Enhancing resilience of smallholder farmers against climate change—can parametric agricultural insurance make a difference?

• by Partha Ghosh and Puneet Chopra
• Jan 27, 2023
• 5 min

Parametric insurance solutions can offer smallholder farmers in developing countries an accessible, reliable, and affordable way to protect themselves. A multi-stakeholder approach is needed to make these solutions work for smallholder farmers, supported by catalytic capital for their development and scale-up.

In its sixth assessment report, the Intergovernmental Panel on Climate Change (IPCC) raised alarms for the agriculture sector, especially in the developing world. Many parts of Africa^[1] will suffer from the extreme oscillation between agricultural drought and pluvial flooding. Heavy precipitation across South and Southeast Asia^[2] will likely lead to intense floods and prolonged inundation. Meanwhile, farmers in small island nations will continue to experience spatially varying yet decreased precipitation.

The economic impacts of climate change on agriculture will worsen further, as around 75% of agricultural risks worldwide remain uninsured^[3]. The vast majority of those risks mitigated through suitable insurance or other means are in developed countries. Less than 3% of smallholders in Sub-Saharan Africa and 22% in Asia have insurance protection for their crops.^[4]

Smallholder farmers across the developing world face several hurdles to adopting insurance, affecting scale-up efforts by providers. These adverse factors include high costs, complex process of application and claim settlement, the lack of disclosure of indemnity terms, and a low claim settlement rates of traditional indemnity-based agriculture insurance products.

Can parametric insurance make a difference? Evidence from our engagements

Parametric insurance offers the advantages of objectivity, simplicity, transparency, and certainty of claim settlement ver traditional crop insurance products. It requires less effort and costs for underwriting, administration, and processing of claims.

Parametric insurance has started gaining prominence across the developing world. Weather-based crop insurance schemes (WBICS) are among the most common forms of parametric insurance. In Kenya, seed production company Agri SeedCo offers a Replanting Guarantee scheme (RGS) in collaboration with Safaricom and Acre Africa—an insurance surveyor. The service assures farmers of a refund for seeds through M-PESA if the original seed pack fails to germinate due to inadequate rainfall during the sowing season. Agri SeedCo uses public satellite data over a 10 by 10-kilometer grid from the National Oceanic and Atmospheric Administration (NOAA) to determine if a failure in germination resulted from drought.

Similarly, the Green Delta Insurance Company in Bangladesh has launched weather-based index insurance products in collaboration with food processors, seed companies, microfinance companies for cassava, hybrid rice, and tomato farmers.

In India, The Government of India supports the Restructured Weather Based Crop Insurance Scheme (RWBCIS), a form of parametric insurance. It protects insured farmers and producers against the likelihood of financial loss due to anticipated crop loss resulting from adverse weather conditions. Under RWBCIS, weather parameters are used as a proxy for crop yields to compensate the insured. In RWBCIS, the insurer develops a claim payout structure based on the extent of clients’ economic losses. The payout is triggered when the weather parameter is breached. To date, more than 1.5 million farmers have enrolled for RWBCIS and benefited from it.

MSC has tracked the development of agriculture insurance and microinsurance across the developing world for many years. We have conducted several studies and worked with multiple governments, insurers, and international agencies, supporting product design and implementation of agricultural insurance schemes for smallholders. We have also evaluated, designed, and supported various agricultural insurance schemes in Asia and Africa.

Our first-hand experiences with parametric insurance products in Kenya and Ethiopia helped us appreciate the advantage of parametric crop insurance over traditional insurance schemes. While working on an assignment to develop a community-led promotion model for the Replanting Guarantee scheme of Acre Kenya, we saw how simple and intuitive it is for maize farmers to secure their crops against germination failure. Even though the technology backbone of the service is sophisticated, end users are entirely relieved of any physical or mental efforts throughout enrolment and claim of damages.

We know that multi-peril crop insurance works well in some situations. We have seen it at work in our feasibility study of the crop insurance scheme in Tanzania and the evaluation of the Pradhan Mantri Fasal Bima Yojana in India. This type of insurance works particularly well in subsidized insurance programs for staple crops with vast acreage in a region. Traditional multi-peril products are effective because they provide comprehensive coverage over the entire lifecycle of these staple crops and make it easier to assess productivity losses in staple crops. However, these products are also costly, so governments or international agencies either introduce or support these schemes to ensure food security. Our study in Bihar, India revealed that smallholder farmers do not trust the effectiveness of the scheme due to its length claim assessment and settlement process which is based on loss assessment over a wide area. In our experience, beneficiaries of these insurance schemes also fail to understand the benefits of the schemes. Several questions remain unresolved—around their value, cost-benefit analysis, and claims process.

Challenges and opportunities

Parametric crop insurance has its advantages. However, not every country or region has the requisite infrastructure to implement it. Parametric insurance requires access to advanced real-time weather and other parametric data over large territories. It also requires sophisticated technology and expertise, such as actuaries, to model the risks.

Another challenge for parametric insurance is its reliance on technologies, such as satellite imagery, which may not provide accurate data at all times. For example, Normalized Difference Vegetation Index (NDVI) may provide false results. NDVI relies on the color of vegetation as the sole parameter to determine if a crop is healthy. It throws up false positives if crops appear standing, healthy, and green yet may be infested by pests and pathogens. Such crops may fail to produce grains later. However, services like NDVI can serve as effective tools to measure the impact of drought. Alongside other technologies, more solutions can emerge to support multi-peril parametric insurance products.

So, how can we make parametric insurance inclusive? How can smallholders across Least Developed Countries (LDCs) and Small Island Developing States (SIDS) avail of such effective risk transfer instruments? And how can we overcome technological barriers and make parametric insurance further accurate, reliable, accessible, and affordable?

Driving the implementation and adoption of parametric insurance will require cooperation at the systems level through complementing solutions. A wide range of stakeholders have a vital role in the acceleration and scale of suitable low-cost and acceptable parametric insurance solutions, particularly for smallholder producers. Such stakeholders include governments, insurers, reinsurers, weather and satellite data providers, InsurTechs and AgTechs, philanthropic organizations, and multilateral institutions. Catalytic capital from global climate change funds, such as the Green Climate Fund, Global Environment Facility, the Adaptation Fund, programs such as the Global Shield Against Climate Risks, and from other risk capital, will help insurance companies develop parametric insurance products through available meteorological data, climate risk models, and technology.

Parametric insurance solutions can achieve outcomes that are not possible with conventional insurance products. Equally importantly, inclusive parametric insurance products can enhance the resilience of smallholders against the vagaries of climate change. Parametric insurance solutions can complement traditional insurance programs. Together, they can push the envelope of insurability.

Therefore, governments, development agencies, insurers, AgTechs, InsurTechs, and other stakeholders need to collaborate effectively to develop and strengthen parametric insurance products and enabling technologies and infrastructure. Community-level influencers such as progressive farmers, village leaders, and social workers have a vital role in creating awareness among smallholders, overcoming their fears and myths, marketing insurance, and driving demand and usage. Communities, too, need to be an integral part of a multi-stakeholder and systems-driven approach to make insurance inclusive.

[1] IPCC – Sixth assessment report – Regional fact sheet- Africa, August 2021

[2] IPCC- Sixth assessment report – Regional fact sheet- Asia, August 2021

[3] SwissRe and FAO data

[4] Agricultural insurance for smallholder farmers, GSMA, 2020