What is Weather Index Insurance? ================================ Topic: What is Weather Index Insurance? --------------------------------------- Objective ~~~~~~~~~ The objective of this section is to introduce the reader to the concept of weather index insurance, how it differs from more traditional crop insurance products, and to describe how weather index insurance might fit within a farmer's overall risk management strategy/portfolio. Introduction: What is Insurance? ~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~ Insurance is a financial arrangement that is intended to provide protection from risk. This risk can be for any number of things, including death, a car accident, or even for crop losses. Insurance is not a gift or a subsidy, but a way in which a person can pay a small amount in good years and receive protection in bad years. However, you should expect that over time the amount that you pay will ALWAYS be more than the amount you receive to pay for the profit of the insurance company that holds your risk for you. To obtain insurance, one must agree to and sign a contract with an insurance company. In exchange for a fixed, upfront payment called a "premium", the insurance company provides a guaranteed compensation if the specified contract terms (usually relating to a loss) occur. However, if something bad happens that is not covered by the contract, than the purchaser is not given money. In addition, if the agreed upon loss does not occur, you will not get your premium back. One benefit of purchasing insurance is that there are pre-agreed upon terms that dictate the amount of compensation you receive. Traditional Insurance verse Index Insurance? ~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~ Index insurance is a relatively new tool that farmers can use to help manage risk. It pays out based on an index, such as rainfall, measured at a local weather station or by satellite, rather than based on a consequence of weather, such as a farmer's crop yield. This subtle distinction resolves a number of fundamental problems that makes traditional insurance unworkable in rural parts of developing countries. Unlike traditional crop insurance, the insurance company does not need to visit a farmer's field to determine premiums or assess damages; if the rainfall amount is below a pre-specified threshold, then the insurance pays out. Since the payout is not linked to the crop survival or failure, the farmer always has an incentive to make the best decisions for crop survival. This innovation significantly lowers the insurance company's transaction costs and risks, reducing insurance premiums and increasing accessibility. How Does Drought Index Insurance Work? ~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~ Erratic rainfall is a problem for farmers. If the fields do not receive enough rainfall at the right times, then the crops will wither and die. Drought index insurance is a way to possibly protect against some of the losses associated with below average rainfall. If there is a drought (i.e. low rainfall over a given period of time), and this drought falls under the terms agreed to in the insurance contract, than the farmer will receive money to help make up for some of the loss. Let's pretend you have a crop in the field, from which you will earn 10 dollars in a normal year. If there is a drought, indicated by a lack of rainfall, you may only earn 2 or 3 dollars instead, since much of the crop will likely be lost. If you had purchased insurance before the start of the season, and the rainfall during the drought was below the amount needed to trigger your insurance contract, then the insurance company will pay you some money. It is important to note that the exact terms of the contract must be met for a payout. If there is no drought, the insurance company will not pay anything, even if you have a bad year due to other factors like floods or pests. If there is bad rainfall during part of the year, but this low level of rainfall does not fall within the agreed upon contract dates, then the insurance company will not compensate the farmer. Index Insurance As the Last Piece ~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~ We have found that insurance works best when it is combined with other development and disaster management strategies. Index insurance is not a stand-alone solution, but one tool of many. It works most effectively when it is addressing a clearly defined risk, such as drought, with other risks covered by other risk management options. It is almost always cheaper to reduce your risk (through irrigation or terracing or using improved seeds) than to transfer it by purchasing insurance. **Therefore, insurance works best when it addresses risks that cannot be reduced in other ways. For example, national cooperative movements, farmer credit access programs, contract farming and rural development programs all act as platforms for index insurance.** These programs help to manage a variety of risks for farmers, allowing index insurance to effectively target a very specific risk. Insurance should be built to address the risks remaining when these other interventions have been developed. Key Points ~~~~~~~~~~~ #. For drought index insurance, payouts are determined by the amount of rainfall measured by rain gauges or satellites, not by the actual amount of rainfall that falls on your field. This is a limitation of the insurance that you should think about when deciding if you want to purchase it. #. You must pay for index insurance. It is not a subsidy; you pay for what you get. #. Index insurance cannot be used to address every risk; rather it is one part of a larger risk management package. #. Farmers will still experience bad years in which their losses are not fully covered, or covered at all by their insurance contracts. #. You will not receive a payment in most years, and you will not receive a payment in all bad years. #. There are many things that drought index insurance is NOT designed to help with, like floods or termites. You will only be compensated when the specific contract terms are met. #. If and when you receive an insurance payout it does not need to be paid back. It is the payment that is made to you in return for the premium that you bought as a climate risk management strategy. #. Typically, a premium covers one year only and is not cumulative. You can make the decision each year as to whether or not you wish to purchase insurance; if yes, then you can pay the premium and receive coverage for that specific year. Your commitment is only for the one year. Checkpoint: What is Weather Index Insurance? -------------------------------------------- *Note: Please answer "True" if you agree with the following statement, or "False" if you believe that the following statement is incorrect. When the group is finished, we will go over these statements together and correct the false sentences.* **Questions** *Example:* By purchasing weather index insurance, any kind of damage to or loss of my crops will be covered. **False** *By purchasing weather index insurance, only the terms agreed to in the contract will be covered.* #. To obtain insurance, one must agree to and sign a contract with an insurance company. ___________ #. If the terms of the insurance contract are fulfilled and the specific loss covered does occur, I will receive a pre-agreed upon payment. ______________ #. If there is a bad rainfall year, but this low level of rainfall does not fall within the agreed upon contract dates, I will still receive a payout. ______________ #. The exact terms of a contract must be met for a payout to occur. _______________ #. Insurance can help cover all my risks and alone act as my disaster management tool. ________________ #. With this type of index insurance, I will receive a payment in most years. ____________ #. I will not receive a payment in all bad years. Farmers will still experience bad years that are not fully covered or covered at all by their insurance contracts. _______________ #. Typically, insurance needs to be repurchased each year and only covers one year at a time. Your commitment is only for the one year. ____________