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Index Insurance and Agricultural Credit: Lessons Learned and Way Forward
Index Insurance and Agricultural Credit:
Lessons Learned and Way Forward
Mario J. MirandaProfessor of Finance and Risk Management
The Ohio State University
1 / 13
Index Insurance and Agricultural Credit: Lessons Learned and Way Forward
Introduction
Introduction
◮ Lending to poorer farmers is costly and risky:◮ high transactions costs◮ lack of collateral◮ exposure to systemic risk due to droughts, floods, etc.
◮ For this reason, banks simply avoid lending to poor farmers.
◮ This is unfortunate, as most poor farmers could realize hugereturns from investment, but lack access to credit.
◮ Money to be made from lending to poor farmers, but how?
2 / 13
Index Insurance and Agricultural Credit: Lessons Learned and Way Forward
Introduction
Introduction
◮ Lending to poorer farmers is costly and risky:◮ high transactions costs◮ lack of collateral◮ exposure to systemic risk due to droughts, floods, etc.
◮ For this reason, banks simply avoid lending to poor farmers.
◮ This is unfortunate, as most poor farmers could realize hugereturns from investment, but lack access to credit.
◮ Money to be made from lending to poor farmers, but how?
2 / 13
Index Insurance and Agricultural Credit: Lessons Learned and Way Forward
Introduction
Introduction
◮ Lending to poorer farmers is costly and risky:◮ high transactions costs◮ lack of collateral◮ exposure to systemic risk due to droughts, floods, etc.
◮ For this reason, banks simply avoid lending to poor farmers.
◮ This is unfortunate, as most poor farmers could realize hugereturns from investment, but lack access to credit.
◮ Money to be made from lending to poor farmers, but how?
2 / 13
Index Insurance and Agricultural Credit: Lessons Learned and Way Forward
Introduction
Introduction
◮ Lending to poorer farmers is costly and risky:◮ high transactions costs◮ lack of collateral◮ exposure to systemic risk due to droughts, floods, etc.
◮ For this reason, banks simply avoid lending to poor farmers.
◮ This is unfortunate, as most poor farmers could realize hugereturns from investment, but lack access to credit.
◮ Money to be made from lending to poor farmers, but how?
2 / 13
Index Insurance and Agricultural Credit: Lessons Learned and Way Forward
Introduction
Introduction
◮ Lending to poorer farmers is costly and risky:◮ high transactions costs◮ lack of collateral◮ exposure to systemic risk due to droughts, floods, etc.
◮ For this reason, banks simply avoid lending to poor farmers.
◮ This is unfortunate, as most poor farmers could realize hugereturns from investment, but lack access to credit.
◮ Money to be made from lending to poor farmers, but how?
2 / 13
Index Insurance and Agricultural Credit: Lessons Learned and Way Forward
Introduction
Introduction
◮ Lending to poorer farmers is costly and risky:◮ high transactions costs◮ lack of collateral◮ exposure to systemic risk due to droughts, floods, etc.
◮ For this reason, banks simply avoid lending to poor farmers.
◮ This is unfortunate, as most poor farmers could realize hugereturns from investment, but lack access to credit.
◮ Money to be made from lending to poor farmers, but how?
2 / 13
Index Insurance and Agricultural Credit: Lessons Learned and Way Forward
Introduction
Introduction
◮ Lending to poorer farmers is costly and risky:◮ high transactions costs◮ lack of collateral◮ exposure to systemic risk due to droughts, floods, etc.
◮ For this reason, banks simply avoid lending to poor farmers.
◮ This is unfortunate, as most poor farmers could realize hugereturns from investment, but lack access to credit.
◮ Money to be made from lending to poor farmers, but how?
2 / 13
Index Insurance and Agricultural Credit: Lessons Learned and Way Forward
Introduction
◮ Can index insurance, properly applied, make lending to poorfarmers safer and profitable for ALIDE banks?
◮ Yes ... however, index insurance is not a panacea and must beproperly integrated into bank risk management and creditpolicies.
