Crop Insurance Client Value
by Balasubramanian S and Karthikeyan M*
*Balasubramanian S, Chief Executive, People Mutuals, and Karthikeyan M, Programme Leader, DHAN Foundation
Index insurance may be a solution to problems with traditional agricultural insurance. From an insurer’s perspective it may reduce problems of moral hazard and adverse selection and reduce high administration costs (Skees and Collier, 2008, Barnett, Barrett and Skees, 2008). However, index-insurance also poses a challenge: basis risk. Especially from the client’s perspective, In this article, client value in weather index insurance
is discussed on DHAN Foundation’s rainfall index insurance. This insurance is an interesting case as with the help of ILO’s Micro insurance Innovation Facility, DHAN Foundation has set up a dense network of local automatic rain gauges in the state of Tamil Nadu and Andhra Pradesh, India. In this dense network, the average distance between rain gauges is around five kilometers. It can be assumed that basis risk caused by spatial variation between the
farm and the reference weather station is relatively low, which makes the study of additional sources of basis risk and their impact on client value feasible.
Another interesting feature of this rainfall index insurance is that it is delivered through a mutual organization: DHAN People Mutuals. Through the mutuals, farmers are involved in processes of installation of rain gauges, product design and supporting processes. It is hypothesized that their involvement in these processes contributes to an increase of client value of the product, potentially solving certain problems with weather index
As was mentioned above client value tries to understand the insurance product from the client’s perspective.
In this article we use the ILO’s Micro insurance Innovation Facility’s PACE tool to analyze the client value of DHAN’s rainfall index insurance. The PACE tool analyzes client value based on four dimensions: product, access, cost and experience:
- Product: Describes the degree to which the product meets the most important risk management needs of the target population. It reviews coverage, benefit level, eligibility criteria and availability of value-added services.
- Access: Describes the accessibility and simplicity of the product by investigating choice, enrolment, information, education, premium payment method and proximity.
- Cost: Measures both affordability and value for money, while also looking at additional costs and efforts to keep down overall costs of delivery.
- Experience: Assesses responsiveness and simplicity by looking at claims procedures and processing time, policy administration, product tangibility and customer care.
Weather index insurance and basis risk
Index insurance uses a weather parameter which correlates with realized crop losses such as measurements of rainfall or temperature at a weather station. Claims are paid as soon as the index reaches a certain level, regardless of actual losses (Skees, Barnett and Collier, 2008). Index insurance allows for removal of individual loss assessment and reduction in administration costs because it can make use of standardized contracts. In addition, the independently verifiable index allows for reinsurance and therefore insurance companies can efficiently transfer part of their risk to international markets (Hazell et al., 2010).
As mentioned above, index-insurance also has many challenges. The major one is basis risk. Basis risk refers to situations where individuals suffer losses but don’t receive a payout or situations where individuals don’t suffer losses but do get a payout. From the perspective of a farmer the first situation leads to demotivation for uptake of the insurance. However, the the second situation may lead to opportunistic behavior of the farmer because it may
provide payouts while there are no losses.
Moreover, time periods in which losses can occur may vary from the risk cover periods in the design of the insurance product. This would imply for the farmer that some of the risks to his or her crops are not covered. Further experience with insurance in developing countries is low and often negative. Building trust and understanding of index insurance products is therefore a challenge (Barnett and Mahul, 2007), especially because it carries basis risk.
Hypothesized client value from weather index insurance
In relation to the product dimension of client value, it seems straight forward that weather index insurance meets an important risk management need: protection against weather risk. However, farmers are not necessarily interested directly in weather risk but more, like is the case with traditional indemnity insurance, in protection against crop losses. In this light it is assumed that the correlation between weather and crop growth should be at least 80%. It can therefore be hypothesized that weather index insurance leads to lower value with respect to the product dimension than traditional insurance.
With respect to the access and experience dimensions weather index insurance is not a simple product which is one of the client value determinants. Understanding the product, the weather stations and claim payment methods is more complicated than with indemnity insurances. However, claim payment, because it is based on an index, can be done faster, which contributes to client value.
The cost dimension, because of removal of expensive loss assessment procedures, should make weather index insurance more affordable from the clients’ perspective.
Additional value from the mutual model?
The institution responsible for most of the execution of DHAN’s rainfall index insurance project is People Mutuals. People Mutuals is owned by villagers and facilitated and organized by DHAN foundation. The experience of People Mutuals with offering life insurance to its members dates back to 2003, while DHAN Foundation has been working in many villages since 1990. The existing institutional structure for the delivery of insurance is based
on mutual pools organized in locations through federations of farmers’ groups. The location pools typically are small. A mutual catastrophe system between the locations is organized via DHAN People Mutuals. This mutual catastrophe program diversifies risk over two states. Till 2009-2010 the reinsurance was done by Eureko Re, but since 2010-2011 the entire risk was transferred to AIC of India.
