FINANCE & MARKETS GLOBAL PRACTICE | GLOBAL INDEX INSURANCE FACILITY
When And How Should Agricultural
Insurance Be Subsidized?
Issues And Good Practices
Global Index
Insurance Facility
MANAGED BY
Rights and Permissions
This work is available under the Creative Commons CC BY-NC-ND 3.0 IGO license. Copyright 2017 International Labour
Organization (“ILO”) and International Finance Corporation (“IFC”). All rights reserved. This is a joint publication of ILO and
IFC.
The material in this work is copyrighted. Copying and/or transmitting portions or all of this work without permission
may be a violation of applicable law. IFC does not guarantee the accuracy, reliability or completeness of the content
included in this work, or for the conclusions or judgments described herein, and accepts no responsibility or liability for
any omissions or errors (including, without limitation, typographical errors and technical errors) in the content
whatsoever or for reliance thereon.
The contents of this work are intended for general informational purposes only and are not intended to constitute legal,
securities, or investment advice, an opinion regarding the appropriateness of any investment, or a solicitation of any type.
IFC or its affiliates may have an investment in, provide other advice or services to, or otherwise have a financial interest in,
certain of the companies and parties (including named herein).
All other queries on rights and licenses, including subsidiary rights, should be addressed to IFC’s Corporate
Relations Department, 2121 Pennsylvania Avenue, N.W., Washington, D.C. 20433 and ILO Publications (Rights and
Permissions), International Labour Office, CH-1211 Geneva 22, Switzerland or by email: pubdroit@ilo.org.
International Finance Corporation is an international organization established by Articles of Agreement among its
member countries, and a member of the World Bank Group.
All names, logos and trademarks in this publication are the property of either the IFC or the World Bank Group, or
property of the International Labor Organization. Unless expressly stated otherwise, and you may not use any of such
materials for any purpose without express written consent from the trademark owner. Additionally, “International
Finance Corporation” and “IFC” are registered trademarks of IFC and are protected under international law.
Publications of the International Labour Office enjoy copyright under Protocol 2 of the Universal Copyright
Convention. Nevertheless, short excerpts from them may be reproduced without authorization, on condition that the
source is indicated.
Photo Credits: World Bank Photo Library and Shutterstock
WHEN AND HOW SHOULD AGRICULTURAL INSURANCE BE SUBSIDIZED? ISSUES AND GOOD PRACTICES
Peter Hazell | Independent Researcher
Rachel Sberro-Kessler & Panos Varangis | Finance & Markets Global Practice |
World Bank Group
Table of Contents
Acknowledgements..................................................................................................III
Executive Summary................................................................................................. V
1. Introduction............................................................................................................ 1
2. Existing Types of Levels of Subsidies for Agricultural Insurance...................3
3. Reasons for Subsidizing Agricultural Insurance..............................................7
Subsidies to Correct Failures and Externalities in Insurance Markets..............7
Subsidies to Achieve Broader Social and Political Goals...................................... 9
4. Challenges in Subsidizing Agricultural Insurance.......................................... 11
5. Does Subsidizing Agricultural Insurance Pay?...............................................15
6. Principles And Good Practices in the Design of Subsidies for Agricultural
Insurance..................................................................................................................21
Guidelines for Subsidizing Insurance for Commercial Farmers........................22
Guidelines for Subsidizing Agricultural Insurance for Poor Farmers...............24
Guidelines for Subsidizing Insurance to Improve or Replace Disaster
Assistance.................................................................................................................... 27
7. Conclusions......................................................................................................... 35
References............................................................................................................... 39
Annex: The Choice Between Subsidizing an Insurer’s Costs Versus Providing
Subsidized Reinsurance........................................................................................ 43
LIST OF BOXES
Box 1: Ex Ante Cost-Benefit Evaluation of an Insurance Program in
Bangladesh...............................................................................................................16
Box 2: The R4 Risk Resilience Initiative in Ethiopia.......................................... 26
Box 3: Early Recovery Vouchers (ERVOs)............................................................ 28
Box 4: Seguro Agricola Catastrófico (SAC) in Peru........................................... 30
Box 5: The CADENA Program in Mexico.............................................................. 33
TABLE OF CONTENTS
I
Box 6: Pros and Cons of Premiums Subsidies and Public Reinsurance
of Extreme Risk Layers.......................................................................................... 44
Box 7: Some Examples of Public Reinsurance Arrangements Verses Direct
Subsidies for Risk Loading Costs......................................................................... 45
LIST OF FIGURES
Figure 1: Illustrative Comparison of Disaster Relief and 50 Percent
Subsidized AYII Across Years With Different Levels of Shocks........................ 17
Figure 2: Overlap Between Agricultural Insurance and Disaster Assistance....22
Figure 3: Government of Mongolia is “Double Exposed” to Extreme Risks........46
Figure 4: Agricultural Insurance Program in Kenya...........................................47
LIST OF TABLES
Table 1: Producer Claim Ratios for Seven Countries............................................5
Table 2: Cost to Government of Transferring Income to Farmers Through
Subsidized Crop Insurance Programs in Four Countries ...................................18
WHEN AND HOW SHOULD AGRICULTURAL INSURANCE BE SUBSIDIZED? ISSUES AND GOOD PRACTICES
II
Acknowledgements
The authors are grateful to Joe Glauber, Ruth Hill, and Oliver Mahul for
reviewing this paper. The authors also thank Carlos Arce, Ulrich Hess, Michal
Matul, Roy Parizat, and Pranav Prashad for helpful comments on earlier
drafts. Appreciation is also extended to Pavis Devahasadin and Joost Tijdink
for coordinating the production process and Aichin Lim Jones for design and
layout support.
Global Index Insurance Facility
The Global Index Insurance Facility (GIIF) is a multidonor program that
supports the development and growth of local markets for indexed/catastrophic
insurance in developing countries, primarily in Sub-Saharan Africa, Latin
America and the Caribbean, and Asia Pacific. Funded by the European Union,
Japan, and the Netherlands, the Global Index Insurance Facility is managed by
the World Bank Group, as part of the Finance & Markets Global Practice.
Impact Insurance Facility
Housed at the International Labour Organization, the Impact Insurance Facility
enables the insurance industry, governments, and their partners to realize the
potential of insurance for social and economic development. The Facility
was launched in 2008 with generous support from the Bill & Melinda Gates
Foundation, and has received subsequent funding from several donors.
ACKNOWLEDGEMENTS
III
WHEN AND HOW SHOULD AGRICULTURAL INSURANCE BE SUBSIDIZED? ISSUES AND GOOD PRACTICES
IV
Executive Summary
Agricultural insurance is subsidized in many countries, at a global cost to
governments of well over $20 billion each year. There are many reasons behind
these subsidies, some having to do with market failures and externalities that
constrain the development of privately provided and unsubsidized insurance,
and some having more overt political and social objectives such as helping
specific segments of poorer farmers access insurance, protecting agricultural
lending institutions, reducing the need for disaster assistance payments, or
simply as a politically acceptable means of supporting farm incomes. Very little
is really known about the effectiveness of insurance subsidies in achieving their
intended purposes, or whether the impacts they generate justify their costs, and
there is a real need for more evaluations and impact assessments of subsidized
agricultural insurance programs. Much more is known about the challenges that
can all too easily undermine the benefits from agricultural insurance subsidies.
These include well known challenges with the design and operation of
agricultural insurance programs themselves, poorly designed subsidies added to
those programs, plus political dynamics that make it hard to terminate or contain
the amount of the subsidy. Poorly designed subsidies can also inadvertently
create disincentive problems that lead to significant economic costs and
inefficiencies, and in some circumstances, to environmental degradation. To
avoid these problems, any insurance subsidy needs to be carefully designed
to be “smart”, in the sense that it is cost effective in achieving its underlying
purpose, minimizes disincentive problems, and does not become a growing
financial burden on the government. This paper discusses these issues in detail
and draws upon available literature and case study experiences to propose
some good practice guidelines for the design and implementation of subsidized
agricultural insurance.
EXECUTIVE SUMMARY
V
WHEN AND HOW SHOULD AGRICULTURAL INSURANCE BE SUBSIDIZED? ISSUES AND GOOD PRACTICES
VI
1. Introduction
Agricultural insurance, defined here to include crop and livestock insurance,
is an instrument of choice in many countries for helping farmers and rural
communities cope with risk. Some insurance is private, sold by insurance
companies to farmers on a purely commercial, non-subsidized basis, but, as will
be seen, most agricultural insurance is provided on a subsidized basis as part
of government efforts to further development, social or political goals. Many
billions of dollars are spent each year on premium subsidies and other forms
of financial support for agricultural insurance. A World Bank study estimated
that in 2007, the total global cost to governments was about $20 billion (Mahul
and Stutley, 2010). However, that figure seems low today given that just three
countries - China, India and the US, are together spending about $17.7 billion
each year. To put this in perspective, total OECD bilateral and multilateral
support for agriculture in the developing world was about $11 billion in 20141.
This paper explores the reasons why governments and donors subsidize
agricultural insurance, and asks a) is this a worthwhile way to spend public
money, and b) if insurance must be subsidized are there smarter ways of doing
it that can achieve the same objectives, but at lower cost, and which avoid
some of the economic and institutional pitfalls that have plagued subsidized
agricultural insurance in the past.
The paper is structured as follows. The next section reviews existing types
and levels of subsidies for agricultural insurance, both globally and for the
developing world. Section 3 reviews the various arguments that have been
offered for subsidizing agricultural insurance, while section 4 discusses some
of the key challenges that have arisen when insurance subsidies are poorly
designed. Section 5 seeks to balance the benefits and costs of subsidized
agricultural insurance, and asks whether this has proven to be a worthwhile
way of spending public funds. Given that many governments and donors
seem likely to continue to subsidize agricultural insurance, section 6 presents
a set of guiding principles and best practices to be used in their design and
implementation. Finally, section 7 concludes.
1
Calculated from OECD DAC data: http://www.oecd.org/dac/stats/documentupload/1%20World%20
-%20Development%20Aid%20at%20a%20Glance%202016.pdf
1. INTRODUCTION
1
WHEN AND HOW SHOULD AGRICULTURAL INSURANCE BE SUBSIDIZED? ISSUES AND GOOD PRACTICES
2
2. Existing Types and Levels
of Subsidies for Agricultural
Insurance
The extent of agricultural insurance around the world was assessed in 2008 by
researchers at the World Bank. They estimated that 104 countries had some
form of agricultural insurance in 2007, and that the total premium collected
that year, including premium subsidies, was an impressive $20 billion (Mahul
and Stutley, 2010). More detailed insights were obtained for 65 countries that
completed a questionnaire. The total premium collected in these countries in
2008 was $15.1 billion. Of this amount, 86% was collected in high-income
countries and only 0.03% was collected in low income countries, showing that
agricultural insurance is largely the preserve of the rich.
Globally, about 90% of the total premium collected was for crop insurance and
10% was for livestock insurance. Multiple Peril Crop Insurance (MPCI) was
available in two thirds of the countries, but was most popular in the middle-
income countries. Named peril insurance was available in 69% of the countries,
including half of the low-income countries. Area-yield insurance was available
in 15% of the countries, and weather index insurance was available in 22% of
the countries, but mostly on a pilot basis.
There has been significant expansion of agricultural insurance since 2008,
especially of index based schemes in the US, India and China. Based on a
recent review of documented index-based agricultural insurance programs in
the developing world, Hess and Hazell (2016) estimate that about 198 million
farmers were insured in 2014, divided into approximately 650,000 in Africa,
3.3 million in Latin America and the Caribbean, and about 194.2 million in
Asia - of which 160 million were in China and 33.2 million in India. Given that
there are about 550 million farms in the developing world (Lowder et al., 2014),
it would seem that about one third of them now have some kind of agricultural
index insurance. Clearly IBI has achieved scale.
