Thank you for Subscribing to Agri Business Review Weekly Brief
"Agricultural index insurance provides a method to manage risk and promote sustainable development."
Agricultural index insurance promotes sustainable development and resilience by facilitating risk management. Farmers and pastoralists can benefit from index insurance by increasing their resilience to weather shocks such as droughts or floods, thereby creating a pathway to prosperity in good years. The implementation of agricultural index insurance has been complicated, however. Creating agricultural index insurance interventions requires collaboration between the public and private sectors. Individual farmers have also had difficulty adopting these contracts due to expensive, poor-quality contracts and inadequate consumer education. Since the earliest interventions occurred in the 1970s, our understanding of agricultural index insurance and its potential for sustainable development has grown substantially. The G7 InsuResilience initiative, which seeks to extend insurance coverage to 400 million more households worldwide by 2020, is among many resilience-based initiatives that will use agricultural index insurance as a primary risk management tool. Farmers with uninsured risks also affect local and regional economies that depend on agriculture. Agricultural index insurance contracts and interventions are at the forefront of research at the MRR Innovation Lab's Index Insurance Innovation Initiative (I4). The article provides an overview of agricultural index insurance, including an explanation of how it works and it's potential to manage risk and promote sustainable development. The Workings Of Index Insurance For Agriculture Agri-index insurance predicts individual losses based on an easy-to-measure index of factors, such as rainfall or average yields. The low cost of verifying claims for small farms makes index insurance an attractive risk-management tool in developing countries. Agricultural index insurance overcomes adverse selection and moral hazard, two critical problems associated with conventional insurance. A farmer more likely to suffer losses is the only one who buys insurance, an example of adverse selection in agriculture. A moral hazard occurs when farmers sacrifice effort or yields to receive an insurance payment. Since the index is based on factors that any individual cannot influence, index insurance overcomes both adverse selection and moral hazard. Indicators (plural for "index") include average area yields, vegetation growth (NDVI), and rainfall. The accuracy and cost of each of these indices can vary concerning predicting an individual farmer's crop or livestock losses. The cost of measuring area yield indices depends on how much area is measured, but it is possible to measure NDVI and rainfall remotely, thus increasing accuracy without increasing expenditures. Index insurance has a drawback, namely basis risk, which refers to the difference between an index's estimate of an individual farmer's losses and their reality. The risk of not receiving an insurance payout exists with index insurance for individual farmers, and a farmer who had a year without losses may also receive a payout. An index insurance contract is a failure in either case. A trade-off for avoiding the need to verify individual losses is basis risk. The cost of index insurance will always be subject to basis risk since an index of average conditions in an area will not necessarily reflect conditions on individual plots. Moving forward, researchers must develop more accurate indices that predict individual losses more accurately and build better contracts with failsafe to protect farmers who do not receive payments. Economic Development Through Agricultural Index Insurance Agri-index insurance supports agriculture in developing countries by providing a safety net in the event of disasters and by encouraging greater investment in productivity. Agricultural index insurance can have a disproportionately larger impact than other development interventions by providing both a safety net in bad years and an income boost in good ones. Agri-index insurance differs from other development interventions because it mitigates risks that act as barriers to productivity investments. Farmers and pastoralists insure themselves against weather and other risks. Hybrid seeds, for example, can triple yields but must be purchased yearly, and some farmers prefer traditional varieties of seeds saved from previous seasons. An effective way to limit losses in a catastrophe is to limit investments. Self-insurance strategies can cost households already struggling a lot of money, and the opportunity to safeguard a primary source of food may be lost. Agronomists who study the impacts of agricultural index insurance call increased investments in productivity "ex-ante" effects. Ex-ante effects result from a farmer or pastoralist's decisions based on insurance coverage. A growing body of literature shows that quality agricultural index insurance interventions have significant ex-ante impacts. The presence of insurance increased productivity among cotton farmers in Mali and Burkina Faso, according to a recent study. For instance, Mali saw the greatest effect, with an estimated annual cost of insurance of US $48, resulting in additional cotton cultivation worth $300 at harvest, leading to a cost/benefit ratio of 6.25. Prospects for agricultural index insurance Farmers with uninsured risks also affect local and regional economies that depend on agriculture. Small-scale farmers could benefit from practical risk-management tools, which promote economic and agricultural growth. With advances in remote sensing and satellite technology, opportunities for more accurate agricultural index insurance indices have grown substantially in recent years. Agricultural index insurance markets will continue to reduce basis risk as indices become more accurate. The high insurance cost may significantly impact uptake since farmers don't purchase insurance because of the cost.
