Index Based Weather Insurance Index Based Weather Insurance

William DickCommodity Risk Management Group

Agriculture and Rural Development DepartmentWorld Bank

Johannesburg, April 2009

Managing Risk in Financing Agriculture - Expert MeetingManaging Risk in Financing Agriculture - Expert Meeting

ALL ACP AGRICULTURAL COMMODITIES PROGRAMME

EUROPEAN DEVELOPMENT FUND ACP GROUP OF STATES

Global agricultural insurance market

Source: Paris Re, 2008

Rural insurance constraints in developing countries

Highly challenging environment for insurers Insurers lack rural networks, expertise, data Technically complex to insure crops and livestock Catastrophe risk exposures High transaction and loss assessment costs More profitable opportunities exist in commercial and urban

areas Clients

Small size, geographically spread Lack insurance awareness Lack capacity or willingness to pay premiums Lack incentives to insure if there is government disaster

assistance Inadequate data and infrastructure

Poor statistical base (crop production, risks, losses) Poor rural services including credit Difficult to establish distribution channels and linkages

Agricultural insurance – product range

Traditional crop and livestock indemnity products Named peril crop insurance (e.g. hail) Multiple peril crop insurance (yield guarantee) Revenue insurance (yield and some price protection) Livestock mortality insurance

Index-based products Weather index products Area yield index products Livestock index products

Rural insurance products Health, life, property, motor… Microinsurance - a growing sector enabling rural

households to access simplified policies

Risk assessment

Rainfed Crops: Causes of Crop Losses

Bird attack6%

Flood5%

Locusts5%

Other4%

Theft2%

Wind1%

Fire1% Drought

29%

Insects (excl. locusts)

16%

Animals9%

Unseasonal rainfall

9%

Disease13%

Irrigated Crops: Causes of Crop Loss

Bird attack7%

Theft5%

Locusts3%

Disease15%

Flood13%Animals

12%

Irrigation equipment breakdown

10%

Insects (excl. locusts)

7%

Lack Irrigation water7%

Commercial risks4%

Wind 1% Unseasonal

rainfall16%

Senegal: Causes of Loss in Rain-fed and Irrigated Crops

Typhoon & Flood

1,046,09755%

Drought255,869

13%

Pest365,004

19%

Diseases241,642

12%

Others28,738

1%

Philippines - Rice Crop Insured Causes of Loss1981 to 2006 (26 years) (P.Pesos ’000)

Total: P1,937,350

Source: Philippines Crop Insurance Corporation (Multi-Peril Crop Insurance)

What are index insurance contracts ?

An index insurance contract pays out based on the value of an “index”, not on losses measured in the field

An index is a variable that is highly correlated with losses and that cannot be influenced by the insured

Example indexes - rainfall, temperature, regional yield, river levels etc.

Key strengths Index insurance overcome most of the supply side problems of

MPCI Objective and transparent Provides timely payout Reduce administrative costs Facilitates international reinsurance

Constraints Basis risk – the potential mismatch between losses and payouts Provides single-risk protection High inputs required during development phase Weather data and networks Requires local adaptation – slows the scaling up

Simple Index Insurance Contract

Three-phase deficit rainfall weather insurance contract, indexed to a weather station

Pioneered by Indian insurance company ICICI Lombard in 2004 and subsequently in many CRMG pilots around the world (Malawi, Central America, Thailand)

Deficit Rainfall (mm)

Payou

t ($

)

PHASE 1Sowing & Establishment

PHASE 3Yield Formation to Harvest

Deficit Rainfall (mm) P

ayou

t ($

)

Deficit Rainfall (mm)

Payou

t ($

)

PHASE 2Growth & Flowering

Dekadal Cropping Calendar* Sowing Window &

Dynamic Start Date

* Cumulative rainfall per dekad is capped to prevent excessive rainfall impacting the phase-wise total

Motivation/Benefits

Traditional crop insurance for smallholder economies is extremely challenging

Many constraints for traditional products based on individual loss assessments

Agricultural production suffers from covariant risks (e.g. drought)

Needs reinsurance Risk management products adapted to developing countries

could increase access to, and reduce cost of, agricultural credit

Index-based weather insurance: Avoids the need for loss assessments Lowers programme costs and technical complexity Objective and timely Works well for spatially correlated risks Reinsurable

Product Limitations

Addresses only one aspect of production risk – deficit rainfall, excess rainfall, low temperatures etc. – amongst many – pests, poor inputs, farm management… Similar to “named peril” insurance, but for systemic risk

“Basis Risk”, the potential mismatch of insurance payouts and actual losses on a farmer’s field, has two forms: The inability of an index to faithfully capture the risk in question

as effectively as individual field inspections “Perceived” basis risk, another peril impacts a farmer’s crop

production

New product, therefore training and capacity building required For insurance sector, insured parties and distribution channels Needs regulatory approval, adjustment to framework

Like all insurance, it is a commercial product Presents limitations when dealing with non-commercial

clients

Index Based Products

Assess loss based on estimates of the area yield.

