ETHIOPIAN DEVELOPMENT RESEARCH INSTITUTE

Selling weather-index insurance to farmers in Ethiopia: lessons learned

IFPRI-ESSPPresentation at DFID

Oct 5, 2015

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Weather risk remains a major challenge to farming in the Ethiopia;

A large fraction of rural households in Ethiopia were affected by drought – 50% (ERHS), 32% (AGP);

Drought had a significant impact on the short- and long-term welfare of affected households:

16% lower consumption levels than those of the unaffected ones, (Dercon, Hoddinott and Woldehanna (2005)), and

lower growth rates in consumption in the 1990s compared to those who had not faced serious problems in the 1984-85 drought (Dercon (2004)).

lower adoption of chemical fertilizers that would help increase productivity (Dercon and Christiaensen (2011)).

Background

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Background Informal insurance hampered by risk covariance;

Information asymmetry problems and high implementation costs limit viability of traditional formal insurance;

Index-based weather insurance offers new possibilities;

However, demand remains invariably low with basis-risk a key challenge;

Basis-risk (together with lack of trust) key motivations for our Ethiopia study, focusing on iddirs as platforms

Can informal risk sharing arrangements such as iddirs serve as sustainable retail outlets for index insurance? reduce basis risk, reduce transaction costs, increase trust.

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Two contrasting views

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OptimistManaging agricultural risk in rain-fed production systems requires a financial product that: • Can handle covariate risk (pay many farmers at once);

• Is robust to the problem of moral hazard (the fact that in agriculture it is hard to distinguish bad luck from too little effort);

• Weather index insurance is a unique financial product that fits these needs and provides the only realistic solution to managing risk for rural households;

• Providing weather insurance will allow farmers to undertake investments that carry risk allowing them to escape poverty

Two contrasting views

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Two contrasting views Pessimist• Weather index insurance is a hedging product and as such the basis

risk is too high for it to offer much value to farmers.

• It is expensive. • Demand is very low and if anything purchases are too low. Perhaps

because the product is too complex to be understood properly.

• There may be a role for weather indexes to insure risks of financial institutions that lend to farmers, or to governments that provide relief to farmers in times of need;

• • But unlikely to work as a stand-alone financial product sold to

farmers.

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The Ethiopia Study

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• Over 2011-2014, a group of researchers at IFPRI and the University of Oxford have worked with Buusaa Gonoffa and Oromia Insurance to sell insurance to farmers in Oromia (and also with Nyala insurance in SNNPR in the first year).

• Can informal risk sharing arrangements such as iddirs serve as sustainable retail outlets for index insurance?

• 110 villages selected around 3 weather stations in Oromia region of Ethiopia – Shashemene, Dodota and Bako Tibe (all ERHS woredas).

• A number of different approaches were tried and we tried to be scientific as much as possible, using RCT methods to learn from the process.

• Overall more than 5,000 farmers bought insurance in 55 sites.

• We had wide variation in penetration rates from less than 1% to 45% in different places and at different times

Selling insurance to farmers in Ethiopia

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Lessons learned

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• Basis risk was a major constraint to sales in the first year, even with a unique 10 year household panel data set to help design contracts (very rare)

• Introducing “gap insurance” seemed to have helped increase farmers trust and value of the product and sales increased substantially in the second year

• Gap insurance fills the gap between village level yield loss and the weather index:

Gap insuranceIf widespread yield losses are observed but the weather index does not suggest a payout, a petition of farmers can call for a crop cut. If the average yield is lower than a specified amount an insurance payout is made.

Lesson 1: a good product with minimal basis risk

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• Not everyone needs it—consistently low demand in our site with the least amount of rainfall risk.

• Not everyone can afford it but still a willingness to pay -something to be insured beyond the insurance provided by safety nets– We randomized price discounts and this was an important

factor in determining demand.

– Demand was very low when unsubsidized.