Yet despite these impressive numbers, market penetration remains small, even
in rich countries. In 2008, the total insurance premium collected (including
subsidies) in the World Bank survey amounted to 0.9% of agricultural GDP,
ranging from virtually zero in low-income countries to 2.3% in high-income
countries (Mahul and Stutley 2010). One reason for this low coverage is that
only a small part of the crop area and livestock population is insured. Another
2. EXISTING TYPES AND LEVELS OF SUBSIDIES FOR AGRICULTURAL INSURANCE
3
reason is that most programs only insure farmers Of all the IBI-like programs Hess, Hazell and Kuhn
against losses for specific crops or livestock, or pay (2016) reviewed, the only programs with low or
to replace purchased inputs or repay credit when no subsidies were for insurance coverage provided
insured losses occur. As such, the insured coverage within contract farming arrangements, which also
typically represents just a small fraction of a included access to modern inputs, markets and
farmer’s total exposure to farm income and asset credit. Most other forms of IBI were subsidized:
risks. the average subsidy was 37% for input supplier
schemes, 40% for farmer group schemes, 63% for
The majority of agricultural insurance programs
credit-linked schemes, 67% for direct insurance,
are subsidized. Mahul and Stutley (2010) found
and 80% for safety net insurance schemes.
that of the 65 countries that completed their
questionnaire, one third had an unsubsidized crop The producer claims ratio (PCR), calculated as
or livestock insurance program. However, the I/P, where I is total claim payments and P is total
unsubsidized programs are at a much smaller scale, premium collected from farmers net of any subsidy,
and of the total premium collected from farmers in is a direct measure of how much the farmer gets
all 65 countries, only 15% was not matched by a back in claim payments on average for each dollar
premium subsidy (Mahul and Stutley, 2010, Tables of premium he/she pays. Hazell (1992) reported
3.23 and 3.24). The premium subsidies added PCRs for 7 country programs in the 1980s, ranging
up to $6.6 billion, or 44% of the total premium from 0.99 in Japan to 5.11 in India. This meant that
collected. In addition, governments spent at least in India, for example, farmers on average received
another $1.5 billion subsidizing administrative and payments worth $5.11 for every dollar of premium
operational costs, and another $2.2 billion in the they paid. Remarkably, the insurance still had to
form of direct payments to insurers to help settle be made compulsory for farmers who borrowed
claims. When these additional costs are added in, credit. In their update, Mahul and Stutley (2010)
the average subsidy equivalent increases from 44% found that PCRs were lower during 2003-07, as, for
to 68%. The cost of insurance to governments has example, in the comparative numbers reported in
since increased, largely because they have been Table 1. Yet still most farmers are getting back far
scaled up. For example, each year the Chinese more than they pay on average (e.g., Indian farmers
government now spends about $6 billion annually2 are getting back $3.36 for every dollar of premium
on its insurance programs, the Indian government they pay) and still many farmers are choosing not to
spends $ 2.75 billion3, and the US government is purchase insurance.
programmed to spend $9 billion annually over the
next 10 years4.
2
2014, source: CIRC, Chinese Regulatory Authority.
3
Proposed budget for the new PMFBY scheme, comprehensive agricultural insurance especially for farmers with loans. http://
pmjandhanyojana.co.in/pradhan-mantri-fasal-bima-crop-insurance-scheme/.
4
Joe Glaubner, personal communication.
WHEN AND HOW SHOULD AGRICULTURAL INSURANCE BE SUBSIDIZED? ISSUES AND GOOD PRACTICES
4
Table 1: Producer Claim Ratios for Seven Countries
Country Producer Loss Ratio
Brazil 1975-81 4.29 2004-07 1.19
Costa Rica 1970-89 2.26 2003-07 1.75
India 1985-89 5.11 2003-07 3.36
Japan 1985-89 0.99 2003-05 1.84
Mexico 1980-89 3.18 2003-07 0.72
Philippines 1981-89 3.94 2003-07 1.42
US 1980-89 1.87 2003-07 1.70
Canada 2003-07 2.20
Iran 2003-07 4.05
Italy 2003-06 1.47
Russia 2003-06 1.23
Spain 2003-07 2.44
Note: Calculated as total claim payments divided by total premium paid by farmers.
Source: Hazell (1992) and author’s calculations based on data in Mahul and Stutley (2010).
2. EXISTING TYPES AND LEVELS OF SUBSIDIES FOR AGRICULTURAL INSURANCE
5
WHEN AND HOW SHOULD AGRICULTURAL INSURANCE BE SUBSIDIZED? ISSUES AND GOOD PRACTICES
6
3. Reasons for Subsidizing
Agricultural Insurance
There are many reasons why governments and donors subsidize agricultural
insurance. Some are based on narrow economic arguments like market failures,
externalities and establishment problems that constrain the development of
private sector insurance and insurance markets, or which systematically exclude
certain segments of farmers from insurance, such as poor or women farmers,
or farmers in high risk regions. Many governments also subsidize agricultural
insurance as a way of achieving other social and political goals in addition
to risk management, where insurance subsidies are seen as a more politically
acceptable or cost efficient way of achieving those goals than other available
policies. Despite their varying purposes, insurance subsidies all seek to reduce
risk exposure for farmers, whether against catastrophic natural disasters or
more normal agricultural production risks. Most often, subsidies also help scale
up the demand for agricultural insurance.
Subsidies to Correct Failures and Externalities in
Insurance Markets.
Several economic arguments have been made in the literature for subsidizing
agricultural insurance programs to correct market failures and externalities
(Hill et al., 2014; Clarke, 2011). These include:
• Public spending in the form of subsidies or direct service provision for
building and maintaining weather station infrastructure and data systems,
supporting agro-meteorological research leading to product design, and
educating farmers about the value of insurance. These services are needed
to enable insurance markets to work. Private insurers are willing to make
some of these investments themselves, but there is an inherent problem in
that they may not be able to recoup their investment costs given the ease
with which competitors can use the same knowledge and services once
established. This is a classic ‘public goods’ problem that inevitably leads
to insufficient investment, and hence a need for complementary public
spending. There may also be spillover benefits for other types of financial
and service sectors, including public relief or disaster assistance programs,
which help justify such public spending;
3. REASONS FOR SUBSIDIZING AGRICULTURAL INSURANCE
7
• Temporary subsidies might be warranted for uncertain about how climate change will impact
some types of farmers if there are positive on the risks they are insuring. Another view is
externalities. A good example is when the that since many small farmers are the victims
insurance enables poor farm households to of climate change, they should be entitled to
access credit and game changing technologies a temporary premium subsidy that helps them
that can lift them out of poverty. In this case adopt new climate smart technologies that have
the underlying problem is often an inability of risk characteristics that are initially not well
many poor farmers to bear the initial risk of known5.
adopting such innovations without subsidized
• Siamwalla and Valdes (1986) have argued
insurance, and/or an inability to access credit
that a subsidy might be warranted in some
without insurance because they are perceived to
circumstances when region-wide agricultural
be high-risk borrowers by financial institutions.
losses impact on the nonfarm population by
• Temporary subsidies might be justified when reducing farmers’ demand for the services and
farmers or insurers are initially uncertain about outputs of small businesses in the rural nonfarm
a new type of insurance product because they economy. In this case, the insurance subsidy
have insufficient knowledge to assess its real might help by buffering reductions in farmers’
risks and benefits. For example, a premium spending, though it ought first to be established
subsidy might encourage farmers to purchase that insuring farmers was more effective than
and experiment with a new insurance product offering insurance products to the community
about which they have no prior experience, at large.
much as seed companies sometimes give out
• A less credible argument is that insurance
free trial seed packets. Another example is
subsidies may be justified if they lead to positive
when an insurer initially charges a high-risk
benefits for consumers. For example, if the
loading for a new line of insurance because
introduction of an insurance subsidy leads to
it has inadequate data to properly assess the
greater production of food staples which lowers
actuarial risks, and the risk loading is expected
food prices and benefits consumers, then a
to fall once the insurer has acquired additional
subsidy would essentially transfer some of the
data over time. In this case the government
consumer benefit back to producers. The need
might want to subsidize part of the risk loading
for such a subsidy is perceived to be greater
cost, or offer subsidized reinsurance, during an
the more inelastic the demand for food staples,
initial learning phase;
since consumers then capture a larger share
• Related to the previous point, temporary of the total benefits from an increased food
subsidies might also be warranted as part of supply. Siamwalla and Valdes (1986) refute this
a strategy to assist farmers adapt to climate argument by showing that if the subsidy lowers
change. This might take the form of subsidizing the cost of the insurance to producers and shifts
some of the high-risk loadings that insurers the supply function for food staples outwards
build into premium rates when they are compared to unsubsidized insurance, the net
5
Some have argued, based on the principle of ‘polluter pays’, that there is a case for the industrialized countries (through green climate
funds, for example), subsidizing the increase in the pure risk component of insurance premiums as a result of climate change in developing
countries.
WHEN AND HOW SHOULD AGRICULTURAL INSURANCE BE SUBSIDIZED? ISSUES AND GOOD PRACTICES
8
social gain from that shift will always be less people with subsidized insurance against
than the cost of the subsidy. The effect is similar catastrophic losses, like droughts;
to a subsidy on any other farm input (such as
• Insure disaster assistance programs (DAPs)
fertilizer or credit). The reduction in unit cost
so that they have assured and quick access to
is partly paid for by the subsidy, and the cost
funds when disaster payments need to be made,
of the subsidy is always greater than sum of the
whilst also annualizing the cost of DAPs in the
additional producer and consumer welfare that
form of an insurance premium rather than lump
it generates (Siamwalla and Valdes 1986). Only
sum payments when disasters occur;
if there are externality benefits beyond the gain
to consumers could there conceivably be a net • Protect banks and agricultural credit programs
social gain from a subsidy. from bad debt, especially against systemic
losses that lead many farmers to default on their
Subsidies to Achieve Broader Social loans at the same time. It is often hoped that
and Political Goals this will also encourage banks to extend credit
Governments are rarely constrained by narrow to riskier farmers.
market failure arguments, and often choose to
heavily subsidize agricultural insurance for broader Sometimes subsides are used to obtain multiple
political and social purposes. Insurance subsidies goals. For example, in the US, the crop insurance
are commonly used as a means to: program provides income support to farmers - an
average PCR of 1.7 during 2003-07 (Table 1), and
• To increase food production or agricultural since the major claim payments are tied to disaster
exports for national purposes, even though the years, the insurance also helps substitute for disaster
value of that production may be less than the assistance programs. In India, insurance subsidies
cost of the subsidy (see previous section); are intended to expand agricultural lending, while
also providing protection for the agricultural banks.
• Improve equity of coverage by extending
If the insurance also encourages farmers to adopt
insurance access to previously excluded
riskier but higher income earning strategies, the
groups, such as low-income farmers or high-
social and political goals may also be win-win with
risk regions, on a more permanent basis.
agricultural growth and higher farm incomes.
• Support farm incomes more generally, as
Of course, governments usually have alternative
is done in many middle and high-income
ways of achieving many of these social and political
countries. This happens when the average
goals, and using an insurance subsidy to achieve
annual claim payment exceeds the unsubsidized
them is only justified from an economic perspective
part of the premium rate by farmers (i.e., PCRs
if it is more cost effective and less distortionary for
greater than 1.0), and which, as seen in Table
markets and resource allocation decisions (see next
1, amounts to a substantial income transfer in
section).
some countries.
• Substitute for safety net and disaster assistance
spending by providing farmers and other rural
3. REASONS FOR SUBSIDIZING AGRICULTURAL INSURANCE
9
WHEN AND HOW SHOULD AGRICULTURAL INSURANCE BE SUBSIDIZED? ISSUES AND GOOD PRACTICES
10
4. Challenges in Subsidizing
Agricultural Insurance
Agricultural insurance faces challenges of its own when it comes to the
design, delivery and administration of insurance contracts that farmers are
willing to buy, and as reviewed elsewhere, important problems remain despite
considerable progress over recent decades (Hazell, Hess and Kuhn, 2016).
Additional challenges arise when the insurance is to be subsidized, and as
discussed in this section, care is needed in the design and implementation of
subsidies, otherwise they can prove unnecessarily expensive, worsen inequality,
and create disincentive problems that undermine the insurance program, distort
markets and resource allocation decisions.
Poorly designed insurance subsidies can inadvertently create disincentive
problems that lead to significant economic costs and inefficiencies. The main
reason for this is that subsidizing insurance leads farmers to assume more risk
in their resource allocation decisions than when the insurance is not subsidized.
In some circumstances this may be desirable. For example, it might enable
smallholders who were previously underinsured to adopt more risky crop mixes
and technologies that increase their average incomes and help lift them out of
poverty. However, premium subsidies that reduce the cost of insurance below
its actuarially fair value may also encourage farmers to take on too much risk,
such as growing unsuitable crops in risky environments, or growing more
of them, adding to the future costs of insurance and possibly damaging the
environment (Siamwalla and Valdes, 1986; Hess and Hazell, 2016; Goodwin
and Smith, 2013).
