africa and is currently commercially available in a handful of countries only including South Africa, Sudan, Morocco, Nigeria, Malawi and Kenya and is being pilot tested in several other counties including Ethiopia, Ghana and Senegal. The most popular class of agricultural insurance is individual grower multiple peril crop insurance, MPCI, which in 2009 accounted for two-thirds of the total global premium volume of US$ 19.4 billion. MPCI is widely available in North America and Europe and also in parts of Latin America (Mexico and Brazil) and in Asia (China, Japan, the Philippines, Pakistan, and Sri Lanka). This was followed by crop hail insurance accounting for 15% of 2009 total global premium: crop hail insurance is widely available in temperate climatic regions of the world

9 Livestock insurance is a very important class of agricultural insurance accounting for 12% of 2009 total global premium and then small specialist lines of business include bloodstock (2% of premium), and forestry, aquaculture and greenhouse insurance each accounting for 1% of total global premium. Non-traditional index insurance (including crop area-yield index insurance, weather index insurance, remote sensing / NDVI insurance and livestock index insurance) accounted for about 2.6% of total global premium in The main markets for index insurance are currently the USA, Mexico and India. Traditional Crop Hail and MPCI Insurance Individual farmer crop-hail insurance has been underwritten by private mutual and commercial insurance companies for more than 100 years in the mainly developed markets of Europe, North America, Australasia, South Africa and Argentina. This class of crop insurance is usually underwritten by private commercial insurance companies and or farmer mutual insurance companies with no government premium subsidy or other support. Private crop hail is profitable over time in nearly all the major hail markets (Mahul and Stutley 2010). The oldest individual grower MPCI program in the world is the US Federal Crop Insurance Program (FCIP) which was introduced by the Roosevelt Government in the mid-1930s as a response to the dust bowl crisis and in order to stabilize farm production and incomes. Today, the FCIP is the World s largest and most heavily subsidised public-private partnership (PPP) crop insurance program. Japan also has a long history of public sector subsidised MPCI crop insurance and in late 1970 s both Spain and Portugal introduced subsidised MPCI insurance programs. Between the 1970s and 1980s governments in many developing countries including in Asia (India, Bangladesh, Sri Lanka, the Philippines, China) and Latin America (Mexico, Costa Rica, Panama, Dominican Republic, Venezuela, Brazil) introduced subsidised public-mpci programs targeted at small and marginal and subsistence farmers. Most of these programs were established with social as opposed to economic objectives and premium rates were often capped at well below actuarially required premium rates (e.g. India, Bangladesh, Philippines, Mexico, and Brazil)

10 The international experience with individual farmer MPCI is with few exceptions extremely poor. Programs typically suffer from problems of low uptake, high levels of anti-selection and moral hazard, high administrative and operational costs and the underwriting results are usually negative. Most individual grower MPCI programmes that are voluntary suffer from very high levels of anti-selection and moral hazard; the programmes are usually very exposed to systemic drought, flood and windstorm losses, which correlate at regional and national level, and the premium rates that have to be charged in order to cover the combination of high losses and high administrative costs are often in excess of 10 percent to 15 percent. Nearly all individual grower MPCI programmes operate at a financial loss (negative underwriting results) and are dependent on government premium subsidies to make the cover more affordable and acceptable to farmers and/or government subsidies on excess claims. 6. On account of the very poor financial performance many of the developing country MPCI programs most of these were either subsequently discontinued (e.g. Bangladesh, Dominican Republic, Venezuela, Brazil) or extensively reformed along more commercial market principles (e.g. Mexico, the Philippines and most recently China and India). Index Insurance There are three broad groupings of crop index insurance products including (1) areayield index insurance, (2) weather index insurance and (3) remote sensing indexes including NDVI and satellite rainfall indexes. One country, Mongolia has also implemented an innovative livestock mortality index program since Area-Yield Index Insurance Crop Area-Yield Index insurance, AYII, makes indemnity payments to growers according to yield loss or shortfall against an average area yield (the index) in a defined geographical area (e.g. a county or department). As such the product does not insure individual farmers against yield loss on their own fields, but according to the area yield index. AYII was adopted in India in the late 1970 s where it has been expanded to cover practically all states under the National Agricultural Insurance Scheme NAIS as a 6 For a comprehensive review of the performance of public-sector crop insurance refer to Hazell et al, 1986, Hazel 1992 and Mahul and Stutley,