3 / 13
Index Insurance and Agricultural Credit: Lessons Learned and Way Forward
Introduction
◮ Can index insurance, properly applied, make lending to poorfarmers safer and profitable for ALIDE banks?
◮ Yes ... however, index insurance is not a panacea and must beproperly integrated into bank risk management and creditpolicies.
3 / 13
Index Insurance and Agricultural Credit: Lessons Learned and Way Forward
Indemnity Insurance
Indemnity Insurance
◮ Indemnity insurance pays when insured suffers provable losses
◮ Multiple peril crop insurance available in developed countries
◮ However, MPCI is not financially sustainable
◮ Subsidized premiums, administrative costs, reinsurance
◮ Causes of market failure◮ Adverse selection◮ Moral hazard◮ High administrative costs◮ Systemic risk
4 / 13
Index Insurance and Agricultural Credit: Lessons Learned and Way Forward
Indemnity Insurance
Indemnity Insurance
◮ Indemnity insurance pays when insured suffers provable losses
◮ Multiple peril crop insurance available in developed countries
◮ However, MPCI is not financially sustainable
◮ Subsidized premiums, administrative costs, reinsurance
◮ Causes of market failure◮ Adverse selection◮ Moral hazard◮ High administrative costs◮ Systemic risk
4 / 13
Index Insurance and Agricultural Credit: Lessons Learned and Way Forward
Indemnity Insurance
Indemnity Insurance
◮ Indemnity insurance pays when insured suffers provable losses
◮ Multiple peril crop insurance available in developed countries
◮ However, MPCI is not financially sustainable
◮ Subsidized premiums, administrative costs, reinsurance
◮ Causes of market failure◮ Adverse selection◮ Moral hazard◮ High administrative costs◮ Systemic risk
4 / 13
Index Insurance and Agricultural Credit: Lessons Learned and Way Forward
Indemnity Insurance
Indemnity Insurance
◮ Indemnity insurance pays when insured suffers provable losses
◮ Multiple peril crop insurance available in developed countries
◮ However, MPCI is not financially sustainable
◮ Subsidized premiums, administrative costs, reinsurance
◮ Causes of market failure◮ Adverse selection◮ Moral hazard◮ High administrative costs◮ Systemic risk
4 / 13
Index Insurance and Agricultural Credit: Lessons Learned and Way Forward
Indemnity Insurance
Indemnity Insurance
◮ Indemnity insurance pays when insured suffers provable losses
◮ Multiple peril crop insurance available in developed countries
◮ However, MPCI is not financially sustainable
◮ Subsidized premiums, administrative costs, reinsurance
◮ Causes of market failure◮ Adverse selection◮ Moral hazard◮ High administrative costs◮ Systemic risk
4 / 13
Index Insurance and Agricultural Credit: Lessons Learned and Way Forward
Indemnity Insurance
Indemnity Insurance
◮ Indemnity insurance pays when insured suffers provable losses
◮ Multiple peril crop insurance available in developed countries
◮ However, MPCI is not financially sustainable
◮ Subsidized premiums, administrative costs, reinsurance
◮ Causes of market failure◮ Adverse selection◮ Moral hazard◮ High administrative costs◮ Systemic risk
4 / 13
Index Insurance and Agricultural Credit: Lessons Learned and Way Forward
Indemnity Insurance
Indemnity Insurance
◮ Indemnity insurance pays when insured suffers provable losses
◮ Multiple peril crop insurance available in developed countries
◮ However, MPCI is not financially sustainable
◮ Subsidized premiums, administrative costs, reinsurance
◮ Causes of market failure◮ Adverse selection◮ Moral hazard◮ High administrative costs◮ Systemic risk
4 / 13
Index Insurance and Agricultural Credit: Lessons Learned and Way Forward
Indemnity Insurance
Indemnity Insurance
◮ Indemnity insurance pays when insured suffers provable losses
◮ Multiple peril crop insurance available in developed countries
◮ However, MPCI is not financially sustainable
◮ Subsidized premiums, administrative costs, reinsurance
◮ Causes of market failure◮ Adverse selection◮ Moral hazard◮ High administrative costs◮ Systemic risk
4 / 13
Index Insurance and Agricultural Credit: Lessons Learned and Way Forward
Indemnity Insurance
Indemnity Insurance
◮ Indemnity insurance pays when insured suffers provable losses
◮ Multiple peril crop insurance available in developed countries
◮ However, MPCI is not financially sustainable
◮ Subsidized premiums, administrative costs, reinsurance
◮ Causes of market failure◮ Adverse selection◮ Moral hazard◮ High administrative costs◮ Systemic risk
4 / 13
Index Insurance and Agricultural Credit: Lessons Learned and Way Forward
Index Insurance
Index Insurance
◮ Index insurance offers an alternative to indemnity insurance.
