HomeOpinion‘Crop insurance necessary’

‘Crop insurance necessary’

Batanai Matsika

Financial ANALYST

THE 43rd  Organisation of Eastern and Southern Africa Insurers Conference (OESAI) that was held in Kenya reiterated the need to act on the part of insurance players through product innovation in relevant areas such as crop insurance.

New business models combined with new digital technologies can change many insurance markets for the better. The century-old market for crop insurance is no exception. In fact, it is a good example of how purpose-driven insurance can meet the needs of the post-Covid-19 risk landscape.

From an African context, one of the sectors most vulnerable to climate change and weather events is the farming industry. Most farmers in Africa are dependent on rainfall for their crops and their livelihood yet very few are insured against adverse weather events.

A bad farming season can have long-lasting effects on farmers’ financial situations as it could leave them unable to purchase inputs for the following season.

Agriculture is the dominant sector in Sub-Saharan Africa as it accounts for a major share of key economic indicators such as value of total exports, national gross domestic product (GDP) and employment hence its potential to spur growth and reduce poverty in Africa.

In Zimbabwe, the economic recession in 2019 and 2020 was largely triggered by a drought as well as the impact of Cyclone Idai. The economic outlook in 2021 has changed largely because of rainfall patterns.

According to the statement from Twenty-Fifth Annual Southern Africa Regional Climate Outlook Forum (SARCOF-25), it is expected that the Southern African region will receive normal to above normal rainfall from the period October to December 2021. The January to March 2022 period is also expected to receive normal to above normal rainfall for most of the region.

While there has been a significant improvement in terms of weather patterns in the region, there are a plethora of reasons why it is important to protect the small farmers in developing countries.

Traditionally farmers in Africa have devised a diverse portfolio of risk avoidance and reduction mechanisms such as reduced input application, use of drought resistant varieties and diversification of crop or income portfolio to self-insure against agricultural risks. However, research shows that traditional risk minimisation strategies are unfavourable to some extent and they cannot adequately absorb the resultant economic shocks hence leading to a poverty trap.

Therefore, risk transfer strategies in form of formal insurance is a suitable tool to; (i) transferrisk to a third-party — in this case an insurer, thereby eliminating fear of risk and encourageinvestment and (ii) spread covariate risks, for example drought and disease outbreaks across awider geographical region by pooling risks that individual farmers nor the local risk sharinginitiatives like farmer groups or cooperative are incapable.

Overall, a well-designed agricultural insurance can help to mitigate the impact of systemic risks by providing the much-needed protection and contributing to timely recovery in case a disaster strikes.

An important development has been weather index-based insurance. This is a product designed to offer protection against losses caused by extreme or catastrophic weather-related events, such as droughts, floods, typhoons, hurricanes, snowstorms.

Payments to the policyholder are triggered by a pre-agreed index (which should be objective and independent).

This insurance has been used mainly to mitigate risks in the agriculture and livestock sectors, taken out against extreme weather events, but also used to protect properties and companies against catastrophic events.

Overall, while literature suggests that crop insurance has the potential to unlock key services that enhance farm productivity, the insurance concept is also not well understood by farmers.

Inaddition, basis risk hinders uptake of crop insurance since farmers exhibit high levels of dissatisfaction with claim payments.

Generally, the concept of agricultural insurance is not popular in Africa except among the large-scale farmers.

Furthermore, even with numerous efforts to avail formal insurance to farmers in low incomerural settings through pilot programmes, to date, very little success has been achieved to moveindex insurance beyond the piloting phase hence the uptake levels remainslow.

Affordability of premiums and inaccessibility of crop insurance services especially because of distribution challenges have also hindered its uptake. Below we highlight some of the key problems inherent in crop insurance;

Adverse selection

Adverse selection arises because producers are better informed about the distribution of their own yields and are thus better able to assess the actuarialfairness of their premiums than the insurer, who lacks access to reliableindividual yield data and other relevant information. Producers who recognise that their expected indemnities exceed their premiums are more likely topurchase coverage than those whose premiums are actuarially high.

As a result,the insurers expected indemnity outlays exceed total premium income, and, in the long run, the insurance operation loses money. Efforts by the insurer to avoidthese losses by raising premiums only result in a smaller and more adverselyselected pool of participants.

Moral hazard

Moral hazard results from asymmetric information. It occurs when, without theknowledge of the insurer, the insured changes behaviour after purchasinginsurance in a manner that increases the probability of receiving an indemnitypayment.

High administration costs

Record keeping and other manpower requirements needed to verify individualproduction histories and to adjust individual yield-loss claims raise insurerexpenditures and impose high transactions costs.

Systemic risk

Systemic risk in agriculture stems primarily from the impact of geographicallyextensive unfavourable weather events, such as drought or extremetemperatures, which induce significant correlation among individual farm-levelyields. Insurers of random events such as automobile insurance need not keephigh reserves as claims can be paid by premiums received even over relativelyshort periods.

Insurers of non-random events such as drought need to keep largereserves which are costly. This lack of stochastic independence among individualyields defeats insurer efforts to pool crop loss risk across farms, causing cropinsurers to bear substantially higher risk per unit of premium than other propertyliability and business insurers. Without adequate reinsurance or government subsidies, crop insurers pass the cost of bearing the additional risk onto farmers,rendering individual crop insurance extremely, if not prohibitively, expensive

In conclusion, droughts are a common phenomenon in Southern Africa. It is therefore important to bepro-active rather than reactive and government’s concern regarding riskmanagement strategies is a wise decision.

This risk protection can facilitate access to operating loans by offering some financial security to a lender. There is need to encourage farmers to insure their crops to mitigate theimpacts of drought.

In the face of escalating climate variability and change, smallholders need crops insurance more than ever before to manage weather related risk to enhance their resilience against income shocks.

Awareness and training on crop insurance,density of automated weather stations and ownership of savings accounts are integral factors inenhancing its insurance uptake.

There is clear evidence of the need to educate farmers on theprinciples of crop insurance and different products that exist.

Similarly, designing of cropinsurance products and selection of target crop enterprises should involve all stakeholders to enhance uptake.

In Zimbabwe, the Insurance and Pensions Commission (Ipec) is focused on developing the local insurance industry and supporting financial inclusion initiatives.

The Commission has partnered the World Bank for technical and financial support in the development of a regulatory framework for weather-index insurance.

In addition to the development of a regulatory framework, the Commission and industry players will also receive capacity building in weather-index insurance.

Matsika is the head of research at Morgan & Co and founder of piggybankadvisor.com. — +263 7835 4745 or batanai@mor-ganzim.com/batanai@piggybankadvisor.com

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