11 compulsory crop-credit insurance program which currently insures about 26 million Indian farmers each year. Other countries which have adopted the area-yield approach include the USA, Mexico, Brazil and Ukraine 7. AYII is currently being studied as an alternative to individual grower crop MPCI cover by several countries in Africa, Asia and the Pacific. 8 Weather Index Insurance (WII) Crop weather index insurance (WII) represents an alternative approach to crop insurance that aims to overcome many of the drawbacks of traditional individual grower indemnity-based crop insurance. The key feature of WII products is that they do not indemnify crop yield losses at the individual field or grower level, but instead they use a proxy variable (the index) such as the amount of rainfall, or temperature, or wind speed to trigger indemnity payouts to farmers. WII is a simplified form of insurance where payments are made based on a weather index, rather than a measurement of crop loss in the field. The index is selected to represent as closely as possible the crop yield loss likely to be experienced by the farmer. To date, the most common application of WII is against rainfall deficit or drought, where rainfall measurements are made at a reference weather station or stations, during a defined period or defined periods, and insurance payouts are made based on a preestablished indemnity scale set out in the insurance policy. The sum insured is normally based on the production costs for the selected crop and indemnity payments are made when actual rainfall in the current cropping season, as measured at the selected weather station, falls below pre-defined threshold levels. The main advantage of WII is the elimination of adverse selection and moral hazard, problems that are common to MPCI. Since payouts are made based on an objective measurement at the reference weather station, there are few information asymmetries to 7 See Hellmuth et al 2009 for a review of the Brazil AYII scheme for seed maize producers in Rio Grande do Sul State. See WFP and IFAD 2010 for reviews of the AYII Pilot Index scheme in Ukraine and updated review of the maize AYII program in Rio Grande do Sul, Brazil. 8 The World Bank has conducted technical studies for the introduction of AYII into Senegal, Nepal, Bangladesh, Guyana, Burkina Faso and Kazakhstan between 2008 and 2011 and since 2010 GIZ has been researching options to introduce AYII into the Philippines and Ghana (GTZ 2010)

12 be exploited, and the behaviour of the insured cannot influence the extent of payouts. In addition, WII reduces administration costs (particularly because it does not require infield inspections or loss adjustment) for the insurer and thus can make premiums more affordable. Indexed products are also likely to facilitate risk transfer to the international reinsurance markets. However, although WII offers opportunities for reduced A&O costs, the development phase requires intensive technical inputs, and ongoing technical inputs are required to refine products over time. The most important challenge for WII is basis risk, which significantly limits the applicability of index instruments. Basis risk is the difference between the payout as measured by the index and the actual loss incurred by the insured farmer(s). Because no field loss assessment is made under index insurance, the payout may be higher or lower than the actual loss of crop suffered by the farmer(s). Basis risk is lower when the risk is highly correlated, i.e. affecting a relatively large geographical area to the same extent and simultaneously. Basis risk can also arise due to difficulties of designing an appropriate index and it may not capture the damaging weather event. The extent of basis risk can to a certain extent be mitigated by careful index design and by the installation of new weather stations, thereby providing more localized precision in the measured climatic peril (Collier et al 2009). Other challenges for weather index insurance include the need for high quality weather data and infrastructure and the currently limited product options, with most applications in developing countries so far concentrated on rainfall indexes. Remote Sensing: (NDVI Insurance, Satellite Rainfall, Radar) 9 Since the mid-2000s, five countries have used applications of satellite-based Normalised Difference Vegetative Indexes (NDVI) to insure against pasture losses due to natural and climatic perils, most notably drought. These counties include Spain, the USA and Canada which operate individual livestock producer (micro-level) pasture-drought NDVI programs and Mexico where the national and state governments purchase macro-level NDVI-pasture insurance on behalf of small-scale livestock producers in each state. 9 For a comprehensive review of remote sensing satellite-based indexes see GlobalAgRisk 2010a