The characteristics of the mutual model have their implications for client value. It is hypothesized that involvement of farmers in product design will increase the value of the product dimension because it is assumed that the risk management needs of the farmers are better represented if they themselves are involved in the design of the product. The access dimension by involving farmers is also assumed to improve because of farmer involvement in education, marketing and sales, which leads to increased understanding of knowledge needs and trust. Additional value from the cost dimension is uncertain. On the one hand the mutual can take over activities such as education and trust building which implies that the product can be cheaper. However, involvement in product design may lead to an increase in costs. Finally, the mutual is assumed to increase the value of the experience dimension of the
product especially because of farmer involvement in claims settlement.
DHAN’s rainfall index insurance and its alternatives
DHAN’s rainfall index insurance covers the main crops in the region: Chillies, Paddy, Cumbu, Sorghum, Maize, Pulses and Groundnut. The unique feature of this product is that the product design is done at the level of location. The premium varies, depending on the crop, between 725 – 1300Rs. per hectare which is 5 – 12% of the sum insured. Up to 2011 almost 6000 farmers bought the insurance. The net income ratio, incurred expense ratio and incurred claims ratio were 82,18,2 respectively for the year 2009-2010 and -61, 90, 70 for the year 2010-2011 against ideal ratios of 5,20,75 (Wipf and Garand, 2010).
As Matul, Tatin-Jaleran and Kelly (2011) explain, client value of an insurance product should always be considered in relation to alternatives.In relation to client value it is important to establish what the clients consider to be alternatives. In this light, two other crop insurance products were mentioned by the farmers. The government crop insurance scheme ‘National Agriculture Insurance Scheme’ (NAIS) and the ‘VarshaBima’ (VB) product of the Agriculture Insurance Company. The NAIS product is an area-yield index and the VB product is a rainfall index product. Even though NAIS is not a rainfall index the fact that farmers discuss both products as competitive products is an indication of the fact that in the view of the clients not the type of insurance is important but the fact that the insurance provides a cover for crop losses. DHAN RII and VB will be easier to compare because they are similar insurance products (rainfall index) while NAIS is a different product. However, to do justice to the client value view, NAIS is also considered in our comparison.
Raju and Chand (2008) and Ifft (2009) explain about NAIS that the scheme is operating on the basis of both an ‘area approach’ for widespread calamities, and an ‘individual approach’ for localized calamities such as hailstorm, landslide, cyclone, flood, etc. The product covers all food grains, oilseeds and annual horticultural and commercial crops. The premium in 2006 was 194 Rs. per hectare which is 1.5 to 3.5% of the sum insured. There is a 50% subsidy for small and marginal farmers, to be shared equally by the Government of India and respective State governments.
The VarshaBima product of AIC, like the DHAN RII, consists of a cover for deficit rainfall, consecutive dry days and excess rain. The premium for paddy in 2010 varied between Rs.898 to 3250 per hectare according to the risk profile of different blocks in different districts. For each different cover there is a different pay out. Crops covered include paddy, groundnut etc Methods
Mr.Balasubramanian and Mr.Sivaprakash from People Mutuals (PM) of DHAN foundation (DHAN) and Mr.PranavPrashad from the Micro Insurance Innovation Facility (MIF) of the International Labour Organization (ILO) and Ms.KarlijnMorsink, external consultant to the MIF jointly studied the program and implementation of DHAN’s ainfall index insurance. Two days were spent at the DHAN office to interact with DHAN and PM staff and two days were spent
in the field to allow for extensive interaction with farmers. During the two days spent in the field, two out of a total of five locations were visited.
Mudukulathur and Singampunari
These were chosen because they vary with respect to the financial status of the population and type of 15
crops. Mudukulathur is a relatively poor area where farmers mostly crop one season while Singampunari is better off and farmers tend to crop two seasons. These factors are assumed to influence the value that farmers perceive from the product.
In Mudukulathur two focus groups were held. One focus group with 30 farmers representatives from the farmer federations. The second focus group was held with about 15 DHAN field staff from Mudukulathur. In the afternoon two villages were visited where the rainfall index insurance had been introduced in 2010. Both villages rely on the same rain gauge but in one village all federation members took the insurance while in the other village none of the federation members took it. This was seen as an interesting exposure. Focus groups were held in both villages with 20 participants.
In Singampunari also two focus groups were held. One with representatives from the farmer federations and one with the Singampunari field staff. In the afternoon one location which had been exposed to the crop Insurance in both 2009 and 2010 was selected with the aim of understanding changes in the demand for the insurance. Three separate interviews were held with farmers to understand their perception of value of the product.
Further to these focus groups, interviews and discussions with DHAN and People Mutuals staff, documents and reports were analyzed on the product, access, cost and experience dimensions.
Conclusions: Basis risks and client value from DHAN RII
The analysis led us to conclude that the index insurance is associated with basis risk influences. The product value would be challenged because of low correlation between actual crop growth and the index in the rainfall index insurance. Because DHAN RII leads us to conclude that the weather index and its associated basis risk influences especially the product, access and experience dimensions of client value.