Of course, other types of policy interventions designed to help farmers manage
risk also create disincentive problems. These problems can be particularly
severe for some types of disaster assistance programs (DAPs) because
DAPs are invariably fully funded by governments and/or donors given the
difficulties of recovering costs from beneficiaries. In effect, a DAP provides
what is equivalent to 100% subsidized insurance payouts. A classic example
of the disincentive problems associated with DAPs is how publicly provided
compensation to repair or rebuild houses after hurricane disasters in the US
may have contributed to a net increase in the housing stock in vulnerable
areas (Kunreuther et al., 1978). Another example was the negative impact of
publicly subsidized barley feed and credit for herders in drought years in the
4. CHALLENGES IN SUBSIDIZING AGRICULTURAL INSURANCE
11
low-rainfall areas of the North Africa and Middle • Subsidies in the form of direct payments to
East region. This intervention contributed to the insurers to help settle claims have the potential
eventual overstocking of rangeland areas and crop to undermine efficiencies and incentives for
expansion into drought prone rangelands, helping due diligence within the insurance industry,
to undermine well established and sustainable especially if the government automatically
rangeland management systems (Hazell, Oram and covers any claims that the insurer cannot pay
Chaherli, 2003). One way to reduce the negative (Hazell, Pomareda and Valdes, 1986; Hazell,
incentives associated with DAPs is to combine 1992). Direct payments to insurers need to
them with compulsory insurance for some kinds be tied ex ante to specific formulas, such as
of catastrophic losses, even if the premium has to reinsurance within agreed rules on the tail end
be partially or fully subsidized for poorer people. risks to be covered.
This is a common practice in many higher income
• Subsidized insurance may raise WTO concerns
countries for managing flood risks. Another way
if the subsidies have more than a minimal
is to provide insurance coverage as long as the
impact on production and trade.
beneficiaries take some prescribed actions to reduce
risks. For example, in several countries earthquake • Without a clearly defined strategy, using
insurance is conditioned on houses being built or insurance subsidies for some political and
adapted to building codes that make them more social purposes can easily become more
earthquake resistant expensive than planned, in part because the
demand for insurance is typically inelastic, and
Poorly designed insurance subsidies can also create
premium subsidies have to be set at high levels
other kinds of problems:
to attract the kinds of participation rates that
• When subsidized insurance is used to insure governments look for to achieve their social
farmers’ credit, the claim payments need to and political purposes (Glauber, 2012; Hill et
be tied to verifiable losses against specific and al., 2014).
insured perils or index outcomes, otherwise
• Insurance subsidies can also lead to undesired
there is potential to reduce due diligence in
distributional consequences. For example,
the lending practices of banks. An egregious
the benefits from proportional subsidies are
example was the former Mexican insurer
skewed towards those farmers who buy more
ANAGSA, which insured the loans of an
insurance, and they are unlikely to be poor.
agricultural development bank (Banrural) with
MPCI policies that repaid the bank for most Another difficulty with insurance subsidies is that
sources of farmers’ crop losses. Not only did they can be difficult to phase out or remove once
ANAGSA end up making large claim payments established. In fact, like most input subsidies,
each year to offset loan defaults, but knowing experience shows that their cost to government
that they could easily collude with farmers typically grows over time as more of the input is
to obtain claim payments from ANAGSA, used, or in this case, larger crop areas are insured
Banrural staff had limited incentive to perform (Hazell, 1992; Glauber, 2012). Recent examples are
due diligence on loan applications or to attempt the rapid growth in public spending on subsidized
to recover defaulted loans (Hazell, 1992). insurance in China, India, and the US. The problem
WHEN AND HOW SHOULD AGRICULTURAL INSURANCE BE SUBSIDIZED? ISSUES AND GOOD PRACTICES
12
can be especially acute when the subsidies are control over insurance subsidies seems greater
untargeted and paid on a proportional basis, since this when used for broader political and social purposes
can benefit a clientele of larger and politically well- than when targeted at fixing specific market failure
connected farmers who lobby for its continuation or externality problems.
and expansion (e.g., in the US). Subsidies may also
Of course, alternative policies for achieving some
benefit the insurance and financial sectors, which
of the same political and social objectives as
are also effective lobbying groups. The dynamics of
subsidized insurance (e.g. farm income or price
the political support for subsidies can even be driven
support policies) can also become politically
by governments themselves, as, for example, when
entrenched and distort incentives and markets. As
subsidized insurance is seen as a way of influencing
such, the indirect costs of subsidized insurance
election outcomes, or writing down farm debt (the
need to be evaluated relative to the indirect costs of
former ANAGSA program in Mexico was a classic
alternative policies, and not held to unrealistically
example – Hazell 1992). The danger of losing
high standards that eliminate it from consideration.
4. CHALLENGES IN SUBSIDIZING AGRICULTURAL INSURANCE
13
WHEN AND HOW SHOULD AGRICULTURAL INSURANCE BE SUBSIDIZED? ISSUES AND GOOD PRACTICES
14
5. Does Subsidizing Agricultural
Insurance Pay?
Although there may be sound economic reasons for subsidizing agricultural
insurance in some contexts, it is not guaranteed that it is a worthwhile way to
spend public money. That depends on more than the just the size of the hoped
for benefits. In the first place, an insurance program that is being subsidized
may have problems of its own in designing, delivering and administering
insurance contracts that farmers want to buy. Problems have been widespread
in the past (Hazell, 1992), and challenges remain despite recent progress in the
use of public-private partnerships and new forms of IBI (Mahul and Stutley,
2010; Hazell, Hess and Kuhn, 2016; Jensen and Barrett, 2017). Problems with
underlying insurance programs are not necessarily resolved by adding a subsidy
(e.g., a subsidy would not solve a basis risk problem), and in some circumstances
a subsidy could compound existing problems (e.g., by crowding out alternative
insurance programs). Then there are the potential disincentive problems that
arise from adding a subsidy, and which could lead to additional economic costs
and inefficiencies. So whether or not it pays to subsidize agricultural insurance
is an empirical matter that requires careful collection and analysis of data about
the performance of insurance programs.
Unfortunately, there have been only a few quantitative studies of whether or
not subsidized agricultural insurance leads to favorable net social returns for a
country. These include ex post cost-benefit studies of the Japanese and Mexican
programs, where it was found that the social returns were negligible in relation
to the programs’ high costs (Tsujii, 1986; Bassoco, Cartas and Norton, 1986).
However, these were evaluations of old style MPCI programs, and there have
been significant improvements in the design and implementation of agricultural
insurance programs since then (Hess, Hazell and Kuhn, 2016). At present,
we simply do not know if subsidizing agricultural insurance is economically
worthwhile, or how the net benefit might vary with the type of insurance subsidy
and the context in which it is introduced. This does not mean that subsidizing
agricultural insurance is not economically worthwhile - the lack of evidence
does not prove the case one way or the other, but it does highlight the urgent
need for ex post cost-benefit evaluations of more recent types of subsidized
crop insurance programs, including IBI products.
5. DOES SUBSIDIZING AGRICULTURAL INSURANCE PAY?
15
There is a growing body of experimental data insurance program for Bangladesh shows how this
showing how subsidized insurance can help can be done (World Bank, 2015 – Box 1). Although
immediate beneficiaries (Cole et al, 2012; de the ex ante benefits look favorable in this case, the
Janvry; Jensen and Barrett, 2017), but these gains analysis did not go so far as to sum all the benefits
have not been valued and compared to the costs and compare them to the projected cost of the
of the insurance programs, nor have they been program to the Government of Bangladesh, so it is
tested and evaluated at scale. A good starting point not entirely clear that the program would be socially
would be more ex ante evaluations of subsidized worthwhile. Ex ante evaluations would not only
insurance programs before they are launched, help screen out less promising proposals, but also
and a recent World Bank analysis of a proposed provide a basis for subsequent ex post evaluations.
Box 1: Ex Ante Cost-Benefit Evaluation of an Insurance Program in Bangladesh
Agriculture is a key sector in Bangladesh, but it is highly exposed to risks. Indeed, Bangladesh is
commonly ranked as one of the most vulnerable countries in the world to natural disasters with agriculture
heavily exposed to floods, cyclones, and drought. In 2007, for instance, Cyclone Sidr destroyed 0.69 million
ha of cultivated crop lands and killed over 460,000 head of livestock and poultry.
In the past, the government of Bangladesh and development partners have provided substantial
support to farmers in the aftermath of large disasters, but this approach has disadvantages in that
support is not guaranteed to farmers and may be slow. In the aftermath of Cyclone Sidr, recovery and
reconstruction needs were estimated at US$1.3 billion, or 28 percent of government expenditures.
Agricultural insurance offers the government a planned, fast, ex ante alternative to ad hoc disaster
response, one that (1) reduces the ex post fiscal burden on the government, (2) improves farmers’
resilience to shocks, and (3) supports the expansion of agricultural credit.
To assist the government, the World Bank undertook an ex ante evaluation of a proposed agricultural insurance
scheme, which is now being implemented. Key findings from the evaluation follow.
Annual fiscal costs to be borne by the government for supporting the development of a national area
yield index insurance (AYII program) for aman and boro paddy are estimated at between US$6 million
and US$9 million in 2020, when about 10 percent of the area cultivated with aman and boro paddy
would be insured. This fiscal costing exercise is based on the assumption that the government will provide
financial support to the AYII scheme through 50 percent premium subsidies as well as investment in data
market infrastructure and support to awareness-raising activities. As a reference, this amounts to about 0.05
percent of the government of Bangladesh’s 2014 budget, and 1 percent of the Ministry of Agriculture’s budget
for the same year.
Welfare impact analysis shows that commercial insurance could help small- and medium-scale farmers
stabilize and increase their crop income by up to 41 percent if insurance unlocks credit and adoption
of high-yielding varieties. Indeed, if farmers currently growing aman local or boro HYV switched to higher-
yielding varieties (aman HYV or boro hybrid respectively), the increase in expected yield would largely
compensate for the increase in input costs. Given that AYII could increase loan repayment by up to 35 percent
in bad (1-in 10) years, insurance could unlock these productive investments through enhanced access to
WHEN AND HOW SHOULD AGRICULTURAL INSURANCE BE SUBSIDIZED? ISSUES AND GOOD PRACTICES
16
cheaper credit. For large-scale farmers, the impact of AYII on access to credit and adoption of technologies
would be more moderate.
Subsidized AYII could also result in a 100 percent increase in small- and medium-scale farmers’ crop
income in bad (1-in-10) years, compared to pure disaster relief. This positive impact of insurance is
expected to result from two combined effects. On the one hand, AYII could crowd in credit and adoption of
high-yielding varieties, thus increasing crop income in bad years by 83 percent. On the other hand, insurance
could mobilize larger compensation to farmers following catastrophic shocks than can existing disaster relief
programs, thus increasing crop income by 17 percent in bad years relative to disaster relief program (see
figure 1).
Figure 1. Illustrative Comparison of Disaster Relief and 50 percent
Subsidized AYII Across Years with Different Levels of Shocks
Transfers to
Beneficiaries Each farmer
receives 80%
of input costs
+17% in crop
income for Each
farmers farmer
receives
No insurance 30%
payouts when of input
stocks are costs
moderate
Expenditures
Moderate Large
shock shock
Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7 Year 8 Year 9 Year 10
Disaster relief Disaster relief Premium paid Premium paid Insurance
expense transfer (Gvt) (beneficiaries) payouts
Source: World Bank (2015).
There have also been only a few studies that compare bank’s lending portfolio. Even a subsidy to cover the
the relative costs and benefits of subsidized insurance extra 2% interest charge would have been more cost
with alternative policy approaches for achieving the effective for the government than funding many of
same political and social goals. Pomareda (1986) the costs of the insurance agency.
showed that for the Agricultural Development Bank
Using subsidized insurance as a means to transfer
of Panama during the 1980s, a 2% increase in the
income, either as a safety net or a farm income
interest rate it was allowed to charge on farm loans
support measure can be expensive. As shown in
would have been equally as effective as the entire
Table 2, it cost governments about $0.50 to transfer
crop credit insurance program in protecting the
each $1 to farmers through subsidized insurance in
5. DOES SUBSIDIZING AGRICULTURAL INSURANCE PAY?
17
four major insurance programs during the 1980s, Table 2: Cost to Government of
and the transfer cost had increased from $0.63 to Transferring Income to Farmers
$0.95 in more recent years in the US program, Through Subsidized Crop Insurance
despite improvements to the design of the program6.
Programs in Four Countries
This is expensive compared to an average 2009-13
transfer cost of between $0.12 and $0.19 per $1 Country Total government
spending in dollars to
delivered for the Ethiopian Productive Safety Net transfer $1 to farmers*
Program (World Bank, 2016, pp. 57-58). It is also
expensive compared to a cost of $0.20 to transfer USA 1.63
a dollar of food under Mexico’s Oportunidades 1981-90 1.95
program, which itself is ten times higher than the 2000-11
cost of transferring one dollar of cash (Gentilini,
Mexico (1980-89) 1.22
2016). In richer countries with well developed
income tax systems, it may also be less costly to Costa Rica (1970- 1.43
allow farmers to offset weather related losses in 89)
any one year through income tax averaging over
several subsequent years (as in the US). Subsidized Philippines (1981- 1.61
insurance does have an advantage over some 89)
alternative income transfer mechanisms in that it Source: Hazell (1992) and author’s calculations based on data in
pays out during years of insured losses, and hence Glauber (2012).
