Interview with Peer Stein: Index Insurance Is For Farmers What Credit Scoring Was For Consumer and Small Bank Lending
Is index insurance poised for a great leap forward similar to the rapid growth experienced by microfinance and credit bureaus in the 1990s?
Index insurance clearly holds a lot of promise to help unlock productivity gains and protect farmers all around the world. Index insurance is for insuring farmers, MSMEs and individuals what credit scoring was for consumer and small business lending - a huge opportunity to make financial services much more widely available at lower cost by using smart analytics and data. In this sense, index insurance may be even more promising than microcredit because the underlying business model is inherently scalable and less demanding in terms of client interaction than microfinance. Index insurance is also an important missing piece of the microfinance risk management strategy.
What are the main constraints to the growth of index insurance markets in developing countries? Price? Lack of historical weather data? Design? Distribution?
As for any insurance product, distribution is key. Finding and being able to work with the right aggregators, and building smart distribution channels that leverage technology, will be critical to its success because the objective in the agriculture space is to reach millions of small farmers in rural areas. Index insurance should take advantage of the growth in mobile banking, leveraging among others distribution partnerships with mobile telecommunications companies.
Data is just as important as distribution. For index insurance to work, product design requires data. Lots of it. And that is truly the main constraint for emerging markets. Similar to the constraints we see in introducing low-cost lending technologies using credit scoring for developing markets - which rely heavily on data available through credit bureaus in particular - the adaptation of index-based insurance for farmers relies heavily on the availability of rainfall and moisture data, historical yield data, and soil type data.
How can IFC ensure that sustainable markets for index insurance succeed in developing countries?
It will require time and effort to develop the required data infrastructure in emerging markets. Similar to the efforts building credit bureaus and movable collateral registries for small business lending to be possible at low cost and scale, index insurance will require significant investments in the data infrastructure, including weather stations and satellite data, typically under the stewardship or close involvement of national meteorological departments. Investments in data infrastructure will have to be complemented by efforts to build markets for index- based insurance and ensure that companies serving small farmers and other low income beneficiaries in developing countries will be viable in the long run.
Can Weather Index Insurance Increase Finance for Smallholder Farmers?
Smallholder farmers need finance. According to a recent report of 1,800 banks conducted by the Initiative for Smallholder Finance – “Local Bank Financing for Smallholder Farmers: A $9 Billion Drop in the Ocean” - local banks in developing countries are currently lending approximately $9 billion to smallholder farmers compared to a total estimated demand of $300 billion globally for smallholder finance ($450 billion if China is included). Although smallholder farmer financing also occurs through MFIs and non- financial intermediaries like supply chain participants, cooperatives and moneylenders, this is a notable gap in available bank financing.
There are 450-500 million smallholder farmer households (2.5 billion people) in the world, and many smallholder farmers live on less than $2 a day. Figuring out their financial needs is a challenge. Financial institutions have traditionally been reluctant to lend to smallholder farmers as the loan amounts are small, and default risks are high due to a variety of factors such as small land holdings, weak value chains, and increasingly adverse weather. Weather has always been one of the biggest risks that farmers face, and it is increasing in severity due to climate change.
A variety of innovative risk management instruments are springing up to increase bank and MFI lending to smallholders such as flexible repayment terms linked to crop cycles and the use of mobile technology to distribute finance and collect loan repayment. But with severe weather on the rise globally, insurance is one of the essential tools to help farmers recover quickly after harvests fail due to adverse weather, and enable financial lenders to secure their loans.
If well designed, index insurance may be an important instrument to increase finance to the smallholder farmer sector. Some banks and MFIs may accept insurance as partial collateral for loans and hence increase their lending. Index insurance pays out benefits directly to farmers on the basis of parametric triggers (eg. rainfall levels), without requiring traditional resource intensive insurance claim assessment. It is ideally suited to the needs of smallholder farmers.
