97471 Weather Index-based Crop Insurance in Malawi Facilitating Farmers’ Access to Agricultural Credit Background Highlights Agriculture, mostly smallholder farming, constitutes  Prior to 2005, only 50,000 of the millions of smallholder approximately 38% of Malawi’s economy. Banks in farming households in Malawi secured credit from Malawi are unwilling, however, to lend to smallholder formal financial institutions. farmers, primarily because of the risk that they would not pay back their loans if there were a drought. As a  The World Bank worked with the National Association result, prior to 2005, only 50,000 of the millions of of Small Farmers in Malawi to develop an index-based smallholder farming households in the country were crop insurance contract. able to secure credit from formal financial institutions.  Payouts are automatically made when the index Without access to loans, farmers could not purchase crosses the specified contract threshold at the end of high quality seeds that would increase productivity and the contract period. raise their living standards. compensation when rainfall during a crop growing cycle Traditional crop insurance is difficult to deliver in was insufficient for farmers to grow and to optimize smallholder economies as it involves costly individual their yields. Weather index insurance does not measure loss assessments and is prone to moral hazard and changes in yields; instead, it measures changes in adverse selection. Index-based crop insurance, on the rainfall, assuming that if rainfall is low, then farmers’ other hand, uses weather observations as proxies for yields will also be poor. losses in production or quality and does not require loss assessments. Index-based crop insurance systems The Malawi index-based crop insurance measures the have lower administrative costs and are less amount of rain recorded at local meteorological technically complex than traditional crop insurance, stations. In case of severe drought, it is assumed that all but are exposed to basis risk (that is, mismatch farmers within a 20-30 kilometer radius will be similarly between actual loss and insurance indemnity) and only affected. The insurance contract is bundled with loans cover selected perils. to farmers that cover the cost of high-quality seeds. The insurance pays off part or the entire loan in case of The World Bank, in close collaboration with Malawi’s severe drought. The sum insured is the loan amount National Association of Small Farmers (NASFAM), and interest payable. Payouts are automatically made developed an index-based crop insurance contract that to the bank if the index hits the specified contract is more efficient and cost-effective than traditional threshold at the end of the contract. crop insurance and can easily be distributed to individual smallholder farmers to increase their access Outcome to finance and to protect farmers and loan providers from weather risk. The program was piloted in 2005. In 2005, 892 groundnut farmers purchased weather- based crop insurance policies for a total premium of Objectives US$36,600. As the crop insurance contracts mitigated the weather risk associated with lending, local banks  Help farmers manage weather (drought) risk; came forward to offer loans to insured farmers. The  Facilitate farmers’ access to agricultural credit by farmers used these loans to purchase certified reducing the risk of smallholder loan default; groundnut seed. This arrangement — lending coupled  Allow banks to expand their lending portfolio to the with crop insurance — allowed farmers in the pilot agriculture sector without increasing default risk. areas to access finance that would not have been Structure and Description available to them otherwise. Credit, in turn, allowed them to invest in higher yield, higher return activities. In The weather-based crop insurance contracts were 2007, the pilot was expanded to cash crops. By 2008, initially offered to farmers as a pilot program in the the number of participants had increased significantly, areas of Kasungu, Nhkotakota, Lilongwe North, and with 2,600 farmers buying policies worth US$2.5 Chitedze. The contracts were designed to provide million. Lessons Learned Main Features: Malawi Index-based Crop Insurance in Chitedze Research Station 1. Index-based weather insurance is not a panacea. It is necessary to raise awareness of the limited role that Crop Groundnut weather insurance has in managing the larger spectrum Participants NASFAM members of risks farmers face and to control these risks as much Peril Covered Drought as possible within the program. The two pilot phases in Proxy for Peril Rainfall Deficiency Malawi illustrated that problems related to production, marketing, and sale of crops can undermine credit Weather Station Chitedze Research Station repayment. Insurance programs must be integrated into Term One crop cycle (three stages) supply chains so that other risks related to agricultural 60 mm (in establishment and production can be managed. vegetative growth stage) 160 mm (in flowering and pod Trigger 2. Effective index-based weather insurance contracts formation stage) require reliable, timely, and high quality data weather 100 mm (in pod filling and maturity station networks. A committed meteorological services phase) authority is essential to ensure adherence to strict Maximum Payout Loan given by bank quality requirements, including trustworthy ongoing daily collection and reporting procedures, daily quality Glossary control and cleaning, and an independent source of data for verification. Also required is a long, clean, and Bundled loan: In this context, the packaging of a loan internally consistent historical record to allow for a for agricultural inputs with a rainfall index-based proper actuarial analysis of the weather risks involved. insurance policy. The premium for the insurance policy is added to the interest payment for the loan. In the 3. An enabling legal and regulatory framework is case of a drought, the insurance policy repays a portion necessary for the expansion of the program. Nine of the loan recipient’s obligation. insurance companies worked together to underwrite the risk from the program in Malawi. If the private Weather index-based insurance: Contingent claims sector is interested in expanding the program, it will contracts for which payouts are determined by an need to engage regulatory authorities in revising the objective weather parameter (such as rainfall, existing legal and regulatory insurance framework to temperature, or soil moisture) that is highly correlated explicitly reference weather-based index insurance. with farm-level yields or revenue outcomes. 4. Client/stakeholder education and outreach is Contact essential to establish successful micro-level insurance Marc Sadler, Agricultural Risk Management Team programs. Lack of understanding of insurance can lead Leader, The World Bank, msadler@worldbank.org, to dissatisfaction with the program and resistance to +1(202) 458-2633 insurance purchase. In Malawi, monthly meetings are held with smallholder farmer groups to disseminate Olivier Mahul, Program Coordinator, Disaster Risk financial education and technical agricultural Financing and Insurance, Capital Markets Practice knowledge. (NBFI), and GFDRR, The World Bank, omahul@worldbank.org, +1(202) 458-8955 Further Reading World Bank. (2009). Micro- and Meso-Level Weather Risk Management: Deficit Rainfall in Malawi. Washington, DC: Bryla, E., and Syroka, J. World Bank Agricultural Risk Management Group: www.worldbank.org/agrm Updated March 2012 www.worldbank.org/fpd/drfip www.gfdrr.org