*Calculated as total cost to government (premium subsidies
also helps to stabilize incomes. But so do programs plus A&O subsidies and reinsurance payments) divided by net
like the Ethiopian Productive Safety Net Program indemnities received by farmers.
and Mexico’s Oportunidades program.
rigorous studies have shown significant impact
On the other hand, as an income support measure,
of agricultural insurance on farmers’ risk-taking
insurance subsidies might be less costly than
behavior (Karlan et al., 2012; Elabed and Carter,
payment schemes for environmental services, given
2015), evidence of the impact of insurance on
the high administrative costs incurred in selecting,
credit is still missing. There is virtually no credible
monitoring and enforcing environmental projects at
evidence available to show that subsidized credit
farm and landscape levels. It may also be less costly
insurance has any impact on the lending practices
than price support mechanisms, which can lead to
of agricultural lenders. Even with large scale and
costly public storage schemes and distortions in
well-established agricultural insurance programs
commodity markets.
such as in India or Mexico, there is no credible
One of the key expected benefits of agriculture evidence to show whether the insurance has helped
insurance is to unlock credit for agricultural activities to protect agricultural lending ex post (e.g. through
exposed to risks such as drought, floods or pests a reduction in non-performing loans in bad years),
and diseases. Indeed by absorbing large covariate or has been used by financial institutions to expand
agriculture production risks, subsidized insurance agricultural lending ex ante (e.g. larger volumes
has the potential to help financial institutions offer of credit, a broader segment of borrowers reached,
larger loans and to more farmers. While several cheaper rates, longer maturities). To the contrary,
6
According to Joe Glauber (personal communication) this is in part because of the severe drought in 2012 when the government had to pick
up a substantial part of the producers’ claim payments.
WHEN AND HOW SHOULD AGRICULTURAL INSURANCE BE SUBSIDIZED? ISSUES AND GOOD PRACTICES
18
many financial institutions in India are finding ways experiences agricultural losses but does not receive
to avoid the requirement of bundling rural loans payouts (or “basis risk”); and banks cherry picking
with insurance. An estimated 30-40% of rural loans and only asking for insurance for riskier loans/
are actually insured, which suggests that financial clients. Research is too scarce to fully understand
institutions are not strictly enforcing mandatory the mechanisms involved, but it seems clear that,
bundling even though it ought to be in their self- regardless of the potential benefits to small farms,
interest. A series of factors could explain this bundling insurance with credit for individual farm
relatively low penetration: burdensome paperwork loans is not necessarily seen by financial institutions
for insurance enrollment; borrowers unwilling to as a way to protect and expand their agriculture
pay additional charges for insurance; reputation lending.
risk faced by financial institutions if a customer
5. DOES SUBSIDIZING AGRICULTURAL INSURANCE PAY?
19
WHEN AND HOW SHOULD AGRICULTURAL INSURANCE BE SUBSIDIZED? ISSUES AND GOOD PRACTICES
20
6. Principles and Good Practices
in the Design of Subsidies for
Agricultural Insurance
As seen in earlier sections, there are contexts in which subsidized agricultural
insurance has the potential to offer private and social benefits, but experience
shows that once introduced, challenges in the design and operation of
insurance programs, poor design of subsidies, plus political dynamics can
lead to disappointing results, an expensive draw on the public purse, and the
creation of disincentive problems that lead to significant economic costs and
inefficiencies, and in some circumstances, to environmental degradation. To
avoid these problems, any insurance subsidy needs to be carefully designed
and implemented so that it is cost effective in achieving its underlying purpose,
minimizes disincentive problems, and does not become a growing financial
burden on the government. Some useful good practice guidelines have been
proposed in the literature, and we draw on these and our own work in proposing
the guidelines set out below (e.g., Hill et al., 2014; Clark, 2011; Hess, Hazell
and Kuhn, 2016).
In developing guidelines, it is useful to distinguish between agricultural
production insurance for farmers (including yield and credit insurance), and
catastrophe insurance against natural hazards that is intended to complement or
replace disaster assistance programs for farmers. While both types of insurance
should be limited to objective and verifiable risks using index based or special
peril contracts, a key difference between the two is that agricultural production
insurance is designed to cover a range of crop and livestock production risks,
while disaster insurance covers extreme natural hazards that can lead to loss of
lives, assets and livelihoods, not just seasonal losses in agricultural production.
Another difference is that disaster assistance is nearly always provided free of
charge to beneficiaries, whereas agricultural insurance typically requires at least
a co-payment. Within agricultural insurance, it is also useful to separate out
insurance that is targeted specifically to poor farm households, as this requires
additional care in setting guidelines.
Agricultural insurance and disaster assistance (or insurance) programs are not
necessarily mutually exclusive, and often coexist in many disaster prone regions
(Figure 2). When this happens, special care is needed in their design to avoid
a) undermining each other (e.g., farmers have less incentive to buy agricultural
6. PRINCIPLES AND GOOD PRACTICES IN THE DESIGN OF SUBSIDIES FOR AGRICULTURAL INSURANCE
21
insurance if they can rely on free disaster assistance), Since a primary purpose of most agricultural
and b) to exploit possible complementarities (e.g., insurance subsidies is to reduce the risk exposure
if disaster assistance removes extreme covariate of farmers, a good place to start is to ask if
risks, then this can facilitate the development of insurable farm risks are the main problem in
more flexible forms of agricultural insurance). terms of their severity and frequency compared
One advantage of replacing part or all of disaster to other risks that farmers face. In some contexts,
assistance program with disaster insurance is that it market, natural disaster, and security risks are more
opens up the possibility of bundling the insurance important than agricultural production risks, in
with other forms of agricultural insurance. which case subsidized agricultural insurance may
not be effective. Even where production risks are
Figure 2. Overlap Between dominant, subsidized insurance is not necessarily
Agricultural Insurance and Disaster the best solution. Some production risks can be
Assistance reduced by taking preventative actions, such as
investing in irrigation, plant breeding, and flood
control. Some of these preventative investments
also contribute to higher productivity over time,
Agricultural Disaster and may offer more attractive ‘win-win’ solutions
Insurance Assistance to the risk problem than spending public money on
insurance subsidies. Governments may be able to
make their own investments in risk reduction or
use policies to create incentives for farmers and
local communities to make investments. Other
risks may be more difficult or costly to prevent,
Guidelines for Subsidizing Insurance but farmers can often reduce their exposure
by using risk-avoiding strategies like crop and
for Commercial Farmers
income diversification. Such risk avoidance
Assuming governments supply the basic public generally comes at a cost in terms of average
goods needed to create an enabling environment income forgone, in which case insurance should
for insurance markets to work (e.g., maintaining be explored to see if it is more cost effective. In
weather station infrastructure and data systems), short, subsidized insurance is best seen as a way
then agricultural insurance for commercial farmers to handle some of the residual risk after other and
ought in principle to be financially viable without more cost effective measures have been taken to
subsidies, except perhaps on a temporary basis reduce farmers’ exposure to production risks. The
because of some externality or establishment World Bank, amongst others, works with countries
problem that constrains the development of the in undertaking broad risk assessments, and this is
insurance market. However, as seen in section 3, a useful first step before setting up an insurance
many governments subsidize farm insurance at high program. Such risk assessments should also take
and sustained levels in the pursuit of broader social account of expected changes in climate risks.
and political goals, and this complicates some of
the guidelines. Our guidelines are as follows: • Articulate what the subsidy aims to achieve.
Once the need for insurance has been verified,
• Start by assessing risks and establish the the next step is to develop a clearly stated and
need for insurance within a broader policy well-documented purpose for the subsidy that
framework that also encourages risk reduction. is agreed with the relevant policy makers. This
WHEN AND HOW SHOULD AGRICULTURAL INSURANCE BE SUBSIDIZED? ISSUES AND GOOD PRACTICES
22
should be based on some of the arguments onto their premiums and then provide vouchers
presented in section 3 of this paper, and which to farmers to cover delivery costs and let
have been empirically analyzed to demonstrate them choose their preferred supplier. Also,
a clear ex ante economic rational (for an awareness campaigns amongst farmers and
example, see Box 1). their organizations can help them become
more savvy clients when buying insurance.
• Provide a financing plan for the subsidy. As
Consumer protection agencies can also help
part of the plan, there should be an explicit strategy
protect farmers from bad practices by insurers
or financing arrangement for the subsidy. If the
and lenders. In countries where there are few if
subsidy is intended to help insurers overcome
any existing agricultural insurers, the challenge
initial establishment problems for the insurance,
is to avoid setting up institutional arrangements
then there should be a time bound sunset clause.
that crowd out the subsequent development of
If the subsidy is intended to continue on a longer-
private sector competition.
term basis in the pursuit of some social or political
goal, then there should be an agreed financing • Avoid using subsidies to reduce the cost of
plan so that the subsidy does not become an insurance below its pure risk premium. In
unexpected burden on the public purse. order to reduce disincentive problems that lead
farmers to take on too much risk or of the wrong
• The subsidy should be implemented through
types, the premium rate farmers pay (net of
credible agricultural insurance programs
any subsidy) should ideally never be less than
or agencies. Agricultural insurance faces its
the actuarially fair (or pure risk) premium. This
own challenges in designing, delivering and
means that subsidies will be less distorting if
administering insurance contracts that farmers
limited to offsetting an insurer’s administration
are willing to purchase, and adding a subsidy
and development costs rather than subsidizing
to a badly performing insurance program or
the premium rates paid by farmers, and these
insurer is unlikely to be a recipe for success. For
costs can be quite substantial during the early
example, subsidizing an index based insurance
stages of a new insurance program. Few publicly
program that suffers from a serious basis risk
subsidized insurance programs adhere to this
problem is unlikely to make it more attractive
guideline7, and as discussed earlier, governments
to farmers. The first priority in this case should
provide higher premium subsidy rates for
be to overcome the basis risk problem.
commercial farmers in pursuit of broader social
• Encourage competition amongst insurance and political purposes. Where the pure risk cost
providers. Where possible, the subsidy should is to be subsidized, there are ways to reduce
be used to encourage competition among the disincentive problem. One way is to restrict
insurers. For example, if delivery costs are the amount of subsidized insurance farmers
subsidized, insurance companies should be can buy for each insured crop, or not to offer
encouraged to deliver at the lowest possible a subsidy at all for high-risk crops, farmers or
cost. This could be done by having companies regions where disincentive problems are likely
bid their delivery services to the government, to be large. Yet another way is to structure the
or by allowing the companies to load expenses subsidy in a way that respects the relative risk
Mahul and Stutley (2010) found only 7 countries with subsidized insurance programs during 2003-07 met this requirement.
7
6. PRINCIPLES AND GOOD PRACTICES IN THE DESIGN OF SUBSIDIES FOR AGRICULTURAL INSURANCE
23
levels across insured activities8. For example, the audit costs, awareness campaigns, stop-loss
pure risk component of the premium rates could arrangements etc. Tracking impact will depend
be subsidized on a proportional basis so that if on the purpose of the subsidy. For instance,
the unsubsidized premium rate for one crop is if the subsidy is intended to increase farmers’
initially twice that of another, then its subsidized access to agricultural credit, then the terms of
premium rate would also be kept twice as high. loan (interest rate, maturity) and loan recovery
rates should all be monitored. Morsink, Clarke
• Consider what form the subsidy should take.
and Mapfumo (2016) discuss suitable M&E
Where a subsidy is to be paid directly to an
indicators in more detail.
insurer to help cover some initial set up costs,
then depending on circumstances, it may be • Conduct a cost-benefit analysis. To
better to provide subsidized reinsurance rather demonstrate that the subsidy is money well
than a direct administrative subsidy. A good spent, it should be shown that either the subsidy
example is when the subsidy is designed to leads to a net social gain through a cost-benefit
offset high but temporary risk loadings because analysis (as when correcting market failures
of inadequate information about the insured and externalities), or when the subsidy is being
risks. The Annex to this paper explores this used to achieve broader social and political
guideline in more detail. gains, that it is more cost effective than
alternative intervention policies.