Lesson 2: farmers are willing to spend on insurance, but not much

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• Piloted selling through iddirs in all years

• Iddirs play two roles: – make marketing easier and cheaper– can help manage idiosyncratic basis risk

• Sales are consistently higher through groups than through individuals even with very intensive marketing effort to individuals.

• The role of the group in managing idiosyncratic basis risk increases demand by 29%

Lesson 3: selling through groups helps

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• Trust in the provider is important– The first year of sales in a place where there was no prior

experience of BG was much more difficult than in areas where they were well known

• Selling early—around Meher harvest—also seems to be important, both when the farmer has money and before uncertainty surrounding rains in the current season is resolved.

Lessons 4 and 5: trust and timing

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• Strong impact on fertilizer use.

– Households with insurance are 13% more likely to use fertlizer.

• Consistent with other studies on weather index insurance (for example Karlan et al 2013 in Ghana) and on the role of risk in fertilizer investments in Ethiopia (Dercon and Christiaensen 2012).

Learning about the impact of insurance on encouraging investment

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The Middle Ground

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• When low-basis-risk insurance is subsidized and combined with other approaches to reduce uninsured risk there is high demand and it brings about increased investments and income for vulnerable households.

• Market-priced, weather hedges sold as stand-alone products are less likely to meet the needs of Ethiopian farmers and will likely not bring about welfare gains.

• Selling index insurance to farmers in Ethiopia does make sense, but this kind of market is likely to require public support.

The middle ground?

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• How to subsidize in a smart way?– Supporting the development and capitalization of an

Ethiopian risk pool: a lot of risk can be pooled within Ethiopia.

– Subsidizing reinsurance that needs to be purchased on the international market.

– Supporting large investments in farmer training and “learning by buying” in the first years, perhaps an initial subsidy that is then removed.

– Invest in a regulatory capacity that checks due diligence has been done in the design of products and that there is a public recourse mechanism.

Key message: smart subsidy needed

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– Develop transparent products that minimize basis risk

– Start selling in areas of strong client demand

– Develop and implement a good marketing strategy, working with local groups where appropriate

– Develop with other financial products to manage risk and encourage complementarity, e.g. personal savings or group savings. Insurance is expensive as a stand-alone product.

Key message: address basis risk robustly plus

5 October, 2015DFID Ethiopia

Index-Based Insurance and Slow-onset Emergencies

Outline

Perspective

Potential benefits

Requirements

Observations

Perspective

Insurance is not necessarily the best policy intervention to deal with many types of risk (Dercon (2009));

risk reduction and management may be the most relevant response (conflict, crime, preventive health measures, water management, and environmental protection);

many types of risk are not easily insurable – cannot be actuarially priced (lack of data) or the risks are unknown (rare natural disasters or catastrophes);

more general policies to promote income growth are always necessary;

Potential Benefits Emergency response vs. premium–pay-out mix; Opportunity to layer risk:

individuals and communities – self-insurance; donors, governments, insurance – covariate risk;

Better and immediate link between emergency response and recipient need – role of food aid supply;

Improve timeliness and adequacy – reduce costly shortfalls (requirements vs. delivery) and delays (onset vs. assistance - months);

Simplicity and transparency – asymmetric information, transaction costs;

Requirements An index closely correlated with the outcome variable(s):

Underlying index highly correlated with the loss being insured against over a relatively large geographic area;

Data

Sufficient historical data must exist to estimate the probability distribution of the index; the link between index and outcome variable;

Legal and institutional framework;

Capacity – expertise, platform

Reinsurance – covariate risk

Experience WFP insurance for Ethiopia with AXA

Contract cost = US$930,000; Pay-out = US$7.1 million (maximum);

Good year, no pay-out;

No repeat

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Observations

Risk Financing Scheme part of the PSNP; Design regions/woreda level coverage, but risk pooled

nationally; Increase the incentives for local commercial insurance to get

involved, possibly, through local reinsurance facility; Reinsurance from global markets as appropriate;