Concept Note on Farm Income Insurance: Issues and Way Forward

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1 Farm Income Insurance India, an agrarian economy with 1/3 rd population depending on the agriculture sector directly or indirectly has ~ 116 million farm holdings covering an area of 163 million hectares of which small and marginal farmers (with holdings of 2 hectares or less) make up 80 per cent of the producer population. Farming is an inherently risky business and farmers face many types of risks. The two most important risks that farmers face are: 1. Yield Risk and 2. Price Risk Yield Risk: - Agriculture, in India is heavily dependent on monsoon, which at times is uncertain. About 60 per cent of net sown area of the country is rain-fed and 65% of Indian farmers depend on rain-fed irrigation. The growth of crops and realization of output are determined by the quantum of rainfall and its distribution during the monsoon season. Rainfall pattern affects the irrigated crops also. Nearly 2/3 rd of the cropped acreage in India is vulnerable to drought in different degrees. This leads to operating risk in cultivation of different crops. On an average 12 million hectares of crop area is affected annually by these calamities severely impacting the yields and total agricultural production. Immemorial weather has been the major adversary that the farmers are not able to control. Price Risk:- Price or market risk refers to uncertainty about the prices farmers will receive for commodities or the prices they must pay for inputs. Revenue depends on production, prices, and interactions between the two. Prices received by farmers depend largely on global market conditions, while yields depend on localized factors, such as weather. The nature of price risk varies significantly from commodity to commodity. Price of Commodity and Yield of Commodity are inversely related i.e., when yield and aggregate production of a commodity increase, price decreases; when yield falls, price rises. The price-yield relationship, measured by the price-yield correlation, tends to be strongest in areas where most farm-level yields are closely related to area-wide production 0 P a g e

2 and where the area s production normally accounts for a significant share of world production. Aspects of Financial Risk:- 1. Borrowing money for farm business & repaying debt 2. Rising interest rates 3. Prospect of loans being called by lenders 4. Restricted credit availability Farmers find they are unable and to some extent unwilling to pay interest on their crop loans in a drought year and seek to reschedule principal repayments. Institutional risk: - Institutional risk results from uncertainties surrounding government actions. Government decisions that can have a major impact on the farm business are:- 1. Tax laws 2. Regulations for chemical use 3. Rules for animal waste disposal 4. Level of price or income support payments Thus, revenue variability across farms is largely the result of yield variability and differences in the relationship between prices and individual farm-level yields. The ultimate impact is seen in the form of high inflation and low gross domestic product growth (Agriculture contributes around 14 per cent to the Indian economy). With every one per cent deficit in rains, the country's Gross Domestic Product (GDP) falls by 0.35 per cent. 51% of farmers in India have no bank account and are financially excluded. De-risking smallholder farmers is of paramount interest and to cover the risk which may occur in future, there is need to have some provision and crop insurance is only mechanism available to safeguard against production risk in agriculture. Farmers, like other business people, are responsible for managing risks that will occur from year to year. Uncertain weather conditions, market shifts, and other events beyond a farmer s control affect farm yields and commodity prices, creating variability in farm revenue. When extreme events 1 P a g e

3 happen which are uninsurable simply because there is no insurance cover offered there may be both a moral and economic argument. Government of India (GoI) has introduced several crop insurance schemes over the past three decades. After experimenting with pilot schemes; individual farm based, which had adverse claim ratio and area based with voluntary participation provision, the Government introduced the first nationwide area yield guarantee insurance scheme in 1985 named Comprehensive Crop Insurance Scheme (CCIS), which was compulsory for loanee farmers. In 1999, it was replaced by National Agricultural Insurance Scheme (NAIS), expanding the coverage base and introducing additional features. It was further improved and a pilot Modified NAIS (MNAIS) scheme was introduced in Rabi Apart from this a Weather Index Based Crop Insurance Scheme (WBCIS) was also launched as a pilot scheme in Kharif Coconut Palm Insurance Scheme (CPIS) was also implemented on pilot basis from in 8 states. Recently, GoI has approved National Crop Insurance Programme (NCIP) for implementation throughout the country from Rabi by merging MNAIS, WBCIS and CPIS. A brief note about some of the schemes are as follows:- National Agricultural Insurance Scheme (NAIS): Operates on the basis of area-based crop insurance mechanism with the goal of providing a farm safety net and the development of the agricultural sector. NAIS protects yields against unavoidable perils such as but not limited to: drought, heat, hail, excess moisture, frost, freeze, insects, etc. NAIS coverage is offered only for food crops (cereals, millet and pulses) and selected annual commercial crops, potentially representing in excess of 90% of the total cropped area in the country. Approximately 15% of India s cropped area is insured under NAIS and over 65% of NAIS participants are small or marginal farmers. However, the NAIS doesn t offer any income assurance to farmers against the price fluctuations. 2 P a g e

