African initiatives in parametric insurance for agriculture

Parametric or index-based insurance can play a significant role in closing the insurance protection gap – the gap between insured and uninsured losses – and fostering global resilience to the impacts of climate change. Parametric insurance Conventional insurance indemnifies the policyholder for the loss it incurs from an insured event. Parametric insurance pays a fixed amount upon the occurrence of a triggering event. The amount payable can be based on a modelled forecast of the loss that the policyholder will incur. The nature of the product means that no loss adjusting need take place. As soon as a pre-determined threshold has been met, the policy is triggered and payment is made. The trigger is an indicator of a loss occurring, but does not measure the loss itself. The trigger effectively is a proxy for the loss (for example, lack of rainfall could be an indicator of drought and excess rainfall an indicator of flooding). For agricultural cover, the parameter might be based on satellite images of the colour of the ground or volume and frequency of rainfall over defined periods, specifically tailored to the type of target crop and its growth cycle. Because parametric payments do not require loss adjusting on the ground, payments can be made quickly to hard-to-reach insureds in remote locations, often via online payment platforms and mobile phone networks. Parametric products are also extremely useful where there are wide-ranging and hard-to-quantify losses, for example at the national scale. African index-based insurance solutions The applications of index-based risk transfer mechanisms to drought-prone farming communities are well recognised on the African continent and governments and international bodies are increasingly looking to parametric insurance solutions to foster resilience to drought and improve lives, livelihoods and food security. African initiatives comprise some of the most well-known applications of parametric insurance at both macro and micro levels: African Risk Capacity (ARC) is a mutual set up by the African Union that issues parametric insurance policies to Sub Saharan African countries. Widespread drought in a country triggers a fixed payout within two to four weeks of harvest, so that the first assistance should start to reach needy households within 120 days, before household food supplies run out. Research has shown that one dollar spent on early intervention through ARC saves four and a half dollars spent after a crisis is allowed to evolve. In May 2018, poor rainfall in Ethiopia, Kenya, Malawi, Senegal and Zambia led to insurance payouts through Oxfam and UN World Food Programme's R4 Rural Resilience Initiative, enabling nearly 30,000 farming households to cover their immediate needs. There are a number of World Bank initiatives in Sub Saharan Africa through the Global Index Insurance Facility (GIIF), whose stated aim is to facilitate access to finance for smallholder farmers, micro-entrepreneurs, and microfinance institutions through index-based insurance. ACRE Africa, which evolved from the Kilimo Salama project funded by Syngenta Foundation and GIIF, was one of the first agricultural index insurance programmes to reach smallholders using mobile technologies. Challenges and solutions One of the oft-cited challenges in parametric insurance is the incidence of basis risk – the gap between the insurance payment triggered and the actual loss. With an indemnity product, the loss will be adjusted to accord with the loss suffered by the insured policyholder. With a parametric product, the payment is made automatically in a pre-determined sum, based on the modelled loss. Where the model is imprecise, or the input data for the parametric trigger is inaccurate, there may be a disconnect between the loss experienced and the payment made. This is a particular problem where there may not be a wealth of historical data upon which to base a model or where there is little or poor input data for the parametric trigger (or if that data is prone to manipulation). These are issues for agricultural products in general and the problem of reliable historical weather data can be more acute in certain parts of Africa. Another potential issue is a lack of homogeneity in farming techniques and weather between individual farms or households covered by the same parametric product. Where satellite images do not have a sufficient level of resolution or weather stations are widely spaced, there may not be sufficient differentiation to enable precise payments to individual households (geographical basis risk). However, there are potential workarounds. Improvements in remote sensing may reduce geographical basis risk. Products can couple a parametric payment with an indemnity-based adjustment. This permits the flow of funding to immediate relief efforts – allowing farmers to purchase medicine for drought-afflicted cattle, fund additional irrigation measures, or purchase additional seed. The initial payment may mitigate the effects of what would have been a larger loss with final loss adjustment after the immediate emergency has passed, allowing the policyholder to recover before the next growing season. For more information or to download Clyde & Co's Parametric Insurance Report, click: https://resilience.clydeco.com Contributed by Ernie van der Vyver, Nigel Brook and Wynne Lawrence

African initiatives in parametric insurance for agriculture

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