Watch the live streamed Science Seminar: http://ccafs.cgiar.org/videostream On 19 September, the CGIAR Research Program on Climate Change, Agriculture and Food Security (CCAFS) organized an online Science Seminar from University of California-Davis, USA. Dr. Michael Carter, from UC-Davis gave a presentation on the limitations and promise of risk transfer innovations in developing countries. Dr. Carter presented case studies from East Africa, including index-based livestock insurance in Kenya, and interlinking credit and insurance in Ethiopia. Watch: http://ccafs.cgiar.org/videostream

1. Index-based Insurance in Agriculture
Managing Risks and Uncertainty for Smallholder Farmers
Michael R. Carter
University of California, Davis
BASIS Collaborative Research Support Program
I4 Index Insurance Innovation Initiative
.
The CGIAR Research Program on Climate Change, Agriculture and Food Security
(CCAFS)
CGIAR Science Seminar
September 19, 2012
M.R. Carter Managing risks

2. Outline
The ’same old story’ about risk:
Uninsured risk makes & keeps smallholders poor
Correlated risk undercuts rural financial market development
Cycle continues
Crafting a new ending to this same old story:
Change the structural conditions (uninsured risk) that create
these problems
Index Insurance as an instrument to remove correlated risk and
change this story
Index insurance
Logic
Social protection through satellite-based livestock insurance in
Northern Kenya
Crowding in credit supply & demand in Ethiopia for improved
productivity
Moving forward: a research agenda for index insurance
M.R. Carter Managing risks

3. Risk Makes Smallholders Poor
The same old story, part 1
 Peruvian coastal
agriculture is a
commercially-oriented,
high potential area
 Dominated by small
holders (land reform
beneficiaries)
 Yet a recent study
suggests that financial
market constraints on
both demand and
supply sides may
reduce production by
25%
 Index insurance can
work on both sides of
the financial market
M.R. Carter Managing risks

4. Risk Keeps Smallholders Poor
The same old story, part 2
 Evidence of poverty
traps in N. Kenya
 Households whose
assets fall below a
critical threshold are
unable to recover nor
craft a pathway from
poverty
 This dynamic over
time creates ever
growing numbers of
food aid dependent
people
 Index insurance can
potentially alter this
dynamic with ex ante &
ex post effects
M.R. Carter Managing risks

5. Index Insurance
Crafting a new ending to the story?
Neither markets nor the public sector have been able to
surmount the risk & information conditions to find a happier
ending to this same old story about risk
But, is it possible to modify these conditions that underlie
both market and policy failures and open the door to a new
ending to this story?
M.R. Carter Managing risks

6. Index Insurance
Crafting a new ending to the story?
Index Insurance Hypothesis is that the removal of correlated
risk with index insurance contracts will have important
development impacts because it will:
Serve as a novel form of social protection & alter poverty
dynamics in risk-prone areas
In higher potential areas, it will:
Crowd-in credit institutions and credit supply
Relax risk rationing & enhance demand
Undercut destructive political economy
In both, it will incentivize prudential risk taking, spurring small
farm productivity & income growth
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7. Index Insurance
What it is and how it functions
Conventional insurance measures individual losses and makes
indemnity payouts based on those losses.
Index insurance does not require measurement of individual
losses and makes common payments to insured based on the
level of a single index correlated with losses
Index insurance avoids problems that make individual
insurance unprofitable for small scale agricultural:
No transactions costs of measuring individual losses
Preserves effort incentives (no moral hazard) as no single
individual can influence whether the index pays out
Adverse Selection does not matter as payouts do not depend
on the riskiness of those who buy the insurance
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8. Design of Index Insurance
IBLI Project in Northern Kenya (an I4-ILRI-Cornell collaboration)
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9. Design of Index Insurance
IBLI Project in Northern Kenya
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10. Design of Index Insurance
IBLI Project in Northern Kenya
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11. Evaluating the Development Impacts of Index Insurance
IBLI Project in Northern Kenya
Insurance functions, but will it modify poverty dynamics–the
forces that keep households poor?
Experimental design to test its impacts against conventional
aid
Region has a pilot cash transfer scheme„ the HSNP
Means-tested transfers are around $15/family/month
Theory suggests that we will see reduced long-term poverty
rates when index insurance complements cash transfers
through both ex post effects (fewer slide into poverty) and ex
ante effects (more are incentivized to graduate from poverty)
M.R. Carter Managing risks