◮ Payouts based, not on provable losses, but an “index”correlated to losses, such as
◮ Rainfall◮ satellite-measured vegetation indices◮ “ENSO” indices◮ area-yields
5 / 13
Index Insurance and Agricultural Credit: Lessons Learned and Way Forward
Index Insurance
Index Insurance
◮ Index insurance offers an alternative to indemnity insurance.
◮ Payouts based, not on provable losses, but an “index”correlated to losses, such as
◮ Rainfall◮ satellite-measured vegetation indices◮ “ENSO” indices◮ area-yields
5 / 13
Index Insurance and Agricultural Credit: Lessons Learned and Way Forward
Index Insurance
Index Insurance
◮ Index insurance offers an alternative to indemnity insurance.
◮ Payouts based, not on provable losses, but an “index”correlated to losses, such as
◮ Rainfall◮ satellite-measured vegetation indices◮ “ENSO” indices◮ area-yields
5 / 13
Index Insurance and Agricultural Credit: Lessons Learned and Way Forward
Index Insurance
Index Insurance
◮ Index insurance offers an alternative to indemnity insurance.
◮ Payouts based, not on provable losses, but an “index”correlated to losses, such as
◮ Rainfall◮ satellite-measured vegetation indices◮ “ENSO” indices◮ area-yields
5 / 13
Index Insurance and Agricultural Credit: Lessons Learned and Way Forward
Index Insurance
Index Insurance
◮ Index insurance offers an alternative to indemnity insurance.
◮ Payouts based, not on provable losses, but an “index”correlated to losses, such as
◮ Rainfall◮ satellite-measured vegetation indices◮ “ENSO” indices◮ area-yields
5 / 13
Index Insurance and Agricultural Credit: Lessons Learned and Way Forward
Index Insurance
Index Insurance
◮ Index insurance offers an alternative to indemnity insurance.
◮ Payouts based, not on provable losses, but an “index”correlated to losses, such as
◮ Rainfall◮ satellite-measured vegetation indices◮ “ENSO” indices◮ area-yields
5 / 13
Index Insurance and Agricultural Credit: Lessons Learned and Way Forward
Index Insurance
◮ Pros◮ Free of many problems that plague conventional insurance◮ No moral hazard - insured cannot influence indemnity◮ Low adverse selection - rated using public information◮ Low administrative costs - claims adjustment unnecessary
◮ Cons◮ Basis risk: does not cover all losses experienced by insured◮ Effectiveness depends on correlation between index and losses
6 / 13
Index Insurance and Agricultural Credit: Lessons Learned and Way Forward
Index Insurance
◮ Pros◮ Free of many problems that plague conventional insurance◮ No moral hazard - insured cannot influence indemnity◮ Low adverse selection - rated using public information◮ Low administrative costs - claims adjustment unnecessary
◮ Cons◮ Basis risk: does not cover all losses experienced by insured◮ Effectiveness depends on correlation between index and losses
6 / 13
Index Insurance and Agricultural Credit: Lessons Learned and Way Forward
Index Insurance
◮ Pros◮ Free of many problems that plague conventional insurance◮ No moral hazard - insured cannot influence indemnity◮ Low adverse selection - rated using public information◮ Low administrative costs - claims adjustment unnecessary
◮ Cons◮ Basis risk: does not cover all losses experienced by insured◮ Effectiveness depends on correlation between index and losses
6 / 13
Index Insurance and Agricultural Credit: Lessons Learned and Way Forward
Index Insurance
◮ Pros◮ Free of many problems that plague conventional insurance◮ No moral hazard - insured cannot influence indemnity◮ Low adverse selection - rated using public information◮ Low administrative costs - claims adjustment unnecessary
◮ Cons◮ Basis risk: does not cover all losses experienced by insured◮ Effectiveness depends on correlation between index and losses
