Rethinking the Role of Index Insurance—Accessing Markets for the Poor

FARMD (September 2011) | “Don’t be seduced with the logic common wisdom suggests; in the index insurance field there is a lot of logic, yet it implies a lot of effort to make it work”— said Jerry Skees at the FARMD annual conference. Skees highlighted the challenges associated with index insurance, a financial innovation receiving considerable attention in the last decade, but that is still in need of experimentation and learning to truly understand the role that it can play in breaking the poverty trap.  

 

In his presentation, Jerry Skees, Director of GlobalAgrisk, provided perspectives on the experience of his company in this field. Although there is a common understanding of the problems associated with index insurance products, in terms of basic risks, limited demand, the challenges associated with scaling-up products, etc.; Skees drew attention to the need “to rethink and recast the problem, even in terms of the fundamental economics.”

 

In his view, index insurance products are best suited for natural disasters and the catastrophic losses. Natural disasters in developing countries constitute a correlated risk, in which catastrophic losses occur simultaneously and destabilize poor farmers’ income in a way that can lock them into a poverty trap. This is a high cost in society that someone has to pay.

 

GlobalAgRisk, Inc. focuses on designing sustainable and scalable weather index insurance programs to deal efficiently with these correlated risks around the world, such as El Niño in Peru; livestock death in Mongolia; and flood and drought in Vietnam among others. 

 

An uninsured risk of such magnitude takes a toll at every level. The poor farmer pays through direct losses and long-term economic impacts. Financial institutions constrain loans as they learn that the correlated losses of many of their borrowers create banking problems.

 

Finally, government subsidizes agricultural insurance, while donors forgive the holders' debt. However, often this kind of interventions actually undermines the emergence of markets and new moral hazards appear as people take more risks if they will be paid for doing so. 

From initially working with micro-level contracts, GlobalAgRisk has taken the approach of working directly with the risk aggregators: financial institutions and actors in the value chain.  Index insurance addressing weather risk of firms serving the poor presents a feasible avenue for market growth by building a sustainable market first and then moving to micro products. Skees briefly presented experiences from Peru and Mongolia (Watch the videos above) illustrating the importance of agregators and risk layering.