Carter - Index-based insurance in agriculture - 2012-09-19

Index-based Insurance in Agriculture Managing Risks and Uncertainty for Smallholder Farmers Michael R. Carter University of California, Davis BASIS Collaborative Research Support Program I4 Index Insurance Innovation Initiative .The CGIAR Research Program on Climate Change, Agriculture and Food Security (CCAFS) CGIAR Science Seminar September 19, 2012 M.R. Carter Managing risks

Outline The ’same old story’ about risk: Uninsured risk makes & keeps smallholders poor Correlated risk undercuts rural ﬁnancial market development Cycle continues Crafting a new ending to this same old story: Change the structural conditions (uninsured risk) that create these problems Index Insurance as an instrument to remove correlated risk and change this story Index insurance Logic Social protection through satellite-based livestock insurance in Northern Kenya Crowding in credit supply & demand in Ethiopia for improved productivity Moving forward: a research agenda for index insurance M.R. Carter Managing risks

Risk Makes Smallholders PoorThe same old story, part 1   Peruvian coastal agriculture is a commercially-oriented, high potential area   Dominated by small holders (land reform beneficiaries)   Yet a recent study suggests that financial market constraints on both demand and supply sides may reduce production by 25%   Index insurance can work on both sides of the financial market M.R. Carter Managing risks

Risk Keeps Smallholders PoorThe same old story, part 2   Evidence of poverty traps in N. Kenya   Households whose assets fall below a critical threshold are unable to recover nor craft a pathway from poverty   This dynamic over time creates ever growing numbers of food aid dependent people   Index insurance can potentially alter this dynamic with ex ante & ex post effects M.R. Carter Managing risks

Index InsuranceCrafting a new ending to the story? Neither markets nor the public sector have been able to surmount the risk & information conditions to ﬁnd a happier ending to this same old story about risk But, is it possible to modify these conditions that underlie both market and policy failures and open the door to a new ending to this story? M.R. Carter Managing risks

Index InsuranceCrafting a new ending to the story? Index Insurance Hypothesis is that the removal of correlated risk with index insurance contracts will have important development impacts because it will: Serve as a novel form of social protection & alter poverty dynamics in risk-prone areas In higher potential areas, it will: Crowd-in credit institutions and credit supply Relax risk rationing & enhance demand Undercut destructive political economy In both, it will incentivize prudential risk taking, spurring small farm productivity & income growth M.R. Carter Managing risks

Index InsuranceWhat it is and how it functions Conventional insurance measures individual losses and makes indemnity payouts based on those losses. Index insurance does not require measurement of individual losses and makes common payments to insured based on the level of a single index correlated with losses Index insurance avoids problems that make individual insurance unprofitable for small scale agricultural: No transactions costs of measuring individual losses Preserves effort incentives (no moral hazard) as no single individual can influence whether the index pays out Adverse Selection does not matter as payouts do not depend on the riskiness of those who buy the insurance M.R. Carter Managing risks

Design of Index InsuranceIBLI Project in Northern Kenya (an I4-ILRI-Cornell collaboration) M.R. Carter Managing risks

Design of Index InsuranceIBLI Project in Northern Kenya M.R. Carter Managing risks

Evaluating the Development Impacts of Index InsuranceIBLI Project in Northern Kenya Insurance functions, but will it modify poverty dynamics–the forces that keep households poor? Experimental design to test its impacts against conventional aid Region has a pilot cash transfer scheme„ the HSNP Means-tested transfers are around $15/family/month Theory suggests that we will see reduced long-term poverty rates when index insurance complements cash transfers through both ex post eﬀects (fewer slide into poverty) and ex ante eﬀects (more are incentivized to graduate from poverty) M.R. Carter Managing risks

Evaluating the Development Impacts of Index InsuranceIBLI Project in Northern Kenya Implemented privately provisioned index insurance in pastoral regions of Northern Kenya 2x2 research design to measure impacts Long-term design, but in 2011, payouts made throughout the insured area Took a quick look at impacts of these payouts on coping and asset accumulation/de-accumulation M.R. Carter Managing risks