6 / 13
Index Insurance and Agricultural Credit: Lessons Learned and Way Forward
Index Insurance
◮ Pros◮ Free of many problems that plague conventional insurance◮ No moral hazard - insured cannot influence indemnity◮ Low adverse selection - rated using public information◮ Low administrative costs - claims adjustment unnecessary
◮ Cons◮ Basis risk: does not cover all losses experienced by insured◮ Effectiveness depends on correlation between index and losses
6 / 13
Index Insurance and Agricultural Credit: Lessons Learned and Way Forward
Index Insurance
◮ Pros◮ Free of many problems that plague conventional insurance◮ No moral hazard - insured cannot influence indemnity◮ Low adverse selection - rated using public information◮ Low administrative costs - claims adjustment unnecessary
◮ Cons◮ Basis risk: does not cover all losses experienced by insured◮ Effectiveness depends on correlation between index and losses
6 / 13
Index Insurance and Agricultural Credit: Lessons Learned and Way Forward
Index Insurance
◮ Pros◮ Free of many problems that plague conventional insurance◮ No moral hazard - insured cannot influence indemnity◮ Low adverse selection - rated using public information◮ Low administrative costs - claims adjustment unnecessary
◮ Cons◮ Basis risk: does not cover all losses experienced by insured◮ Effectiveness depends on correlation between index and losses
6 / 13
Index Insurance and Agricultural Credit: Lessons Learned and Way Forward
Index Insurance
◮ Pros◮ Free of many problems that plague conventional insurance◮ No moral hazard - insured cannot influence indemnity◮ Low adverse selection - rated using public information◮ Low administrative costs - claims adjustment unnecessary
◮ Cons◮ Basis risk: does not cover all losses experienced by insured◮ Effectiveness depends on correlation between index and losses
6 / 13
Index Insurance and Agricultural Credit: Lessons Learned and Way Forward
Lessons Learned
Lessons Learned
◮ Impact of index insurance depends on who receives indemnity
◮ Micro - farmers
◮ Meso - banks, cooperatives, processors, NGOs
◮ Macro - district/national governments
7 / 13
Index Insurance and Agricultural Credit: Lessons Learned and Way Forward
Lessons Learned
Lessons Learned
◮ Impact of index insurance depends on who receives indemnity
◮ Micro - farmers
◮ Meso - banks, cooperatives, processors, NGOs
◮ Macro - district/national governments
7 / 13
Index Insurance and Agricultural Credit: Lessons Learned and Way Forward
Lessons Learned
Lessons Learned
◮ Impact of index insurance depends on who receives indemnity
◮ Micro - farmers
◮ Meso - banks, cooperatives, processors, NGOs
◮ Macro - district/national governments
7 / 13
Index Insurance and Agricultural Credit: Lessons Learned and Way Forward
Lessons Learned
Lessons Learned
◮ Impact of index insurance depends on who receives indemnity
◮ Micro - farmers
◮ Meso - banks, cooperatives, processors, NGOs
◮ Macro - district/national governments
7 / 13
Index Insurance and Agricultural Credit: Lessons Learned and Way Forward
Lessons Learned
◮ Many index insurance studies and pilot projects conductedthroughout the developing world over past 15 years.
◮ Most have involved micro insurance to farmers,
◮ Most have shown no sustainable positive effects
◮ Farmers abandon insurance as soon as subsidies are lifted.
8 / 13
Index Insurance and Agricultural Credit: Lessons Learned and Way Forward
Lessons Learned
◮ Many index insurance studies and pilot projects conductedthroughout the developing world over past 15 years.
◮ Most have involved micro insurance to farmers,
◮ Most have shown no sustainable positive effects
◮ Farmers abandon insurance as soon as subsidies are lifted.