• Consider a cap on the subsidy level. To avoid
adverse distributional outcomes in which larger Guidelines for Subsidizing
farms capture a disproportionate share of the Agricultural Insurance for Poor
subsidy, a cap could be placed on the level of Farmers
subsidy or subsidized insurance available to
Even when agricultural insurance for commercial
each farm.
farmers is well developed, it is often the case that
• Establish an M&E framework. To ensure that many poor farmers are left out because they are
the subsidy is achieving its intended purpose, perceived to be too risky or too costly to serve,
a good long-term monitoring and evaluation or because they are too poor to pay an insurance
(M&E) system that tracks the performance of premium. This has led to many attempts to provide
the subsidized insurance is required. This has targeted and subsidized insurance that meets the
rarely been done in the past. In addition to special needs of poor farmers. It is often hoped
basic performance data on coverage (number that providing them with subsidized insurance will
farmers, sum insured), premium collected, provide a pathway that enables them to access credit
claim payments made, and claims ratios (C and adopt higher earning but more risky farming
over P) recorded by insurers, etc., it is also strategies and technologies that will lift them out
important to monitor the costs of the insurance of poverty. For some farmers, an initial subsidy
to government, and its impacts against the may be sufficient to enable them to transition to
intended goals of the subsidy. The cost data unsubsidized commercial insurance, but for many
should include the cost to the government in of the poorest a sustained subsidy may be necessary
annual premiums subsidies, investments in data to help keep them afloat. Most of the guidelines
collection, contributions to management and provided above for subsidizing insurance for
8
Past experiences in India has shown that subsidies directed at risky crops may encourage farmers to cultivate more of these crops (e.g.,
groundnut in Andhra Pradesh and Gujarat). Changes in actuarial design introduced by the Government of India in 2010, with support from
the WBG, have significantly improved risk signaling and incentives to adapt to climate change.
WHEN AND HOW SHOULD AGRICULTURAL INSURANCE BE SUBSIDIZED? ISSUES AND GOOD PRACTICES
24
commercial farmers still hold, but we make the there are potential negative incentive problems,
following exceptions and additions: although these are likely to be less severe for
small scale, often subsistence oriented farmers
• Since the insurance is targeted to poor farmers
than for larger-scale commercial farmers. One
each of whom will buy only a small amount of
way to reduce the problem for poor farmers is to
insurance, then an intermediary organization
require them to repay the subsidy in the form of in-
that can aggregate up the needs of many small
kind labor payments by working on community
farms and administer the insurance on behalf
projects that contribute to greater resilience
of an insurance company is typically needed.
against losses, as with the R4 Risk Resilience
A variety of institutions might fill this role,
initiative in Ethiopia9 (Box 2). Another way
including an NGO, a farmers association
would be to limit the payments so it can be more
or cooperative, a mutual insurance group,
of an income support (rather than compensation
an agricultural development bank, and a
for actual losses) to protect basic needs in the
microfinance organization. It is important to
event of severe crop or livestock losses.
identify and select an appropriate intermediary.
It also needs to be recognized that providing • When the subsidy is intended to benefit specific
subsidized insurance on its own is unlikely segments of farmers or herders to help them
to be a game changer for the poor unless a) escape poverty, the subsidy should be well
they can access credit if they purchase the targeted to those segments to minimize the cost
subsidized insurance, and b) are able to use of inadvertently subsidizing others. When the
the credit to obtain the complementary inputs insurance subsidy is tied to credit at selected
like fertilizer, improved seeds, and extension financial institutions, then it is relatively easy for
needed to raise their farm productivity. This the financial institution to distinguish between
can be a challenge for many poor farmers who targeted and non-targeted borrowers. More
are anyway disadvantaged by high transactions generally, insurers or intermediary institutions
costs in accessing inputs and markets, and like cooperatives and NGOs will need
who are typically the least likely to receive sufficient household specific information and
assistance from public extension agents. For an operational capacity to identify and service
many poor households, it typically takes poor households, and some compensation for
concerted action by governments, donors or an the extra administrative costs. Hill et al (2014)
intermediary organization like a cooperative discuss the issues and some of the options
or NGO to provide the subsidized insurance for targeting subsidies in some detail. One
within a complementary package of other promising approach is to link the insurance
requirements for change, and this should also with existing social protection systems, such
be considered when selecting an intermediary as safety net and cash transfer programs, as
organization to aggregate and distribute the these already have an infrastructure in place
subsidized insurance. A good example is the R4 for identifying the poor and vulnerable and
Risk Resilience initiative in Ethiopia (Box 2). delivering assistance. The R4 Risk Resilience
initiative in northern Ethiopia has used the
• Most insurance subsidies for poor smallholders
Ethiopian Government’s safety net program to
will need to cover a substantial part of the pure
identify poor households (Box 2).
risk cost if it is to be affordable. This does mean
9
Based on RCTs in Ethiopia, Tadesse et al (2016) found that most smallholders were willing to undertake such work at below normal wage
rates.
6. PRINCIPLES AND GOOD PRACTICES IN THE DESIGN OF SUBSIDIES FOR AGRICULTURAL INSURANCE
25
Box 2: The R4 Risk Resilience Initiative in Ethiopia
Weather-related shocks are a constant threat to the security and well-being of many poor farmers in Ethiopia.
To help them build resilience and face these challenges, Oxfam America, Swiss Re, and their partners
developed the Horn of Africa Risk Transfer for Adaptation (HARITA) program in the state of Tigray in
Ethiopia in 2008. HARITA is an integrated risk management program aimed at strengthening farmers’ food
and income security through a combination of improved resource management, insurance and microcredit.
HARITA allows cash-poor farmers the option to work for their insurance cover by engaging in community-
identified projects to reduce risk and build climate resilience, such as improving irrigation or managing soil.
Though the premium is fully subsidized for some farmers, they still contribute to the cost of the insurance
with their work. Farmers who are in a slightly better financial situation, on the other hand, must contribute in
cash to the cost of the coverage in order to enjoy the same benefits. The long-term goal of the program is that
farmers participating in the “work-for-insurance” modality can eventually graduate and afford to pay in cash,
allowing other farmers in need to take their place in the program.
In the event of a seasonal drought, insurance payouts are triggered automatically when rainfall drops below
the determined threshold, enabling farmers to afford the inputs necessary to plant in the following season and
protecting them from having to sell their assets. However, the most innovative feature of HARITA is that
farmers benefit even when there is no payout, as the risk management infrastructures built through their work
will help reduce risk during next seasons.
In order to target the vulnerable low-income rural population living in Tigray to participate in the program,
HARITA is integrated with the Government’s “food- and cash-for-work” Productive Safety Net Program
(PSNP), a well-established scheme that serves 8 million chronically food-insecure households in Ethiopia. By
using an already existent safety net program, HARITA managed not only to better reach its target population,
but also to reduce the costs of establishing a distribution network from the start. While the distribution model
makes it easier to reach those who have time to spend on community work, it excludes poor households that
do not have excess labor capacity, such as female-headed or elderly households.
In December 2010, after a partnership with the WFP, HARITA was renamed “R4” and expanded to 76 villages
in Tigray, reaching around 20,000 farmers. The program has experienced high demand and the “work-for-
insurance” segment reaches capacity within the first couple of days of being introduced in a new area. Though
the idea is to extend the program to other areas that face the same constraints, lack of funding limits scale. The
reliance on subsidies limits the scale at which the insurance can be offered, as funding is needed to pay for the
public works and to pay for the premium.
The R4 illustrates several good practices: a) it uses a safety net program to identify the poor, b) it encourages
farmers to undertake ex ante risk reduction measures, c) it packages the insurance with access to credit, inputs
and extension advice to help promote increases in farm productivity, and d) requires farmers to contribute to
the cost of the insurance either in cash or by providing labor to community development projects. However,
despite its promise, the program has yet to demonstrate its full impact and net social value through a cost-
benefit analysis. Also, while the initiative demonstrates several good practices, and is generally a well designed
and administered program, it has not reached scale, even after 8 years, there is no obvious strategy for phasing
out the annual subsidy that is provided by donors.
Source: Hill et al (2014) and authors.
WHEN AND HOW SHOULD AGRICULTURAL INSURANCE BE SUBSIDIZED? ISSUES AND GOOD PRACTICES
26
Guidelines for Subsidizing Insurance To obtain quicker and more assured access to funds
to Improve or Replace Disaster in times of need, some DAPs have been able to
Assistance purchase international reinsurance to cover part of
their expected assistance payments. Not only does
Spending on disaster assistance programs (DAPs)
this lead to more assured and timely payments from
has increased significantly in recent years, and
a reinsurer when a disaster occurs, but reinsurance
seems destined to increase further in many countries
can also help smooth out the annual cost of a
with climate change. Such spending is driven
DAP to government and/or donors in the form of
more by humanitarian concerns than development
a predictable and regular annual premium. Even
agendas and often its primary value is in saving
if only part of the disaster risk is insured, this can
lives. Some DAPs also aim to rebuild assets and
enable governments to better plan for disasters, and
livelihoods as part of recovery efforts. DAPs are
help fill the short-term post-disaster funding gap
particularly helpful to the poor, who are generally
while additional assistance is being sourced (Clarke
more exposed to catastrophic risks because they
and Dercon, 2016). This kind of reinsurance
have the least options for coping with losses when
works because most catastrophic losses caused by
they occur, and because they often live in more
natural disasters are relatively easy and transparent
remote and high-risk areas.
to observe, and can be indexed on the basis of
While most DAPs achieve their primary objective of existing data series to create an attractive index
saving lives, they vary widely in terms of their cost, based insurance (IBI) product for the reinsurance
efficiency, and protection of assets and livelihoods. market. A good example is the Agricultural Fund
Two of the biggest practical challenges facing DAPs for Natural Disasters (CADENA) in Mexico,
are a) the difficulty of targeting assistance to the which internationally reinsures part of the costs
truly needy under emergency conditions while at the of Mexico’s state-managed relief programs (Hess,
same time not wasting assistance on the non-needy; Hazell and Kuhn, 2016).
and b) by the time an emergency has been declared
To solve the targeting problem, one promising
and an assistance effort funded and launched, the
development is the linking of DAPs with existing
assistance may arrive too late to relieve the worst
social protection systems, such as safety net and
suffering and losses. Another problem discussed in
cash transfer programs, as these already have an
Section 4 is that since DAPs are fully funded by
infrastructure in place for identifying the poor and
donors, UN agencies and governments, and, unlike
vulnerable and delivering assistance (Grosh et al.,
insurance, do not try to recoup their costs from
2008; Alderman and Haque, 2008). The objective is
the beneficiaries, they may lead to disincentive
to give these social protection schemes the capacity
problems, particularly once people begin to take
to scale up rapidly after a disaster and increase the
them for granted. Finally, because DAPs focus on
size of the cash payments they make to beneficiaries
ex post compensation and recovery, they may do
and the number of beneficiaries they can support.
little to encourage recipients to take preventative ex
In Ethiopia, for example, the government, World
ante actions that reduce risk exposure and increase
Food Program and the World Bank established
resilience, including discouraging recipients from
the Livelihoods, Early Assessment and Protection
purchasing their own insurance. Recognizing
(LEAP) mechanism in 2008 (Hess and Hazell,
these limitations, there have been some recent and
2016). LEAP is an integrated food security and
useful innovations in developing better approaches
early response system that combines early warning,
to DAPs, and which involve the application of
capacity building, contingency planning and
subsidized insurance.
contingent finance. While LEAP is based on donor-
6. PRINCIPLES AND GOOD PRACTICES IN THE DESIGN OF SUBSIDIES FOR AGRICULTURAL INSURANCE
27
provided contingent financing rather than commercial the vouchers for free, recipient households can be
insurance, it uses an index-based approach. asked to contribute labor towards enacting certain
risk reduction measures, such as participation
To help encourage greater ex ante risk prevention
in training for good agricultural practices or
and management practices among recipients,
disaster proofing homes, or by participating in
another innovative approach is to replace part or all
community organized activities to improve disaster
of disaster relief with new types of subsidized IBI.
preparedness and mitigation. This can help increase
The primary object here is to provide subsidized
resilience, and, as with the R4 Risk Resilience
insurance contracts to vulnerable households
initiative in Ethiopia, reduce some of the perverse
each year so that when an insured catastrophe
incentive problems associated with subsidizing
occurs, they receive automatic cash payouts from
the true risk cost of the insurance. The availability
the insurance without having to wait for a relief
of ERVOs that remove important covariate risks
effort. One example is the use of Early Recovery
may also encourage the uptake of complementary
VOuchers (ERVOs) as proposed by the World Food
forms of agricultural insurance for managing other
Program (WFP) and GIZ (Hess et al., 2010. ERVOs
agricultural production risks. The index chosen
are index based insurance contracts targeted to poor
for the insurance should correlate highly (on the
households who are identified ex ante based on
downside) with major losses in the income or assets
national poverty lines or by a relevant safety net or
of poor households due to catastrophic events, and
cash transfer program (see Box 3). When a disaster
need not be limited to farming households. ERVO
occurs, insured households receive a guaranteed and
like schemes are being piloted in China and Peru
immediate cash payment, preferably though mobile
(Box 4), and have been proposed in Paraguay, and
bank accounts. Moreover, instead of distributing
their experience bears watching.
