Managing Agricultural Production Risk – Innovations in Developing Countries
In developed countries formal global markets are widely used for offsetting natural disaster and weather risks. This document aims to demonstrate how these markets can be used to insure these risks in developing countries. It stresses the key challenge remains of how to make insurance against extreme weather events both more effective and affordable. Two major issues are seen to obstruct the development of risk transfer markets for agricultural losses caused by such events:
- Organising ex ante financing for highly correlated losses that result in extremely large financial exposure; and
- High transaction costs due to asymmetric information problems such as moral hazard and adverse selection.
This document has been written to inform a broad range of decision makers about progress being made in risk transfer for natural disaster risk with a focus on defining practical roles for governments of developing countries and the World Bank in developing risk management strategies.
The document begins with an overview of risk and how decision makers currently cope with and manage risk in developing countries and examines the impediments to developing effective risk transfer markets. A review of the experience of some developed countries then follows. Consideration is also given to alternative solutions that might be possible by introducing the concept of weather index insurance and the advantages of such systems for developing countries. Two basic innovations dominate the conceptual framework behind this proposal:
- Use of index-based insurance; and
- Layering risk to facilitate risk transfer.
Several case studies and a number of pilot programs are also provided to illustrate how these concepts are being applied in countries around the world. Finally, the paper concludes with recommendations for the role of the World Bank and country governments in facilitating the development of innovation in agricultural risk management.