Index insurance design & implementation - IRI’s perspective


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WorldFish Bangladesh organized a seminar “Challenges on Indexed Based Insurance (IBI) design and implementation”, on the 11th of September 2013. The seminar was conducted by Dr. Helen Greatrex, Post-doctoral research scientist at the International Research Institute (IRI) for Climate and Society, University of Columbia, New York.

IRI's Financial Instruments Sector Team helps people overcome climate risk through financial tools, and has been working on index insurance since its introduction 10 years ago. IRI have worked in over a dozen countries on hundreds of index contracts leading to many tens of thousands of policies purchased by farmers. Through IRI’s work on index insurance for climate adaptation and poverty reduction, they have unlocked many of the key constraints for index insurance to be able to meaningfully address poverty at large scales, overcoming what have previously been considered impossible hurdles in technology, information, poverty levels, and farmer involvement. This talk was designed to share some of our experiences and to highlight the growing index insurance community in Bangladesh, including a report back on the WorldFish led Index Insurance workshop held this week in Dhaka.

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  • The climate has always presented a challenge to those who depend on it. Many people focus on climate risk as the direct impact of an event such as a drought or a flood, such as crop failure or food insecurity. However, an equally important aspect of climate risk is the THREAT of a bad year. To develop, farmers need to increase productivity in ALL years. If they can significantly increase productivity in the good years, they can protect themselves against the bad ones. Farmers in Europe suffer much less from droughts because they have the resources to cope. But, most of the things a farmer can do to increase productivity require her to take a chance, a change that leaves her very vulnerable to climate risk, which is often too high to allow her to take that chance.A very common example of a chance a farmer could take to greatly increase productivity is to take out a loan for high quality seeds. Lets say that years out of five, the farmer might triple her income using the loan and quality seeds. But if this coming season is the one bad year out of five, the farmer cannot repay her loan and loses everything. Because the farmer doesn’t know if this year will be a bad year or not, she cannot take the productive choice. The bottom line is that the key to adaptation is to reduce the risk from the bad year enough so that the farmer can take the productive chance. This is similar to the development challenges. The difference is that with climate change, farmers are forced to improve to be able to continue their livelihoods.
  • So it all comes down to that choice at the start of a season. Do you take a risk, knowing that most of the time you will make a huge profit – but that maybe, you will lose it all? The bottom line is that the key to adaptation is to reduce the risk from the bad year enough so that the farmer can take the productive chance. This is similar to the development challenges. Climate change for many farmers means more bad years. Adaptation for those farmers means doing much better in the remaining "non-bad" years, even if those years are not quite as good as they used to be. But, most of the things a farmer can do to increase productivity require her to take a chance, a change that leaves her very vulnerable to climate risk. So this is how index insurance fits in to the climate change picture
  • If insurance can reduce risk enough so that the farmer can become more productive, it is valuable for adaptation and developmentThe value of the insurance is that it unlocks productivity. Because the farmer has more money from increased productivity, she can easily pay for insurance, and she understands that its value comes from yield increases in the normal, non-payout years. This same story holds for wealthy and extremely low income farmers. If the insurance does not allow them to make much more money than the premium costs, the insurance is pretty much worthless, even if the premiums are subsidized. If the insurance allows a farmer to make more money, it is very profitable, highly demanded, and dramatically scalable. Traditional “indemnity based” insurance has faced many challenges preventing it from being widely used around the world. With traditional insurance, the farmers get a payout if their crops die. The problem is that if the farmer is rewarded for letting their crops die. This means that in many places the insurance has more payouts than it should have. Because the insurance fees (premiums) need to be big enough to cover the payouts, the insurance cost becomes too high to be workable. The other problem is that for traditional insurance the insurance company needs to visit each farm. This might be affordable if there is 1 farm on 1000 hectares, but for many developing countries, you have 1000 or more farmers on the same land, so it becomes too expensive to visit farms.Index insurance is a new strategy for insurance. It is very young, less than 10 years old (younger than the ipod), so we are still learning. Still there are some successes and some optimism. Here is the way it works. Instead of paying if the crop dies (like traditional insurance), it pays when something happens that will probably kill the crops. One of the most common strategies is to provide a payout when there is widespread drought. Then the farmer is not penalized for working to keep her crop alive, and it can be much cheaper to measure drought than crop loss. But now insurance is something very different. It does not protect from everything. Instead, it only reduces the number of things a farmer has to worry about. Her crops can still be hurt, but she knows she is protected against major drought.  The insurance is only the last piece of the risk management system.   Many things will remain uninsuredThings that the insurance cannot target well should be handled through other tools (such as savings or community risk pooling). The risk of the index being wrong is often called “basis risk”. Farmers need to know exactly what is NOT covered and be comfortable with its limitations for index insurance to be responsible. The insurance does not remove all of the risk from people's life.  That would be insanely expensive, and is not something that can be bought. Instead insurance is simply reducing the specific pieces of risk that cannot be covered more effectively other ways only just enough so that the productive chance can be safely taken.
