Module 11 - India: Innovative Rainfall-Indexed Insurance

In much of India, weather volatility is the single most important risk faced by farmers who cannot irrigate their crops. Drought risk especially affects the poor, who typically have smaller landholdings and less access to irrigation. Due to an absence of formal mechanisms such as insurance, farmers have developed a variety of informal strategies to deal with these risks, including accumulation of buffer stocks, diversification of income-generating activities, and variation of cropping practices. These strategies are often ineffective, however, particularly with regard to catastrophic events such as widespread drought, and they result in risk-averse decision making and suboptimal resource allocation.

A pilot program in India initiated by KBS Bank (Krishna Bhima Samruddi Local Area Bank) and ICICI Lombard, supported by the World Bank, shows how farmers in such areas can protect their livelihoods.¹⁶  Weather-indexed insurance does not suffer from the usual problems of traditional crop insurance, including moral hazard, adverse selection, and high administrative costs, and it is therefore better suited to small-scale farmers who depend on rainfall.

Proposed Objectives and Description

Having worked on crop insurance pilot programs for the previous four years, BASIX—one of India’s largest microfinance institutions, with approximately 150,000 active borrowers in nine states—launched India’s first rainfall insurance program in July 2003 through its KBS Bank in Mahabubnagar in Andhra Pradesh, bordering Karnataka. The district has experienced three consecutive droughts during the last years. One of the main incentives for KBS Bank to offer rainfall insurance was that local banks are limited to operations in three adjacent districts and therefore face limited portfolio diversification. Rainfall insurance for its borrowers would mitigate the natural default risk inherent in lending in such drought-prone areas.

The 2003 pilot. During the 2003 pilot, the insurance contracts were designed to protect farmers from drought during the groundnut and castor growing season. ICICI Lombard underwrote a bulk insurance policy for KBS Bank, which then sold individual policies to farmers in four villages in Mahahbubnagar through workshops and meetings. Farmers were classified into three categories: small-scale farmers (defined as households farming less than 0.8 hectares); medium-scale farmers (farming between 0.8 and 2 hectares); and large-scale farmers (farming more than 2 hectares).