Managing drought risk through agricultural insurance
Source: CGIAR Climate

In India’s rain-fed agricultural system, drought poses a significant threat to agricultural productivity, food security, and rural livelihoods. Over the past several years, droughts have become a more common occurrence across India – between 2009 and 2015, the country as a whole experienced three years of drought due to weak monsoon rainfall. When faced with the risk of drought, farmers may choose not to invest in higher risk-higher reward production activities, such as the use of chemical fertilizers, irrigation, or higher yielding seeds. In this way, the specter of drought can negatively impact agricultural productivity even in years with adequate rainfall.

A recent article in World Development examines ways to help farmers in Odisha, India manage their drought risk. Specifically, the paper looks at the impact of a bundled risk management package that includes both drought-tolerant rice varieties and weather index insurance. Using a discrete choice experiment conducted among 2,160 farmers as part of a multi-year project’s mid-line survey, the study finds that bundling these two products together improved farmers’ perceptions of the value of the drought-tolerant rice varietal and increased their willingness to pay for both interventions.

Both drought-tolerant crop varieties and weather index insurance carry certain limitations that may reduce uptake of each intervention alone. Drought-tolerant varieties may not be as productive in periods of severe drought or in periods of normal rainfall as they are under moderate drought stress. Weather index insurance, in turn, carries with it a certain amount of basis risk, meaning that insured farmers could experience a loss and still not receive compensation if location where weather outcomes are measured differs from actual weather conditions on farmers’ fields. The authors of the study posited by that by combining the two products, they could address these limitations and help reduce farmers’ risk.

The study finds that farmers in the control group, who were not exposed to the drought-tolerant rice, would be willing to pay slightly more for the new rice variety than farmers who received either the drought-tolerant variety alone or the drought-tolerant variety coupled with the insurance product. The authors posit that this may stem from disappointing experiences with the variety in years of either normal precipitation or severe drought. However, overall, farmers were willing to pay an average of around INR 209 (approximately 290 USD, in 2018 prices) for the drought-tolerant variety, signifying positive willingness-to-pay.

In addition, among farmers who received the drought-tolerant variety, willingness-to-pay was higher (above INR 200) among those who received both the seed and the insurance product. This suggests that bundling the two products together increases farmers’ valuation of the drought-tolerant variety above what it would be valued at independently. In other words, providing access to weather index insurance could increase farmers’ likelihood of investing in higher return inputs like drought-tolerant seeds.

In terms of the weather index insurance product, the authors find that farmers were willing to pay an average of INR 263 for coverage; this amount is 129-251 percent higher than the actuarially fair prices for the product. In addition, farmers who received both the drought-tolerant rice and the insurance product were willing to pay INR 40 more for the insurance coverage than farmers in the other treatment arm and in the control group.

Farmers in the sample appear to be sensitive to basis risk, which could require a reduction in the price of the insurance product to stimulate uptake. The study found that when faced with a 35 percent change of purchasing insurance and not receiving a payout, farmers would need roughly a INR 125 reduction in the cost of the insurance product. However, even after factoring in such discounts to account for basis risk, the authors find that farmers would still be willing to pay more than actuarially fair prices.

The results of this study provide some early insights into whether a bundled risk management product, such as a combination of drought-tolerant crop varieties and targeted weather index insurance, could be a viable way to help farmers in rain-fed agricultural areas better manage their weather risk. The authors emphasize that farmers’ sensitivity to basis risk will likely increase as they gain more experience with insurance products. In addition, more analysis is needed to fully understand the demand for, uptake of, and impact of this risk management product on production and livelihoods. However, overall, the initial results suggest that such a product may be an effective way to address drought risk in rain-fed agricultural zones.

Photo credit:CGIAR Climate