Box 3: Early Recovery Vouchers (ERVOs)
ERVOs seek to make relief more assured and effective for the poor (Hess, Balzer and Calmanti, 2009). ERVOs
are motivated by two concerns. First, it is not enough to respond to shocks and rebuild livelihoods; there is a
need to invest in disaster preparedness and mitigation measures. Communities that become more resilient and
prepared to respond to disasters, when combined with government disaster preparedness efforts, significantly
reduce disaster-related losses of life and livelihoods. In fact, studies show that every dollar invested in disaster
risk reduction saves four or more dollars in future costs of recovery and rehabilitation.10
A second motivation is that the poor, who rely disproportionally on disaster relief when catastrophic events
occur, are probably the least well served. The relief they receive is often inadequate because of the type of aid
they receive (e.g., food aid rather than cash), the amount they receive (especially when there are high leakages
to the non-poor), and the timing is often too late to be truly effective.
ERVOs attempt to address both these problems by providing direct ex ante disaster protection for the poor
In a report to the United States Congress, the Federal Emergency Management Agency (FEMA) and the Multihazard Mitigation Council
10
stated that “On average, a dollar spent by FEMA on hazard mitigation (actions to reduce disaster losses) provides the nation about $4 in
future benefits.” WFP estimates that US$1 spent on early livelihood protection in Ethiopia generates about US$4 in future cost savings and
benefits.
WHEN AND HOW SHOULD AGRICULTURAL INSURANCE BE SUBSIDIZED? ISSUES AND GOOD PRACTICES
28
by covering eligible households with an insurance policy that guarantees immediate disaster payments in
cash following natural disasters. Moreover, instead of distributing the vouchers for free, recipient households
might be asked to enact certain risk reduction measures, such as participation in training for good agricultural
practices or disaster proofing homes, or by participating in community organized activities to improve disaster
preparedness and mitigation.
ERVOs payments would be triggered by an index using weather station or satellite data about catastrophic
events, and which would meet the objectivity and transparency requirements for international reinsurance.
The insurance cover is aimed at poor households identified ex ante based on national poverty lines or by a
relevant safety net or cash transfer program. With the development of mobile banking systems like M-PESA
in Kenya, households could be uniquely identified and registered by mobile phone and payments, when due,
made directly into their accounts where they could be accessed by mobile phone. For example, the identified
and registered households might receive a natural disaster insurance that paid out up to $500 on their private
account in the event of an extreme drought, flood or storm. Governments and donors pay the premiums
and the insured household covers a small processing fee in order for the households to realize that they are
insured. Where mobile banking is not available, ERVOs might be distributed by existing organizations that
have a grass roots presence, such as safety net and cash transfer programs, microfinance institutions, NGOs,
farmer cooperatives, etc. Payments could be announced on public radio, and made available at local banks
or post offices. Technological advances in delivery technology (mobile wallets) as well as index technology
(satellite-based) and geo-referencing of household locations (GPS) allow for the large-scale roll out of such
ERVO schemes.
ERVOs have several attractive features:
• They offer benefits to the poor in terms of direct and timely assistance when a catastrophic loss occurs.
Moreover, since the amount of assistance is assured, poor households would be able to take on greater risk
in their livelihood strategies, hopefully increasing their average incomes.
• Through their conditionality, they could contribute to building more resilient community infrastructure,
livelihoods and farming systems.
• They are an indexed form of insurance that can be reinsured through an index product for the managing
agency.
• They can also be interfaced with existing safety net and cash transfer programs, which offer a reliable way
for the ex ante identification of the poor and vulnerable.
• To avoid the negative incentives that arise from assured but free disaster assistance, households might be
asked to make a small financial contribution (e.g. pay a processing fee), or pay a graduated premium – a
basic amount of coverage could be free but there would be an option to buy more coverage at an escalating
price. For the poor, there might be an option to pay the premium through an insurance-for-work scheme
working on community projects that help build resilience. A graduated premium would solve the problem
of what to do with households who choose not to buy the insurance – disaster relief would be provided to
all the needy during an emergency, but those who had not bought vouchers would only be given the basic
amount of assistance that is free.
6. PRINCIPLES AND GOOD PRACTICES IN THE DESIGN OF SUBSIDIES FOR AGRICULTURAL INSURANCE
29
• Another nice feature of ERVOs is that by removing some of the worst catastrophic risks facing farmers,
this could open up more possibilities for insuring the more normal and less covariate risks that arise in
agriculture. This might be especially relevant for many small to medium sized farms that want to pursue
commercial farming opportunities.
A challenge for ERVOs is finding an index with a low basis risk for the households who receive the vouchers.
This is a less daunting task than finding indices for crop insurance because a) the insurance is limited to the
kinds of low frequency, high impact, highly covariate weather risks that affect most people in a region at
the same time; and b) an index that correlates highly (on the downside) with losses in household incomes or
assets may be more robust than indices that correlate with yield losses for specific crops. The type of index
required for an ERVO scheme could also be meaningful to poor households in a region who are not engaged
in farming, and who would benefit from receiving ERVOs.
ERVOs would have to be substantially funded by governments and donors, but if they could replace part
of existing disaster assistance programs, and possibly some forms of publicly funded agricultural insurance
that insure some of the same catastrophic risks, then there might be sufficient savings from existing funding
commitments to enable ERVOs to be implemented at some scale.
Source: Hess, Hazell and Kuhn (2016).
Box 4: Seguro Agricola Catastrófico (SAC) in Peru
The catastrophic agricultural insurance (or SAC by its Spanish acronym) in Peru, is a government program
that has the objective to support the small producers in the poorer and most climatic vulnerable regions of the
country. It aims to protect a portfolio of basic crops against various climatic risks. The program started in 2009
and is being implemented in 8 departments, covering approximately 425,000 ha on average per crop year.
SAC is not only a financial resource to enable the provision of this insurance, but the first element of an
agricultural policy that aims to strengthen the strategies for prevention and protection of agricultural families
within the policy framework for social inclusion.
The main characteristics of SAC are as follows.
• Same insurance policy protects homogeneous groups of crops (basic crops, fruits, vegetables), in extensive
areas of small and medium producers.
• Insured value per hectare is the same for all the insured/protected crops corresponding to an average
area yield that has been established statistically. This average area yield is the trigger that determines the
occurrence of the catastrophic event.
• SAC does not cover all the production costs nor the total losses of farmers when the catastrophic event
occurs. SAC aims to provide for a basic compensation that increases the capacity of farmers to endure the
negative impacts of the catastrophic event, and more specifically, to enable them to recover their own labor
cost and be able to re-plant. The sum insured for 2015/16 was approximately $160/ha.
• Premium is 100% subsidized and paid by the government.
• In 2007 the government passed Law 29148 that establishes SAC.
• Insurance offered by a pool of two private companies: La Positiva and Mapfre Peru. Insurance companies
are competitively selected.
WHEN AND HOW SHOULD AGRICULTURAL INSURANCE BE SUBSIDIZED? ISSUES AND GOOD PRACTICES
30
Year Premium (Soles) Insured Area (Ha) Sum Insured (Soles) Loss Ratio %
2009-10 S/.39,447,693.84 490,069 S/.220,995,300.00 29.14
2010-11 S/.39,970,678.29 442,210 S/.238,387,122.00 71.4
2011-12 S/.39,982,850.01 450,108 S/.241,922,716.20 28.85
2012-13 S/.39,589,760.05 414,149 S/.239,543,306.00 35.52
2013-14 S/.30,000,000.00 329,943 S/.181,468,697.62 47.99
2014-15 S/.24,117,855.22 343,441 S/.188,892,324.50 46.35
2015-16 S/.39,000,001.22 550,296 S/.302,662,800.00 NA
Source: Seguro Agricola Catastrófico, MINAGRI, GIZ (2016).
Farmers receive indemnification when a certain threshold of yield loss (average area yield loss) is exceeded.
Payment of indemnification is done directly from the insurance company to the beneficiaries, the small holder
farmers, who have an account at a financial institution to receive directly into their account the payment from
the insurance company. Farmers who are the beneficiaries of SAC are pre-identified and registered. The 8
departments selected for SAC are those with the higher concentration of poorer small holder farmers exposed
to climatic risks. Between 2009/10 and 2013/14 crop years a total of 310,587 small holder producers received
compensation reaching the sum of S/. 67.5 million (approx. US$22 million; or US$70 average per beneficiary).
According to a report by MINAGRI (2016), a key factor for the success of SAC has been the strong support
by the government, not only in terms of financial support, but also investments in technical capacity related
to understanding small holder agriculture, agroclimatic risk analysis, and insurance, and making insurance an
important instrument for the public policies for agriculture.
For the insurance sector, SAC has brought new opportunities for the private insurance companies and increased
their interest to develop additional insurance products for agriculture beyond catastrophic insurance. An
important impact of SAC, has been its impact on financial inclusion, by requiring beneficiary small holder
farmers to open an account at a financial institution to receive payments. Many of these farmers prior to SAC
had no relation with formal financial institutions. Furthermore, relations with financial institutions now open
the possibility that the small holder farmer could potentially access credit. SAC also offers opportunities
for these small holder farmers to take new decisions about crop choices to grow and cultivation practices.
The protection offered by SAC could enable farmers to take some additional risks in choosing to grow other
crops/products or putting more investments in existing crops they grow with potential positive effects on
productivity and income growth.
ACKNOWLEDGEMENTS
31
Best practice guidelines for using subsidized not correlate highly with individual losses, this
catastrophe insurance to complement or replace discretion helps reduce basis risk problems for
DAPs are as follows: farmers,. In Peru, the farmers are pre-identified
individually and know that they are insured.
• First, assess whether insurable catastrophe
When an insured event occurs, they receive
risks are the main problem, otherwise continue
compensation directly into their bank accounts
with a DAP which can be more flexible and ad
from the insurance company (Box 4).
hoc in choosing when to provide assistance.
Also, consider whether it might be better to • If opting for direct farmer insurance such as
invest in infrastructure and technologies that ERVOs, then there needs to be an efficient way
can improve resilience and reduce exposure to of identifying the target households who should
catastrophic losses. receive the ERVOs on a fully subsidized basis.
One promising development is the linking of
• Develop a clearly stated and well documented
DAPs with existing social protection systems,
plan that is agreed with policy makers, and
such as safety net and cash transfer programs,
which is clear about the risks that are to be
as these already have an infrastructure in place
insured and which risks may still need to be
for identifying the poor and vulnerable and
covered by a DAP.
delivering assistance.
• Develop a long term financing plan for the
• By removing important covariate risk, ERVOs
subsidy.
could open the way for supplementary forms
• Determine whether the subsidized insurance of agricultural insurance for some types of
is to be distributed directly to intended farmers. This should be encouraged.
beneficiaries like farmers who would also
• Since DAPs are heavily subsidized, then
receive the claim payments (e.g., ERVOs),
insurance substitutes are likely to be so too.
or used to insure a DAP agency that retains
However, given the ex ante nature of insurance,
responsibility for making payments to
there is greater opportunity with ERVOs to ask
beneficiaries. The Agricultural Fund for
some beneficiaries to pay part of the premium,
Natural Disasters (CADENA) in Mexico is a
perhaps on a compulsory basis, and this
good example of the latter approach (Box 5).
could reduce potential disincentive problems.
In this case, the budget of local governments
As with insurance for poor farmers, it may
for disaster assistance in protected, but farmers
also be plausible to ask poor beneficiaries to
may or may not know that they are insured.
participate in community projects to build
The scheme only specifies what type of
greater resilience.
farmers are eligible to receive assistance but
leaves discretion to the local government to • As with agricultural insurance for farmers,
decide ex post which individual farmers will there should be an M&E system in place
be compensated. Since the insurance payouts and occasional evaluations to check that the
are tied to a regional weather index that may program is achieving its purposes and giving
value.
WHEN AND HOW SHOULD AGRICULTURAL INSURANCE BE SUBSIDIZED? ISSUES AND GOOD PRACTICES
32
Box 5: The CADENA Program in Mexico
The Mexican Agricultural Fund for Natural Disasters (CADENA) aims to internationally reinsure part of the
costs of its state managed relief programs. CADENA was launched in 2003 by the Ministry of Agriculture
and contains two main components: a) the Catastrophe Agricultural Insurance (SAC) program for farmers,
livestock producers, aquaculture farmers and fishermen; and b) in States where SAC is not provided, direct
compensation payments to farmers in the event of natural disasters. Under the program, State Governments
purchase insurance to protect their budgetary allocations against natural disaster compensation for the
most vulnerable farmers. The states are the insured, and the premiums are financed by the federal and state
governments. Payments are made against a number of indices. Small-scale, low-income farmers without
access to commercial crop, livestock, or aquaculture insurance are the intended beneficiaries of the insurance
coverage, and the program is designed to provide a minimum level of compensation to smallholder farmers
to put them back into production following a major catastrophic event. In 2011, the CADENA program
insured about 8 million hectares of crops and slightly over 4.2 million head of livestock. There were around
2.5 million beneficiaries and the total sum insured was approximately US$ 1 billion. CADENA is part of a
larger national program – the Fund for Natural Disasters (FONDEN), which transfers part of its risk to the
international market through reinsurance and the issuing of catastrophe bonds.
