Agricultural insurance has evolved a foolproof mechanism to protect agriculture equipment, inputs, outputs, resources and assets against imagined or foreseen loss of or damage. It has great potential to provide value to low-income farmers and their communities, both by protecting farmers when shocks occur and by encouraging greater investment in crops. However, in practice its effectiveness has often been constrained by the difficulty of designing good products and by demand constraints.
Agricultural insurance can indemnify policyholders for losses, though such indemnity products are relatively rare due to the high costs of administration and the risk of fraud.
More commonly, agricultural micro-insurance is index-based, providing farmers with pay-outs tied to the performance of an index, rather than indemnifying them for crop, animal, asset or liability, losses actually experienced.
While they avoid the need for costly (and often impossible) verification of damage, index products have a shortcoming in the form of basis risk, the difference between the performance of the index and the damage the policyholder actually suffered. In some cases, this basis risk can be quite large, but can be reduced through improvements in the index.
Designing appropriate products with limited or inaccurate data about the risk and about clients’ alternatives without insurance.
Designing sustainable products (from the insurer’s perspective), given the risks of fraud, adverse selection, and moral hazard.
Minimising distribution costs, which often involves tapping into an existing distribution infrastructure.
Explaining how these relatively complex products work to overcome understanding and trust barriers among target clients and to ensure that those who buy the product have a clear understanding of what is covered.
Overcoming liquidity constraints to purchasing insurance from farmers, who earn income seasonally (this can be done through careful timing of enrollment or through creative payment arrangements).
Retention of clients, who may not receive a payout for years and lack tangible evidence that the product will work as promised.
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