Mitigating Weather Risk
The livelihoods of many rural poor in low income countries remain predominantly dependent on agricultural activity, and agriculture activity is vulnerable to a wide range of risks, including those related to weather. Without mechanisms to protect themselves against risk, these rural households and enterprises are often unable or unwilling to take advantage of market opportunities. Instead, they follow low-risk/low-return livelihood strategies and may even retreat from profitable projects for which they have adequate liquidity, resulting in lower than necessary incomes and growth. Insurance, flexible savings and other financial services that help households to smooth consumption and protect themselves against shocks can help minimize potentially devastating asset losses and facilitate shifts toward adoption of livelihood strategies with potentially higher returns. In addition, instruments that mitigate risk to these households also remove a primary constraint to the supply of finance as private sector financial institutions are better able to reduce a major cause of default on loans in rural areas and to agricultural enterprises. Improved access to finance further reduces rural households’ and agricultural enterprises’ vulnerability by enabling them to improve technologies, expand assets, and take advantage of economic opportunities.
This note explores the relationship between agricultural sector development, weather risk and finance, and examines an insurance innovation that is designed to mitigate some of the risk that rural households and agricultural enterprises experience as a result of extreme weather events. It also examines the potential impact of such an insurance product on financial institutions with significant agricultural loan portfolios.
The note’s conclusion includes a set of general factors that donors and governments should consider to stimulate the development and practical applications of index-based insurance in developing countries:
- Identifying/creating relevant data set
- Ensuring secure data collection
- Educating rural people and institutions about the value and use of weather insurance
- Legal and regulatory framework