Insurtech | The Basics: What is Crop Microinsurance?
This series is produced by Mercy Corps Ventures in partnership with CASE at Duke University. Each article explores the challenges the microinsurance industry faces to scale to support more than 600 million smallholder farmers around the world in becoming financially included and more climate resilient.
Find out more about the project here, and stay tuned for the full series of six articles here.
Smallholder farmer, Mali. Photo courtesy of OKO.
Ironically, the majority of the world’s hungriest people are farmers.
Smallholder farmers, or farmers who cultivate less than two hectares of land, produce one-third of the world’s food and make up the majority of the 608 million farmers in the world. But many of these rural smallholder farmers live in poverty, unable to feed themselves and their own families due to various challenges along the value chain toward a productive harvest. Global crises such as COVID-19 and climate change have only intensified food insecurity and introduced new risks, making it even harder for these farmers to break out of the vicious cycle of poverty.
“Smallholder farmers are going to be among the most climate-impacted people on the planet — but they are among those least responsible for climate change.”
Colin Christensen, Global Policy Director, One Acre Fund*
Governments, non-governmental organizations (NGOs), and social enterprises have long attempted to offer creative solutions to alleviate the numerous plights faced by the smallholder farmer. From the provision of microloans to irrigation pumps, there are now multiple players addressing the challenges along the harvest cycle. However, the risks to smallholders facing crisis after crisis still drive hundreds of millions of people into poverty and food insecurity around the world — leaving families increasingly ill-equipped to face the dire consequences of climate change.
One promising intervention is found in the nascent field of microinsurance, an insurance offering specifically designed for the underserved. Microinsurance is being increasingly applied and tested with crop-related risk factors faced by smallholder farmers. This article series from Mercy Corps Ventures in partnership with CASE at Duke will explore the complexities of the microinsurance ecosystem and the challenges the industry faces to scale to help protect the more than 600 million smallholder farmers around the world.
I. What risks could crop microinsurance mitigate?
Diagram 1. Key periods of risk in smallholder farmer crop lifecycle.
The majority of smallholder farmers reside in rural areas and lack access to the financial and physical tools they need to invest in their farms. Most smallholders are subsistence farmers, eating most of what they grow and selling remaining harvests through local markets. They primarily grow crops that are part of loose value chains, or crops that do not have a guaranteed buyer, making it even harder to generate additional income. Smallholder farmers are thus typically stuck in a cycle of poverty that is difficult to break. Climate change-related phenomena, such as drought and pests, can ruin a season for a farmer who relies on their harvest to feed their family and to generate income. And while smallholder farmers produce about 30% of the world’s entire food supply, most do not know or understand the extent of the risks that they face. Diagram 1 outlines a typical smallholder farmer’s one-season crop lifecycle and the risks at each step; later in the article, we will discuss how crop microinsurance attempts to mitigate some of these risks.
Risk 1: Financing
Most smallholder farmers have an uneven cash flow. They have the most cash immediately after harvest time, but after spending throughout the year their cash supply is largely depleted when the time comes to plant for the next season. This means they are unable to invest in items that will increase productivity for their farms, such as fertilizer or labor.
This cash flow issue led to the emergence of farmer financing products, such as microloans and savings groups. While these solutions enable some smallholder farmers to access the cash they need to invest in their farms, many are still excluded from accessing this type of financing due to physical distance or credit profile risk.
Risk 2: Inputs & Planting
Fertilizer can increase crop yields by 30 to 50%. Proper planting techniques and education on fertilizer usage can further improve yields. High quality and affordable fertilizer, however, is usually out of reach for the average rural smallholder, as it is commonly sold in bulk quantities in city centers. This means that even if farmers are able to access financing, they are not necessarily able to access inputs. Most smallholder farmer-focused organizations, such as myAgro and One Acre Fund, try to mitigate this challenge by more seamlessly packaging inputs, such as fertilizer, with a microloan or financing product.
Planting is also extremely time-sensitive and labor intensive. Rain has become more irregular due to climate change, making the ability to plant quickly and effectively crucial for an abundant harvest. Most smallholder farmers, however, are unable to pay for and access labor when needed, whether it’s human, machinery, or livestock.
Risk 3: Growing
During the growing season, the smallholder farmer must monitor their crops for disease and pests. The use of insecticides is a common solution to pest control, but insecticides are not commonly available in rural areas and require additional training around safety and usage in order to be most effective. Meanwhile, climate change is introducing new non-indigenous pests that farmers don’t know how to manage. A recent example is the Fall Army Worm, which migrated from South America to several African countries in 2016 and destroyed maize crops across the continent.
