Fourth in a series of IFPRI blog posts examining the role of risk in agriculture under climate change, in connection with the UN Climate Change Conference (COP25) in Madrid Dec. 2-13. Read the first post here, the second here, and the third here. This blog first appeared on IFPRI Issue Post.
The COP25 talks will have focused mainly on how to mitigate and adapt to an average temperature increase. However, climate change also means that extreme weather events such as floods, droughts, and cyclones are growing in frequency and intensity. We should not ignore the behavioral impacts of these events when modeling or predicting the effects of climate change. Going a step further, effective climate change policies should focus not only on adaptation to changing temperatures in the long run, but also on adaptation to the increasing incidence and intensity of weather extremes.
Weather index insurance is a promising adaptation instrument in this regard: Losses and payouts are determined using measured variables such as rainfall, and insurance companies don't have to send claims adjusters out to assess damages. Participating farmers can purchase insurance at relatively low cost that can help them recover from floods and other disasters and lower various forms of risk.
Weather extremes can have long-lasting impacts on smallholder farmers’ livelihoods through at least two channels. First, they destroy assets and production, and to make up for the lost income households may resort to costly coping strategies such as borrowing at high interest rates or reducing investments in children’s education—all of which compromise future household welfare. Second, even the mere possibility of weather extremes can have severe consequences, as risk discourages investments in agriculture. This risk ex ante—without the shock necessarily occurring—reduces welfare by a substantial amount, even relative to the welfare losses from shocks themselves.
So, effective adaptation policies should promote instruments that help households cope and recover from weather extremes ex post, but also help them in reducing their exposure to risk and increasing their investments ex ante, so that the policies deliver value even during good years without a shock. How can we improve the ways smallholder farmers manage these two different aspects of risk?
Financial inclusion offers part of the solution. A review by Innovations for Poverty Action (IPA) and IFPRI suggests that well-designed financial products and services such as insurance, savings, credit, and mobile money all play a role in increasing smallholder farmers’ resilience. They help farming families to prepare for risk, to respond to emergencies when they occur, and to access funds to invest in risk-reducing technologies. They can also help households increase their investments in a volatile environment, in profitable yet risky opportunities that raise incomes over time; this in turn helps households grow out of poverty that makes them more vulnerable to disasters in the first place.
Many trials show that weather index insurance products, by reducing exposure to risk, can lead to higher investments by both crop and livestock farmers. However, as with many new products and services, voluntary take-up of index insurance typically remains low, even with subsidized premiums, and scaling up is a challenge. A forthcoming review by researchers from the CGIAR Research Programs on Climate Change, Agriculture, and Food Security (CCAFS) and Policies, Institutions, and Markets (PIM) describes how CGIAR organizations can work with the insurance industry on these key efforts to adapt to climate change, and outlines a number of challenges and evidence gaps:
Data availability. Insurance schemes struggle with an absence of data—for instance, data on rainfall and crop yields needed to develop indices and monitor risks. Information and communications technologies (ICTs) and advances in data processing offer new opportunities to improve the quality of index insurance and reduce basis risk.
Targeting and design of insurance. Insurance must be appropriately targeted, and this means recognizing heterogeneity in farmer populations and designing insurance products that best meet the needs of specific farmer groups, even at scale.
Distribution channels and capturing the full value chain. It is importance to market insurance through existing distribution channels that farmers use and trust, such as microfinance or input suppliers. And while insurance is typically offered to farmers, there are opportunities to market it to actors engaged in non-farm activities such as input suppliers and traders.
Bundling with climate smart agriculture and risk layering. Bundling index insurance with credit, climate smart technologies, and/or life insurance can make it a real value-adding proposition for farmers and increase demand.
Regulatory and enabling environment. Establishing a legal and regulatory environment for enforcing contracts that both buyer and seller can trust is fundamental to making insurance and other financial instruments work. Partnerships between government, local insurers and international reinsurers are key to this effort. In some cases, smart subsidies may be required alongside regulatory reform to provide an enabling environment for insurance to have an impact on resilience.
Many obstacles remain to understanding the long-term resilience impacts of weather index insurance and other products. Future research is sorely needed in these areas. Bridging these knowledge gaps will require more partnerships between various stakeholders to build evidence, encourage innovation, and scale promising solutions to strengthen the use of financial inclusion in building resilience.
Berber Kramer is a Research Fellow with the Markets, Trade, and Institutions Division at the International Food Policy Research Institute (IFPRI) and works closely with the CGIAR Research Program on Policies, Institutions, and Markets, which supports the research on Picture-Based Insurance (PBI).
Photo: A farmer in Bihar, India, cultivates bitter melon. A flood index insurance program integrating modeling and satellite imagery with other data is helping bitter melon farmers deal with rising climate risks. Metro Media / IWMI