Some key characteristics of CADENA:
• Designed as a safety net for small scale farmers (less than 20 ha and 60 Tropical Livestock Units or
TLUs) which covers a small sum insured (about 200 USD per ha).
• State governments are strongly incentivized to opt in the insurance program: they receive a 80-90%
federal premium subsidy when they opt in. Alternatively, if they opt-out, the federal Government supports
60% of ex-post disaster relief expenses (“Direct support”). As a result 30 out of 32 states have opted in
to the insurance program.
• States can choose type of insurance coverage (weather index, area yield, traditional) and have full
autonomy on the use of insurance payouts (can be used to pay next year’s premiums). Most of CADENA
is under area yield index insurance (AYII).
• Municipalities distribute payouts to farmers by check, and farmers need to show proof of identification
and property title.
6. PRINCIPLES AND GOOD PRACTICES IN THE DESIGN OF SUBSIDIES FOR AGRICULTURAL INSURANCE
33
WHEN AND HOW SHOULD AGRICULTURAL INSURANCE BE SUBSIDIZED? ISSUES AND GOOD PRACTICES
34
7. Conclusions
Many governments use subsidized agricultural insurance as an instrument of
choice for helping farmers and rural communities cope with risk; so widely in
fact that globally they spend well over $20 billion annually on such subsidies.
There are many reasons behind these subsidies, some having to do with
market failures and externalities that constrain the development of privately
provided and unsubsidized insurance, and some having more overt political and
social objectives such as helping specific segments of poorer farmers access
insurance, encouraging increased production of important food or export crops,
protecting agricultural lending institutions, reducing the need for disaster
assistance payments, or simply as a politically acceptable means of supporting
farm incomes.
In reviewing the available literature and evidence on insurance subsidies, we are
struck by how little is really known about the effectiveness of insurance subsidies
in achieving their intended purposes, or whether the impacts they generate
justify their costs. In many cases, it is hard to obtain even basic performance
data about subsidized insurance programs and pilot projects, let alone evidence
about how they affect the behavior of financial institutions and private insurers,
or how they impact on the farmers themselves. This leads us to one general
recommendation: there is a fundamental need for more evaluations and impact
assessments of subsidized agricultural insurance programs. This should involve
a) more widespread use of ex ante impact assessments at the design stage of
subsidized insurance programs, b) collection, release and analysis of basic data
about the operations and performance of subsidized insurance programs, and c)
implementation of more formal M&E systems that can provide credible data for
assessing the impacts of insurance subsidies.
While there would appear to be many contexts in which subsidized agricultural
insurance has the potential to offer attractive benefits, experience shows that once
introduced, well known challenges with the design and operation of agricultural
insurance programs, poor design of subsidies, plus political dynamics can all
contribute to disappointing results, an expensive draw on government budgets,
and the creation of disincentive problems that lead to significant economic costs
and inefficiencies, and in some circumstances, to environmental degradation. To
7. CONCLUSIONS
35
avoid these problems, any insurance subsidy needs • Any insurance subsidy that lowers the cost of
to be carefully designed to be “smart”, in the sense insurance to farmers below the actuarially fair
that it is cost effective in achieving its underlying (pure risk) premium rate has the potential to
purpose, minimizes disincentive problems, and create disincentive problems that distort resource
does not become a growing financial burden on allocation decisions. If the insurance is targeted
the government. To this end we have proposed at commercial farmers, then it is best if the
some best practice guidelines for the design subsidy is limited to the insurer’s administration
and implementation of subsidized agricultural and development costs, including any high-
insurance. Some of these guidelines are quite risk loadings due to inadequate data about the
general, while others are more specific to the exact risks involved. As such, the subsidy could be
purpose of the insurance. The general guidelines paid directly to the insurer rather than used to
can be summarized as follows: subsidize premium rates. If the insurance is
targeted at a specific segment of poor farmers,
• First establish that the insurance is the
or is intended to replace part of disaster
appropriate intervention for the risk problems
assistance, then the subsidy will likely have to
that farmers face, and that there are no better
cover part, if not all, of the pure risk premium.
alternatives.
Wherever the subsidy does include part of the
• Then develop a clearly stated and well- pure risk cost, then practices should be adopted
documented purpose for the subsidy that is to reduce disincentive problems. These include
agreed with the relevant policy makers. restricting the amount of subsidized insurance
farmers can buy for each insured crop, and
• As part of the plan there should be an
structuring the subsidy in ways that respect the
explicit exit strategy or long-term financing
relative risk levels across insured activities.
arrangement for the subsidy so that it does not
When the insurance is targeted at poor farmers,
become a growing and uncontrolled financial
they could be asked to pay an in-kind premium
burden on the government.
by working on community projects that build
• Select capable partner institutions for resilience.
implementing the subsidized insurance. Adding
• Wherever possible, and especially for
a subsidy to an already badly performing
subsidized insurance intended for commercial
insurance, credit program, or NGO program or
farmers, the subsidy should be used in ways
project may make things worse, not better.
that crowd in private insurers and encourage
• To avoid adverse distributional outcomes, cap competition among them.
the amount of subsidized insurance available to
• Where the subsidized insurance is intended to
each farmer.
give a segment of poor farmers access credit
• To ensure the subsidy is achieving its intended and thence game changing technologies and
purpose, establish a good monitoring and modern inputs, then the insurance should be
evaluation (M&E) system, and undertake channeled through credible institutions that
periodic evaluations. can a) link the insurance to credit, b) ensure
that access to credit also means access to
Some additional guidelines apply but vary according
complementary inputs, and c) can identify and
to the purpose of the subsidy:
efficiently reach the intended target group of
farmers.
WHEN AND HOW SHOULD AGRICULTURAL INSURANCE BE SUBSIDIZED? ISSUES AND GOOD PRACTICES
36
• In the case of subsidized insurance intended • In regions where both agricultural insurance
to compliment or replace disaster assistance and DAPs or catastrophe insurance coexist,
payments, it is important to identify which then efforts should be made to make them
catastrophe risks the insurance will be able to complementary and not to undermine each
cover, and which will still need to be covered other. Since DAPs or catastrophe insurance
be a disaster assistance program. like ERVOs remove important covariate risks,
they should in principle be complementary to
agricultural insurance that covers some of the
remaining production risks.
7. CONCLUSIONS
37
WHEN AND HOW SHOULD AGRICULTURAL INSURANCE BE SUBSIDIZED? ISSUES AND GOOD PRACTICES
38
REFERENCES
Alderman, Harold, and Trina Haque. 2010. Insurance Against Covariate
Shocks: The Role of Index-Based Insurance in Social Protection in Low-
Income Countries of Africa, World Bank Working Paper No. 95, Africa Human
Development Series, Washington DC. http://elibrary.worldbank.org/doi/
abs/10.1596/978-0-8213-7036-0
Bassoco, Cartas and Norton. 1986. Sectoral Analysis of the Benefits of
Subsidized Insurance in Mexico. In: Hazell, P., Pomareda, C., & Valdés, A.
(eds.). (1986). Crop insurance for Agricultural Development: Issues and
Experience. Baltimore, Johns Hopkins University Press.
Carter, M. 2013. Sharing the risk and uncertainty: Public-private reinsurance
partnerships for viable agricultural insurance markets. Policy Brief No. 78,
Foundation pour les Etudes et Recherches sur le Development International.
Clarke, D. J. 2011. A Theory of Rational Demand for Index Insurance.
Economics Series Working Papers 572, Department of Economics. University
of Oxford. Oxford.
Clarke, Daniel and Stefan Dercon. 2016. Dull disasters? How planning ahead
will make a difference. Oxford University Press.
Cole, S., G. G. Bastian, S. Vyas, C. Wendel and D. Stein. 2012. The effectiveness
of index-based micro-insurance in helping smallholders manage weather-
related risks. London: EPPI Centre, Social Science Research Unit, Institute of
Education, University of London.
Elabed, G and Michael R Carter. 2015. Ex-ante Impacts of Agricultural
Insurance: Evidence from a Field Experiment in Mali. Paper presented at the
Annual Global Development Conference, Casablanca , 13 June 2015 http://
www.gdn.int/fullpaper/Paper%20for%20Session%2017-Elabed-Carter-
Cotton-Ex-Ante%20Impacts%20of%20Agricultural.....pdf
Gentilini, Ugo. 2016. The revival of the “Cash versus Food” debate; New
evidence for an old quandary. Policy Research Working Paper 7584, World
Bank, Washington DC.
REFERENCES
39
Glauber, J. W. 2012. The Growth of the Federal Kenny Tang, http://www.researchandmarkets.com/
Crop Insurance Program, 1990-2011, Amer. J. Ag. reports/1213964/weather_risk_management_a_
Econ. 95(2): 482-488. guide_for.pdf
Glauber, J. W. 2015. Agricultural Insurance and the Hill, R. V., G. Gajate-Garrido, C. Phily and A. Dalal.
World Trade Organization. IFPRI Discussion Paper 2014. Using subsidies for inclusive insurance:
01473, October. lessons from agriculture and health. Microinsurance
Paper No. 29, ILO, Geneva.
Grosh, M., C. del Ninno, E. Tesliuc, and A. Ouerghi
2008: For Protection and Promotion: The Design Jensen N., and C. Barrett. 2017. Agricultural Index
and Implementation of Effective Safety Nets. Insurance for Development. Applied Economic
World Bank, Washington DC. Perspectives and Policy, forthcoming.
Hazell, Peter, Peter Oram, and Nabil Chaherli. Karlan, D., R. D. Osei, I. Osei-Akoto, and C. Udry.
2003. Managing Livestock in Drought-Prone Areas 2012. Agricultural Decisions after relaxing credit
of the Middle East and North Africa: Policy Issues. and risk constraints, NBER Working Paper No.
In Food, Agriculture, and Economic Policy in the 18463. http://www.nber.org/papers/w18463
Middle Eas and North Africa, Volume 5. Hans
Kunreuther, H.C., R. Ginsberg, L. Miller, P. Sagi,
Löfgren (ed.), pp. 70-104, New York: Elsevier
P. Slovic, B. Borkan, and N. Katz. 1978. Disaster
Science, Ltd.
Insurance Protection: Public Policy Lessons. New
Hazell, P. 1992. The Appropriate Role of York, NY: John Wiley and Sons.
Agricultural Insurance in Developing Countries.
Mahul, O. and C. J. Stutley. 2010. Government
Journal of International Development, 4(6): 567-
Support to Agricultural Insurance: Challenges and
581.
Options for Developing Countries. World Bank,
Hazell, P., Pomareda, C., & Valdés, A. (eds.). 1986. Washington DC.
Crop insurance for Agricultural Development:
Morsink, K., D. J. Clarke and S. Mapfumo.
Issues and Experience. Baltimore, Johns Hopkins
2016. How To Measure Whether Index Insurance
University Press.
Provides Reliable Protection. Policy Research
Hess, U., P. Hazell, and S. Kuhn. 2016. Innovations Working Paper 7744, World Bank.
and Emerging Trends in Agricultural Insurance.
Pomareda, C. 1986. An evaluation of the impact
Deutsche Gesellschaft für Internationale
of credit insurance on bank performance in
Zusammenarbeit (GIZ) GmbH, Bonn and Eschborn,
Panama. In: Hazell, P., Pomareda, C., & Valdés,
Germany. https://lnkd.in/eVsH4xh
A. (eds.). (1986). Crop insurance for Agricultural
Hess, Ulrich, Niels Balzer, Sandro Calmanti Development: Issues and Experience. Baltimore,
and Michael Portegies-Zwart. 2010. CERVO: Johns Hopkins University Press.
Community Early Recovery Voucher Scheme for
Tadesse, M. A., F. Alfnes, O. Erenstein and S.
Catastrophic Weather Disaster Hedging. In: Weather
Holden. 2016. Demand for a labor-based drought
Risk Management: A Guide for Corporations,
insurance scheme in Ethiopia: a stated choice
Hedge Funds and Investors, March 2010, Ed. by
experiment approach. Agricultural Economics,
00(2016): 1-11.
WHEN AND HOW SHOULD AGRICULTURAL INSURANCE BE SUBSIDIZED? ISSUES AND GOOD PRACTICES
40
Tsujii, H. 1986. An Economic Analysis of Rice World Bank. 2015. Bangladesh: Agricultural
Insurance in Japan. In: Hazell, P., Pomareda, C., Insurance Solutions Appraisal Technical report,
& Valdés, A. (eds.). (1986). Crop insurance for World Bank, Washington DC.
Agricultural Development: Issues and Experience.
World Bank. 2016. Ethiopia Public Expenditure
Baltimore, Johns Hopkins University Press.
Review. Report No: ACS14541, World Bank,
Washington DC.