4 Unfortunately, NAIS suffered low acceptability among the farmers due to reasons such as large unit area of insurance, unattractive threshold yield and indemnity level, delay in claims settlement and non-coverage of risk of pre-sowing and post harvesting losses. In addition, due to occurrence of natural calamities such as drought, flood, cyclone, pest, diseases etc. in different parts of the country; funds-requirement for scheme is unpredictable and unexpected, which cannot be planned / assessed correctly. Modified National Agricultural Insurance Scheme (MNAIS): Implemented on pilot basis to overcome the shortcomings in the NAIS. Use yield as an index to arrive at the loss experienced and the compensation payable. Unit area of insurance was reduced and private-sector participation was introduced to create a competitive crop insurance environment. More proficient basis for calculation of threshold yield was introduced (average yield of last 7 years excluding up to two years of declared national calamity) Individual assessment of claims in case of specified localized calamities Uniform seasonality norms for both loanee and non-loanee farmers Farm Income Insurance Scheme (FIIS): FIIS was introduced by Government of India during on pilot basis in 22 districts of 14 states, which was later discontinued. This scheme was envisaged to address both yield risk and price risk so as to stabilize farmers incomes. It, however, focused on income with respect to individual crops, and not on farm income. The scheme used area approach for actual yield and price measurement. If the actual income of the farmer falls short of the guaranteed income (i.e., product of average yield and minimum support price), they would be eligible for compensation to the extent of indemnity. The scheme covered mainly paddy and wheat crops. The scheme observed low participation of farmers. The reasons being: 3 P a g e

5 Farmer were not benefitted adequately due to off-setting behavior of yield and price. Unattractive guaranteed income, high premium rates, not covering risky crops like oilseeds / pulses were the reasons for low participation. Weather Based Crop Insurance Scheme (WBCIS): WBCIS is a unique weather based insurance product designed to provide insurance protection against losses in crop yield resulting from adverse weather incidences including deficit and excess rainfall, high or low temperature, humidity etc. The pilot WBCIS was based on actuarial rates of premium. To make the scheme attractive, premium charged was at par with NAIS. Under this scheme onion, tomato, chillies, gherkins, tapioca, turmeric, banana, jasmine, rose, tuberose and grapes are been covered presently. A compressive Revenue Assurance (RA) / Income Protection (IP) plan is thus required which protects the farmers against revenue losses (i.e., yield multiplied by price) caused by declines in either yields or prices. Under the Revenue Insurance scheme farmers can purchase crop insurance to reduce yield and/or price risk. Benefits of Revenue Insurance:- 1. Revenue insurance can be more effective at stabilizing income than insurance plans or farm programs that protect against yield and price risks separately or that provide fixed-income transfers. 2. A revenue-based program may also offer a simple way of assisting a wider variety of farms than programs linked to current or historical production of particular commodities, a practice that focuses risk management support only on certain segments of the farm sector. 3. Revenue insurance plans are designed to match costs of risk protection with benefits and to base coverage on the market value of the item insured. 4. Revenue insurance will help reduce the revenue risk and enhance the possibilities for farmers to increase productivity to offset negative terms of trade trends. 4 P a g e

6 Challenge:- 1. The challenge for the Government and Private Insurance companies operating in the Agriculture Insurance space and who are willing to offer new Farm Income / Revenue protection schemes will be to device a mechanism to fix the reference price to calculate the insurance amount (for e.g. take the average of the last seven years of a farmer's income) and offer insurance for that amount. One main characteristic of most of the USA insurance products which offer some price risk protection is that the reference price is the futures markets price, and mainly, the guaranteed price is that predicted by the futures market. So, they provide coverage against the oscillation of the price within the year. 2. Government will also need to ascertain that who will bear the cost of the premium. If it will be paid by the government, the liability on the Government will increase assuming the Government plans to continue with all the existing subsidies that are provided to farmers. The revenue-based insurance model may also utilize revenue and expense history calculation to conduct an assessment of the estimated costs that Insurance companies will replace in the event of a peril generally the full cash cost of production, including seed, chemical, fertilizer, interest and overheads will be made available in the form of coverage to growers. Given this scenario, the private insurance players, also need to expand the farm insurance cover. Self-model of crop insurance should cover claims, administrative costs and also generate surplus to absorb catastrophic losses. There is a need to introduce innovative insurance products covering different risks to be introduced in place of multiperil crop insurance. As in USA, it would be prudent if the expected revenue from the crop is insured. This would help farmers to manage consumption needs in event of crop failure. India needs a breakthrough crop income and revenue insurance-based program that will provide a revolutionary new way for farming families to recover their business and production costs of their cropping enterprise when weather related disaster strikes. It is important that the Insurance scheme provides a secure insurance solution to the farmers by transferring risk from the farm to the insurance industry that financially supports the 5 P a g e

7 program, thus providing farming families with access to vast amounts of working capital when they need it most and offering a comforting level of security. The Income Protection / Revenue Assurance schemes will help de-risking the small holder farmer and will help protect their incomes by integrating production with prices. A national adoption of revenue insurance would create opportunities for the top-performing farms to continue to grow, offering a demonstrator effect to other farming communities and increasing the likelihood of success across the country. It would also allow farmers to confidently undertake succession planning, consider opportunities around scale and generate diversity of production. 6 P a g e