8 / 13
Index Insurance and Agricultural Credit: Lessons Learned and Way Forward
Lessons Learned
◮ Many index insurance studies and pilot projects conductedthroughout the developing world over past 15 years.
◮ Most have involved micro insurance to farmers,
◮ Most have shown no sustainable positive effects
◮ Farmers abandon insurance as soon as subsidies are lifted.
8 / 13
Index Insurance and Agricultural Credit: Lessons Learned and Way Forward
Lessons Learned
◮ Many index insurance studies and pilot projects conductedthroughout the developing world over past 15 years.
◮ Most have involved micro insurance to farmers,
◮ Most have shown no sustainable positive effects
◮ Farmers abandon insurance as soon as subsidies are lifted.
8 / 13
Index Insurance and Agricultural Credit: Lessons Learned and Way Forward
Lessons Learned
◮ Skepticism regarding benefits of index insurance has beengrowing.
◮ Basis risk profoundly limits benefits of index insurance as afarm-level risk management tool.
◮ Farmer demand for index insurance would be non-existent ifsold at premiums that reflect “market” loads.
9 / 13
Index Insurance and Agricultural Credit: Lessons Learned and Way Forward
Lessons Learned
◮ Skepticism regarding benefits of index insurance has beengrowing.
◮ Basis risk profoundly limits benefits of index insurance as afarm-level risk management tool.
◮ Farmer demand for index insurance would be non-existent ifsold at premiums that reflect “market” loads.
9 / 13
Index Insurance and Agricultural Credit: Lessons Learned and Way Forward
Lessons Learned
◮ Skepticism regarding benefits of index insurance has beengrowing.
◮ Basis risk profoundly limits benefits of index insurance as afarm-level risk management tool.
◮ Farmer demand for index insurance would be non-existent ifsold at premiums that reflect “market” loads.
9 / 13
Index Insurance and Agricultural Credit: Lessons Learned and Way Forward
Lessons Learned
◮ However, we maintain that index insurance pilots have failedbecause they market micro insurance directly to farmers.
◮ The best use of index insurance is not be as farm-level riskmanagement tool ...
10 / 13
Index Insurance and Agricultural Credit: Lessons Learned and Way Forward
Lessons Learned
◮ However, we maintain that index insurance pilots have failedbecause they market micro insurance directly to farmers.
◮ The best use of index insurance is not be as farm-level riskmanagement tool ...
10 / 13
Index Insurance and Agricultural Credit: Lessons Learned and Way Forward
Ways Forward
Ways Forward
◮ Most promising uses of index insurance are at meso level tostrengthen the agricultural credit and marketing chains.
◮ Banks, in particular, should use index insurance to protecttheir agricultural loan portfolios against widespread defaultsdue to catastrophic weather.
◮ Banks diversify idiosyncratic farm-level risk, face lower basisrisk than individual farmers.
11 / 13
Index Insurance and Agricultural Credit: Lessons Learned and Way Forward
Ways Forward
Ways Forward
◮ Most promising uses of index insurance are at meso level tostrengthen the agricultural credit and marketing chains.
◮ Banks, in particular, should use index insurance to protecttheir agricultural loan portfolios against widespread defaultsdue to catastrophic weather.
◮ Banks diversify idiosyncratic farm-level risk, face lower basisrisk than individual farmers.
11 / 13
Index Insurance and Agricultural Credit: Lessons Learned and Way Forward
Ways Forward
Ways Forward
◮ Most promising uses of index insurance are at meso level tostrengthen the agricultural credit and marketing chains.
◮ Banks, in particular, should use index insurance to protecttheir agricultural loan portfolios against widespread defaultsdue to catastrophic weather.
◮ Banks diversify idiosyncratic farm-level risk, face lower basisrisk than individual farmers.
