60178 NOVEMBER 2010 ABOUT THE AUTHORS Making Insurance Markets Work for Farmers OLIVIER MAHUL (omahul@worldbank.org) in India is the Co-task Team Leader and Program Coordinator in the India’s crop insurance program is the world’s largest with 25 million farmers Finance and Private-Sector Development Global Capital insured. Yet 85 million farmer households are not covered. Issues in design, Markets Non-Banking Unit. He has expertise in agricultural particularly related to delays in claims settlements, explain the low coverage. insurance and disaster risk To address these problems, the World Bank provided actuarial inputs, financing. engaged in policy dialogue, and facilitated the launch of an innovative crop NIRAJ VERMA insurance program that would improve equity, risk mitigation, and claims (nverma@worldbank.org) is the Co-task Team Leader and settlement for farmers; provide tools for budget management and Senior Financial Sector Specialist in the South Asia agricultural policy for government; and open up the market for public- and Region Finance and Private- private-sector insurers and reinsurers. Initially, the program will be available Sector Development Unit. His expertise is in banking and to an estimated 8 to 10 million farmers, of whom 3 million are expected to access to finance. participate in the first year with a total sum insured in excess of $1 billion. APPROVING MANAGER Over time, this project could be scaled up to be available to India’s 110 Ivan Rossignol, Sector Manager of the South Asia Finance and million farmers. This SmartLesson describes lessons learned in developing Private-Sector Development Unit. and implementing the crop insurance program. Loic Chiquier, Sector Manager of the Finance and Private- Sector Development Global Background Agriculture Insurance Company of India (AICI), Capital Markets Non-Banking is the main crop insurance program in the Unit. The need. With a high degree of dependence country and has been supplemented more on rain-fed cultivation, India needs a well- recently by the Weather-Based Crop Insurance developed and widely used agriculture Scheme (WBCIS). insurance program. For more than 110 million farmer households (of whom 80 percent are The broad structure of NAIS is technically small and marginal farmers operating less sound and appropriate in the context of India. than two hectares), access to risk mitigation NAIS is based on an indexed approach known for crop production is critical. Otherwise, they as the area yield-based approach, where the run the risk of crop failures, which in turn, index used is the crop yield of a defined area leads to an inability to service debts. Because called an insurance unit (IU, e.g., an successive crop cycles follow seamlessly from administrative block). The actual yield of the one to the next, delinquency on account of insured crop, measured by crop-cutting one crop failure means being ruled out of the experiments in the IU, is compared to historical formal banking system, leading to dependence yields. If the former is lower than the latter, all on high-cost informal sector credit and a insured farmers in the IU are eligible for the potential debt trap. Crop insurance also helps same rate of indemnity payout. Individual enhance the viability of agriculture lending crop insurance would have been virtually through risk mitigation and hence is vital for impossible, given the large number of very banks. small landholdings. Further, using the area yield-based approach has other merits. Most The response so far. The government of India importantly, it mitigates moral hazards and (GOI) has historically focused on crop insurance adverse selection. as a planned mechanism to mitigate the risks of natural perils on farm production. The The problem. NAIS is funded by post-disaster National Agriculture Insurance Scheme (NAIS), government contributions, entailing an open- implemented by the public crop insurer, the ended and highly variable fiscal exposure for SMARTLESSONS — NOVEMBER 2010 1 the government. Being subsidized, the annual claim/ The NLTA Project produced the following key outputs and farmers’ premium ratio is higher than 100 percent. At the milestones: end of the crop season, aggregate claims exceeding the farmers’ premium, are funded 50-50 by the state and • a detailed review of NAIS, including its underwriting central governments. India’s post-disaster funding and ratemaking methodology. arrangement, which, in turn, was necessitated on account of a lack of an actuarially sound premium rating • development of a best practice standard actuarially methodology without which estimating payouts is not sound ratemaking procedure (as a public good) using feasible, is not optimum for budget management for the an experience-based approach for area-yield insurance. GOI and delays claims settlement, leading to farmers’ This became the foundation for a move to an ex-ante, distress and exposing them to a vicious debt cycle. This market-based crop insurance program, as the actuarial situation explains NAIS’s low coverage (20 percent) and that prices helped assess farmer, state, and central of banks lending to farmers (45 percent). government contributions to premiums up front. The solution. The GOI asked the World Bank to improve the • development of commercial weather-based crop crop insurance program through an actuarially sound rating insurance products, which led to an increase in the AICI methodology that would improve the design of NAIS and weather-based crop insurance portfolio to almost 1 reduce delays in claims settlement. The Bank was asked to million farmers and a total annual premium volume in propose design and ratemaking of new weather index excess