  • Sending your money through the international financial system isn’t always the best option. For example, if there’s a localised drought, could the farmer borrow money from their brother, or walk their cow to the next village? But if there’s a big regional event then your brother will have no money and the next village has no water either. And this is where index insurance could protect you, against these obvious and important village level events.The insurance is the last piece of the risk management system.   Many things will remain uninsured. Things that the insurance cannot target well should be handled through other tools (such as savings or community risk pooling). IRI’s role is to work with partners at every level from farmers to re-insurers:linking experiencesbuilding training materials togetherworking on technical issues (e.g. remote sensing)building technologies,
  • We are here from the international research institute for climate and society, which is based at the University of Columbia in New York. Specifically, we are here as part of the Financial Instruments Sector Team, or FIST team. Our area of expertise is to examine economic methods which can be used to understand and manage climate risk.FIST has been working on index insurance since the first few II schemes. We have worked at every stage of the index insurance chain (from farmers to re-insurers), on everything from improving the science basis, to improving farmer visits, to informing policy.We have also worked alongside many different index insurance schemes from around the world. From this, we have had an opportunity to see what works, and what doesn’t – so a lot of our work is to help link different partners and schemes from around the world and promote good practice.IRI’s main role is to help partners stitch these fundamentals into all project analysis/decisions by linking experiences, building training together, doing research together, building technology and practices together
  • We find it important to work with local partners and to make any of our trainings or materials locally relevant and to let each new scheme across the world learn from the experiences of the others
  • For example, we translate our materials into local languages
  • In the DR they helped local partners play these games with the Dominican pineapple farmers. We helped the local partners facilitate a farmer index design discussion.
  • In Indonesia we used the games to help initiate farmer contract design discussions
  • The interactive exercises that we have developed elsewhere were brought back to Ethiopia in 2013 to validate satellite rainfall data. These processes that we have helped develop are coming back to Ethiopia to help design the contracts as the project there scales.
  • And the ideas were then applied in Senegal
  • The projects we have been involved in that follow these strategies have been highly demanded, scaled dramatically, and show significant development and adaptation impacts, without premium subsidies. Index insurance needs to address a big obvious risk. Call it big obvious risk insurance! It is not there to take away every risk that a farmer might face – in that case perhaps a different risk management strategy is better.1 - Firstly, as we discussed earlier, successful schemes unlock productivity. Often a good way to do this is through a holistic approach – where the scheme has worked with farmers to find out what opportunities the threat of drought is denying them.2 –Schemes that work well often have a strong link with end clients or farmers. Imagine you are insuring your car – you want to have a clear idea what is covered, and what is not. Plus you want to be able to select a contract that best fits your price, your level of cover and your situation. It is no different in index insurance. Farmers who play a part in the design process are much more likely to understand and use index insurance.It is important focus on deciding what the insurance should and should not do, and making it clear what is not covered. We work closely with farmers, community leaders, and experts in each village to have the end clients formally design the complete adaptation strategy, building insurance products that compliment the other pieces of the package. The farmers have ownership of the insurance product, and have worked with us to validate it. If issues arise, farmers work with us to fix them.
  • 4 – Index insurance will always have basis risk – and meteorology can be notoriously complex. It is important that your contract has a solid scientific background so that you can quantify the basis risk, and reduce it as much as possible. 5 – If you understand your basis risk (e.g. when might the product fail to pay out), then you can start to discuss with farmers about their plans if there is a climate shock but no payout. This strengthens their risk management strategies and helps them to fully understand what they are being offered.6 – If you want your scheme to have a meaningful impact on poverty, it must last beyond the scope or your funding and expand past your pilot sites. Scaling and sustainability are two of the hardest challenges facing most index insurance schemes, but it is possible to achieve this7 – Simple is often betterThe index can be simple if it is very carefully thought out and based on advanced analysis. For many farmers, the most important problems are if the rainfall season starts badly, or if the rainfall season ends badly. If the rainfall starts badly, it can kill recently planted crops, or delay planting so that the farmer must plant less productive crops, have fewer cropping cycles, or simply delay planting to become vulnerable to problems at the end of the rainfall season. If the season ends badly, crops are often left without water in their most vulnerable growth phase (such as flowering).If the index is simple, it is more powerful.By targeting these simple things, it is easy for the farmer to know what is covered, what is not covered, and how to adjust her own practices to make the best choices. These simple things are also much easier to flag by observing rainfall, and more likely to impact a lot of farmers. It allows the farmer to play an active role in designing the index, and in verifying that the index is working correctly.An example indexAn example index uses a slightly modified rainfall total from the end of the season, paying out if the total is the worst out of 5. Often there is a window at the beginning of the season as well. The modifications of the total are used to make sure that a day or two of massive rainfall is not enough to indicate a good year if the rest of the window is dry.A great deal of sophisticated analysis is necessary to be able to arrive at indexes that are simple but effective.IRI has experience with tens of thousands of farmers successfully using these kinds indexes in projects such as HARITA/R4, (led by Oxfam America and driven by the Relief Society of Tigray) in Ethiopia.
