What Should be the Minimum Quality Standard for an Agricultural Insurance Product?
Risk management and resilience are increasingly a focus for how to support and empower agricultural households who are vulnerable to weather-related shocks. Index insurance has shown tremendous promise where conventional, indemnity agricultural insurance is not possible or cost-effective.
Over the past three years, the Global Action Network (GAN) to advance agricultural insurance has drawn together stakeholders from academia, the public sector, the private sector and donor organizations to discuss challenges that are creating barriers to the creation of a strong market for agricultural insurance. This collaboration between the AMA Innovation Lab and the ILO’s Impact Insurance Facility has also brought to the forefront one of the greatest challenges facing the advancement of agricultural index insurance: quality.
Bringing People to the Problem
I recall the inaugural meeting of the GAN, and how clearly and quickly quality standards emerged as a key challenge. A working group was created around this challenge, with the intention of seeking to better understand and develop mechanisms to address this challenge. Over several meetings, the discussion shifted from theoretical thinking about basis risk to the more specific (and perhaps directly relevant) topic of contract quality and what quality implies. There was considerable apprehension that poor quality products do more harm than good, and hence there needs to be a check against poor quality products being commercialized or scaled up.
This problem is not theoretical. The increasing investments in agricultural index insurance have often been more focused on expanding access than assuring product safety and improving quality and value to farmers. There have been a number of high-profile contract failures that clearly demonstrated the risks associated with poorly designed products. These failures sow distrust for an otherwise promising solution, sabotaging the impacts that are possible with high-quality contracts.
The 3D Client Value Assessment Tool
The GAN has produced a number of resources governments and donors can use to develop index insurance products and markets that are responsive to the needs of small-scale farmers, including guidelines for consumer education and bundled solutions. The most recently released of these resources directly addresses the issue of quality and empowers implementation partners and funders alike to assess the quality of a product. The “3-D” Client Value Assessment tool for index insurance provides a multi-dimensional measure of an insurance contract’s total value proposition for potential or existing clients.
This multi-dimensional tool merges the Facility’s PACE Analysis, adapted for index-based agricultural insurance, with the AMA Innovation Lab’s calculations for Minimum Quality Standards (MQS) for index insurance. It was created as part of an iterative process with stakeholders from all perspectives and was piloted and refined to ensure efficacy and applicability.
Minimum Quality Standards (MQS)
The AMA Innovation Lab’s MQS measure forms the foundation of this 3-D assessment, and it is the first of 14 indicators of index insurance quality. The definition of an index insurance contract that meets a minimum quality standard is that its cost in premiums, whoever pays them, has a greater potential to support farmers who face environmental risks than if they had no insurance. While some failure is unavoidable with index insurance, it is a fundamental problem when the overall quality is so low that it predictably leaves farmers worse off than if they had no insurance at all. To identify such products, the AMA Innovation Lab developed an objective measure of quality to easily compare the value over time of an index insurance contract, having no insurance, and an equivalent cash transfer. This measure calculates an index insurance contract’s market price, average risk, potential payouts and farmer income/consumption into a comparable expected utility value.
Minimum Quality Standard, based on the simple comparison of our index insurance quality measure’s expected utility value, provides a clear and objective definition of when — at a minimum — a contract is likely to leave farmers better off. A good contract should, of course, exceed this minimum standard and make farmers much better off than if they had no insurance.
Beyond establishing minimum quality, a MQS analysis can also establish whether an index insurance contract is a cost-effective means to support farmers’ wellbeing. From the perspective of donors or governments, index insurance should have a better dollar-for-dollar potential to provide stability than an equivalent direct cash transfer.
Using the tool requires historical data on the index measure and yields that are needed to develop an index insurance contract and also historical data on household income/consumption. This reality was frequently met with concern by stakeholders in the GAN, who worried the lack of data, and the subsequent need for investment in data collection, would be prohibitive to effective use of the tool. This additional household data, however, is critical for determining how the performance of an index insurance contract affects a family’s level of need in the event of a shock. In order to design a high-quality agricultural index insurance product, it is essential to have this data. It is also not expensive to collect. In a recent Nepal feasibility study, the cost for collecting this data from about 600 households was about $15,000.
The development of both MQS and the 3-D Client Value Assessment tool is the culmination of years of consultations with index insurance experts from around the world. This included experts from research, markets, governments and donors. The result is a tool that responds directly to the greatest challenge that index insurance for development faces today, and that challenge is not uptake in itself, but the quality of products available.
Ensuring Quality at Scale
As governments and donors have been increasing their investments in insurance for agricultural development, the need for quality standards and a client value focus become imperative. The 3D Client Value Assessment Tool and its Minimum Quality Standard are an important first step to ensuring that products put into market or taken to scale are high quality, such that they can fulfill the positive welfare impact potential of agricultural index insurance. As the Global Action Network continues, we look forward to continuing our work to sustainably transfer the lessons learned from index insurance interventions to key stakeholders. These continued outreach efforts enhance the capacity of local institutions and produce policy documents and dissemination events that communicate risks of agricultural index insurance and present potential solutions to overcome these risks.
Tara Chiu is the assistant director of the AMA Innovation Lab. This article originally appeared on the ILO Impact Insurance Facility Medium blog.