of $50 million. insurance products under the WBCIS, perform a risk assessment of AICI’s insurance portfolio, and suggest cost- • detailed inputs into the design of the innovative effective risk financing solutions (including reinsurance). modified NAIS (mNAIS) for India (see Box 1). The project, conducted in three successive phases, culminated in 2010 and entailed working closely with the • a buildup of AICI’s capacity to transition NAIS to a client and national and international experts. The Bank also market-based approach. provided capacity building in the form of quarterly visits by the Bank’s team (including a certified actuary) and monthly • a policy dialogue, in parallel with the Ministry of teleconferences. Finance, the Ministry of Agriculture, and the Planning Commission, about the fiscal impact of the modified This work started with funding from the Swiss Development NAIS for the GOI as well as the welfare implications of and Cooperation Agency (Phase 1, 2005) to engage a the modified scheme dialogue with the GOI on agricultural insurance. During Phase 2, 2005–2007, the FIRST Initiative provided technical • a decision to launch an mNAIS pilot in 50 districts for and financial assistance for the development of an three seasons, starting in Rabi in the winter of 2010. actuarially sound product design and ratemaking methodology for the NAIS and the WBCIS. Under Phase 3 • prototype actuarial software design and pricing of more (2008–2010) of the nonlending technical assistance (NLTA), than 200 insurance products, as well as advice on the use funded by the Global Facility for Disaster Reduction and of mobile technology for improving crop-cutting data Recovery, the actuarial methodology developed under quality and timeliness. Phase 2 was made operational through the development of prototype actuarial software and intensive technical In September 2010, the GOI approved the mNAIS, reflecting capacity building. In addition, these actuarial and risk most of the Bank’s suggestions, moving from a social crop assessment tools were used as part of a policy dialogue on insurance scheme to a market-based crop insurance program the fiscal impact of agricultural insurance. involving the private insurance and reinsurance industry. The implications of this project for the performance and Box 1. Main Features of mNAIS • Actuarial regime: The mNAIS scheme operates on an “actuarial regime” in which the government’s financial liability would be predomi- nantly in the form of premium subsidies given to AICI and funded ex-ante, thereby reducing the contingent and uncertain ex-post fiscal exposure currently faced by the government under NAIS, and reducing delays in claims settlement. • Up-front premium subsidies: AICI receives premiums (farmer collections + premium subsidies from the government) and is responsible for managing the liability of the mNAIS through risk transfer to private reinsurance markets and risk retention through its reserves and is able to operate on a sustainable basis. • On-account partial payment: The mNAIS product continues to be based on an area yield-based approach, with a provision for an early part payment to farmers (in season) based on weather indices. • Small IUs: Crop-cutting experiments conducted to assess crop yield estimates are lowered from the block level to the village level to reduce basis risk (i.e., the mismatch between the actual individual crop yield losses and the insurance indemnity). • Cutoff dates. Adverse selection is reduced through the enforcement of early purchase deadlines in advance of the crop season. • Additional benefits. Additional benefits are offered for prevention of sowing, replanting, post-harvest losses, and localized risk such as hail losses or landslides. 2 SMARTLESSONS — NOVEMBER 2010 Box 2: Key Benefits from mNAIS • Actuarial rating enables risk-based pricing and ex-ante estimation of subsidy (better budget management). Risk-based pricing helps differentiate risks and improve equity between farmers (Figure 1 shows highly varied risk profiles within a state al- though all farmers were earlier paying the same premium under NAIS). Risk-based pricing can also be used for agriculture policy signaling. For example, in the case of a crop with a very high premium rate, the mNAIS could indicate that it should not be grown in a given area, and this could feed into agriculture extension policy. • Ex-ante subsidy determination enables up-front government and farmer contributions toward premiums, thereby passing residual risks to the insurers (market approach) and enabling fast claim settlements. • Combining weather-indexed insurance (that allows for quick payments and enables interim payments within a crop season) with area yield insurance (that allows for payouts with closer correlation to yield losses) makes the best use of both indices. • Improving the underwriting terms and conditions of the crop insurance policy, such as purchase deadlines and additional benefits, makes the product more sustainable. • Increasing competition and expanding the role of the private sector in crop insurance contribute to the promotion of effective public-private partnerships in agricultural insurance. sustainability of the mNAIS are monumental: Although ensured the financial sustainability of the program and its initially this product could be available to 8 to 10 million relevance to the country context. An open approach helped farmers, over time it could be expanded to India’s 110 close collaboration with the client, leading to drawing on million farmer households with improved crop insurance their country and domain knowledge to a significant products and timely claims settlement (see Box 2 for key extent, a