AfCFTA creating a big market for agricultural insurance

WHILE others are seeing greater opportunities for trade and trade finance, the African Continental Free Trade Area (AfCFTA) will create an opportunity for rapid development of the most neglected sector, agricultural insurance.

Across the African continent, smallholder farmers make the most part of the agricultural sector in terms of both employment and ensuring food security. However, smallholder farmers face a range of shocks and challenges beyond their control that can have a drastic impact on their incomes and livelihoods. These include unexpected non-agricultural events, such as health problems, and agricultural events, such as market and price fluctuations or pest and disease infestations.

The climate crisis is a key driver behind agricultural shocks. More frequent extreme weather events and an increase in the incidence of pests and diseases are increasing financial losses for farmers in Africa.

Insurance services on the continent can struggle to offer safety nets for such shocks. Globally, less than 20% of smallholder farmers have any form of agricultural insurance, and across sub-Saharan Africa this figure is less than 3%. The insurance coverage gap is due to a range of demand-side and supply-side factors.

On the demand-side, lack of awareness of insurance services, largely due to the low penetration of financial services in rural areas, is a key barrier to uptake. Even when farmers are aware of insurance, insufficient knowledge and understanding of financial services means they may not immediately trust the service provider or their ability to pay out a claim as promised. For farmers who are aware of insurance, they are only likely to use it if they understand how the service works and the value it offers.

Insurance uptake amongst smallholder farmers has also been constrained by two potential costs: the cost of insurance premiums and the cost of travelling to nearby towns to register for services and make claims. Governments have used subsidies to lower premiums and drive farmer uptake, in Kenya for example. However, subsidies can sometimes be restricted to government-mandated schemes or to specific agricultural insurance services and are often short lived. For example, Hollard Insurance conducted a pilot to provide insurance to cotton farmers in Mozambique in 2012 with support from the World Bank. However, the scheme ended in 2013 due to a lack of support from key stakeholders.

From the perspective of an insurance service provider, a higher incidence of catastrophic events, such as droughts, would require larger and more frequent payouts. Covering such agricultural risks can be costly for providers, who would struggle to design insurance services that are both affordable and offer adequate cover. Distribution is also a key challenge, as reaching and serving smallholder farmers can be logistically difficult and expensive. Given that smallholder farmers are price sensitive, insurance providers often perceive them as a low-profit customer segment, deterring them from offering agricultural insurance altogether.

Without access to formal insurance schemes, smallholder households resort to traditional risk management schemes, such as self-insurance and community funds. Self-insurance involves growing a mix of crops, using pest-resistant or drought-resistant crop varieties,

staggering planting dates, spreading crops out over their fields and investing in livestock. Farmers may also engage in off-farm employment or non-farm business to reduce their dependence on farming.

However, self-insurance can be costly and ineffective against major weather shocks. Community funding schemes, in which farmers pool savings to support those who need financial help, may not always provide an adequate safety net. A key challenge is that traditional risk management schemes are unable to cater for covariate risks, which refer to catastrophic events that affect many farmers in the same region at the same time.

Historically, farmers have been limited to indemnity- based insurance services. Indemnity-based insurance pays out claims based on an actual loss incurred by an insured party. In the event of a disaster, a certified loss assessor conducts an objective loss assessment to determine the compensation due. While large farms may still use indemnity-based insurance, this type of insurance is unaffordable for most smallholder farmers worldwide.

Today, innovative approaches like index insurance offer smallholder farmers an affordable and accessible way to manage agricultural risks. This can be scaled up taking advantage of favorable policies under the AfCFTA. Index insurance is a type of insurance service that pays out benefits based on a predetermined index, such as rainfall level for losses resulting from weather and catastrophic events. Index insurance provides cover against specific perils across a defined area rather than at the farm level. Unlike indemnity-based services, index insurance does not require individual claims to be assessed, allowing them to be settled through a quicker, more objective process.

Indices are developed prior to the planting season and are used to measure deviations from typical levels of common parameters such as rainfall, temperature, crop yield and livestock mortality rates. Farmers can buy policies based on an index correlated with a specific event, such as rainfall, drought or yield losses, for a certain period and across a defined area. Payouts are automatically made when an index falls above or below a predetermined threshold.

Two types of index insurance services have traditionally been available to smallholder farmers: area-yield index (AYII) and weather index insurance (WII). Area-yield index insurance services are similar to indemnity- based services, with assessments made at one farm against a predetermined index for a given area. With weather index insurance, payouts are based on the occurrence of a specific weather event over a specified period in a defined area.

Early weather index insurance services involved assessments at weather stations that kept paper-based rainfall records. While early index insurance gave many farmers their first experience with agricultural insurance, these services were not easily scalable due to the operational costs and effort required, and the use of indices based on incomplete datasets.

Over the last decade, the growth of digitally enabled index insurance services has overcome some of the limitations of indemnity-based and early index insurance services. From a farmer’s perspective, new index insurance services are more affordable, have clearer and faster payouts and cover specific perils.

One drawback to index insurance, and weather index insurance in particular, is the incidence of basis risk, which is the difference between the actual loss incurred by a farmer and the loss determined by the index. An index calculated as an average for an area will be accurate for most farmers, but may not reflect the experiences of those farming on the fringes. Basis risk events occur when a calculated average index does not reflect actual losses or when weather stations, satellites or other data sources provide imprecise measurements. Basis risk events can also be caused by factors not covered by insurance policies, such as when a farmer with a weather index insurance policy suffers losses due to a pest infestation.

Recent index insurance services use technology to automate and digitise key steps in service creation and delivery, such as satellites and automated weather stations (AWS) to collect the weather data needed to calculate indices. As national and international space programmes expand their satellite networks and operate increasingly powerful instruments, more frequent and higher resolution remote sensing data is becoming available. This can be expanded rapidly as Africa become more integrated, become more of a one big village under the AfCFTA.

Many index insurance providers should see this as an opportunity. Already, some have taken advantage of the increased adoption of mobile phones and mobile money to provide services to farmers in remote locations. However, there is an opportunity for mobile technology to play a bigger role in creating and delivering index insurance services especially under the auspices of the AfCFTA.