1. INDEX BASED INSURANCE (IBI)
EZEKIEL MACHARIA FIA
CONSULTING ACTUARY
THE ROLE OF INDEX BASED INSURANCE IN SUPPORTING GDP GROWTH IN KENYA
APRIL 2016
PRESENTED TO MONTHY ACTUARIAL SOCIETY OF KENYA TALK
NAIROBI, KENYA
1

2. AGENDA
What is Index Based Insurance
Regulation and IRA Progressive Support
Pricing a Index Based Contract
Support for WIBI
Conclusion 2

3. INDEX BASED INSURANCE (IBI)
3
 An IBI contract is a contract whose payment to the
policyholder is triggered based on one or more
rather than the individual’s actual loss.
 Payment is designed for compensation and not indemnity
(mitigation costs or losses)

4. INDEX BASED INSURANCE (IBI)
4
 Payment may be triggered before the actual loss is
incurred – can be used to meet cost of preparation or to
mitigating effects of risk.
 It is expected that the insured person has insurance risk –
adverse & material impact (damage, loss -economic &
consequential - and cost of mitigating risk)

5. INDEX BASED INSURANCE (IBI)
5
Agree on
an Index
Set points in
the index
that will
trigger a
claim
Index is
Triggered
Repeat

6. INDEX BASED INSURANCE CONTRACT
6
 A simple trigger can
be to pay a farmer
KES 1,000 per day if
the temperature in
any given month
exceeds 27oC.
 The index is the
observed daily
temperature
 The farmer has an
insurable risk.*Source: World Bank – Climate Dataset

7. INDEX BASED INSURANCE CONTRACT
7
 It doesn’t have to
be for farmers only
 Index Insurance
can pay when it
rains on a
policyholder’s
wedding day.
*Source: 500.px

8. INDEX BASED INSURANCE CONTRACT
8
 The trigger point
can be a
commodity price
 Derivatives
Anyone?
*Source: 500.px

9. BASIS RISK
9
 Basis risk occurs when the
client expects you to pay and
you don’t or you pay when
client is not expecting it.
 For example, using the Rainfall
in Nairobi as a measure when
two clients – one in Langata
and another in Donholm have
different rainfall measures.
NO RAIN RAIN
SAME AREA

10. AGENDA
What is Index Based Insurance
Regulation and IRA Draft Guidelines
Pricing a Index Based Contract
Support for WIBI
Conclusion 10

11. IRA DRAFT GUIDELINES
11
1. Minimise Basis Risk
2. Minimise adverse selection against insurer
3. Contract is fair and adds value
4. Reasonable maximum sum assured that is in line with the losses/costs after
risk
5. Appropriate exclusions
6. Purpose to cover high-impact low-likelihood events instead of low-impact
high-likelihood events.
Criteria for an IBI contract

12. IRA DRAFT GUIDELINES
12
1. Transparent & Objective
2. Data is produced/verifiable by an independent third party
3. Easily accessible data
4. Data is sufficient & adequate to assess risk
5. The trigger and amount payable can be determined in a timely
manner
Key Features

13. IRA DRAFT GUIDELINES
13
1. Payment of a fixed sum based on a stated
index/indices
2. Protect insurer with a maximum sum assured
3. Contract can be purchased by those who have
insurable interest
4. Cash & Carry
Requirements

14. IRA DRAFT GUIDELINES
14
1. No Cancellations
2. Fall back Index in case the main index is unavailable
3. Dispute resolution mechanism
4. No assessment of risk or premium payment grace period
5. Policyholder to provide that that they had insurable interest on
cover start date
Requirements (2)

15. AGENDA
What is Index Based Insurance
Regulation and IRA Draft Guidelines
Pricing a Index Based Contract
Support for WIBI
Conclusion 15

16. DATA
16
1. Source of data used in each index
a) Index used to trigger payment
b) Index used to determine payment
2. Fall back index and its data source
3. Data is appropriate, sufficient & adequate to assess risk
4. If time series – appropriate historical data
5. Data is independently verifiable
6. Data is easily accessible
As actuaries – data is key

17. DERIVATIVES ANYONE?
17
 From the perspective of the person
issuing a derivative (underwriter)
 You give the client the option to buy an
asset at a fixed price in the future.
 Asset is in the money
 Client has to take the option but the
clearance house will ask you to put up
some money immediately the contract is
in the money– margin call.
Call Option
 From the perspective of the
insurer (underwriter)
 Based on a price of a
commodity (the index)
 On trigger, pay a certain
amount
 Automatic Payments based on
contract
Commodity IBI

18. HOW TO PRICE AN IBI CONTRACT
18
1. Future level of index is unknown
2. Pricing model will depend on the index and models used include:-
 Binomial model
 Stochastic models (Brownian Motion – a stochastic process)
 Replicate the pay-off (Black Scholes Model - replicates the volatile Stocks price)
3. Reinsurer and pass the headache
How do you price for a derivative?

19. What is Index Based Insurance
Regulation and IRA Draft Guidelines
Pricing a Index Based Contract
Support for WIBI
Conclusion
AGENDA
19

20. KENYA
20
Why Agriculture?
 Accounts for 25% direct contribution to GDP of Kenya
 27% indirect contribution - resulting in over 50% of contribution to GDP
 Small scale (75% below 3 hectares) and rain fed
Catastrophes in Agriculture
 2011 Drought worst in history – killed 30% of livestock in Kenya
 Annual burden on extreme climate events in Kenya is KES 50b (2% of GDP)

21. KENYA
21
Private Sector
 APA: Global Index Insurance Facility
 Swiss Re, APA, ILRI – Livestock drought at 3% - 5% of cattle cost.
 AIG Index Based Weather Insurance
 CIC Index Based Weather Insurance
 UAP: Kilimo Salama
 Jubilee – Crop Insurance (Sorghum)
 Freshco Seeds: Discount on Seeds bought after extreme weather
 Ngao ya Mkulima - APA & Micro-ensure

22. UGANDA : SUBSIDIES FOR MARKET
22
 Expectations of subsidy as per IRAU: Increase
investments in agriculture sector and boost
agriculture productivity due increased access
to credit.
 Risks covered: Excessive rain, fire, flood,
drought, epidemics, crop pests and diseases.
 After a BUNDALANGI government pays regular
annual premium instead of 100%.
 Subsidy based on acreage owned, annual
income, kukus owned, pigs, fish farm and
cattle
 Everybody gets at least 30% subsidy
Kungula Agrinsurance
 Start Date: 1 July 2016
 Farmers in Uganda get UGX 5b (KES
160m) subsidy – to be allocated in the
next financial year (2016/17).
 Participating insurers:
 NIC, FICO
 Lion Assurance, APA, UAP, NIKO

23. What is Index Based Insurance
Regulation and IRA Draft Guidelines
Pricing a Index Based Contract
Support for WIBI
Conclusion
AGENDA
23

24. CONCLUSION
24
Next Steps
 Index based insurance contract has an automatic payment after
an agreed trigger based on an index.
 IRA is already ahead of the market and developed Draft
Guidelines
 Pricing a IBI and pricing a derivative is similar
 There is a lot of capital from private and public sector to support
IBI and in particular Weather IBI – Climate Risk

25. 25
?
QUESTIONS
Ezekiel Macharia FIA, FeASK
Consulting Actuary
ezekiel@kenbright.co.ke