The Potential for Scale and Sustainability in Weather Index Insurance

THE POTENTIAL FOR SCALE AND SUSTAINABILITY IN WEATHER INDEX INSURANCE
FOR AGRICULTURE AND RURAL LIVELIHOODS
Chapter 1
Risk in agriculture
The problem
Agricultural production is a risky business. Farmers face a variety of price, yield and
resource risks that make their incomes unstable and unpredictable from year to year.
In many cases, they are also confronted by the risk of catastrophe. Crops may be
totally destroyed by drought or new pest outbreaks, input costs may increase and
product prices may plummet because of adjustments in local or world markets, and
assets and lives may be lost due to hurricanes, fires and floods. The types and severity
of the risks confronting farmers vary by farming system, agroclimatic region, local
policy, and institutional settings, but agricultural risks are particularly burdensome to
small-scale farmers in the developing world. Their livelihoods depend to a large extent
on agricultural production, and their access to formal financial services is usually very
limited. Unless well managed, agricultural risks slow economic development and
poverty reduction, and contribute to humanitarian crises.
Types of risk in agriculture
Risks can be characterized according to a number of elements, including:
Covariance. The degree to which they are correlated across households within a
community or region, ranging from independent (affecting one person) to highly
covariate (affecting everyone at the same time);
Frequency. How often they occur;
Types and severity of losses incurred. Shortfalls in seasonal production and
income, damage to assets and loss of life.
As illustrated in Table 1, at one extreme are highly covariate risks that generally occur
with low frequency (such as floods, hurricanes and severe drought), but that can have
catastrophic impacts within affected regions. For example, the 2002 drought in Ethiopia
affected most of the country and led to 12.5 million people requiring food aid. In
addition to short-term humanitarian challenges arising from loss of life, production
and income, the associated loss of or damage to key assets can make recovery slow
and uncertain. Without help, many people may slip into long-term poverty.
At the other extreme, there is a wide array of risks that are weakly if at all covariate,
but that occur with high frequency. These risks impact more randomly on individual
households (e.g. deaths and illnesses of people or livestock), but the proportion of
total households affected each year is often predictable. Many of the risks that affect
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