11 / 13
Index Insurance and Agricultural Credit: Lessons Learned and Way Forward
Ways Forward
◮ But how can banks use index insurance?◮ Banks require borrowers to purchase insurance, borrowers
receive payouts — but this makes insurance a micro product◮ Banks purchase index insurance to hedge their agricultural
loan portfolios, pass costs on to borrowers◮ Banks could offer contingent credit — index insurance payouts
explicitly designated to retire debt◮ Banks could use index insurance to support restructuring and
retirement of debt, but more methodically
12 / 13
Index Insurance and Agricultural Credit: Lessons Learned and Way Forward
Ways Forward
◮ But how can banks use index insurance?◮ Banks require borrowers to purchase insurance, borrowers
receive payouts — but this makes insurance a micro product◮ Banks purchase index insurance to hedge their agricultural
loan portfolios, pass costs on to borrowers◮ Banks could offer contingent credit — index insurance payouts
explicitly designated to retire debt◮ Banks could use index insurance to support restructuring and
retirement of debt, but more methodically
12 / 13
Index Insurance and Agricultural Credit: Lessons Learned and Way Forward
Ways Forward
◮ But how can banks use index insurance?◮ Banks require borrowers to purchase insurance, borrowers
receive payouts — but this makes insurance a micro product◮ Banks purchase index insurance to hedge their agricultural
loan portfolios, pass costs on to borrowers◮ Banks could offer contingent credit — index insurance payouts
explicitly designated to retire debt◮ Banks could use index insurance to support restructuring and
retirement of debt, but more methodically
12 / 13
Index Insurance and Agricultural Credit: Lessons Learned and Way Forward
Ways Forward
◮ But how can banks use index insurance?◮ Banks require borrowers to purchase insurance, borrowers
receive payouts — but this makes insurance a micro product◮ Banks purchase index insurance to hedge their agricultural
loan portfolios, pass costs on to borrowers◮ Banks could offer contingent credit — index insurance payouts
explicitly designated to retire debt◮ Banks could use index insurance to support restructuring and
retirement of debt, but more methodically
12 / 13
Index Insurance and Agricultural Credit: Lessons Learned and Way Forward
Ways Forward
◮ But how can banks use index insurance?◮ Banks require borrowers to purchase insurance, borrowers
receive payouts — but this makes insurance a micro product◮ Banks purchase index insurance to hedge their agricultural
loan portfolios, pass costs on to borrowers◮ Banks could offer contingent credit — index insurance payouts
explicitly designated to retire debt◮ Banks could use index insurance to support restructuring and
retirement of debt, but more methodically
12 / 13
Index Insurance and Agricultural Credit: Lessons Learned and Way Forward
Closing Comments
Closing Comments
◮ Consultant reports document opportunities for ALIDE banksto expand agricultural credit using index insurance.
◮ However, agricultural lending practices, risk exposures, andmarket environments vary greatly across Latin America.
◮ Implementation must be adapted to local environment.
◮ However, principles are the same — index insurance, properlyused, can make agricultural lending less risky, more profitable
13 / 13
Index Insurance and Agricultural Credit: Lessons Learned and Way Forward
Closing Comments
Closing Comments
◮ Consultant reports document opportunities for ALIDE banksto expand agricultural credit using index insurance.
◮ However, agricultural lending practices, risk exposures, andmarket environments vary greatly across Latin America.
◮ Implementation must be adapted to local environment.
◮ However, principles are the same — index insurance, properlyused, can make agricultural lending less risky, more profitable
13 / 13
Index Insurance and Agricultural Credit: Lessons Learned and Way Forward
Closing Comments
Closing Comments
◮ Consultant reports document opportunities for ALIDE banksto expand agricultural credit using index insurance.
◮ However, agricultural lending practices, risk exposures, andmarket environments vary greatly across Latin America.
◮ Implementation must be adapted to local environment.
◮ However, principles are the same — index insurance, properlyused, can make agricultural lending less risky, more profitable
13 / 13
Index Insurance and Agricultural Credit: Lessons Learned and Way Forward
Closing Comments
Closing Comments
◮ Consultant reports document opportunities for ALIDE banksto expand agricultural credit using index insurance.
◮ However, agricultural lending practices, risk exposures, andmarket environments vary greatly across Latin America.
◮ Implementation must be adapted to local environment.
◮ However, principles are the same — index insurance, properlyused, can make agricultural lending less risky, more profitable
13 / 13
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