13 Furthermore, since 2010 Kenya has been piloting a new NDVI pasture-drought scheme for nomadic pastoralists 10. Satellite estimation of rainfall using infrared and passive microwave radiation data offers the potential to overcome the lack of adequate density of ground-based weather recording stations in many developing countries and especially in Africa. Satellite rainfall indexes are a very new concept and currently such products are under research and development in Ethiopia and in some West African countries. Finally, research is being conducted into applications of Synthetic Aperture Radar (SAR) to flood mapping, flood loss adjustment and flood index insurance for rice and other crops: flood remains one of the most difficult perils to underwrite in agriculture either through traditional indemnity-based crop insurance products or through river flow indexes or satellite-based indexes 11. Weather Index Insurance as a Food Security Instrument for Small Farmers (Micro-level Insurance) At the individual farmer level (micro-level), WII has the potential to contribute towards food security by stabilising and smoothing consumption and farm income in times of catastrophe drought, flood or other causes of loss and by ensure that a farmer is able to repay his credit and thereby remain credit worthy. Weather index Insurance (WII) has only been commercially available since 2003 following the introduction by ICICI Lombard Insurance Company in conjunction with BASIX (a Hyderabad-based MFI) of an individual grower (micro-level) rainfall deficit contract for castor and groundnuts for resource poor farmers in Andhra Pradesh, India. The Indian model was based on a multi-vegetative growth stage rainfall deficit index 10 In 2011 GIIF is funding research through the World Bank into NDVI-pasture index cover for livestock producers in Argentina and Uruguay. 11 Currently there are no commercial crop flood-index insurance programs under implementation. In Vietnam an innovative meso-level business interruption flood index cover using river gauge which is designed to protect the country s largest credit banks crop loans to rice growers is awaiting approval. In Jakarta, GIZ-MunichRe have for several years piloted a flood index cover for urban households

14 designed to make payouts at each growth state from sowing through to crop ripening and maturity. Since its origin eight years ago in India, WII has received major interest in development circles as a weather risk transfer product that is better suited to the needs of small farmers in developing countries than traditional indemnity-based MPCI. The product has been widely promoted in Asia and Africa by international development organizations including the World Bank, IFAD and WFP (who are working jointly to increase the access of resource poor farmers to WII through the IFAD-WFP Weather Risk Management Facility, WRMF), ILO, the Gates Foundation, and GIZ, various NGOs including Oxfam, microfinance/intermediary organizations such as MicroEnsure and Planet Guarantee, and academic institutions such as IRI Colombia State University etc. Several reinsurers are also actively involved in the design and rating of WII, most notably Swiss Re and Partner Re (which in 2010 acquired Paris Re and their WII team). The proliferation of interest in WII is evidenced by the fact that in 2009 there were at least 30 micro-level developmental weather index insurance programmes in 18, mainly developing, countries and a further six meso-level or macro-level disaster-relief programmes in 20 countries either under pilot implementation or commercial scale-up (IFAD and WFP, 2010). In addition, since this IFAD/WFP report was prepared, several other new weather index programs have been started up including in Ghana and in Peru. In Ghana Innovations for Poverty Action (IPA) has since 2009 been researching a number of dry days and wet days rainfall index (termed Takayua Rainfall Policy) for maize producers located in northern Ghana and starting in 2011 the Takuya program was formally underwritten by the newly formed Ghana Agricultural Insurance Pool (GAIP). In 2011 GAIP also underwrote a separate maize rainfall deficit program which was designed as a mesolevel bank assurance product targeted at the rural banks, national development banks and commercial banks lending to agriculture 12. In Peru a new innovative ENSO (El Niño- Southern Oscillation) flood index program has been launched at the end of This 12 The GAIP Project is a four year project which is being implemented with technical support from the German Development Cooperation GIZ under the Innovative Insurance Products for the Adaptation to Climate Change (IIPACC) Project and which is funded by the German Federal Ministry for the Environment, Nature Conservation and Nuclear Safety. See GTZ (2010)

15 product uses ENSO1.2 Pacific seas surface temperature measurements in November and December to make timely payouts prior to actual El N Niño flooding occurs (usually between January and April in the following year). The product has been designed as a meso-level business interruption cover to protect the banking sector against losses to its crop lending portfolio in catastrophe El Nino flood years (Skees and Murphy 2009, Khalil et al 2007). Furthermore, in , WII research and development is being conducted in a number of other African countries 13 including Rwanda, Mali, Burkina Faso, Senegal, Uganda, Tanzania and Nigeria and in Asia (e.g. Indonesia for maize, in Vietnam for rice and coffee). Experience, Challenges and Issues with Micro-level WII programs This section summarises some of the lessons and challenges which have been identified on the first decade of experience with micro-level or individual farmer WII in developing countries. According to IFAD-WFP 2010 by the 30 micro-level or developmental weather index programs were reaching nearly 1.3 million beneficiaries (farmers) and generated a total sum insured of nearly US$ 1.0 billion. Of this total, the rainfall and NDVI index programs in the USA and Canada accounted for only 1% of the beneficiaries, but 58% of total insured liability (TSI). Of the remaining 26 developing country programs, the one public sector and four private sector WII initiatives in India accounted for 96% of the total beneficiaries and 39% of total liability. With the notable exceptions of Thailand (voluntary rainfall deficit program for maize since 2007 underwritten by a local pool of insurers and implemented through the national Bank of Agriculture and Agricultural Cooperatives, BAAC) and Malawi (rainfall deficit cover since 2005 for groundnuts, maize, and tobacco underwritten by a local insurance pool and bundled with input supplies and credit), in nearly all of the other programs were still at an initial pilot start-up phase and had yet to achieve any significant penetration or take-up. 13 For example, in 2010 MicroEnsure was provided funding by the Common Market for Eastern and Southern Africa (COMESA) to conduct training in 8 eastern and southern African countries for insurance regulators, insurers, MFIs into weather index design and rating. MicroEnsure has designed a series of simplified number of dry day insurance contracts for Africa and Asia