Threshold is established less than the expected district yield

Indemnities paid when area average yield is < than threshold.

Requires sound official yield sampling

Products date to the 1950s (Sweden) and has since been offered in Canada (since 1977) and the US (since 1992).

India’s national crop insurance program (NAIS) is area yield

Mixed social and market goals Actuarial performance is quite

poor

Assess loss based on the changes in a weather index over a pre-specified period of time at a particular weather station.

Appropriate for highly correlated weather risks

excess and deficit rainfall excess and deficit

temperature. Strong, quantifiable

relationship, must exist between weather risk and yield loss in order to establish the index on which the contract will be based.

Relatively low administrative costs and does not face moral hazard issues.

Area Yield Index Insurance Weather Index Insurance

Applications and experience

Index insurance experience to date Main application has been for drought risk at Micro level Pilot scale implementation in several countries Private sector scale-up of micro level only in India Research to expand to other risks: flood, ENSO, cyclone

Micro level Weather-indexed insurance for smallholder farmers, intermediated through institutions with rural outreach Ex. India, Nicaragua, Malawi, Ukraine, Thailand

Meso level Weather-indexed portfolio hedge for rural financial institutions that lend to poor farmers Ex. India

Macro level Weather insurance or weather-indexed contingent credit line for governments or international organizations that provide safety nets for the poor Ex. Ethiopia, Malawi, Mexico

Index insurance structures and entry points

Insurer

Distributor

Policyholder isFarmer

Micro level insurance program

Policies, premiums, claims

Policies, premiums, claims

Meso/Macro insurance program

Insurer

Policies, premiums, claims

Policyholder is Aggregator (e.g. processor, bank)

Farmers

Aggregator sets the payout rules

Clear, well-defined, responsibilities are needed for stakeholdersAggregator/Distributor is critical link

Stakeholders in rural insurance

Category Potential stakeholders Role

Insurers Insurance companies Insurance association

Underwriting of the risk

Reinsurers Reinsurance companies Acceptance of transferred risks

Delivery Channels Agricultural banks Rural Service organizations NGO’s MFI ’s Input suppliers

Distribution channel of insurance to farmersFarmer education and extension

Farmers Farmer Association Co-operatives

Representing farmers, as buyers and beneficiaries

Government Departments

Meteorological Service Regulator of Insurance Ministry of Finance Ministry of Agriculture Planning Ministries

Representation of government organizations at policy, research or operational level. Possible subsidy and/or ongoing support to the program.

Donors Technical assistance Support (financial and/or consultancy) mainly during design and implementation phases

Scope, limitations and lessons

Opportunity to embed weather insurance into larger development projects and lending

An integrated approach is needed linked to other rural services Natural linkage to improved availability of agricultural credit

Climate adaptation and role of insurance Insurance plays a supportive but not a leading role Insurance is not a substitute for climate adaptation measures Increased risk from climate change is a challenge to insurers

Lessons learned in agricultural insurance Technically demanding and sometimes infeasible or costly There is no universal insurance product Public-private partnerships are needed for agricultural insurance Devil is in the detail Insurance is only one component of risk management Insurance is not a panacea Practice may differ from theory

Some issues for workshop consideration

Assessing the risks facing lenders Understanding of reasons for loan performance

• Risks – type, frequency, severity, client vulnerability • External, structural or political constraints in agricultural economy• Willingness and ability to repay• Systemic versus independent risk exposure

Insurance as collateral Does index insurance meet lender requirements

• Basis risk• Can risks not covered by an index be retained or managed elsewhere • Can index insurance be scaled up

Role of traditional versus index insurance Role of credit guarantees

Smart structuring and delivery options Improving entry points into the agri value chain Meso versus micro solutions Bundling/packaging

Public/private sector roles and donor involvement