process which also enabled the Bank team to learn benefits of mNAIS). The modified scheme crowds in the from the client’s experience and knowledge. private insurance sector by allowing domestic insurance companies to offer mNAIS and by attracting international Adaptations were required in order to make the rating reinsurance capacity. Finally, the GOI will be better equipped methodology practical. For example, while risk differentiation to manage its fiscal exposure to natural disasters, while is desirable from an actuarial viewpoint, applying it to each IU insurance companies will now bear risks and compete to (left side, Figure 1) would have been difficult because of offer products and services to farmers. political and administrative constraints. A second-best approach was deployed, using district pricing (right side, Lessons Learned Figure 1) and a strategy to keep the nominal price constant but vary the coverage levels (insurance deductibles). 1) Make sure that any state-of-the-art tools are developed in close collaboration with the client, and be 2) Design technical tools that can pave the way for prepared to deploy second-best technical solutions policy dialogue. when necessary to reflect on-the-ground realities and political and economic considerations. The actuarial tool by itself was the defined output sought by the client. These actuarial tools were used as the basis for Drawing on international best practice and in-country a shift from ex-post to ex-ante funding. They were also used experience, the rating methodology improves pricing of to demonstrate efficiency and the political and economic catastrophic losses and allows decomposition between gains possible through faster claims settlements. The tools catastrophic and noncatastrophic losses, which helps attract therefore helped translate technical work into policy international reinsurance capacity. The rating methodology dialogue. The result was the launch of a new program potentially benefiting India’s 110 million farmers in the coming years. Figure 1. Pure Premium Rate at 90% Coverage Level, Rice Crop in Province A Figure 2. NAIS Premium Income and Claims by State Note: Rs 1 lakh is approx. $2,500. SMARTLESSONS — NOVEMBER 2010 3 Conclusion Figure 3. NAIS Loss Ratio for Major Crops, 2000-07 The shift from a social crop insurance program with ad-hoc funding from the GOI to a market-based crop insurance program where the product design and premium rates are actuarially sound makes the Indian crop insurance program attractive for private insurance and reinsurance companies. Two domestic private insurers already agreed with some states to offer mNAIS in Rabi in 2010. The public insurer AICI is currently looking for international reinsurance capacity for its mNAIS Further, actuarially sound premiums signaled insurance portfolio. the true cost of growing a given crop in a given district and informed decision makers The piloting of mNAIS is under way in 50 about the viability of some crops in some districts (around a tenth of India). This is a regions and the social cost of maintaining major step forward and can help improve risk them. The actuarial tools were also used to mitigation for farmers, benefit lenders to inform policymakers about the fiscal impact farmers, improve budget management, and of public premium subsidy programs, assess develop private insurance markets. However, targeting (coverage of crops and small and key challenges remain, including improving marginal farmers versus others), and analyze yield estimation, promotion of the product, the associated wealth transfers between the and streamlining of the budget processes. The central government and the states (Figures 2 Bank team is in discussions regarding follow- and 3). up support for institutional capacity building, implementation assistance to increase 3) Invest in extensive institutional capacity outreach, and further fine-tuning of the building and technical inputs for both the product to support development of the crop implementing agency and policymakers. insurance market. Agricultural insurance is a highly specialized line of business that requires intensive institutional capacity building. Major efforts were invested to ensure that the proposed technical recommendations would be fully understood and implemented. Anchor and regional staff, with the assistance of an international certified actuary, provided intensive training to AICI technical staff through technical documents, monthly teleconferences, and quarterly on-site visits. 4) Combine traditional and innovative crop DISCLAIMER insurance. IFC SmartLessons is an awards program to share lessons learned in development-oriented advisory Although much of the development services and investment literature and debate in India and elsewhere operations. The findings, center on traditional versus new generation interpretations, and conclusions (weather-based) insurance, the team here expressed in this paper are those used technical grounds to demonstrate the of the author(s) and do not necessarily reflect the views of IFC benefits of combining the two approaches, or its partner organizations, the based on their respective comparative Executive Directors of The World advantages. Weather-based indices are used Bank or the governments they for on-account partial payment of claims in represent. IFC does not assume any responsibility for the case of adverse mid-season conditions, while completeness or accuracy of the area yield indices are used for final payment information contained in this of claims. document. Please see the terms and conditions at www.ifc.org/ smartlessons or contact the program at smartlessons@ifc.org. 4 SMARTLESSONS — NOVEMBER 2010