This report presents project products to the Commodity Risk Management Group of the World
Bank for the development and evaluation of index insurance contracts for smallholder farmers
in Malawi, Tanzania, and Kenya. The development of some products we are providing was supported
at no cost by the NSF-funded Center for Research on Environmental Decisions.
Index insurance is a relatively new weather risk management tool. While traditional insurance insures
against crop failure, index insurance insures for a specific event or risk, such as rainfall deficits. The
index insurance can be more cost effective since there is no need for in-field assessment of damage
because payouts are triggered by weather data directly. Index insurance addresses two problems associated
with traditional crop insurance: moral hazard (incentives for a farmer to let a crop die in order to
get an insurance payout) and adverse selection (in which insurance is priced based on the risks of the
entire population but only the most vulnerable farmers purchase insurance).
However, index insurance only provides partial protection and is therefore only one part of a complete
risk management package. It is critical that the client have a comprehensive understanding of exactly
what risks are covered (and what risks are not covered) by the index product so that clients can effectively
use the insurance as a part of their risk management system. Products must be transparent and
completely understandable to the client or they will not be able to play their proper role.
We designed and evaluated contracts for Malawi, Kenya and Tanzania. Because some contracts existed
for Malawi prior to this project, and since the insurance is in its second year of implementation in
Malawi, the Malawi initial contracts and implementation are used as a starting point. Following the
project specification, we have developed in depth analysis, such as process based crop simulations and
quantitative analysis of historical data, for the Malawi case study. These additional analyses are unique
to the Malawi case.
In general, the contract development and evaluation process has led to a set of contracts that appear
to perform extremely well. So much so, that demand in many places has overwhelmed administrative
capacity to serve clients. As this is an unsubsidized product that is purchased by clients, some indication
of its value can be seen in its market demand. In interviews, farmers have stated that their primary
strategy for adaptation to climate change is enrollment in the insurance program.