Module 11 - Agricultural Insurance

Concern for risks that stifle investment and contribute to vulnerability of the rural poor is a driving force behind various types of agricultural insurance (typically “crop insurance”). Insuring small-scale farmers against crop losses to adverse weather or other hazards has attracted public sector involvement in the provision of agricultural insurance in many countries. With few exceptions, such interventions have encountered severe problems owing to high administrative costs, moral hazard, and adverse selection. Government interventions should be aimed at improving the accessibility and quality of private sector insurance. This will require the establishment of a framework for responding to severe systemic events affecting agricultural production, and establishing an appropriate regulatory environment to foster private sector innovation and investment in services for less catastrophic events.

Agricultural insurance is a financial tool to transfer production risk associated with farming to a third party via payment of a premium that reflects the true long-term cost of the insurer assuming those risks.⁸  Past public sector interventions to provide insurance and enable the poor to cope in times of hardship typically have failed. Government response in times of severe calamity has been ad hoc and has lacked precise criteria for what “triggers” an insurance payment, thus leading to high potential for political interference and reduced opportunity to obtain reinsurance. As a result, comprehensive publicly supported crop insurance programs have been disastrous, being both ineffective and fiscally burdensome. They have involved heavy subsidization of premiums, large delivery and service costs, and high aggregate losses. To be profitable, the ratio of average administrative costs plus average insurance payouts to the average premiums paid must be less than one. However, for most countries the ratio has far exceeded one, indicating that the programs have been unsustainable without heavy subsidization.

Traditional publicly supported crop insurance is all-risk or multi-peril, covering either all the supposed production risks or a very broad spectrum of those risks.⁹  All-risk insurance usually involves payments to the grower as compensation for any shortfall when yield declines below a level set in the policy (Gudger 1991). In some instances, this has encouraged inappropriate use of insurance and has led to excessive risk taking or moral hazard, such as growing crops in high-risk regions, thus increasing farmers’ exposure to future losses. Assumption by the public sector of massive insurance losses in turn reduces opportunities to participate in broader reinsurance markets. The ad hoc nature of government policy has frequently been coupled with an ineffective and uncertain regulatory framework that increases uncertainty for private sector providers.