Ryan Williams
Index
Insurance Memo
An
insurance-based index is a financial product used in several countries where
agriculture is a prominent source of income for some families. Examples of some
countries can include Malawi, India and even China. This insurance allows small
farm holders to prevent possible yet inevitable agricultural production risks
like a drought or a flood. “A publicly observable index can include the amount
of rainfall recorded on a local rain gauge. This research proves how payouts
can be calculated and disbursed fairly quickly without households needing to
file a claim” (Sadler, and Mahul, p1). A crucial benefit to this procedure is that it reduces
transaction costs that would otherwise drastically increase the cost of insurance.
I have read that there are significant
advantages to index-based insurance because the payouts are based on public
observances unlike claims, which are based on private information. As a result, this could
potentially decrease the problem of moral hazard (Sadler, and Mahul, p1). The difference between index based
insurance and loss adjustment insurance is essentially just the method of
claims and payouts. For loss-adjusted insurance, the insurance company sends
someone to assess any damages made and determine a payout. This proves to be
more difficult due to the fact that the claims adjuster, someone who
investigates insurance, has the ability to make the final decision on a payout
based on what they observe. This can be problematic depending on who the claims
adjuster is, or what reliable information has the ability to obtain making
asymmetric information a consequence. I think implementing an index-based insurance program
could be beneficial because small farm holders make up roughly 38% of Malawi’s
economy, which is over a third of the population. Knowing that the objective of
the program is to help farmers manage unexpected weather risks was a crucial
factor in my support of the program. This program can facilitate farmers’
access to agricultural credit by reducing the risk of smallholder loan default
and it also allows banks to expand their lending portfolio to the agriculture
sector without increasing default risk.
Weather
index-based insurance was initially introduced in 2003 as a program created by
the World Bank. By 2007, the national government had adopted it as an
alternative to the existing crop-yield-index insurance and by 2012, up to 12
million farmers growing 40 different crops over 15 million hectares were
insured against weather-related losses (Sadler,
and Mahul, p1). In certain countries, India for
example, rain is an extremely important factor in their harvest ever year. In
past recent years, there have been patterns of rain and drought, which make the
probability of harvesting crops uncertain. Research from Agricultural and Food
Security states that “rainfall variations account for more than 50% of the
fluctuations in the country’s crop yields”. Under these conditions, weather
index-based insurance offers a means of cushioning farmers against the adverse
financial effects of crop failure (Sadler,
and Mahul, p1).
I
believe in raising awareness of the limited role that weather insurance has in
the larger scheme of the risks that farmers face and try to control these risks
as much as possible. From my research, its states that in Malawi, there have
been problems related to agricultural production, marketing and sales of crops that
could ultimately challenge credit repayment (Hill and Torero, p2). Integrating
insurance programs into the supply chain can help control other risks in
agricultural production. In implementing the program, a committed
meteorological services authority is essential in ensuring there’s adherence to
quality requirements. There should also be weather stations available that can
provide reliable and quality data. This includes trustworthy data collection
and data quality control. “Aside from trust and reporting, an enabling legal
and regulatory framework is necessary for the expansion of the program” (Hill
and Torero, p2). Initially, insurance companies would work together to
underwrite the risk from the program in Malawi and India. If the private sector
is interested in expanding the program, it will need to “engage regulatory
authorities in revising the existing legal and regulatory insurance framework
to explicitly reference weather-based index insurance” (Hill and Torero, p2).
Given
the research that I found on index-based insurance, I believe an insurance
based program is critical because this could really pave the way and help
develop third world countries such as India and Malawi. By having index-based
insurance as a way to allow poor families and farm holders to enter the credit
market and get insurance, it is helping families be self-sufficient by
providing them opportunities to advance their selves. In addition, it could aid
India and Malawi by increasing the number of people without basic needs such as
food and water and can help small farm holders create a business and expand
their farms which could help increase the job market.
Citation
1. Sadler,
Marc, and Mahul, Olivia. “Weather Index-based Crop Insurance in Malawi”
Disaster Risk Financing
& Insurance Case Study. Jan 2011. Print
2. Vargas Hill, Ruth, and Torero, Maxino.
“Innovations in Insuring the Poor” International
Food and Policy Research Institute. Dec 2009. Print.