As Aaltje de Roos, Senior Policy Advisor to the Netherlands Ministry of Foreign Affairs, noted: “The beauty of agri-index insurance is that it can cover small investments, such as the Syngenta Foundation’s work in Africa through its Kilimo Salama insurance initiative which allows farmers to insure inputs only. Farmers can afford to insure a bag of seeds which is a low-cost investment up front and allows time to build farmers’ trust in the index insurance sector.”
It will take time to train staff of lending financial institutions in developing countries on the specific financial needs of farmers and index insurance products. IFC country offices in Sub-Saharan Africa are working with financial institutions to expand their agricultural portfolios but the best bet short term for expanding financial services and insurance to smallholder farmers may be nontraditional players such as the agribusiness sector.
Dave Chalila, Senior Financial Specialist at IFC/Sub-Saharan Africa region, noted “In Sub-Saharan Africa, it is common practice for smallholder farmers to receive credit from agribusiness companies through the provision of inputs and services. IFC needs to recognize that efforts to increase access to finance should focus on both traditional financial services providers, such as banks and microfinance institutions, as well as non-traditional players. In the short term, agri-businesses offer promising opportunities for insurance products because of the larger number of farmers within their supply chains. For example, Ecom Trading is a marketing agent for almost 400,000 coffee farmers in Kenya, and weather index insurance would benefit both the agribusiness firm and its coffee farmers.”
Climate Corporation Builds Massive Data Platform for Agriculture in the US
According to The Climate Corporation – a tech company based in San Francisco -- data science has the potential to fundamentally improve the productivity and sustainability of global agriculture.
Since 2007, the Climate Corporation has been hard at work building a technology platform that combines hyper-local weather monitoring, agronomic data modeling, and high-resolution weather simulations that are updated hourly. On the platform (see www.climate.com), Climate has built products to protect farmers with index-based insurance and improve profits with software that help farmers make more informed operating decisions.
In the United States, government-subsidized Federal Crop Insurance covers up to 85 percent of a farmer’s yield, based on actual production history. So then what exactly do farmers get from weather insurance? Index-based parametric weather insurance supplements Federal Crop Insurance to help protect risk outside of what the government covers. Climate’s products are not subsidized and pay out automatically when bad weather happens. Their flagship product, Total Weather Insurance, is designed to protect against shallow losses (eg.,small yield shortfalls rather than major losses which occur more infrequently) providing coverage against major weather perils including drought, excess moisture, and a shortfall of heat units; correlating with yield losses. On average, the per acre premium is $25-$40, depending on the exact coverage details.
In addition to weather insurance, Climate offers high-tech agricultural advice. Farmers use their free Climate BasicTM app to see up-to-the minute which fields are workable, track crop growth phases, take scouting notes and generate reports. The paid version Climate ProTM goes further to make proactive recommendations on production such as when a farmer should plant, when and how much nitrogen to apply, what to do for pests and disease alerts, and advice on when farmers should harvest and more.
“The Climate Corporation creates moisture and precipitation maps so precise that, in some cases, a farmer can determine whether the field on one side of a road is wetter than the field on the other side,” reported The New Yorker in a November 11, 2013 article “Climate by Numbers.”
To build the hyper-localized weather and yield models that support its insurance platform, the Climate Corporation acquired sixty years of crop-yield statistics for every planting region in the country from the Department of Agriculture (for free) and matched that information with reports from two million locations that the National Weather Service scans regularly with Doppler radar (also free). What wasn’t free was making sense of all that data. The company employs dozens of scientists and mathematicians to create algorithms and simulations for farmland across the country, down to the field level. It took so much computer power to create the underlying models that Climate was one of the world’s largest consumers of Amazon’s Cloud services.
Information technology is as important as the weather for today’s farmers in the US, particularly as climate change makes agriculture a more precarious investment. In 2012, drought affected eighty percent of the country’s farmland.
Something must be working - Monsanto recently bought The Climate Corporation for $1.1 billion. They won’t reveal their client numbers or current revenue, but they have released that today customers in the US are using their Climate Basic product on over 25 million acres, and that number is growing every day. Climate is considering expanding into developing countries, and they are discussing possible collaboration with the WBG Global Index Insurance Facility and its partners.