Developing Indexed-Based Insurance for Agriculture in Developing Countries

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This note focuses on one of the most pervasive production risks, weather, which impacts all aspects of the agricultural supply chain, particularly in economies based on rain-fed agriculture. Even with the introduction of new crop varieties, production technology such as irrigation, and new management practices that offer the potential to increase yields and improve resistance to weather perils, the majority of agriculture in developing countries remains highly susceptible to extreme, uncontrollable weather events that can severely impact both quality and yield of a crop.

As early as 1999, weather index-based insurance was being discussed in academic papers as a possible solution. In 2002, donors began to finance the piloting of these ideas. In particular, the World Bank’s Commodity Risk Management Group (CRMG) was allocated trust funds from the Swiss and the Dutch governments to pilot weather insurance for farmers to complement its price risk management work in commodity markets. Since then CRMG has been involved in many weather risk management technical assistance projects to commercial entities in the developing world, including India, Ukraine, Ethiopia, Malawi, Kenya, Tanzania, Thailand and Central America. Successes like the market growth of weather index insurance in India have had significant demonstration effects and have proven that weather risk management for farmers in the developing world is possible through insurance-type instruments. The CRMG has now begun to synthesize some best practices on how to create successful weather insurance schemes for farmers and how to make such initiatives sustainable and scalable, particularly in Africa.

The note explains the principles of this form of insurance and how a measurable index that can act as a proxy for risk is created. Boxed highlights explain how the product is priced and the seven steps that are required to develop a weather insurance pilot. The authors note that even if it is technically feasible to develop index-based weather risk management products, the operational challenges of reaching end users can be insurmountable for the actual implementation of a program. Attempts to integrate risk management practices into organizations that have problems such as poor communications infrastructure, institutional instability, underdeveloped marketing and financial skills, and weak managerial and decision-making authority, are likely to be ineffective and inefficient. The success of a weather insurance pilot also critically depends on the relationship the farmer has with the institution offering the insurance. The stronger and more trusted this relationship, the easier it will be to educate farmers about new risk management products and their limitations, and to deliver these services efficiently. Engaging local regulators and assisting them in the design of general insurance contractual conditions for these new index-based products is another key component of building a successful program.

This brief provides a quick introduction to the subject of weather index insurance and makes it clear that it is not a simple task to develop and introduce such products. The authors conclude that without the development of thorough training material that can be deployed and taken up locally, and the availability of funding to strengthen National Meteorological Services and their weather observing network, future growth of the market for index-based products will be limited.

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