The Potential for Scale and Sustainability in Weather Index Insurance

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THE POTENTIAL FOR SCALE AND SUSTAINABILITY IN WEATHER INDEX INSURANCE FOR AGRICULTURE AND RURAL LIVELIHOODS Assessment Performance The results for the first season (kharif 2007) of index insurance through PepsiCo showed a significant difference between the level of basis risk and actual risk. The weather index of some locations showed 85 per cent loss when actual losses were roughly 50 per cent; and some locations received payouts without suffering any loss. In other regions, however, the loss recorded (45 per cent) was less than the actual damage (50-60 per cent). In response, more weather stations were installed near farm locations for the following season. Basis risk results in rabi 2007 were slightly better, but they were still not optimal. Payouts matched two damaged locations, but recorded less than actual losses for another two. Reception and adoption In Punjab, only 145 out of 282 potato farmers under contract farming with PepsiCo bought index insurance coverage. This result stems from two important conditions. First, since Punjab had suffered relatively less damage than other regions, fewer farmers were inclined to purchase the insurance. Second, some farmers who did not purchase insurance were new to the contract farming programme and, as such, were still testing the credibility of the PepsiCo programme. Once they became acquainted with it, more farmers bought the insurance. The kharif season of 2008 showed satisfactory results, primarily due to a further increase in the number of weather stations. The product was also adjusted to trigger payout for losses only beyond the break-even level. Small losses would not receive any indemnification, an aspect that was hard to explain to farmers, but necessary to reduce the premium. Additionally, the estimated loss of yield (33 per cent) matched the expected payout. Despite the challenges in its implementation, surveys conducted by WRMS indicated that farmers trusted the programme for its capacity to reflect actual losses and provide for timely claim settlement. Farmers seemed to have a good grasp of the quantitative impact of weather on yields. In many locations, farmers had calculated claims and expected the forthcoming indemnification, which allowed them to plan future investments accordingly. Lessons learned Barriers to scaling up Currently, IMD has 500 weather stations in India, of which only 25 per cent have good historical data, and hail, cyclone and wind data are almost non-existent. In addition, the recording frequency in most stations varies from once every three hours to once per day, making consistent daily data collection and consolidation nearly impossible. Moreover, weather stations are rarely located in poor rural areas. Similarly, the distance between farmers and weather stations needs to be reduced. WRMS plans to install new stations to cover the regions in PepsiCo’s contract farming programme, though significant levels of investment in infrastructure would also be required to offer index insurance in regions where PepsiCo does not operate. WRMS estimates that an additional 10,000 weather stations are required in India, which would imply an investment of US$5-6 million. ANNEX 81
82 CASE STUDY 2 PEPSICO CONTRACT FARMING IN INDIA The limited participation of reinsurers is another constraint on scalability. Reinsurance companies are reluctant to enter the market due to the difficulty of estimating its size and their risk exposure. Since coverage is voluntary, the number of enrolled farmers may vary significantly from one season to the next and may represent a small share of total premium in the insurance market. As a consequence, reinsurers that do enter the market load the premium, owing to a lack of reliable data on a real-time basis. In addition, options for reinsurance are limited for deals under US$1 million in ceded premium (only one reinsurer has accepted a deal for US$100,000). While most reinsurers require the sales process to end 10 days prior to the risk inception date, index insurance cannot work with policies older than 30 days. The lack of pricing and underwriting skills further impedes the development of the local reinsurance market and limits the retention capacity of the insurer. Key lessons Contract farming has been an extremely effective tool in reducing the vulnerability of smallholders. The main drivers of smallholder participation in contract farming programmes appear to be: • Links to a market and buyers; • Fixed prices, which are typically above market prices; • Better access to inputs through PepsiCo, which purchases fertilizer in bulk and can sell it more inexpensively to its contract farmers (who can then produce higher yields); • Technical assistance, including agricultural production and weather forecasts; and • Access to financial services, including loans and index insurance. The main challenges for smallholders in contract farming programmes have been: • High quality standards of buyers (e.g. size, shape, sugar levels and dry-matter content); • Required upfront financing; and • The need to strictly follow specific agronomic practices to produce the required quality and yield (i.e. farmers cannot skip prescribed applications of fertilizers, chemicals and pesticides). The demand for index insurance is difficult to determine, though the product seems to be appreciated by the farmers who did buy it and who received payouts. The main drivers that influence a farmer to purchase index insurance include: • Incentives offered (e.g. higher buy-back price from PepsiCo); • The ability to finance the premium and other production costs through a loan; • Trust in the actors involved (e.g. corporation, processor, insurer, local representatives); • Demonstration of timely payouts in previous seasons; • A perceived need to mitigate the risk of losing the significant upfront costs of production, in part to cover the production costs for the following season; and • Dissatisfaction with the government area-yield insurance programme.
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Contacts IFAD Francesco Rispoli f.r
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The Potential for Scale and Sustainability in Weather Index Insurance

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