Feed the Future
This project is part of the U.S. Government's global hunger and food security initiative.

A Minimum Quality Standard for Agricultural Index Insurance

Agricultural index insurance has shown significant promise as a development tool to promote resilience and to accelerate the end of the need for aid. Feed the Future AMA Innovation Lab researchers have found benefits that include increased health and well-being among pastoralists in Kenya and significantly increased cash crop investments for cotton farmers in Mali and Burkina Faso.

While these kinds of benefits can promote food security and resilience, effectively implementing agricultural index insurance in developing economies around the world has been a challenge. Markets have struggled with expensive but poor-quality contracts and low levels of adoption by farmers. There are also no existing regulations for index insurance quality.

The Feed the Future Innovation Lab for Assets and Market Access (AMA) Index Insurance Innovation Initiative (I4) is at the leading edge of research to improve agricultural index insurance contracts and interventions worldwide. This post is the fourth in a five-part series on index insurance in partnership with Marketlinks. Catch up with post 1 introduction to index insurance, post 2 how index insurance promotes development and resilience, and post 3 indices for insurance.

Governments and donors have rapidly increased investments in agricultural index to promote resilience among households who are vulnerable to weather-related shocks. Index insurance has shown tremendous promise where conventional agricultural insurance is not possible or cost-effective, but this promise can only be reached with high-quality contracts that genuinely protect households.

By definition, agricultural index insurance always has the potential to fail. While some failure is unavoidable, it becomes a problem when the overall quality of a contract is so low that it is most likely to leave farmers worse off than if they had no insurance at all.

Why Agricultural Index Insurance Contracts Fail

One factor that determines the quality of agricultural index insurance is how well the underlying index predicts actual losses on the ground. Index insurance works because an area’s average vegetation growth, weather, or yields can be used to build an index that estimates a farmer’s losses. If it does not, a contract might not pay out when a farmer experiences a loss. It also might pay when a farmer hasn’t.

This kind of contract failure was identified in a World Bank study of a national weather-based crop insurance program in India from 1999-2007. Farmers who experienced total losses had a 33 percent chance of receiving no payment. Farmers with yields at twice the historical average had a 45 percent chance that they would receive a payment.

Another factor that determines agricultural index insurance quality is the contract itself. This includes its pricing and when it is designed to trigger payouts for estimated losses. A contract could trigger payments when there are real losses and still be low quality because the premiums are marked up so high that payouts will never approach a fair proportion of the cost of coverage.

A Minimum Quality Standard for Agricultural Index Insurance

When an index insurance contract fails, a farmer faces a crop loss in addition to the money spent on insurance. The situation is especially dire if having insurance motivated her to take out a loan to invest in higher productivity. In a bad year, she would lose all her income and have no way to repay the loan.

The AMA Innovation Lab defines a quality index insurance contract as one for which the cost in premiums has the potential to leave a household with more financial stability than if they had no insurance at all or an equivalent cash transfer. This definition is the basis for the Innovation Lab’s Minimum Quality Standard (MQS) for agricultural index insurance.

An objective measure for minimum quality is only the first step. Because there is no inherent incentive for offering high-quality contracts, the next step to ensure quality is the broad adoption of a minimum quality certification.

Broad adoption could involve a body of technical specialists who test products to meet government or donor regulatory requirements. For example, national seed sectors rely on germination and yield testing from their own ministries of agriculture. Market-based examples include UL, an body of technical specialists that provides internationally recognized certifications, and ISO, which develops international standards.

For individual farmers, a certification for MQS would ensure a basic level of transparency for complicated financial instruments that could transform their long-term resilience. For governments and donors, it would provide security that investments in promoting agricultural index insurance can have a real impact.

The Feed the Future Innovation Lab for Assets and Market Access at UC Davis conducts and supports research on policies and programs designed to help poor and smallholder farmers worldwide to manage risk, adopt productive technologies, and take an active part in economic growth.