Variable and unpredictable climate can limit development and amplify poverty, particularly in the developing world. The potential of index insurance to help manage climate variability is being tested in a growing number of developing country settings. This report discusses this new type of insurance, presents case studies and outlines key lessons and recommendations. It finds that index insurance has provided access to credit and insurance for high-risk populations previously considered uninsurable, contributing to economic development and poverty reduction. It has also played a role in providing more timely and reliable disaster relief.
Index insurance is insurance that is linked to an index, such as rainfall, temperature, humidity or crop yields, rather than to actual loss. It can be applied across a diverse range of weather-related risk problems (such as loss of crops due to drought and from hurricanes). Index insurance is examined here under two broad categories: for development (farmer and community scales), and for disaster relief (national and multinational scales).
At farmer and community levels, index insurance has facilitated access to credit and insurance for high-risk populations previously considered uninsurable. Some farmers have received credit for the first time, allowing them to buy and use critical agricultural inputs and technologies. Index insurance makes this possible by lowering the transaction costs of designing and managing contracts and payouts. By linking payouts to an easily verifiable index (such as the level of rainfall), there is no need to visit farmers’ fields to assess losses and determine payout. This makes it viable to sell insurance with low premiums that are affordable even to poor farmers. At national and multinational levels, index insurance has also contributed to more effective disaster relief. As in the case of index insurance products designed for development, integrating index insurance into disaster management strategies can help poor people whose livelihoods are closely linked to the weather and who are at risk of poverty from weather shocks.
For index insurance to be successful, transaction costs must be kept low without diminishing the quality of insurance coverage as it is scaled up. In addition:
- Low data quality and quantity restricts the implementation and scale-up of index insurance. It is important to improve data systems and explore new technologies to fill data gaps (for example weather stations and various modelling technologies).
- Premium subsidies for development-oriented projects need to be carefully considered, as they can distort apparent risk, and impair farmers’ judgement. Investments in public goods may reap more benefits and result in more sustainable markets over the long term.
- Index insurance works best when integrated into broader programs for development and disaster management. It should form part of a comprehensive risk management package with complementary resources targeted to other components (for example national co-operative movements, farmer credit access programs, contract farming and rural development programs).
- Investments in capacity building and marketing are needed to support the scaling up of index insurance, across the full range of stakeholders: insurance companies and other financial groups, potential clients and policy makers. Local capacity building is especially important, to design contracts catered to local needs.
- Insurance must be demand driven and locally owned. Risk and needs assessments should be carried out before designing and implementing a project.
Areas for further research and intervention should include climate change adaptation, regulatory systems and evaluation of poverty impact and knowledge sharing.
- Index insurance can help vulnerable populations better manage climate risk, and should be investigated as an adaptation strategy.
- Governments should prioritise the development of a strong legal and regulatory system for index insurance, to avoid abuse and build trust. This should be in place before scaling up is attempted.
- Results should be built into future project design and implementation, and product improvement. Learning should feed into an international product development community of practice.
- A network forum for sharing information and experiences is needed to promote rapid and effective uptake of innovative practices, technologies and research results.