16 The issue of how to achieve scaleability and sustainability of WII poses a considerable challenge for policy makers in developing countries. In India the public sector specialist crop insurer, Agricultural Insurance Corporation, AIC, started underwriting WII insurance in 2006 and today is the World s largest WII crop insurer. In the Kharif 2010 AIC insured 3.9 million farmers under its Pilot Weather Based Crop Insurance Scheme (WBCIS) which covers excess and deficit rainfall risks, with TSI of nearly US$ 1 billion and total premium of US$ 103 million (average rate of 10.4%): in the Rabi 2010/11 season where covers include frost, heat, relative humidity, unseasonalrainfall, a total of 3.2 million farmers were insured with insured area of 6 million Ha, TSI of US$ 1.2 billion, premium of US$ 97 million (average rate of 8.1%) 14. The reasons for the major uptake of this program include: (i) cover is compulsory for all farmers borrowing seasonal crop credit and (ii) starting in the Kharif season 2007, Government of India, GOI, has approved up to 50% premium subsidies on all Crop WII business underwritten by AIC. In India the private sector WII insurers until recently did not receive any premium subsidy support for their programs and were therefore operating at a major disadvantage to AIC with its much cheaper subsidised premium WII products. Since , several of the private sector programs in India have received approval by state governments for premium subsidies and therefore they are able to compete more directly with AIC. The automatic linkage or bundling of individual farmer WII to input supply and seasonal crop production credit offers potential for insurers to achieve risk spread and scale on their WII programs. In when WFP-IFAD reported on the 30 micro-level or developmental WII schemes, 13 or 43% of the programs were tied to credit, including most notably Malawi, which is cited in the literature as one example of a successful African WII scheme where bundling of crop WII crop insurance with inputs and credit has provided a win-win situation for farmers, lending institutions and insurers alike. The farmer gains access to seasonal crop credit, lending institutions are more willing to lend to small farmers because their loans are protected by crop insurance and the insurer benefits from: (a) reduced anti-selection, which in turn reduces the need for preinspections; (b) the reduced costs of marketing crop insurance; and (c) the insurance uptake and spread of risk is much better than would normally be achieved under a 14 AIC Annual Report available at

17 purely voluntary programme. (CRMG 2008; Mulalo 2008; Hellmuth et al 2009). In India, Hazell and Hess 2010 also note that linking of crop insurance, input supply and credit on the PepsiCo WII program for potato out-growers seems to have been a catalyst for the stronger demand for crop insurance. There is much debate whether traditional or new WII crop insurance can be successfully marketed to small and marginal farmers in developing countries without premium subsidies. Within insurance and reinsurance circles 15 it is often argued that sustainable crop insurance in developing countries can only work where governments provide financial support for premiums and administrative costs and share in the reinsurance of catastrophe losses in order to keep insurance terms affordable for the farmer and thereby facilitating a large market penetration and the stability of the program. The World Bank 2008 study of government support to agricultural insurance showed that crop insurance premium subsidies were the most common form of public intervention in agricultural insurance provided in almost two thirds of all the 65 surveyed countries and that in general governments in emerging economies were as likely to provide premium subsidy support as in high income counties, although only 40% of the low income countries with crop insurance, provided premium subsidies (Mahul and Stutley 2010). The same study, however, noted that premium subsidies were not always a precondition for high crop insurance uptake and penetration rates: in developed countries unsubsidized crop hail and named peril insurance is highly demanded by farmers (e.g. USA, Sweden, Germany, Australia and New Zealand) and this also applies to emerging markets (e.g. private-sector unsubsidized crop hail in Argentina). In the case of crop WII in developing countries, the private sector programs in India formerly did not qualify for any premium subsidy support, and this also applies up to today to the unsubsidized Thailand and Malawi rainfall deficit WII programs. The WFP-IFAD 2010 survey of 30 micro-level WII programs showed that 12 or 40% of the programs carried premium subsidies including all the programs in high income countries of the USA and Canada and most notably the AIC India WBSIC program in emerging economies. Since that report was completed several of the Indian private sector schemes have now started to receive state-level government premium subsidy support. In Africa, the Syngenta Foundation Kenya Kilimo Salama rainfall-deficit program for maize is a unique example 15 For example, see article by J Herbold (2010)

