index based weather insurance william dick commodity risk management group agriculture and rural...
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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