Risk 4: Harvest & Post-Harvest
The biggest risk during harvest and post-harvest is related to storage. For crops that can be stored and eaten or sold throughout the year, farmers need access to proper storage facilities and must be familiar with maintenance techniques. Common smallholder crops, like peanuts, can grow aflatoxin if not stored properly, which can be detrimental if consumed in large quantities or over long periods of time.
Risk 5: Market Access
After setting aside the yield that will be consumed by their family, the smallholder farmer sells the remaining harvest at local markets for cash to be used for household expenses (and, ideally, for inputs for the next harvest). The more that’s grown, the more there is to sell. The COVID-19 pandemic greatly complicated access to markets, shutting local markets down for weeks and disrupting local and global food supply chains.
Several NGOs and social enterprises have presented market access solutions, linking farmers to larger buyers through aggregation, testing, and sometimes certification. However, market access solutions work best in structured value chain crops such as coffee and cotton, as opposed to the more common staple crops grown by most smallholders.
The “loose” vs. “structured” value chains of the smallholder farmer
A value chain in agriculture refers to the set of connected activities that add value to a product or crop. It consists of actors and actions that link the farmer to the end user (the buyer or consumer). The formality and sophistication of agricultural value chains vary by crop and have an impact on the potential for farmers to access crop microinsurance, as we will later explore.
Loose Value Chains: Informal, excess staple crops (e.g., maize, cassava, peanuts) that are sold in local markets. Transactions usually involve just the farmer and the final buyer or consumer. The majority of smallholder farmers are involved in loose value chains.
Structured Value Chains: More formal, complex value chains involving exports or cash crops (e.g., coffee, tea, cotton). In this scenario, there are multiple actors connecting the farmer to the end buyer, such as processors and exporters. Only about 7% of all smallholder farmers are part of structured value chains.
II. The Crop Microinsurance Offering
As detailed above, multiple risks exist within the smallholder farmer’s crop value chain, all of which may be exacerbated by climate change. Crop insurance can help protect the farmer from several of these risks — but, as a relatively new and extremely complex product, it presents its own challenges and limitations.
Not Your Typical Insurance Offering
Conventional (indemnity-based) insurance pays out individual clients based on the individual’s losses. This type of insurance can be extremely costly, as it commonly requires visual and/or human verification in order to receive a claim payout, and has been viewed as unsustainable for insuring the millions of smallholders who have two or fewer hectares of land and are spread out across vast rural areas.
Instead, most agricultural microinsurance for smallholder farmers is index-based insurance, which makes claim payouts based on the average losses of farmers in the same geographic area.
This arrangement eliminates the need to make verifications of individual farms, and can make use of either weather data or yield samples. Although early versions of agricultural insurance have existed for hundreds of years, index insurance was first conceptualized in the 1920s when an economist envisioned an insurance product that would pay out if the season’s rainfall fell below a certain amount; it was popularized with Grameen Bank’s microinsurance products.
Types of Indices
The most common type of index-based microinsurance will trigger payouts based on weather indices, such as the amount of rain in a certain area. Another type pays farmers in a predetermined area based on harvest yield. The indices are calculated using historic data, but since this industry is still quite nascent in most geographies, this data is often limited. Some companies have experimented with drones and satellites to more accurately gauge the harvest losses that would trigger payments to individual farmers, but most agree that these technologies are not yet living up to their potential.
Types of Payout
Most commonly, microinsurance is bundled with inputs such as seed and fertilizer, and the farmer is reimbursed the value of the inputs. Harvest loss implies revenue loss, but revenue coverage in microinsurance policies is less common, as there is uncertainty around how to calculate the perceived loss in crops that also provide sustenance to the farmer and their family. Additionally, the cost of covering revenue is also much higher, both because the dollar amount insured is greater for revenue versus inputs alone and because the industry lacks the robust historical data required to build accurate actuarial models.
Basis Risk
While index insurance makes coverage of crops more feasible, it introduces the concept of basis risk. Basis risk occurs when an individual farmer’s loss is much lower or higher than the calculated loss of the index. Basis risk can be minimized with more precise data, enabled by several advances in technology.
In this depiction of basis risk, the farmers are all part of one index for a geographical region. Because the weather station will show average rains and sample crop cuts will show an average yield, the farmers further from the rain suffered losses that will not be covered.
Despite the challenges, index-based calculation is what has made microinsurance possible for smallholders and is a potential risk mitigation tool to address many of the challenges along the value chain.