The product value is challenged because of low correlation between actual crop growth and the index. Because DHAN RII’s spatial basis risk is relatively low we were able to identify other sources of basis risk. As is known, basis risk may be caused by other risks than rainfall, such as diseases, farm inputs and soil quality. In addition, the critical risk period which is determined in advance for the design of the product may differ from the actual period of rainfall. Thirdly the nature of rainfall needed for the different stages of the crop growth process should be adequately reflected in the product design and specialized for different crops.
With respect to the access dimension, despite the fact that index insurance is said to be able reach out to larger amounts of farmers, any index insurance leads to problems with marketing and education because farmers intially have to build up trust in the rain gauges / crop cutting experiments and the insurance product. It can be hypothesized based on the interviews and focus groups that farmers need more evidence that the product is reliable than in the case of area index insurance. In all the three crop insurance programmes, premium collection process is problematic because it is collected during periods of cash outflow and the time frame for sales is too short. Significant improvements are anticipated if flexible payment options are offered for the premium by providing a premium loan or allowing payment in installments.
The experience dimension with weather index is positively influenced because the rainfall index allows for relatively fast and transparent claim processing times and procedures, especially because the farmers have access to the rainfall readings under DHAN RII. However, large basis risk may lead to high levels of unsatisfaction with claim payments. Therefore transparency is even more important.
Conclusions: Client value from the mutual model.
Through the mutual model, farmers were involved in placement of rain gauges, product design, processes of marketing, education and sales and claims settlement of DHAN RII. With respect to the product dimension of client value, the involvement of farmers in product design did not contribute to a product with low basis risk especially because of lack of knowledge about insurance principles among farmers.It can therefore be hypothesized that farmer involvement in product design of weather index insurance may not neccesarily contribute to increased client value by lowering basis risk.
However, on the access and experience dimensions their involvement in education, marketing, sales and claims settlement has contributed to trust on rain gauges and a better understanding of claim payments. Their involvement in education has currently not yet led to increased value because there is a lot of misunderstanding about the product because of basis risk. Collier, Barnett and Skees (2010) explain that an important component of education about weather index insurance it to focus on the fact that the insurance provides a cover for rainfall, not for crop growth (Collier, Barnett and Skees, 2010). If a specific index insurance education strategy is developed, the mutual involvement may lead to increased client value. With respect to marketing and sales client value has also not increased which is likely to be caused by short time periods for these activities.
However, farmer involvement in the organization processes has led to trust in the product which has increased client value from both access and experience.
With respect to the cost dimension of client value the costs and benefits of involving farmers in rain gauge installation, product design and processes should be further studied. The involvement of farmers in rain gauge installation led to low labour costs and trust which is likely to outweigh costs of installation if not done in collaboration with the farmers.
Conclusions: Relative client value of DHAN RII, NAIS and VB of AIC
The overall comparison of the four client value dimensions of DHAN RII and NAIS lead to the hypotheses that DHAN RII offers better value with respect to the access and experience dimension and NAIS with respect to the product and cost dimension. However, access to the NAIS and claims settlement is not always perceived as transparent by farmers. In some locations farmers had heard about NAIS but had never been able to access it while in other locations both access and claim payment were common.
However, in locations with access to NAIS the cost dimension appeared to be an important motivation for take up of NAIS.
Discussion and recommendations
Basis risk refers to situations where individuals suffer losses but don’t receive a payout or situations where individuals don’t suffer losses but do get a payout. Next to spatial basis risk an important source of basis risk was found to be the product design. Adequately reflecting the risk period and the pattern of rainfall during different crop growth stages should receive ample attention in designing weather index insurance.
An important lesson here is that next to adequate product design, adequate communication about the product and its design features may also reduce perception of basis risk by farmers. Explaining that weather index insurance insures weather risk and not crop growth risk seems important. Studies testing different education and marketing mechanisms should be done to know how uptake can be increased.
Assessing the influence of basis risk on the four dimensions of client value allows for understanding different mechanisms that lead to client value of weather index insurance. This allows for targeted improvements in the product and processes instead of only focusing on the reduction of spatial basis risk.
It was hypothesized that farmer involvement in product design through the mutual could reduce basis risk but in DHAN RII this was not the case. Farmers without experience with rain gauges were found not to be aware of actual mm rainfall required in different stages of the crop growth process. In addition, unawareness of insurance principles led initially, to a product with low client value. A product with low value is not in the interest of farmers but also not in the interest of the insurer. It should be further studied how weather index insurance experts can work together with farmers to improve product design.
The four dimensions of the PACE tool for assessing client value help in understanding relative client value of both products. This is especially important because access to NAIS and claims settlement is not perceived as transparent in all areas. In these areas DHAN RII can offer competitive value, despite being more expensive, through offering better client value on the access and experience.