Opinion: 5 ways to invest in building agricultural insurance markets

An accumulation of evidence in recent years has shown that index insurance can be a key tool for the future of food security and resilience. This development has governments and donors rushing to invest in subsidies to help speed uptake, but what kinds of investments should be priorities? Index insurance for agriculture has shown remarkable potential for smallholder farmers at risk of climate-related disasters across the developing world. While conventional insurance requires losses to be verified, index insurance avoids these high costs by basing payouts on an averaged index of factors, such as vegetation growth or rainfall, that can be measured remotely. Index insurance has made it possible to evaluate how agricultural insurance can work as a tool for development. Research has shown that insured pastoralists in northern Kenya were much less likely — up to 70 percent less likely — to use harmful coping strategies that can prolong and deepen poverty in the long term. Insured cotton farmers in West Africa increased the area of cotton cultivation by 55 percent and used more productive inputs by 50 percent. This is how insurance works. It protects farmers in the event of a disaster and frees them up to invest prudently and securely in higher productivity, both of which improve their chances of putting poverty behind them. However, with few exceptions demand and uptake remain low. Index insurance pilots are rarely scaled. The demonstrated potential for index insurance has governments and donors eager to develop markets for agricultural index insurance. Last week I took part in a global action network event to discuss how to achieve greater scale and impact with agricultural insurance, and a key recurring theme was the role of governments in enabling index insurance interventions to go to scale. Right now, governments do this almost entirely with subsidies to cover premiums to make both conventional and index-based agricultural insurance affordable for smallholder farmers. In some cases, as is true of the Kenya Livestock Insurance Program, the subsidies cover the entire cost of the insurance. There are a number of potential problems with subsidies. They could distort the regular market for agricultural insurance, index-based or otherwise. There is also now compelling evidence that short-term subsidies do not stimulate market demand. There may still be a place for subsidies to cover the cost of insurance premiums. There has been compelling evidence that short-term subsidies paired with other technologies have had sustained impacts. However, it is time to consider alternative approaches for governments and donors interested in investing in the development of an agricultural index insurance market. 1. Subsidize data collection Building a high-quality index for an index insurance contract starts with high-quality data. Subsidizing the collection of detailed, real-time data on crop yields, livestock mortality, and other information needed to build a high-value index for insurance can reduce costs for insurers and likely reduce the price of the policies they offer to farmers. Area yield-based index insurance is often considered the most accurate, but it is also the most expensive because of the data requirements. This kind of index insurance contract is based on average yields in an area measured every season. If public money supported the data collection, it could reduce the costs that get passed down to the farmer and the data could then become a public good for other purposes. 2. Invest in consumer education For the private sector, trying to establish or enter an agricultural insurance market is risky. In particular, the significant upfront costs of market development and consumer education put each individual company at risk that other companies will jump in and reap the benefits. By investing in consumer education prior to the start of any insurance interventions, public subsidies can overcome this barrier to entry in the market. It would also ensure that farmers are educated by an impartial third party about both the potential benefits and inherent limitations of index-based agricultural insurance. 3. Invest in ICT development In many contexts, much of the overhead related to the implementation of index insurance contracts is related to the high costs of education, sales, and payout distribution. Investing in a well-developed digital infrastructure can help reduce these costs, which are traditionally passed on to the clients in the form of higher premiums. Reducing the administrative burden of the contracts can make insurance more accessible and affordable for smallholder agriculturalists. 4. Purchase coverage for the catastrophic risk layer In many ways, the public sector already subsidizes catastrophic events through disaster responses, so fully subsidizing coverage for total losses is not a significant shift. However, linking that disaster response to index-based insurance has many additional benefits that only come through insurance. First, catastrophic insurance guarantees a minimum market size for insurance companies. It also gives greater certainty for the small-scale agriculturalists that assistance would come in case of disaster, allowing for confidence to invest in higher productivity. It creates an infrastructure so payments can be made much more quickly than most emergency assistance. 5. Create an index-based insurance quality certification process Like a seed certification process, effective regulations would ensure quality standards for index-based insurance. That means investments that finance the creation of a well-trained cadre of individuals charged with ensuring that each index-based contract meets safe minimum standards for quality. Quality standards could ensure that contracts on the market will at a minimum not leave people worse off for having bought insurance. In addition, it can give additional confidence to consumers who are uncertain about the product and unable to verify its value on their own until after an insurable event occurs. No tool or solution is appropriate for every development context, but agricultural index insurance has yielded compelling evidence of its role in moving and keeping vulnerable households out of poverty. Given growing interest from the public sector, it is essential to carefully consider how investments can best be used to accelerate the development of an effective agricultural index insurance market. Join the Devex community and access more in-depth analysis, breaking news and business advice — and a host of other services — on international development, humanitarian aid and global health.