Experiences in Index­Based Weather Insurance for Farmers

Principles and Lessons Learned

Joanna Syroka Commodity Risk Management Group, World Bank

What is Weather Risk Protection?

• Financial protection based on the performance of a specified weather index in relation to a specified trigger

• Offers protection against uncertain costs or revenues that result from volume volatility, i.e. shortfalls in ag production

• Flexible product with many risk management applications from farmer to international organization level

• For farmers and other actors in agricultural supply chains: – Index­based weather insurance products can compensate against adverse weather fluctuations that impact physical volumes or product quality

Simple Insurance Contract

• Three­phase 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) à

Payout ($) à

PHASE 1 Sowing & Establishment

PHASE 3 Yield Formation to Harvest

Deficit Rainfall (mm) à Payout ($) à

Deficit Rainfall (mm) à

Payout ($) à

PHASE 2 Growth & Flowering

Dekadal Cropping Calendar* à Sowing Window & Dynamic Start Date

* Cumulative rainfall per dekad is capped to prevent excessive rainfall impacting the phase­wise 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 are critical for reducing cost and increasing access to agricultural credit

• Index­based weather insurance: – Avoids the need for loss assessments – Lowers programme costs and technical complexity – Objective and timely – Only 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 well 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’s a commercial product – Presents limitations when dealing with non­commercial clients

CRMG Experiences • Interesting experiences at farmer level, with actual transactions for farmers

in: – India (2003­2006), Ukraine (2005), Malawi (2005­present), Ethiopia (2006­2007), Thailand (2006­present), Nicaragua (2007­present), Honduras (2008­present)

• Non­CRMG initiatives leading to transactions: – Mexico (Agroasemex, 2003­present), Philippines (MicroEnsure, 2008) – Indian market has continued to grow independently and with help with further World Bank TA

• Other experiences resulting in no transactions: – Morocco (2002), Tanzania, Vietnam, Cambodia, Senegal, Peru

• Other current CRMG activities: – Kenya, Burkina Faso, Bangladesh, Indonesia, Guatemala, Jamaica – Training, synthesis of lessons learned and best practices to date

Ø Many new actors entering the field

Lessons Learned Technical Pre­Requisites for Reaching Clients

• Weather risk that can be faithfully indexed and is not chronic – Spatially correlated risk, manageable micro­climates

• Official National Weather Service weather network with historical and real­ time data – Sufficiently dense network to start piloting and show potential – High­quality data required for programme

• 20­30 years of daily QC­ed data, few gaps, available in near real­time – New stations can be installed if potential for scalability is good

• India, private sector; Malawi, World Bank project – Usually there are enough stations to start piloting, including in Africa

• Favourable regulatory framework

Ø The key technical components to feasibility, but not enough for success…

Lessons Learned Operational Pre­Requisites

• Local ownerships, strong partners and partnerships, incentives – A “win­win” strategy for all stakeholders – Sustainable base for capacity building and training

• Integrating into agricultural supply chains that work so that other risks are managed – Robust product delivery channels to farmers

– Linkages to finance, inputs and other services, allowing for pre­financing of premiums (incentives!)

– Critical for farmer clients not yet fully commercial – Often a better product for risk aggregators (banks, contract farming) than individual farmers

• When retailing directly to farmers, keep it simple: – Delivery channel critical, must be trusted and comprehensive – Farmer education key, significant outreach and marketing investment

• Piloting critical, several seasonal needed to test approaches – Pilots can evolve with stakeholders

Program Implementation Pre­Requisites

Insurer

Distributor

Policyholder is Farmer

Micro level insurance program

Policies, premiums, claims

Policies, premiums, claims

Meso level insurance program

Insurer

Policies, premiums, claims

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

Farmers

Aggregator sets the payout rules

Ø Clear, well‐defined responsibilities, product accounting practices and communication between all in‐country stakeholders

Experiences in Africa: Malawi

Example Malawi Why Weather Insurance?

• In 2004, the National Smallholder Farmers Association of Malawi (NASFAM) wanted to expand its operations and grow the Malawi groundnut market domestically and for export – Greater output potential for farmers, profit; reliable yields; lower risk of disease; will receive training by NASFAM; access to high quality seed; export potential

– Farmers needed financing to purchase quality seed from NASFAM

• High risks from drought and high loan default rates deterring financing institutions from providing loans – 2004/2005 drought led to recovery rates for lenders in the range 50­70%

– Major government and donor lending program was discontinued – Two microfinance institutions stopped lending to agriculture, many reduced activities

• Gives farmers the ability to mitigate drought risk – Secure access to finance and inputs for improved production – NASFAM training and higher quality seed will improve long­term production and revenues

• Protects both producer and loan provider from weather­related production risks – Allowing banks to expand their lending portfolios in a managed way – Opportunity for NASFAM to expand its operations and grow the Malawi market domestically and for export

• Gives insurers the opportunity to re­enter rural markets – No regulatory impediment and reinsurance potential – Little (and bad!) experience with traditional agriculture insurance

