rice farm in Nepal

Moving Beyond the Index with Financial Tools to Manage Risk in Nepal

Farmers in Nepal grow their crops across a mountainous landscape that creates very different conditions from farm to farm. This often means that farmers, even if they live relatively nearby, can have a very different experience during the annual monsoon season that can bring destructive rainfall.

After a heavy storm, a farmer at the top of the hill could be completely unaffected, while a farmer at the bottom of the hill faces the flooding of their crops and their harvest for the season completely destroyed. This variability is precisely why designing agricultural index insurance in Nepal has been so difficult.

A new effort led from UC Davis is seeking to build on prior USAID-supported research in Nepal to deliver an innovative set of financial tools to small-scale women farmers to reduce their risk of losing crops to weather- and climate-related shocks. These innovations have the potential to increase resilience and spur inclusive agricultural growth.

The Limits of an Index for Insurance in Nepal

Back in 2015, the predecessor to the Feed the Future Innovation Lab for Markets, Risk & Resilience at UC Davis launched a feasibility study to try and create an index for insurance that would work for farmers in Nepal’s Terai region, which produces rice as a staple crop. 

Agricultural index insurance calculates payouts on an easy-to-measure index of factors, such as rainfall or average yields, that predict individual losses. Index insurance is useful in developing countries because costs are much lower than conventional insurance, which has high fixed costs of verifying claims. Also, farmers who buy an index insurance contract receive the same payout—or no payout—regardless of how much each produced individually.

Creating a high-quality, accurate index for insurance in the Terai is difficult mainly because of the variability of farming land. The mountainous topography of Nepal means that farmers are affected differently by weather depending on altitude and location.

“Part of this problem is the varied topography meant that for many losses, you could have some people doing fantastic and other people just decimated, which makes an index-based contract hard,” said Tara Chiu, associate director of the MRR Innovation Lab.

The research team tried two approaches: a satellite-based index and an area-yield index. First, they learned that a satellite index wouldn’t work because dense cloud coverage prevented satellites from capturing accurate images to predict crop losses. The second problem came from collecting accurate historical yield data that both a satellite-based and area-yield index would need to work.

Jisang Yu, a development economist at Kansas State University who worked on the feasibility study as a graduate student at UC Davis, led the collection of historical yield data. This consisted of asking farmers to recall their yields from the previous years.

“A lot of missing data was there,” said Yu. “If you ask farmers, ‘Do you remember how much per-acre you produced in 2007?’ They will probably say they don't remember.”

In the end, the team could not build an index that ensured farmers would be paid accurately for their losses.

“We’re very aware that index insurance can’t fix everything, and it’s not the right tool for every problem,” said Chiu.

Resilience+ and a New Hope

In 2021, Michael Carter, director of the MRR Innovation Lab, along with Chiu, launched the Resilience+ Innovation Facility with funding from the Bill & Melinda Gates Foundation to scale interventions that generate what Carter has coined as “Resilience+.”

The Resilience+ model is based on a body of research showing that when farmers know they will be protected from shocks they tend to invest more into higher productivity and income. The Facility designs and implements large-scale projects that can spark Resilience+ at scale.

Right now, Carter and Chiu are exploring the feasibility of a Facility pilot project in rural Nepal that could be a good fit for horticultural crops, like fruits and vegetables, rather than rice. A way to manage risk in this kind of value chain could have a transformative impact for the women who dominate the sector.

“A pilot in this value chain would be more gender-inclusive, in that it would focus specifically on a female-dominated crop. It’s potentially really impactful for women just by the fact that we’re working in a horticultural value chain,” said Chiu.

By targeting the horticultural value chain, this kind of pilot project would build more financial stability for women by providing the risk management tools. This stability in turn can lead to investments that help to generate Resilience+.

“With effective tools to manage risk, women would have more confidence to make more investments and engage with the formal financial sector,” said Chiu.

New Financial Tools to Manage Risk

To overcome the insurmountable challenges for index insurance found in 2015, Carter and Chiu are considering the potential to combine a different set of financial tools that address risk for individual farmers and farmers across communities in Nepal. At the same time, these financial tools incorporate lessons from 2015 when the team tried to build an index for insurance.

“Horticultural crops are hard for insurance,” said Yu. “I would say it’s harder than rice. Rice crops are more homogenized across farmers, and crop cycles are similar.”

Mutual insurance pools have long been used as a tool for mitigating unique individual losses that don’t affect an entire community. Instead of relying on an index, a mutual insurance pool gives payouts to farmers who are experiencing difficult circumstances, such as a crop loss due to agricultural pests. This serves a similar purpose to an index, as it covers similar shocks and is lower-cost than conventional insurance.

“Instead of waiting for one of those one-in-three-year or one-in-five-year shocks, they’ll be seeing these small losses addressed by the pool along the way, which will hopefully give them a little more confidence to invest more quickly,” said Chiu.

However, mutual insurance is complicated when an entire community experiences a shock. In a widespread flood or drought, the pool’s funds will quickly be exhausted. Insurance pools simply do not have enough resources to protect against these kinds of major shocks.

This is where an emergency line of credit and savings fill the gap. In the event that the mutual insurance pool runs out of funds, the emergency line of credit becomes available, as well as any savings and interest farmers have contributed.

Chiu hopes that this integrated model will encourage cooperative members to invest in the insurance pools and individual savings accounts.

“This is specifically a line of credit to help with emergencies – not a regular line of credit,” said Chiu. “We haven’t seen integration in risk management tools in quite this way before.”

Institutional Partnerships to Scale Impact

With any project Carter and Chiu launch though the Facility, scale is an explicit goal. Carter and Chiu are exploring potential partnerships with institutions in Nepal that have the ability and infrastructure to take their innovations to a much larger scale.

“We will be asking that they also make contributions, so that they’re invested in learning and trying to make it work,” said Chiu. “If an institution has invested money, they will have a clear desire to scale it.”

Another objective is to show financial institutions the value of working with smaller farmers. If the endeavor proves to be profitable, the potential for scale is even higher.

“The idea of trying to come up with a different solution that's based on new kinds of risk management tools is actually really exciting,” said Chiu. “This is a very vulnerable population. It’s a population where if there are risk management tools available, it can really make a difference in people’s lives.”