Exploring the uncharted frontier of farm micro-insurance

In insurance, the adverse selection problem is defined as greater tendency of those in dangerous line-of-work to purchase products such as life-insurance. Because of the information asymmetry between buyer and seller (buyers usually have more information about personal health), insurance companies hedge risk by limiting coverage or raising premiums.

That, in effect, defines the dilemma of poor agricultural insurance market in Pakistan. While the theoretical potential of agri-insurance demand is often prefixed with cheery adjectives such as “immense” and “untapped”, the supply-side is virtually non-existent.

But first, some sordid stats. Out of the thirty non-life insurance members of Insurance Association of Pakistan (IAP), websites of only seven list some sort of agricultural, crop or livestock insurance products. The latest annual yearbook of IAP from 2018, which lists market share and volume of various product categories such as marine, property or life insurance, makes no reference to farm-related insurance products. More unfortunately, last available annual financials of those seven firms only make passing reference to agri-related products – and in some cases, none – often clubbing them under the ‘miscellaneous category’.

Does that mean the insurers are uninterested? To answer this question, let’s refer back to the problem of adverse selection. Demand for farm insurance products, whether crop or livestock, is naturally skewed more towards crops that are at a higher risk of damage due to extreme weather events such as droughts, floods, heavy rain, or failure due to pest attacks or disease. In Pakistan, these primarily include highly perishable crops such as vegetables, and in more recent years, even cash crops such as cotton.

The problem is compounded due to lack of scale. Because Pakistan’s farming is generally small-hold, the cost of making premium-assessment for land-sizes averaging less than five acres generally exceeds the net commission earned. On the other hand, growers that enter natural hedge by growing crops with lower risk of failure, or by investing in varieties that are drought- or flood-resistant, for example, do not find the value proposition of an insurance policy attractive enough.

The negative spill-overs from absence of insurance cover are manifold. Faced with successive episodes of crop failure, small growers find it unable to break through the subsistence-barrier, as higher-value crops – grown to generate income beyond immediate family & livestock’s nutritional needs – are usually ones at greater risk of perishability. This feeds into a vicious cycle of risk aversion, as growers increase their dependency on lower-risk, lower-value crop mixes.

Ten years ago, the launch of Pakistan’s first micro-insurance firm was supposed to resolve this dilemma. Modelled on the principles of microfinance, firms targeting customers in rural settings hoped to reach a critical mass of farming households in model villages to present their low-premium products as a viable proposition.

In the years since, it appears the focus of micro-insurance has become concentrated to risks relating to death, disability, or illness. Preliminary findings of a 2013 paper published in Lahore Journal of Economics, for example, indicates that utilization remains geared towards health microinsurance (HMI) category. The causes of this preference set are unexplained due to paucity of time passed since the product launch. Even so, the consumer behaviour observed makes intuitive sense, considering even the poor must treat disease to survive – and live to fight another day.

The poor offtake of farm micro-insurance also resonates with another consumer behaviour problem observed in Rwanda and Kenya in mid-2000s. Researchers found that unlike micro-credit buyers who benefit from upfront cash inflow, micro-insurance requires upfront payment or cash outflow. Moreover, while the premium may be nominal, it only represents a contingent claim. As a result, farmers, especially small hold, simply see it as an additional expense that eats into their already mediocre returns.

Does that mean the future of agricultural insurance in Pakistan is perpetually forsaken? Available literature appears to agree, considering crop insurance has been successful in countries with enabling environment that includes average land-sizes above hundred acres, corporatized farming with crop-mix tilted toward cash crops, but most of all, prolong periods of government subsidy or public-private partnership such as seen in USA with the enactment of Federal Crop Insurance Act.

Not only the domestic environment lacks these enabling forces, but a subsidy model of farm insurance also comes with the trade-off of increased commodity prices that Pakistan can ill-afford. But the past is not necessarily an indicator of the future.

Subsequent instances of crop failures, increased frequency of extreme weather events, falling predictability of precipitation pattern, floods and frost waves, manifested itself in severe food inflation that touched 20 percent last year. Coupled with a shortage of resistant seed varieties commercially, all point to the fact that the resilience of domestic crop varieties is increasingly failing amidst the onslaught of climate change.

And repeated instances of harvest failure are no longer restricted to high value perishable crops such as tomatoes that were grown on very limited acreage. If news reports are any guide, even main cash crops such as cotton and maize are no longer safe, as extreme weather has reduced yield and productivity of these crops that were once seen as farmer’s informal insurance.

This means that as farm incomes become more exposed to higher degree of variability, micro-insurance may once again find a window of opportunity among small-hold farmers. Lessons from Rwanda and Kenya indicate that the right-mix may involve clubbing micro-insurance policies with micro-credit advances to small-hold farmers. Because the insurance premium is netted off from the credit advance, growers in sub-Saharan Africa no longer saw the transaction as an upfront cash outflow, with the added upside of a hedge against crop failure thanks to insurance policy.

In absence of a localized market study, these are, of course, mere conjectures. Buts if there is any lesson in the massive failure of cotton crop in the now-ending kharif season that saw output falling short of target by over one-third – manifestation of climate change with increasing frequency may present a unique opportunity to untap the latent demand for agri-insurance products. And one that is ripe to be exploited without much governmental intervention. If the entrepreneurs are listening.

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