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Symposium 2009

Proposal - Alternatives to Crop Insurance

The Challenge

Poverty reduction has become the central objective of development policy, as reflected in the United Nations’ Millennium Development Goals (MDGs). While economic growth is seen as an important ing ...

Poverty reduction has become the central objective of development policy, as reflected in the United Nations’ Millennium Development Goals (MDGs). While economic growth is seen as an important ingredient in achieving sustainable poverty reduction, the emerging consensus is that growth has to be pro-poor to reach such ambitious targets as the MDGs.

Why does crop insurance not work? In a theoretical framework, insurance indeed is the best means to achieving full risk cover. However, despite high levels of insurance premiums, we have seen few takers for crop or weather insurance in India. A major obstacle to the commercialization of the small farmer is the increased uncertainty of the market place, compared to subsistence farming. The problem is exacerbated by the fact that they have very little ability to absorb the risk of loss. Such risks are high as market volatility is an integral part of the world agricultural produce market. This is especially true for plantation farmers as close to 80 per cent of their produce is exported. High volatility, in turn, makes insurance an unworkable solution, as the premium rates, which depend on the probability of loss, to cover these risks appear to be too high. Insurance is an extremely good tool for covering low probability events but fails when the risk of loss is significantly higher. The India Development Foundation is now working on a pilot scheme with the Price Stabilisation Fund Trust of the Ministry of Commerce to show how an alternative to insurance is desirable and workable.

 

Now consider an agency that sells contingent claims on behalf of the household. Each claim promises to pay INR 1 if the farmer has a good crop and nothing if it is a bad year. This is like an IOU sold by the farmer to any one who wants to buy it. The major change from the insurance mechanism brought about by this proposed alternative is the sequence of cash transfers. In insurance, the farmer pays first, and the company pays the farmer later and only if the farmer suffers a loss. Since premiums are high, this raises the problem of farmer liquidity or the inability to pay large premiums before the harvest when the farmer is cash-strapped. In the proposed solution, the farmer pays only when the going is good or, the farmer has the ability to pay. This is brought about by simply making the buyer of the IOUs pay first and having the farmer pay after the good state has happened.

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