Climate insurance against crop loss is common in developed country agriculture where farmers insure against crop loss due to extreme climatic events such as flooding or drought. Typically payments are made on the basis of the crop loss from on-farm inspections. However the on-farm inspections can be expensive and potentially subjective. Table 1 gives a summary of different kinds of agricultural climate insurance schemes. Index based climate insurance uses models of how climate extremes affect crop production to determine certain climate triggers that if surpassed cause substantial crop loss and would support a compensation payment. This has the advantage of being totally objective and not requiring on-site inspection. The US Federal Crop Insurance Plan has offered this kind of insurance since the 1990s.
Table 1: Summary of Climate Insurance Products for Agriculture
| Insurance product | Basis | Applicability | Succesful examples |
| Named Risk Climate Insurance | Insurance against loss for specific event, for specific amount, loss verified in the field | Example: hail insurance that causes a specific catastrophic loss that can immediately be identified in the field | All continents, especially USA and Canada |
| Multiple Risk Climate Insurance | Insurance against yield loss below 50-70 per cent of expected yield due to any cause | High costs, and requires verification in the field of actual yields | All continents, especially USA and Canada |
| Area/Yield Index Insurance | Insured against yield loss below a certain per cent across a district. Yield changes verified independently on a sample of farms across the district | Suitable for losses from drought, lower costs as not verified on each farm, but assumes same average effect across all farms in a district | Brazil, India, USA |
| Climate Weighted Index Insurance | Insurance based on certain climatic conditions being met. If met certain loss of production assumed and compensated for | Allows large number of small holdings to be aggregated in a uniform area. Low cost as no verification, but high cost of development of models, and meteorological monitoring | India, Malawi, Mexico, Canada, USA |
| Normalised Difference Vegetation Index | Based on satellite monitoring of vegetation development | Mainly applicable to grazing lands | Mexico, Spain, Canada |
| Livestock Mortality Index | Based on independent estimates of livestock mortality rates | Managed communally or through NGOs | Mongolia |
| Flood Insurance | Traditionally based on individual verification of areas flooded and damage incurred. Exploring index based systems based on satellite monitoring of area and number of days flooded versus crop losses | Requires prior registration of areas under different land-uses by farmers. Risk levels vary considerably over small geographic distances. | Index based insurance under investigation in South East Asia |
Source: Derived from a presentation by P Valdivia 2010.
Description:
Crop losses in years of extreme climatic events can cause extreme hardship on farmers. It can force them into debt, leading them to sell their assets, even their land, and preventing them from being able to invest in the following year’s production. These events are considered to be a considerable cause of why resource poor farmers are unable to accumulate sufficient goods and capital to rise out of poverty. With climate change it is expected that extreme climatic events are likely to become more frequent and thus their impacts on the livelihoods of farmers. Almost all farmers have traditional coping mechanisms for surviving periods of drought, such as selling livestock and temporary migration to sell their labour. However, these mechanisms may not be able buffer the impacts of extreme events, or droughts lasting more than one season. Therefore it is critical to find financial mechanisms to support farmers in years of financial loss due to climatic events. Also if such losses become more frequent then farmers will be less willing to take out credit, and lenders may be less willing to lend (or increase the costs of lending) due to the higher risks involved. If farmers do not have access to credit then this severely limits their capacity to invest in improving productivity and profitability of the agricultural livelihood.
Advantages of the technology
The insurance costs are reduced as no in-situ verifications are made of actual losses. This makes it viable to provide coverage to a large number of small-scale producers for whom it would be unviable to provide standard insurance. The insurance is most easily administered as part of other financial services to farmers, principally credit, and the insurance can be against not being able to pay back the credit in event of losses due to extreme climatic events. This would reduce the risk of farmers losing their land or other assets due to climatic extremes.
Disadvantages of the technology
Index based insurance requires significant capacity for analysis of weather related risk to design the index, good historical weather records, and extensive network of weather stations for monitoring current climate. Another disadvantage is that as payments are connected to the climate surpassing a certain trigger, if crop losses occur without passing this trigger then no payment will be made. Or conversely, if the trigger is passed, payment will be received even if no losses have occurred. This is a cost of not having any in-situ inspection. However, it runs the risk of farmers’ expectations of compensation not being met, and doubting the value of the insurance.
Financial requirements and costs
Costs of Development
The development of indexed linked climate insurance as a commercial product has generally involved the collaboration between interested insurance companies (whether public or private) and facilitated by national or multi-lateral organisations such as the World Bank or regional development banks who have subsidised the costs of development of climate insurance products. Many NGOs have also developed interest in these products, such as Oxfam. It seems clear that a private insurance company on its own is unlikely to develop climate insurance products. Usually, climate insurance is developed through some kind of public-private partnership.
Even after a product has been developed, substantial investment needs to be made to explain the product to farmers or their representatives. One essential aspect is educating farmers to understand the product and not create false expectations about what it offers, but not reinforce the mistrust that many farmers have of these kinds of product.
Cost to Farmers
Normally farmers would pay for the insurance, either directly or more commonly as an additional financial service associated with a loan. In some cases the costs of insurance are subsidised by the government, where it is considered strategic for the country to support buffering the impacts of climate change. Some countries such as Mexico, Peru and Brazil subsidise the insurance premium. Other countries may participate in the re-insuring of the initial insurance, which also reduces the costs of the premium.
Institutional and organisational requirements
The design of index based climate insurance requires two basic information sets.
- Historical data of climate conditions and crop productivity to evaluate the production risk and trigger for substantial crop loss, and the associated economic risk and thus price required for the product
- Real-time weather data with a significant geographic coverage to evaluate whether the climatic trigger has been surpassed and payment should be made.
Barriers to implementation
One of the major barriers to implementation is the need to re-insure the climate insurance provided by insurance companies. This is necessary as an extreme weather event normally covers a substantial proportion of many countries and there may be limited economic capacity to meet all the claims resulting from the event. Nevertheless, achieving re-insurance requires a solid financial model to convince these companies to assume this risk at a reasonable price. Again public participation in these schemes, whether from national or multi-lateral bodies (who would often have to cover the costs of recovery from natural disasters anyway) can reduce the costs of re-insurance or make it more acceptable to the international insurance industry.
Opportunities for implementation
The World Bank has supported the design and piloting of climate insurance schemes in many countries across the world. So have other development agencies such as USAID, DFID and the regional development banks. Nevertheless, most of the initiatives have also required the support from national governments, and technical support financed by external agencies. Most farmers are not accustomed to insurance and in many cases do not have a good understanding of the nature of the product or the probabilities of it compensating for any loss. The success of such schemes offered directly to farmers hinges on considerable investments in raising farmers’ awareness about financial risk management. Fortunately considerable expertise has now been developed. One of the primary tools is using games to illustrate the different insurance packages and the scenarios under which they may compensate and those situations where they do not. There is reason to believe that such games substantially increase farmers’ understanding of the insurance and their willingness to participate (Patt et al, 2010).
References
- Patt, A., P. Suarez, and U. Hess (2010) How do small-holder farmers understand insurance, and how much do they want it? Evidence from Africa. Global Environmental Change 20: 153-161.
- Valdivia, R. O. (2002) The Economics of Terraces in the Peruvian Andes: AN application of sensitivity analysis in an integrated assessment model. Montana State University, Bozeman, Montana.