“It started with index insurance, with big hopes that index insurance as such will solve all of the problems. And of course it solves some of the problems, and in some contexts it’s the best you can do, but we also learned that basis risk and the validity of the product needs to be improved. It has been an important process to learn about the possibilities to complement a pure index with other components, with new technologies where you also have validation of the potential trigger with picture-based solutions, or other hybrids.”
Dr. Annette Detken, Head of InsuResilience Solutions Fund (ISF) Management
Key Challenges to Scaling Crop Microinsurance
Getting the insurance product design right, including addressing the challenges described above, is only one piece of scaling the impact of crop microinsurance. As we heard from our interviewees and gathered from desk research, the key challenges to impact at scale fall largely in four categories:
Meeting farmer needs. Does the design of the insurance product — in particular, what it covers and the timing of assessments and payouts — actually meet the needs of the farmer? Does it help the farmer to be more productive, increase their earnings, become more resilient, adapt to a changing climate, or meet other needs?
Gaining trust. Even those most ingrained in the insurance industry will admit that, in general, people don’t really like insurance. It’s hard to explain, the processes can be laborious and slow, and it’s often difficult to determine if the insured or the insurer is the one actually benefiting. We heard time and again how difficult it is to gain the trust of smallholder farmers around the benefits of crop microinsurance.
Reaching farmers. Distribution is a key challenge for a product intended to reach millions who are generally not part of formal economies and are spread across vast rural areas. What are the most effective ways to bring this product to the end user?
Managing costs. There are two main areas of cost that present challenges to scale: the administrative cost of developing and distributing the insurance product, and then the cost of the product itself, which is influenced by the administrative piece and also by the risk. Trends point to risk continuing to increase, while at the same time many of the newer insurance technology entrants into the field are working to lower administrative costs. How will this impact premiums for farmers? Will reinsurers be willing to continue to take on risks given increasing climate events impacting crops?
As we will unpack in upcoming articles, how different stakeholders choose to meet these challenges will inform the extent to which crop microinsurance can achieve impact at scale.
III. What We Know About Impact
Given the multiple risks that smallholder farmers face and the challenges to implementing crop insurance, is it a feasible solution to improve farmer productivity and resilience? The available research seems to support microinsurance as an effective tool when utilized, but getting farmers to adopt this solution remains a challenge.
In a 2012 study by Karlan et al, “Agricultural Decisions After Relaxing Credit and Risk Constraints,” the researchers studied the effects of index insurance and cash grants on the investment decisions of farmers in Ghana. During the three-year randomized control trial, farmers received either a cash grant, rainfall index insurance, both, or neither. The study found that providing insurance resulted in farmers investing more into their farms than when they were provided cash grants alone. Similar results were seen in a more recent 2021 study focused on livestock microinsurance, “The Effect of Microinsurance on Economic Activities: Evidence from a randomized field experiment,” which found microinsurance may be as important as microfinance in increasing sow production. Evidence from these two studies suggests that providing just credit or other financing may not be sufficient enough to move them to invest more in their farms, and that a risk mitigation tool like insurance provides more incentive.
But will insured farmers who are investing more in their farms experience increased productivity and/or resilience? JPAL, CEGA, and ATAI looked at evidence related to weather index insurance from ten randomized evaluations taking place between 2006 and 2012 (Make it Rain: A synthesis of evidence on weather index insurance). Of the three evaluations measuring farmer behavior, all found that farmers who felt protected from weather shocks moved production to more high-yielding (but weather sensitive) crops.
Despite the evidence that microinsurance encourages farm investment, uptake challenges for crop microinsurance persist.
A 2018 study by Njue, et al, “Uptake of Crop Insurance among Smallholder Farmers: Insights from Maize Producers in Kenya,” collected data from 400 maize-producing households and found that uptake of insurance was limited due to a lack of education and knowledge around microinsurance products, as well as the large amounts of basis risk that left farmers with claim payouts lower than they had expected or desired. The JPAL, CEGA, and ATAI evaluation review also pointed to evidence that, without substantial subsidies for smallholder farmers, uptake of insurance was low.
Given how rapidly the crop microinsurance market is changing with the appearance of innovative insurance technology companies and continued technological advances (including increased usage of mobile phones and mobile money), research on the impact and uptake of crop microinsurance — alongside other risk mitigation tactics — must continue.
Other Risk Mitigation and Response
“What needs to be clear is that insurance can only be complementary. Insurance can complement other measures but should always be based on other risk reduction measures being implemented. Now that’s not always the case — but it should become the standard.”