  • Index insurance design & implementation - IRI’s perspective

    1. 1. Index insurance design & implementation IRI’s perspective Helen Greatrex Financial Instruments Sector Team
    2. 2. IT’S ABOUT THE GOOD YEARS Climate risk is at two levels : 1 – the direct impacts of a bad year e.g. drought/flood.. 2 – the threat of a bad year If you can increase productivity in normal years, you can cover bad year loss e.g. buy high quality seeds… But strategies that increase productivity face increased risk Threat of 1 drought year out of 5 prevents other 4 from being much more productive
    3. 3. Key to adaptation is to relax risk of bad year to unlock productivity options Insurance: reduce risk to allow people to take a productive chance IT’S ABOUT THE GOOD YEARS "The problem is that before the rainy season, you have to make a choice. If you make the wrong choice, you risk losing everything." Oumar Sakho, Senegalese farmer
    4. 4. INDEX INSURANCE Insurance: reduce risk to unlock productivity But problems with traditional insurance have made it tough to implement Recent index innovation Insure weather index eg: provide pay-out if there is drought or flood Cheap, “easy” to implement, good incentives Many limitations Still in early years
    5. 5. Insurance too expensive if it doesn't unlock opportunity or if it replaces a more effective tool Only one part of a risk management system Our challenge Design choices need to be made/understood by farmers, cooperatives, NGOs, insurance companies, satellite experts, banks, agronomists, climate scientists… Must solve sophisticated problems together, build into menu for flexible risk management package, understand level of reliability COMPLEX SYSTEM, MANY DECISION MAKERS
    6. 6. Enhance societies ability to understand and manage climate risk Financial Instruments Sector Team IRI worked since ‘early days’ of index insurance Solid science base, working with farmers, processes, capacity building and training, informing policy Projects: Ethiopia, Ghana, Honduras, Indonesia, Kenya, Malawi, Nicaragua, Nigeria, Philippines, Rwanda, Senegal, Mali, Tanzania, Uganda, Uruguay, Argentina… Purchased by tens of thousands of farmers Significant development impacts Highly demanded, quickly scaling, unsubsidized INTERNATIONAL RESEARCH INSTITUTE FOR CLIMATE AND SOCIETY
    10. 10. INDONESIA
    11. 11. ETHIOPIA
    12. 12. SENEGAL
    13. 13. Kilimo Salama (Kenya/Rwanda, Rainfall Estimate) • Technical support for satellites, • Satellite contracts for 30,000 farmers in a loan bundled satellite insurance R4 (Ethiopia/Senegal, Rainfall Estimate) • Holistic risk reduction, risk management project • Individual farm, Unsubsidized, unbundled, nonmanditory • First sold (Ethiopia) 2009 – 200 farmers • 2012: 77 villages, ~20,000 farms • Min possible, Ave, cash only ave premium ($3, $19, $9) EXAMPLES
    14. 14. CHARACTERISTICS OF A SUCCESSFUL SCHEME Addresses an obvious community level risk Unlocks productivity and development opportunities - Unlocks an opportunity that would otherwise be barred to the client - Holistic process: insurance is not stand-alone Farmer driven – farmers want to be part of the process - Farmers are involved in the design & ‘own’ the product - Contracts are transparent : farmers can see what is, and isn’t being covered - Good feedback channels
    15. 15. CHARACTERISTICS OF A SUCCESSFUL SCHEME Solid science base - You understand what you are insuring Understand level of reliability - Basis risk has been quantified - Discussions with farmers about non pay-out ‘bad years’ Sustainable & scalable Simple is often better - Allows farmers to adjust their own practices - Allows you to hone in on the best possible index - A great deal of sophisticated analysis is necessary to be able to arrive at indexes that are simple but effective…
    16. 16. QUESTIONS?