12. Evaluating the Development Impacts of Index Insurance
IBLI Project in Northern Kenya
Implemented privately provisioned index insurance in pastoral
regions of Northern Kenya
2x2 research design to measure impacts
Long-term design, but in 2011, payouts made throughout the
insured area
Took a quick look at impacts of these payouts on coping and
asset accumulation/de-accumulation
M.R. Carter Managing risks

13. Evaluating the Development Impacts of Index Insurance
IBLI Project in Northern Kenya
33% drop in households employing hunger strategies (with
severe long-term consequences for the young)
50% drop in distress sales of assets
33% drop in food aid reliance (aid traps)
In addition, accumulation & market effects:
M.R. Carter Managing risks

14. Evaluating the Development Impacts of Index Insurance
IBLI Project in Northern Kenya
M.R. Carter Managing risks

15. Ethiopian Project on Interlinking Insurance & Credit in
Agriculture
Substantial yield gap for food grain farmers, even in higher
potential areas
Small fraction of farmers use improved varieties & fertilizers
Flimsy system of agricultural finance based on state banking
that almost completely collapsed in 2009 following a drought
Theoretical work indicates that interlinked credit-insurance
that transfers correlated risk can:
Relax lender portfolio restrictions on ag loans that make credit
scarce & expensive
Undercut the destructive political economy that creates debt
amnesties
Eliminate risk rationing of borrowers
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16. Ethiopian Project on Interlinking Insurance & Credit in
Agriculture
Research team from UC-San Diego, FAO and University of
Athens took on this challenge
Dashen Bank, which had never before lent to small-scale
agriculture, agreed to lend up to 15 million Biir under the
interlinked contract arrangement
Bundled credit-insurance is marketed as ‘state contingent loan’
contracts to cover seed and fertilizer purchases;
Marketed to farmers through village cooperative associations,
which bundle demand and present it to Dashen
Current contract is a (sub-optimal) rainfall contract, with
insurance provided by Nyala Insurance
Contract rolled out in July 2012 to producers in Northern
Shoa, South Wolo, and Gojam.
Demand estimated at 50 million Biir.
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17. Ethiopian Project on Interlinking Insurance & Credit in
Agriculture
Research Design
Two arm trial in which 120 eligible Kebeles randomly divided
into:
A control group (initially 40 Kebeles) receives no insurance
and no credit.
A ‘standalone’ arm (40 Kebeles) receives only the index
insurance product; we don’t prevent the use of credit but we
also don’t provide any explicit form of interlinking.
The ‘interlinked’ arm (40 Kebeles) receives state-contingent
loans.
M.R. Carter Managing risks

18. Ethiopian Project on Interlinking Insurance & Credit in
Agriculture
Research Design
The study will then be conducted by comparing each of the
two treatment arms to the control, and to each other.
Provides a simple, transparent measure of the impact of
insurance, the impact of interlinked insurance, and the impact
of the interlinking itself.
Three years of household surveys to track technology use and
economic well-being
Dashen Bank also needs to be convinced that the correlated
risk concerns that have kept the Bank out of this market are in
fact addressed by the interlinked product
Stay tuned ...
M.R. Carter Managing risks

19. An Index Insurance Research Agenda
While these and other pilot projects seem promising, there is
much still to learn about whether and how to do index
insurance for development
Need innovations that:
Reduce the uncovered basis risk faced by farmers under index
insurance contracts
Respond to the risk management needs of women farmers by
targeting crops typically grown by women and, or that offer
payoff structures that meet the needs and preferences of
women producers
Incentivize climate change adaptation investments
Protect producers against price or revenue fluctuations
Are informed by insights from the behavioral literature on how
households choose amongst risky and uncertain (ambiguous)
prospects.
Cost-effectively scale-up index contracts without undercutting
their effectiveness as risk transfer and development
instruments.
M.R. Carter Managing risks

20. Looking Forward
.
Innovative financial
technologies offer an
important complement to
more conventional
agricultural technology
programs
Drought resistance
through financial or seed
technologies?
While it is clearly important Still much to learn to
to invest in new agricultural resolve demand-side
technologies, also need to challenges & resolving
find ways to realize the risk as a development
underutilized potential of problem
already existing agricultural
technologies
M.R. Carter Managing risks