The Potential for Scale and Sustainability in Weather Index Insurance

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CHAPTER 1
RISK IN AGRICULTURE
Governments and relief agencies
Governments and relief agencies frequently intervene where losses have a catastrophic
impact and the local coping capacity is weak or non-existent. Driven by humanitarian
concerns, their primary objective is to save lives and rebuild assets. Although
humanitarian interventions have proven indispensable in times of need, they have
also been beset by a number of problems:
• It is difficult to target relief aid to the truly needy; large leakages to others are common.
• Emergency relief might arrive too late.
• Food aid can distort incentives and depress local prices for farmers. Moreover, once
disaster assistance has been institutionalized, and people know they can rely on it,
people may inadvertently be encouraged to increase their future exposure to
potential losses. Assured compensation for flood damage to homes, for example,
can lead to the construction of more houses in flood-prone areas.
• Funding for humanitarian relief in the face of catastrophes is not assured, and it often
depends on appeals to international donors after the crisis has already occurred.
Many governments have attempted to help farmers manage more frequent and less
covariate risks in order to protect assets and promote development (e.g. crop insurance
and livestock feed programmes during droughts). The experience has generally been
unfavourable, at a high cost with low gain. These kinds of risks are subject to moral
hazard and asymmetric information problems, and their higher frequency makes the
premiums too expensive for farmers, unless they are heavily subsidized. The
government itself may find this level of support unsustainable over time; and the loss
adjustment and payout process can be difficult to manage effectively.
When assessing vulnerable populations, governments have typically failed to
adequately differentiate between those who can afford insurance and those who
cannot. If suitable commercial risk-management instruments are available, some
households are quite capable of bearing and managing most of the risks they face and
do not need access to subsidized government interventions, except in the event of
major disasters. But there are many vulnerable households that lack this capacity, and
for which all risk-management interventions serve primarily as social safety nets.
These safety nets can only be provided on a heavily subsidized basis. Mixing these two
types of clients leads to the design of public interventions that are heavily subsidized
for all and that end up being very costly, both in terms of their direct government cost
and the economic inefficiencies they create through distorted incentives. If a clear
distinction between the needs of these two types of households could be precisely
differentiated, then more-efficient, targeted instruments could be designed.