• Malawi has excellent weather data and a dense weather station network

Example Malawi The Objective of Insurance

ü A win‐win for all stakeholders, good data

Example Malawi Pilot Details, 2005­2006

• Loans to cover seed, insurance premium and interest: – Opportunity International Bank of Malawi – Malawi Rural Finance Corporation

• Policies: – Insurance Association of Malawi (seven companies pooled the risk) – Premium: 6­7%, Max Payout per farmer: Loan Size given by bank

• Seed & Product Distributor: – NASFAM: Groundnut in 2005, Groundnut & Hybrid Maize in 2006

• Participants: – Farmers all members of NASFAM clubs – 2005: 900 farmers, 4 weather stations, sum insured $35,000 – 2006: 1710 farmers, 5 weather stations, sum insured $110,000

• Insurance Payout Payment details: – Payout: channeled from insurance company directly to the bank; – No Payout: farmers benefit from selling the higher value production

Example Malawi Pilot Results

• Major Achievements: – Unlocking credit facilities for smallholder farmers – Access to high yielding seeds and fertilizers – Generated high­level of interest from banking sector

• But… programme discontinued in 2007 – Groundnuts market prone to side­selling, leading to non­ weather related defaults – Nascent agricultural supply chain with many problems greater than weather

– Banks stopped lending to groundnuts in 2007, so no need for insurance

• Other lessons learned: – Stand alone product had no takers – Premiums will always have to be pre­financed through loans – Distributor channel operational capacity critical

Malawi: 2007 Onwards

• Focus on established agricultural supply chains, e.g. tobacco – 70% of current loan portfolios, has a maize component – Economies of scale and critical diversification for insurers – Tie­in with emerging contract farming relationships in Malawi

• Since 2007: – Working with 3 banks and 2 contract farming companies

• 2600 farmers insured in 2008, portfolio size of $3 million • Access to reinsurance market since 2007

– Working at farmer and risk­aggregator level • Developing off­the­shelf products for other to support emerging supply chains and contract farming relationships

Ø Banks and agri­businesses see this as a product for both themselves and farmers

• In 2009: – World Bank Agricultural Development Programme Support Project supporting: • Demand­driven mainstreaming of weather insurance into ag credit system • Installation of 70 weather stations • Training, capacity building and development of regulatory framework

The Experience of BASIX in India

Example India Why Weather Insurance?

• MFI BASIX operates in over 12,000 villages spread over 9 states in India, serving 1 million customers, with a mission to promote sustainable livelihoods

• BASIX’s customer contact and interactions in the initial years of operations showed that while credit is necessary, it is not sufficient for promoting livelihoods

• Risk management particularly for rain­fed agriculture was identified as an important credit plus service to be offered to its customers

• Between 1999­2001, BASIX carried out research and undertook small pilots in testing an in house crop insurance scheme

• Which culminated in the first weather insurance pilot in 2003, in collaboration with ICICI Lombard and World Bank

But in the beginning… … there were groundnuts

1 st Farmer Weather Insurance Policy

Farmers in Pamireddypally

Program Evolution at BASIX • 2003: 230 policies

• 1 weather station in A.P. • 2004: 427 policies

• 3 districts in A.P • 2005: 6,703 policies

• 6 states • 2006: 11,500 policies

• 7 states, 50 stations • 2007: 4,545 policies

• Changed contract structure to create better, but more expensive products • 7 states, 45 stations

• 2008: 10,600 policies • 8 states, highest volume of business to date

• All India: over 700,000 farmers insured in 2008 by three insurance companies – Finance Ministry allocated a budget of 1 billion INR for 2007­08 for promoting and improving penetration of weather insurance

– Ministry of Agriculture recommends some of the states to replace NAIS with index based weather insurance in select locations

Ø BASIX offer stand‐alone voluntary polices to farmers along side other services

In BASIX’s Words: Dissecting the Challenges in Delivering

Micro Weather Insurance

The Core: Product

The Capsule: Process

Ø BASIX experience and initiatives have been largely to address the process bottlenecks and make fine refinements to

products from time to time.

…and there are several layers to it

Customer Education

Training and Capacity Building

Incentives

Documentation

MIS and IT

Partnerships and product development process

Simple Products and Procedures

Synergy with other products

In BASIX’s Words: Critical Factors for BASIX Success

• Collaboration

• Piloting product concepts

• Channeling customer feedback into product design

• Continuous improvements in each product cycle

• Emphasis on product communication to customers who are illiterate

• Efficient policy distribution and claim servicing

Conclusions • CRMG piloting has shown that weather insurance for farmers in developing countries

is feasible

• Weather insurance is not a panacea – Can only enhance existing agricultural supply chains and businesses, not create them

– It can help support expansion in rural finance and agriculture – It must go hand in hand with other investments in extension services, irrigation, strengthening of input and output markets, other financial services and products etc.

• Sustainability and scalability will not be achieved unless operational hurdles can be overcome: – Robust product delivery channels to farmers, linkages to finance or supply chain with additional farmer products and services

– Local ownership through capacity building and technology transfer for all actors – Strong local partners and incentives

• Just as important for scalability (if not more) than technical hurdles: – Investment in data and weather infrastructure – Synthesizing best practices for contract design, insurance and reinsurance – Favourable regulatory framework