18 of private-sector premium subsidy support. Syngenta is supporting the scheme financially through its investment in automated weather stations and in the provision of 50% premium subsidies to farmers: the farmer therefore pays a flat premium rate of 5% for cover. In 2009 the policy did not carry premium subsidies and was purchased by 200 maize farmers (WFP-IFAD 2010). In 2009 major droughts were experienced in Kenya and in the following year when Syngenta introduced a 50% premium subsidy, the Kilimo Salama product was purchased by over 11,000 maize farmers in 5 regions of Kenya, using 30 weather trigger stations 16. The extent to which demand for crop insurance is driven by farmer s perception of the drought risk exposure as opposed to the inducement of cheap crop insurance is not known. It is understood that local scheme management are targeting 50,000 policy sales of the Kilimo Salama index cover within the next few years. Farmers demand for Crop WII and the affordability of WII cover. The above discussion has highlighted a widely held maxim that the main problem of low demand for crop insurance in developing countries is due to farmer s inability to afford, or unwillingness to pay the often high premium rates of between 5% and 10% or more. Hazell and Hess 2010 highlight the fact that many farmers have proved reluctant to buy weather index insurance even when it is available and forward several alternative reasons for the differences between the hypothetically high demand and actual low demand for crop insurance including: farmers often do not understand the product, and that education and initial wealth are key factors in determining uptake rates, and Alderman and Haque (2007) note that lack of trust in formal insurance may be a factor. Other studies note that in general the household demand for insurance against catastrophe natural risks is low and that in lower income countries that demand is further reduced by limited household resources and the common perception that there should be a return on the premium paid (GlobalAgrisk 2010). In Ethiopia willingness to pay for WII appears to be closely related to higher levels of education, wealth and the degree of proactiveness of the individual (IFPRI 2010a). In Ghana, the IPA research project with maize farmers is one of few studies which have actually tested farmer s demand for crop insurance by offering maize excess and deficit rainfall WII policies in year 1 free of cost 16 For further details see: Syngenta website at temp/final_kilimo_salama_factsheet_for_siakago_event_septemb er_2010.pdf and IFC

19 while accompanying the program with intensive awareness and education programs. In year 2, IPA introduced differential premium rates for the same cover varying from 1% to 13% premium rates against an actuarially fair rate of between 8% to 10% premium rate. The study found that the highest renewal demand (more than 90% of farmers) for crop insurance was among those farmers who were offered very low premium rates of 1% to 3%; however, in excess of 40% of the farmers who were offered CWII cover at the actually fair rate of 8% to 10% elected to purchase crop insurance, in spite of knowing that other farmers in neighbouring locations had been offered much lower rates, The reasons for the high demand for crop insurance even at high premium rates centred on (1) the trust that had been established between IPA (as the risk carrier-insurer) and farmers and (2) the fact that farmers had received intensive education in the product and fully understood the advantages and drawbacks of the Takayua Rainfall policy. (IPA 2008, IPA 2009, IPA 2010). Is WII Crop insurance a cheaper alternative than traditional MPCI cover? The WII literature correctly highlights one of the major advantages of WII namely the fact that as it does not involve any in-field crop damage or yield loss assessment, there is a potential to save on the administration and operating cost loadings that have to be priced into the commercial premium rates charged to farmers. However, WII has been misconceived in some circles as a cheap alternative to traditional MPCI insurance which is not the case. The bulk of the first generation WII programs designed to date are rainfall deficit or drought covers and where the correlation between yield and rainfall is high, the underlying pure loss cost rates calculated for a WII cover or a traditional loss of yield cover will be essentially the same. For the programs which have been offered to date by AIC in India, average premium rates for rainfall deficit cover are typically about 10% in the Kharif season: and for adverse climate in the Rabi season slightly lower at an average of about 8%. Where two or more perils are covered, the calculated pure loss cost rates often exceed 20% for the WII and the only way to bring rates down is either to raise the trigger thresholds to reduce the frequency of payouts, or to amend the payout rate and to cap payouts in each vegetative stage (which is equivalent to introducing a coinsurance on the loss). On the private WII programs in India, average premium rates on the Basix programs are between 3% and 8% (WFP-IFAD 2010). In Kenya, the average premium rate on the Syngenta program is a flat 10% and rates vary from about 7.5% to 15% on the other WII pilot programs in Kenya. In Ghana, the first year premium

