Index Insurance for Ethiopian Farmers

Oxfam America has enlisted the International Research Institute for Climate and Society's expertise on index insurance to design contracts for poor farmers in a remote village in the Ethiopian highlands. The goal of the project is to improve farmers' ability to manage drought risks and subsequently gain better access to credit. If all goes well, the two organizations and their local partners hope to export the success to other villages and potentially scale up the program to cover entire districts.

Agriculture accounts for 47 percent of Ethiopia's gross domestic product, 80 percent of its exports, and 80 percent of its work force, according to the U.S. State Department. Many other economic activities depend on agriculture, including marketing, processing, and export of agricultural products. Small-scale rainfed farming is the dominant form of production and an important subsistence activity.

"Precipitation plays a pivotal role in the country's welfare. With 98% of its cropland on seasonal rains for irrigation, and so much of the population engaged in farming, a highly susceptible dependence is in effect," says IRI scientist Paul Block, who is part of the project. "Add in significant year-to-year variability in rainfall, and it becomes clear why farming in Ethiopia has proven to be a difficult livelihood. Unfortunately most farmers have little choice."

Properly managing the risks of this climate variability is therefore crucial, says IRI's International Development Officer, Haresh Bhojwani. "A single poor season can force farming families to sell off their productive assets, and it can severely weaken their financial and social networks," says Bhojwani. "Fear of droughts and losses prevents investment in agriculture even in the good years."

Oxfam has had longstanding agricultural-development projects in Ethiopia. As a continuation of this commitment, the organization wants to work with local microlending and other companies to provide farmers in Adi Ha (see map) the opportunity to buy index insurance contracts to help reduce their vulnerability to climate shocks.

"With support from the IRI, we are testing ambitious innovations, including new techniques to overcome weather data barriers, meaningful engagement of farmers in contract design, and community-based distribution of payouts in a way that minimizes contract basis risk," says Raymond C. Offenheiser, president of Oxfam America.

Index-based insurance products for agriculture represent an attractive alternative for managing weather risk. Such products use a weather index such as rainfall, rather than a possible consequence of weather, such as crop failure, to determine payouts to farmers. This subtle distinction resolves a number of fundamental problems that make traditional insurance unworkable in rural parts of developing countries. Unlike traditional crop insurance against crop failure, the insurance company doesn't need to visit farmers' fields to determine premiums or to assess damages. Instead, if the rainfall recorded by gauges is below an earlier agreed-upon threshold, the insurance pays out. Such a system significantly lowers transaction costs and makes it viable for insurance companies to sell to small farmers. Having insurance allows those farmers to apply for and receive bank loans and other types of credit previously unavailable to them.

Pilot programs conducted in several developing countries have proven the feasibility and affordability of such products. They may be able to dramatically reduce climate vulnerability and enable investment and growth. But a critical component to a successful index insurance program lies in the design of the contracts.

"This project provides us with the opportunity to address some of the more challenging issues in index insurance that will need to be addressed to be able to use it as a tool to address poverty at large scales," says Dan Osgood, who leads IRI's index insurance research.

"One of these challenges is to have an efficient process through which farmers can identify, develop, and validate the most valuable product with technical and financial parters."

Another challenge, says Osgood, is that there is very limited data for Adi Ha. "So the process must be refined in order to develop robust products that aren't sensitive to data limitations and to validate the quality of these products. These issues must be addressed if the tool is to be applied at large scales," Osgood says.

This work builds on IRI's past successes in using index insurance to reduce drought risks for farmers in eastern and southern Africa and in Central America. IRI also recently co-hosted a policy roundtable with Swiss Re on the potential for index insurance to help countries meet development challenges and adapt to climate change. This fall, IRI will hold a workshop on the role of climate science for index insurance applications and will dedicate its next issue of Climate and Society to the topic.

For more information about this project, please contact Francesco Fiondella at +1.845.680.4476.

Relevant Links

Designing Weather Insurance Contracts for Farmers: In Malawi, Tanzania, and Kenya