REFERENCES
41
WHEN AND HOW SHOULD AGRICULTURAL INSURANCE BE SUBSIDIZED? ISSUES AND GOOD PRACTICES
42
Annex: The Choice Between
Subsidizing An Insurer’s Costs
Verses Providing Subsidized
Reinsurance
A common problem in setting up a new insurance program in data-sparse
environments is that the insurer has inadequate data to properly assess the
actuarial risks, and so adds a high-risk loading component to the premium rate
it charges farmers. Although initially high, this risk loading component can be
expected to fall once the insurer has acquired additional data over time. Climate
change can lead to a similar problem even with established lines of insurance,
since the insurer is confronted by growing uncertainties about the risks they are
insuring. An insurance subsidy introduced as an interim measure to offset part
of the risk loading component of the premium rate charged can help overcome
this problem. An alternative, and possibly more cost effective solution is for
governments to reinsure at subsidized rates some of the extreme layers of risk
faced by the insurer, (Carter, 2013).
Box 6 reviews the pros and cons of providing reinsurance arrangements for
insurers, and the circumstances under which this is better than a direct premium
subsidy. Where reinsurance is warranted, it can be implemented through the
establishment of a public reinsurance company, which provides reinsurance
support to commercial insurers (for example, Agroasemex in Mexico).
Alternatively, a stop loss is an agreement for governments to pay claims
directly to insurance companies above a pre-agreed loss limit (expressed as a
percentage of claims) in the event of a major shock. In order for the government
to control its risk exposure in a stop-loss arrangement, there is generally an
agreement on the minimum premium rate to be charged by insurers. Stop loss
agreements can be funded from government reserves, through contingent debt
financing (e.g. from the World Bank in the case of Mongolia), or by partnering
with a reinsurance company (paying them a regular premium in return for the
reinsurer paying claims).
However, governments do face operational challenges when offering
reinsurance, such as those arising from the cost of managing budget volatility,
timeliness of claim settlement, and challenges with risk-based pricing. Holding
large budget lines or capitalizing large contingency funds that will only be
drawn down according to the rules of the reinsurance that government is
providing can be economically costly, and can undermine sound public financial
management principles. For example, it can be challenging for governments
ANNEX: THE CHOICE BETWEEN SUBSIDIZING AN INSURER’S COSTS VERSES PROVIDING SUBSIDIZED REINSURANCE
43
to justify not fully exhausting contingency funds agricultural insurance programs do so by partnering
when moderately sized disasters occur, even with a regulated reinsurance company or companies,
though additional payments are not due under the paying them a regular premium in return for the
reinsurance contract. Moreover, if the reinsurance reinsurer(s) paying any claims that government
subsidy extends into a more permanent arrangement, has taken responsibility for as they fall due. Box
it may provide incentives for farmers or insurers to 7 provides some contrasting examples illustrating
‘game the system’ by acting in inefficient ways that circumstances when subsidized reinsurance is and
increase the cost to government but reduce the cost is not preferable to subsidized premium payments
to the farmer or insurer. (as in the US) For these for covering risk-loading costs.
reasons, some governments that offer reinsurance to
Box 6: Pros and Cons of Premiums Subsidies and Public Reinsurance of
Extreme Risk Layers
Year Premiums Subsidies Public Reinsurance for Extreme
Risk Layer
Requirement Low: Government only pays for a High: Government might be exposed to
for financial share of commercial premiums ( ex- severe losses which require setting aside
capacity ante payment) large amounts of capital from the beginning
of the project (e.g. Mongolia, Mexico)
Cost- Uncertainty loads Uncertainty loads
effectiveness • In data-sparse environments, insurers • the uncertainty-neutral public sector
charge high uncertainty loads on reinsures extreme layers of risks at a
extreme layers of risks(cf Carter, 2013) lower cost to insurers, which benefits
• For products where long data series farmers
are available (e.g. Satellite products), Profit margins
or where insurance companies see • if no claims are paid during the project
strong market potential, commercial period that money can be rolled over
premiums might not include high to future risk periods
uncertainty loads (e.g. Kenya).
Financing costs
Profit margins • Setting-aside large amounts of capital
• Premiums subsidies are partially might be very costly for Governments
subsidizing insurance companies’ (depends on borrowing rate/
profit margins (not only claims paid to investment returns)
farmers), which Governments/Donors
might be reluctant to do.
Sustainability Premiums subsidies might constitute If the Government does not set a threshold
a large fiscal burden for Governments for commercial premiums, or set the
over time, and are often hard to phase- stop-loss too low, this might not provide
out (Mahul and Stutley, 2010) incentives for insurance companies to
manage risks (e.g. India NAIS). Setting
a threshold for commercial premiums
might be complex where demand
cannot be estimated easily.
WHEN AND HOW SHOULD AGRICULTURAL INSURANCE BE SUBSIDIZED? ISSUES AND GOOD PRACTICES
44
Outreach Premiums subsidies have a direct Stop-loss have can help decrease
(number of positive impact on sales (Cai, 2011) commercial insurance premiums
farmers) rate, but not as much as premiums
subsidies (given a fixed amount of
public support). Stop loss might
have reduced farmer’s outreach (e.g.
Mozambique).
Level of Insurers might not offer risky Public Reinsurance of extreme layers
coverage per products without stop loss (e.g. may incentivize insurers to offer
product I4 projects insurers would not offer innovative or risky products (e.g.
products in half of villages - Hill, Mongolia)
2014)
However Government might choose
to only subsidize certain types of
products to ensure products protect
farmers when bad shocks happen (e.g.
Kenya)
Political High visibility of Government support Low visibility of Government support,
visibility to farmers which can also make exit strategy easier.
Source: Rachel Sbero.
Box 7: Some Examples of Public Reinsurance Arrangements Verses Direct
Subsidies for Risk Loading Costs
Mexico - Setting up a Public Reinsurance Company
Fondos are self-insurance funds that have been operating in Mexico since 1988. In 2004, more than 240
Fondos provided insurance against agricultural production risks (including hail, drought, frost, floods,
diseases, pests) to their members, accounting for 50 percent of the total insured agricultural area in
Mexico. The total liability of the Fondos on an annual basis was approximately US$$400 million dollars
in 2004. The Fondos are not allowed to sell insurance to their members unless they have a proper
reinsurance treaty negotiated before the beginning of any specific agricultural cycle of production. Since
these organizations do not have capital to guarantee the solvency of the Fondos, they must buy enough
reinsurance to guarantee that the members of the Fondo will receive the full amount of indemnity in the
case of a peril. The regulation requires that any reinsurance contract negotiated by the Fondos should
be defined to absorb any exceeding indemnities after the financial reserves of the Fondos have been
exhausted. Therefore, an unlimited stop loss reinsurance treaty is implicitly requested. Historically,
the state-owned reinsurance company Agroasemex has offered to the Fondos this unlimited stop loss
program. Agroasemex provides stop-loss insurance of up to 100 per cent of the total sum insured to
mutuals of smallholder farmers whereas traditional stop-loss reinsurance agreements would usually cap
the percentage of the total sum insured that they cover.
ANNEX: THE CHOICE BETWEEN SUBSIDIZING AN INSURER’S COSTS VERSES PROVIDING SUBSIDIZED REINSURANCE
45
Index-Based Livestock Insurance Program: In a Data-Sparse
Environment, Public Reinsurance of Extreme Risk Layers Can Create
Confidence and Crowd-In Private Insurance and Reinsurance
Started in 2005, this program involved a combination of self-insurance by herders, market-based insurance,
and social insurance. Herders retain small losses, larger losses are transferred to the private insurance industry,
and extreme or catastrophic losses are transferred to the government using a public safety net program. A
syndicate pooling arrangement protects participating insurance companies against excessive insured losses,
with excess of loss reinsurance provided by the government. The fiscal exposure of Government of Mongolia
toward the most extreme losses is protected with a contingent credit facility.
The Government of Mongolia was double exposed to livestock mortality risk under this livestock insurance
program (see figure 3 below). First, it covers losses exceeding a specific threshold (e.g., 25-30% of livestock
mortality rate) through the Disaster Response Program (DRP). Second, it acts as a reinsurer of last resort for
the insurance companies selling the Base Insurance Product (BIP) through stop loss provision at 105% of the
base premiums sold to the LIIP (Livestock Insurance Indemnity Pool (LIIP). This double exposure required
adequate financing in order to avoid an increase in the fiscal burden of the government. This was financed
through: reinsurance premiums received from insurance companies, Government Budget and World Bank
Contingent Loan.
Figure 3: Government of Mongolia Is “Double Exposed” to Extreme Risks
Shock Lifestock
Frequency Mortality
Rate Disaster Response
1 Program (DRP)
1 in 25 Years 30%
Stop loss reinsurance at
2 105% of pre,iu,ms volume
Base Insurance Product
1 in 5 Years 7%
Self-Insurance
This reinsurance agreement between the insurance pool and the government was designed to give the insurance
industry time to find external capital on the reinsurance market. Indeed, after seven years, US$ 10 billion
was transferred to international reinsurers as part of the Mongolian scheme. The Mongolian IBLI has gone
from government reinsurance to international reinsurance funded by donor funds (with some government
reinsurance for losses in excess of 2 billion Mongolian Tughriks).
WHEN AND HOW SHOULD AGRICULTURAL INSURANCE BE SUBSIDIZED? ISSUES AND GOOD PRACTICES
46
Mozambique: Not Enough Capital for Stop Loss to Boost Demand
In Mozambique, GIIF is supporting the development of index insurance and has conducted a comparative
analysis of two options: (1) premiums subsidies, (2) stop loss. Comparing the two options with the same
amount of public support over five years (amounting to 1 million USD), it was estimated that this volume
of financial support would not be sufficient enough for the stop loss to cover extreme layers of risk (e.g.
when claims are above 600% of premiums received). Therefore, preliminary discussions with insurers
highlighted that the effect of the stop loss would be minimal on premiums rate (e.g. 10% discount on
commercial premiums). It was estimated that a stop loss would only reach 60% of the insurance uptake
achieved through premiums subsidy. It was therefore recommended to support agriculture insurance
through premiums subsidies.
Kenya: Limited Uncertainty Loads, Due to Strong Growth Potential and
Investments in Data
The WBG has supported the Government of Kenya in setting up a Public Private Partnership for the
development of livestock and crop insurance (see Figure 4 below). In this case, the Government has opted for
premiums subsidies (50% or 100% depending on product), rather than a stop loss.
Figure 4: Agricultural Insurance Program in Kenya
Livestock Insurance Crop Insurance
Pasture Degradation Asset Protection Index Area Yield Index Insurance
Insurance
• Initially for maize and wheat farmers, further
• Component 1 crops considered going forward
• Fully subsidized insurance-linked social
protection for the most vulnerable • Linkage to agricultural credit and inputs
pastoralists • 50% premium subsidy
• Component 2 • Government target of reaching over 170,000
• 50% premium subsidy support farmers across all 33 crops growing counties by
• Government target of reaching 70,000 2019
vulnerable pastoralists across all 14 ASAL
counties by 2017
As opposed to the livestock insurance product (based on satellite imagery), the crop insurance product
was based on area-yield data, for which long data series were not available. It was expected that
insurers would charge high uncertainty loads on the crop insurance product. However, given the strong
commitment of the Government to support a large-scale program over time and invest in data collection,
insurers did not charge high uncertainty loads. On average, commercial premiums for products that
would cover 1-in-7 year events reached 7%, which would be brought down to 3.5% for farmers with a
50% subsidy. The Government has therefore opted for a premium subsidy.
ANNEX: THE CHOICE BETWEEN SUBSIDIZING AN INSURER’S COSTS VERSES PROVIDING SUBSIDIZED REINSURANCE
47
South Africa: Premiums Subsidies Could Be More Cost-Effective Due to
Good Data Availability and High Opportunity Cost of Capital
The WBG has supported the Government of South Africa in comparing various options for Public Private
Partnership for the development of multi-peril crop insurance. The analysis showed that good data on
commercial farming already existed and data uncertainty loadings in pricing were low, therefore limiting
challenges associated with premium subsidies.
Given South Africa’s cost of sovereign borrowing, and the annual effective interest rate that would be obtained
on undisbursed reserve funds, the opportunity cost of pre-financing a reserve fund invested in liquid assets for
a stop loss would be high (Clarke et al, 2016).
WHEN AND HOW SHOULD AGRICULTURAL INSURANCE BE SUBSIDIZED? ISSUES AND GOOD PRACTICES
48
FINANCE & MARKETS GLOBAL PRACTICE | GLOBAL INDEX INSURANCE FACILITY
www.indexinsuranceforum.org www.ilo.org/impactinsurance
LinkedIn Group: Global Index Insurance Forum impactinsurance@ilo.org
Global Index
Insurance Facility
MANAGED BY