Evaluating the Development Impacts of Index InsuranceIBLI Project in Northern Kenya 33% drop in households employing hunger strategies (with severe long-term consequences for the young) 50% drop in distress sales of assets 33% drop in food aid reliance (aid traps) In addition, accumulation & market eﬀects: M.R. Carter Managing risks

Evaluating the Development Impacts of Index InsuranceIBLI Project in Northern Kenya M.R. Carter Managing risks

Ethiopian Project on Interlinking Insurance & Credit inAgriculture Substantial yield gap for food grain farmers, even in higher potential areas Small fraction of farmers use improved varieties & fertilizers Flimsy system of agricultural ﬁnance based on state banking that almost completely collapsed in 2009 following a drought Theoretical work indicates that interlinked credit-insurance that transfers correlated risk can: Relax lender portfolio restrictions on ag loans that make credit scarce & expensive Undercut the destructive political economy that creates debt amnesties Eliminate risk rationing of borrowers M.R. Carter Managing risks

Ethiopian Project on Interlinking Insurance & Credit inAgriculture Research team from UC-San Diego, FAO and University of Athens took on this challenge Dashen Bank, which had never before lent to small-scale agriculture, agreed to lend up to 15 million Biir under the interlinked contract arrangement Bundled credit-insurance is marketed as ‘state contingent loan’ contracts to cover seed and fertilizer purchases; Marketed to farmers through village cooperative associations, which bundle demand and present it to Dashen Current contract is a (sub-optimal) rainfall contract, with insurance provided by Nyala Insurance Contract rolled out in July 2012 to producers in Northern Shoa, South Wolo, and Gojam. Demand estimated at 50 million Biir. M.R. Carter Managing risks

Ethiopian Project on Interlinking Insurance & Credit inAgricultureResearch Design Two arm trial in which 120 eligible Kebeles randomly divided into: A control group (initially 40 Kebeles) receives no insurance and no credit. A ‘standalone’ arm (40 Kebeles) receives only the index insurance product; we don’t prevent the use of credit but we also don’t provide any explicit form of interlinking. The ‘interlinked’ arm (40 Kebeles) receives state-contingent loans. M.R. Carter Managing risks

Ethiopian Project on Interlinking Insurance & Credit inAgricultureResearch Design The study will then be conducted by comparing each of the two treatment arms to the control, and to each other. Provides a simple, transparent measure of the impact of insurance, the impact of interlinked insurance, and the impact of the interlinking itself. Three years of household surveys to track technology use and economic well-being Dashen Bank also needs to be convinced that the correlated risk concerns that have kept the Bank out of this market are in fact addressed by the interlinked product Stay tuned ... M.R. Carter Managing risks

An Index Insurance Research Agenda While these and other pilot projects seem promising, there is much still to learn about whether and how to do index insurance for development Need innovations that: Reduce the uncovered basis risk faced by farmers under index insurance contracts Respond to the risk management needs of women farmers by targeting crops typically grown by women and, or that offer payoff structures that meet the needs and preferences of women producers Incentivize climate change adaptation investments Protect producers against price or revenue fluctuations Are informed by insights from the behavioral literature on how households choose amongst risky and uncertain (ambiguous) prospects. Cost-effectively scale-up index contracts without undercutting their effectiveness as risk transfer and development instruments. M.R. Carter Managing risks

Looking Forward . Innovative financial technologies offer an important complement to more conventional agricultural technology programs Drought resistance through financial or seed technologies? While it is clearly important Still much to learn to to invest in new agricultural resolve demand-side technologies, also need to challenges & resolving find ways to realize the risk as a development underutilized potential of problem already existing agricultural technologies M.R. Carter Managing risks

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Carter - Index-based insurance in agriculture - 2012-09-19

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Carter - Index-based insurance in agriculture - 2012-09-19 Presentation Transcript