POLICY IMPLICATIONS OF PRICE DYNAMICS AND THE WAY FORWARD - Food Security, Food Prices and Climate Variability - page 185

There are several recent index insurance projects for low-income developing countries that
are growing dramatically, in spite of concern that index insurance demand is not strong (Ban-
erjee and Duflo, 2011; Cole et al ., 2009; Hazell et al ., 2010; Giné and Yang, 2009). Even where
there are programs available, there is low uptake by the community because of a lack of trust
in institutions and governments. Given their growth, the potential for both undesirable and
unintended negative consequences are large due to the number of index insurance projects
exploding from only a few hundred clients to tens of thousands of clients in only two to three
years (Syngenta, 2011; Oxfam, 2011). In India, subsidized index insurance has been adopted
for the first time by many millions of farmers in less than ten years (Clarke et al ., 2012). Since
projects like these have exhibited such dramatic growth it is critical to get them right.
Index insurance is not a gift or a subsidy, but a way in which a person/farmer can pay a small
amount in good years and receive protection in bad years. Typically, in existing pilot projects,
premiums have been designed to provide one year of insurance coverage only, and are not
cumulative. Farmers make the decision each year as to whether or not they wish to re-purchase
insurance for the coming growing season. If yes, then they can pay the premium and receive
coverage for that specific year. The use of a parametric trigger or index has particular advantages
in a developing country context, as it reduces or eliminates economic constraints such as moral
hazard or an incentive to cheat and high transaction costs that reduce the viability of traditional
indemnity-based agricultural insurance in these areas (Brown et al ., 2011). However, a trade-off
with index insurance is an issue referred to as “basis risk.” Basis risk refers to the potential that
an index will not always correspond precisely to a farmer's actual crop loss experience, due to
imperfections in the correlation of the index to actual crop production. The lower the correla-
tion of a particular index to actual crop production, the higher the basis risk and the greater the
chance that a farmer will not receive a payment in all bad years.
Reducing basis risk is a key component of responsible index design, and a key constraint
in the effective scaling of index insurance programs. By assessing the effectiveness of multiple
sources of information for long-term drought recurrence in Africa, and an improved relation-
ship between this information to actual crop loss, these projects will help to develop better
remote-sensing-based datasets and drought records which will reduce basis risk in index
insurance products, and help with the more effective, rapid and responsible scaling of ongoing
and future pilot projects. Such improved remote sensing datasets can also help to speed scaling
by reducing the need for costly, time-consuming visits by project staff to verify indices and
ground-truth satellite measurements to crop loss in advance of contract design. The criteria
for an effective trigger for payout of insurance need to include the following:
• accuracy-demonstratedrelationshipwiththeinsuredcommodityoragriculturalyield;
• timeliness-abilitytoprovidetheinformationsoonafteritsacquisitionwithoutdelay
(hours to days, not weeks to months);
• availabilityofdatatoeveryoneinthecommunitywhowouldliketouseit;
• thecostofobtaining,processingandprovidingdata;
• sustainabilityofthedataproduct-shouldnotbebasedonanexperimentaldataset
without planned replacement;
• comprehensibility-theindexshouldbeexplainabletoamulti-disciplinarycommunity
and the consumers of the insurance products;
• suitability-operationalcapabilityoftheproductanddemonstratedabilitytodistribute
the data to a broad community.