Agriculture is inherently an uncertain business. This is especially true in developing countries, where smallholder farmers often have less capacity to deal with shocks and stresses produced by climate change or market price fluctuations. Insurance is one tool that farmers can use to manage risk. With insurance, part of that risk – from weather, pest, disease or the market – is transferred to another party, who absorbs a share of the risk in return for a fee. When farmers suffer a loss, they claim for financial support from their insurer to mitigate part of the loss. Agricultural insurance is not a complete solution, but rather one component of a risk management strategy where constraints such as the lack of access to finance, improved seed and markets can also be addressed. For example where drought is a severe problem, the construction of irrigation schemes maybe a more cost effective approach.
Crop insurance programmes are structured to support different types of losses. Damage-based indemnity insurance is calculated by measuring the percentage of damage in the field soon after the damage occurs. Yield-based crop insurance allows the farmer to insure a percentage of their average yield; if the actual yield is less than the insured yield, a pay-out is awarded. Crop revenue insurance guarantees the farmer a certain level of revenue from the insured crop. This insurance protects the farmer from shortfalls in the yield and also from market price fluctuations.
In developed countries agricultural insurance schemes are often large in scale covering thousands if not millions of mostly large-scale farmers. A critical factor is the cost of insurance provision. Insurers have to accurately assess the risks and measure the damage while at the same time providing farmers with affordable insurance premiums. Unless these conditions are met the insurance scheme is likely to be unsustainable. Recently a number of pilot projects that offer ‘micro-insurance’ have emerged. Generally, micro-insurance targets low-income smallholder farmers, with limited or no previous exposure to insurance and is based on an observable index.
Index-based insurance is calculated by measures provided by meteorological stations, satellite data, or regional-level yield data. The general characteristics of index-based livestock insurance programmes are similar to those for weather and area yield. In 2008, fewer than 80,000 farmers benefitted from agricultural (crop and livestock) micro-insurance in Africa. By 2011, the number of agricultural policies has tripled, now reaching almost 240,000 farmers in 14 countries, representing US$6.61 million in premiums. For example, the Consultative Group for International Agricultural Research (CGIAR) Index-Based Livestock Insurance (IBLI) project uses forage measurements taken from satellites to identify seasonal forage availability. If forage falls below a certain level, pastoralists can use the pay-outs to buy extra feed, medicine for their livestock, or take other livelihood protection measures.
Micro-insurance protects smallholders from a total loss of income in the event of partial or total crop failure that would otherwise create food insecurity, indebtedness or further deprivation. The financial safety net that insurance provides may encourage smallholders to adopt production systems that are potentially more resilient, productive and more profitable, but involve greater financial risk. For example, insured farmers may be able to invest in long-term Ecological Intensification methods such as multiple cropping, agroforestry or conservation agriculture because they are protected if the investments are not immediately profitable, as is often the case with many on-farm improvements.
Access to agricultural insurance is generally very limited for smallholder farmers. Insurers often focus on urban or industrial risks and do not typically see commercial value in developing networks in agribusiness or in rural areas. Many types of insurance products available in developed countries, are not necessarily suitable for poor farmers in developing countries. For example, yield-based crop insurance is not generally suitable for smallholders because it is too expensive to measure production on a case-by-case basis, causing the premiums to become cost prohibitive.
Where insurance packages are available it can be risky for insurers to provide policies for agricultural activities. Common farming risks such as poor weather or pest and disease infestations tend to affect large numbers of farms at a time, causing pay-outs to be very high. This increases policy premiums rendering the insurance unaffordable for smallholder farmers and unattractive to insurers or re-insurers. The high risk for insurers is why farm insurance in developed countries is heavily subsidised by governments, which may not be a realistic model for African governments to follow. Additionally, the attractiveness of insurance is often not clear for smallholder farmers as many find paying for insurance when you may not actually get anything in return a difficult concept to understand.
Conventional insurance programmes may suffer from moral hazard, whereby farmers do not exert as much effort to avoid risk or its consequences. Moral hazard and adverse selection (whereby farmers know more about their risks than the insurer does), may lead to insurers charging higher premiums, or forego insuring altogether. Insurance that reduces moral hazard, adverse selection and fraud, such as policies indexed to national data systems, have the potential to increase access to insurance for smallholders.
Weather based index insurance may offer a potential solution to manage farmer risk as well as offer a product of interest to farmers and insurers. Assessments of 36 weather-based index insurance pilot programmes by the International Fund for Agricultural Development (IFAD) and the World Food Programme (WFP) highlight its potential for smallholder farmers. They find that index-based insurance can provide agricultural households with a way to mitigate production risk, which in turn allows them to make riskier, more-profitable investments to improve productivity or diversify their activities. Similarly, insurance can help households smooth income across years, with the possibility of improving longer-term outcomes through increases in agricultural production and savings, and increased investment in education and health. Using reliable and objective weather data makes weather based index insurance more efficient and transparent, avoiding some of the moral hazard and fraud that require costly monitoring to deter. Further, in-field loss assessments are not required which reduces costs and time taken for pay-outs.
Despite some success, the World Bank reported mixed results from its index insurance pilots. Most programmes have not moved beyond the pilot stage, especially when insurance is sold on its own (as opposed to being bundled with credit). It is unclear whether this is due to lack of demand, or barriers to uptake linked to affordability, or lack of trust. Technology can improve the affordability and scalability of micro-insurance. For example, remote sensing data for index insurance is being piloted in Senegal. Index-based livestock insurance for northern Kenyan pastoralists is using satellite imagery to determine the potential losses of livestock forage and issue pay-outs to participating herders when droughts are expected to occur.
Farmers are preoccupied with risk – from weather, pest, disease or market – and often characterized as risk averse, unwilling to make adjustments or adopt new technologies for fear that the practice or technology will not work. This is especially true when the farmer must incur an upfront cost for which the benefits may be long to realize. Risk preferences are central to farmer decision-making and can inhibit the likelihood that they will adopt insurance programmes without adequate education and training. The cost of a policy premium is often assumed to be the main barrier to low adoption, but more likely is that the concept of paying for something that you might not need, or may not get back can be foreign and difficult to accept as a beneficial expenditure.
Access to formal agricultural insurance is generally very limited in developing countries. As a result, smallholders tend to rely on informal risk minimisation and coping strategies that are sub-optimal. Although the Landscape of Micro-insurance in Africa study reported a big increase in those insured, up to 240,000 households in 2011, representing US$6.61 million in premiums, this is still a small proportion of the African farmer population. The study also noted that cooperative insurance structures offered the majority, nearly 60%, of the products used.