20 rates for rainfall deficit cover vary from an average of about 8% for individual farmer insurance to an average of 5% to 6% for the rural banking products where the demand is for catastrophe drought cover and the banks are willing to accept high levels of coinsurance. Most individual grower WII programs involve high start-up costs (data acquisition costs, technical design and rating, farmer awareness and education, and infrastructure improvement costs in automated weather stations etc). On account of these very high start-up costs, often linked to limited technical capacity and rural insurance experience, very few local insurance private commercial companies in emerging markets have been willing to fund the start-up costs by themselves. Instead, most of the stimulus for and investment in crop WII pilot program design and implementation has been dependent on financial support and availability of technical assistance from multinational development agencies and non-governmental organizations and development funds. The challenge for these pilot schemes in the implementation phase is to then ensure that the appointed Insurer buys into the pilot and commits resources to marketing and promoting and scaleup of these WII schemes. Furthermore, operational sustainability of these schemes is often dependent on the capacity of local stakeholders (insurers, meteorological agencies etc) to maintain service with limited intervention after external start-up funding and technical support has been withdrawn (GlobalAgRisk 2010). Basis risk often poses a major problem on individual farmer micro-level WII programs. Basis risk in WII is a key constraint. Basis risk is the difference between the loss experienced by the farmer and the payout triggered. It could result in a farmer experiencing yield loss, but not receiving a payout, or in a payout being triggered without any loss being experienced. Index insurance works best where losses are homogeneous in the defined area and highly correlated with the indexed peril. There are various types of basis risk: o Spatial basis risk. Local variations in the peril occurrence (e.g. rainfall) within the area surrounding a weather station. o Temporal basis risk. Inter-annual variations in seasonal crop phases, meaning that the insurance phases are not temporally aligned with the intended crop growth stage. o Product basis risk. Crop losses can be caused by many factors. Where there is no clear-cut relationship between loss and the indexed weather peril, basis risk can

21 be high. WII is most likely to work for rainfed crops and at severe levels of the event, when losses may be more widespread and homogeneous. Basis risk becomes a problem where an individual farmer(s) incurs major crop yield loss, for example, due to rainfall deficit at his location, but does not receive a payout because no rainfall deficit was triggered at the selected measurement weather station. This situation is potentially disastrous not only for the farmer(s) who has paid a premium for the rainfall deficit cover but has lost his crop and not received an indemnity, but also it creates a reputational risk for the insurance industry and potential loss of confidence and acceptance of the product by farmers and other stakeholders (Herbold 2010). Current WII guidelines are that rainfall as measured at a meteorological station is usually representative of a radius of up to 20 km if topography is homogeneous: however, discussion with farmers in many semi-arid regions of the world (including Senegal, Ghana, and Burkina Faso) suggests that rainfall patterns may vary over much smaller distances of 5 km to 10 km only. One solution to the problem of basis risk is to increase the density of weather stations and countries such as India (mainly private sector investment), and Kenya and Ghana (donor funding) are investing in new weather stations. Another alternative is to raise the threshold trigger levels on individual farmer covers so that only major catastrophe events which impact over a wide region are insured: here there is a trade-off which has been identified in India between farmers desire for frequent small payouts from WII insurance and the reduction of potential basis risk by only covering large and infrequent events. Crop WII only insures one or two key perils and cannot provide the same level of yield shortfall guarantee as a traditional MPCI policy. Most of the first generation microlevel insurance programs to date insure against rainfall deficit only, although some covers include both too little and too much rainfall (e.g. WBCIS rainfall cover in the Kharif season in India) and in some cases, policies may insure up to three perils (e.g. some of the Rabi season WBCIS products offered in India which include frost, excess temperature and unseasonable rainfall). Even in semi-arid conditions where rainfall is the major determinant of crop cereal yields, correlations between these two variables often do not exceed 65% to 75%. Under the operation of any WII program there will therefore always be other uninsured factors which influence crop production and yields and it is very important that farmers receive training and fully understand that the WII