Agriculture is an uncertain business in India, partly due to its high dependence on the weather, leaving 120 million farmer households vulnerable to serious hardship. By providing claim payments to farmers in the event of crop failure, agricultural insurance can directly improve the welfare of risk averse farmers, particularly the 80 percent of ‘small and marginal’ Indian farmer households operating less than two hectares. Perhaps even more importantly, affordable agricultural insurance can in effect act as collateral against loans, increasing the creditworthiness of farmers and allowing them the opportunity to invest in appropriate inputs to increase agricultural productivity (Hazell 1992). By strengthening markets for agricultural credit while providing reliable protection that is attractive to the most risk averse, crop insurance may be a more attractive channel for government support to rural livelihoods and risk mitigation than ex-post disaster transfers, which offer no ex-ante guarantee to farmers and may therefore have limited impact on ex-ante decisions, or loan waiver or input subsidy programs, which may adversely distort behavior.
However, the provision of agricultural insurance is challenging, particularly in developing countries. Multiple Peril Crop Insurance programs, where each policyholder is indemnified against their own crop loss, were fraught with moral hazard, fraud and adverse selection, leading to high costs (Hazell 1992, Skees et al. 1999). By comparison, recent experience with voluntary weather indexed insurance has been somewhat underwhelming, with low voluntary demand (Cole et al. 2009, Binswanger-Mkhize 2011).
The Government of India, having historically focused on crop insurance as a planned mechanism to mitigate the risks of natural perils on farm production, is responsible for the world’s largest crop insurance program with 25 million farmers insured. The National Agriculture Insurance Scheme (NAIS) is the main crop insurance program in the country, and in states and union territories that choose to participate, insurance for food crops, oilseeds and selected commercial crops is compulsory for all farmers that borrow from financial institutions and is voluntary for non-borrowing farmers without loans. The NAIS operates on an area yield indexed basis, whereby claim payments to farmers depend on the average yield of the insured crop measured across the insurance unit, typically an administrative block, in which they live. Area yield indexed crop insurance offers a middle ground between indemnity-based multiple peril crop insurance and weather based index-based weather insurance, with the potential for a greater r silience to moral hazard, fraud and adverse selection than the former and lower basis risk, the risk of a mismatch between incurred losses and indexed claim payments, than the latter (Carter et al. 2007).
However, the NAIS is not without its challenges, most notably the open-ended and highly variable fiscal exposure for state and central government, significant delays in the settlement of the farmers’ claims, and dependence on an inefficient crop yield estimation process. The insurance premium rates paid by the farmers are capped and claims in excess of the capped premium volume are borne equally by the state and the central governments after harvest; for every 1 rupee of farmer premium paid between 2000 and 2008 the total claim payment to farmers was 3.5 rupees. The ex-post funding arrangement leads to an open ended fiscal exposure for governments and volatile annual contributions that are difficult to predict in advance of harvest. Indemnity payments tend to get extremely delayed (up to 9-12 months) in part because of administrative and budgetary processes for post-disaster funding of the excess losses. Finally, the crop yield estimation process conducted by the states, used for insurance claims, is subject to reporting delays, inconsistency and moral hazard. In addition, the current NAIS suffers from poor risk classification, which has led to a somewhat arbitrary allocation of government subsidies, and poor marketing.
It was in this context that the Government of India formed a joint task-force with the Ministries of Agriculture and Finance and the public insurance company, the Agricultural Insurance Company of India (AICI) to enhance the crop insurance program and improve insurance coverage. The repor (Joint Group 2004) suggested action on the following items: review current underwriting methodology; develop an actuarially sound design and pricing methodology based on international best practice to act as the foundation for a move to an ex-ante funded, market-based crop insurance program; develop product design and pricing methodology for new weather index insurance products; and suggest cost-effective catastrophe risk financing solutions for the public crop insurance company.
This joint work eventually led to the design and implementation of a modified NAIS (mNAIS), with planned pilot period lasting for three seasons starting winter 2010-11 (Table 1). This is potentially a major initiative given the significant scale of NAIS. If well implemented, an improved program would result in increased benefits for millions of current farmer clients and lead to greater coverage of the insurance program. However, significant challenges remain
World Bank. Author:Mahul, Olivier;Verma, Niraj;Clarke, Daniel J.Document Date: 2012/03/01. Document Type: Policy Research Working Paper. Report Number: WPS5987