Should governments support the development of agricultural insurance markets?

Should governments support the development of agricultural insurance markets?

Previously published here on the World Bank Group's Private Sector Development Blog

How governments can ensure that low-income farmers are financially protected against natural disasters, such as droughts, was at the heart of a panel discussion at the “Global Index Insurance Conference,” which concluded earlier this week in Paris.
The panelists explored various options, such as the disaster reserve fund FONDEN in Mexico as well as three index-based insurance programs aiming to protect vulnerable farmers: the African Risk Capacity, the Kenya Livestock Insurance Program, and the Mexican CADENA program.

The discussion was moderated by Olivier Mahul, program manager of the Disaster Risk Financing and Insurance (DRFI) Program, housed at the World Bank and the Global Facility for Disaster Reduction and Recovery.
The conclusion was clear: Financial protection for farmers, and particularly agricultural insurance, is a vital topic among rural development practitioners.

While agricultural insurance can serve as a shield for poor farmers against drought, excessive rainfall or other production threats, it can also:

  • Improve farmers’ creditworthiness and open the door to agricultural credit and inputs. Agricultural insurance can act as a catalyst for enhanced productivity. Farmers can use it as collateral to agricultural lenders, providing them with access to credit markets needed for investments such as fertilizer and enhanced seeds, which in turn can boost productivity.
  • Help governments efficiently mobilize financial resources for relief spending by securing financial resources for those affected -- farmers and governments alike -- before a natural disaster happens. This allows governments to avoid inefficient ad-hoc financing measures after disasters to support affected farmers.
  • Serve as a government’s social-protection tool to aid the poorest farmers, who are typically hit hardest by natural disasters.

Agricultural insurance, however, doesn’t exist in all countries.
First, agricultural insurance often isn't affordable to farmers. A lower income forces many farmers to focus their spending priorities on more immediate needs.
Second, information on past production yields and natural disasters is required for insurers to price the product premiums. In the case of many low- and middle-income countries, this information is often neither available nor precise enough for pricing purposes. As a result, insurers increase premium rates disproportionately, making their products less affordable to farmers.

Third, some of the existing products don't seem to offer reliable protection against production risks. For example, this can be the case for index insurance, where payouts are conducted based on a quantitative index which is related to crop yields. The index can measure things such as deviations from normal weather patterns or it could compare the crop yield of a given area to the historical average.  If it reaches a predefined threshold, then it triggers a payout. This can be a problem, however, when the index isn’t accurate enough. In India, where more than 30 million farmers are covered by indexed agricultural insurance policies each year, a joint World Bank-Agricultural Insurance Company of India study found that one of the programs didn’t pay claims in about one-third of the worst years, due to inaccuracy of the index.  
What can governments do to promote the development of agricultural insurance markets?

With climate change increasing the frequency and intensity of agricultural losses, it's better to ask how rather than whether governments should support agricultural insurance. In particular, international experience shows that:

  • Successful agricultural insurance markets in many low- and middle-income countries are defined by governments helping overcome the challenges described above. In such public-private partnerships (PPPs), the supporting role of the government is especially critical in two areas: in data and in financial premium support
  • Governments can support the collection, management and quality-auditing process of data needed for agricultural insurance purposes. For example, in India, local governments collect crop yield data through extension workers, store it in a government-owned database and share it with insurance companies to feed into their agricultural insurance product pricing.
  • To boost the uptake of insurance, governments can give financial premium support by providing subsidies to low-income famers. Subsidies can foster a risk-management mentality among farmers, who are encouraged to pay a share of the price of insurance if the government will cover the rest.

There are many other areas where governments can support agricultural insurance markets. They include product distribution (for example, by encouraging linking it to agricultural credit), capacity building, providing public reinsurance to insurers and establishing a prudent legal and regulatory framework.

By supporting agricultural insurance markets, governments could act as catalysts for the financial protection for farmers. They should do so. The alternatives for relief financing haven’t worked in the past, and they won’t work in the future. Agricultural insurance programs can help soften the economic blow of natural disasters and convert previously unpredictable losses into a known cost.