Dr. Annette Detken, Head of InsuResilience Solutions Fund (ISF) Management
What are other ways the average smallholder farmer can mitigate the many challenges along the value chain, beyond insurance? While many social enterprises and NGOs are engaged in improving the livelihoods of smallholders, some practices specific to weather-related crop risks include:
Crop diversification to reduce risk and stabilize income. Farmers can plant more than one crop in the same area, or rotate between crops depending on the season (more commonly known as crop rotation). Diversification can reduce financial risk and stabilize farm income.
Crop rotation for improved soil health. Rotating crops can improve soil health, protect crops from weeds and pests, and also educate a farmer in multiple planting techniques.
Drought-tolerant seeds for weathering periods without rain. For certain crops, varieties of seed are now available that are more resilient to droughts, although the seeds may not be easily accessible or affordable to smallholder farmers.
Agroforestry to build smallholder assets. One Acre Fund is championing tree-planting with its smallholder farmer clients, as trees can provide a safety net when other crops are underperforming (while benefiting the environment).
When faced with challenges in harvest productivity, smallholder farmers also often make lifestyle changes to manage their risks. They’ll eat less when they don’t produce enough food in a season, and they may sell household assets or livestock to buy the extra food they need to feed their families. Some may even work several jobs in order to make up for the income loss from a bad harvest season.
IV. The Crop Microinsurance Ecosystem & Our Research Project
In 2021, Mercy Corps Ventures partnered with CASE at Duke to study the role of insurtech, or enterprises using technology to radically improve insurance offerings, in achieving impact at scale with crop microinsurance. In addition to interviewing five insurtech enterprises offering crop microinsurance in Africa and India, we also interviewed entities playing other key roles in the ecosystem, such as those providing reinsurance, working directly with collectives of smallholder farmers, investing in or providing catalytic grants for insurtech and agriculture, and working in other microinsurance sectors outside of agriculture. While there are many ways to represent the ecosystem of players currently creating, innovating, and scaling crop microinsurance solutions, we have put them into four main categories (with several sub-categories for the “Doer” role):
1. Catalyst/Supporter. Entities that are catalyzing the growth of this industry, whether by providing financial, data, or technical support for experimentation, advocating for regulatory changes, softening markets for new product entry, or setting new standards. Examples include the InsuResilience Solutions Fund, Insurance Development Forum, and government insurance programs such as India’s PMFBY.
2. Doer. Those who are creating, distributing, and managing crop microinsurance products. We identified several sub-roles in this category:
Product Designer. The entity that creates indices (which crops to cover, what losses to protect, which geographies to cover) but does not price or take on the risk.
Insurer. The entity that assumes the risk and who is responsible, through a contract, to compensate for specified losses, liability, or damages. [Legal Dictionary] In most cases, also known as the underwriter.
Reinsurer. The entity that provides financial protection to insurance companies, usually for risks that are too large for the insurance company to manage on its own. [Investopedia]
Distributor. The entity that sets up and manages the distribution of insurance through various steps to the end user, which can include selling the product, collecting premiums, processing claims, and managing payouts.
Most of the insurtech enterprises we interviewed were involved in several of these roles, with the most common being product designer and distributor. A few of the insurtech enterprises we interviewed have also taken on insurer or underwriter roles. The agriculture social enterprises we interviewed, focusing on more holistic support of smallholder farmers, primarily took on distributor roles.
3. Payer. Entities that are paying for or subsidizing premiums and/or other ongoing market subsidies (such as subsidizing reinsurers). Examples of those paying for or subsidizing premiums include the end users (i.e., farmers), governments, development agencies and multilateral institutions, and corporate partners.
4. User. Individuals and entities who are using the microinsurance product. While many stakeholders benefit from the provision of crop microinsurance, this category is focused on the smallholder farmer.
“The government is the reinsurer of last resort, so if everything fails or in a drought situation it’s the governments who have to step in. And oftentimes they are not aware of insurance as an instrument that could allow them to transfer the risk to the insurance industry.”
Mario Wilhelm, Head of Middle East & Africa, Public Sector Solutions, Swiss Re
In the next article, “Insurtech | The Business Models: How is Crop Microinsurance Provided?,” we will explore the elements influencing impact and finances for the Doers. In “Insurtech | The Case Studies: Who is Providing Crop Microinsurance, and How?,” we will provide insights into the approaches and lessons learned from our Doer and Catalyst interviewees.
This article was written by Kimberly Langsam, CASE at Duke, and Jane Choi, CASE consultant, and released in October 2021.
*Unless otherwise noted, all quotations in the articles are from interviews conducted by Kimberly Langsam and Jane Choi between May and August 2021.
