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
return. Another constraint is the tendency of policymakers to underestimate the
frequency and impact of low-probability, covariate events. The demand for this kind
of insurance is currently stimulated by multilateral agencies such as the World Food
Programme (WFP) (Hess, Wiseman and Robertson 2006) and the World Bank (World
Bank 2009, 24), and programmes along these lines have emerged in a few countries
(Case Studies 1 and 3).
Demand for development index insurance will most likely come from regions
where the assets and livelihood strategies of farm households are widely exposed to
weather-related risks. Drought insurance, for example, might be an attractive
proposition in drought-prone agricultural areas. Studies in drought-prone areas have
demonstrated that farmers are often willing to pay 12-20 per cent above the pure risk
cost for drought insurance (Gautam, Hazell and Alderman 1994; Sakurai and
Reardon 1997; Binswanger and Sillers 1984; McCarthy 2003). In contrast, demand
would likely be low in an agricultural area located near an urban manufacturing
centre, where farmers have important sources of non-farm income that reduce their
vulnerability to drought; similarly, an irrigated agricultural area with assured water
supplies would likely show little demand.
Demand for development index insurance has been an important question in
China. Data from the National Statistics Bureau indicate that revenue from
agricultural activities accounts for only one third of the total income of a smallholder
in China. Many farmers engage in other activities to generate income and diversify
risk (e.g. seasonal work in town, small businesses). In addition, production costs are
low, representing approximately 7-9.5 per cent of total income, meaning that some
farmers consider the cost of insurance that would cover only production costs
unappealing (Case Study 4: China).
Farmers’ willingness to buy insurance may be greater when it is tied to credit. Their
willingness is also greatly influenced by their knowledge of how index insurance
works, socio-economic factors such as education, and their initial level of wealth (Patt
et al. 2009; Giné, Townsend and Vickey 2008). This finding suggests that the demand
for insurance can be increased through promotional and educational efforts. Of
course, the manner in which products are designed and marketed is also important,
as is the perceived reliability of the insurer or intermediary providing the insurance
(Patt et al. 2009).
Though farmers may be willing to pay what they consider an affordable premium,
the actual premium depends on the cost of the pure risk premium. If the probability
of the insured event is too large, then the pure risk cost can become prohibitive. As a
practical rule of thumb, events that occur more frequently than once every seven years
may be too costly for most farmers to insure without a subsidy. While insurance might
initially seem too expensive for many households, it could become more affordable
if it overcomes barriers to technology, high-value markets, or credit and other
financial services, and enables insured households to significantly increase their
expected incomes.
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