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Weather-Indexed Insurance: Why Isn't It Working?

05.06.2017Sonja Kelly, Director of Research, Center for Financial Inclusion (CFI)

This post was originally posted on the CFI-Blog Website.

Weather-indexed insurance is brilliant. It's just not working.

It's brilliant because it solves one of the basic challenges of insurance: moral hazard. Under the principle of moral hazard, having insurance tends to make an individual's behavior riskier, increasing the likelihood that the product will be used. If I have fantastic health insurance, for example, I may be more likely to make riskier life decisions because I don't feel the financial effects of the consequences of those decisions quite so acutely. If insurance is tied to the weather, however, nothing an individual does (unless you believe in the efficacy of a rain dance) will "trigger" the insurance.

Weather-indexed insurance is not a new phenomenon. Over the last decade we've heard exciting stories about weather-indexed crop microinsurance and the lifeline it offers to farmers given our world's quickly-changing climate. Weather-indexed insurance was bundled with agricultural inputs like seeds or livestock, and the product was lauded as a way to increase the inclusion of poor people in insurance.

Amazing, right? So why, after a decade, aren't customers buying? In India, for example, only 5 percent of farmers have taken it up where available.

  • It's complicated. Insurance is incredibly complex to explain to a consumer. There are no easy examples for consumers to reference in their mental maps of products. The concept has no analogues in the local culture.
  • It costs a lot. Low-value insurance is very expensive for companies to offer, and weather-indexed insurance is no exception. While the weather-based trigger makes it cheap to determine when claims are valid, the product requires a critical mass of people to break even, and it is costly to acquire all of those customers.
  • And it's undervalued. At the same time, customers often under-value insurance. In experiments looking at whether insurance products are priced appropriately vis-à-vis customer perception, there is skepticism regarding the price of premiums for an intangible product. A number of years ago, some researchers discovered that even when subsidized so that insurance would yield an expected return of 181 percent, only half of households offered the product decided to purchase it.
  • Making an insurance claim is annoying, and recourse mechanisms are not great. Weather-indexed insurance targets individuals living in remote areas who might lack experience with insurance claims or formal financial services. Moreover, available weather data has been a limiting factor for the scope and accuracy of the services' automation. Recourse mechanisms are often a struggle with financial services for the base of the pyramid, and there have been documented incidences of similar issues in the weather-indexed insurance segment.
  • "Freemiums" can give insurance a bad rap. A "freemium" is an insurance product offered for free alongside another product that the customer is paying for. For example, rental car insurance comes with a credit card. Credit life insurance comes with a microloan. Health insurance comes with a mobile wallet. The problem is that customers often don't know they have the product, which can reduce the offering's credibility. The freemium approach has been met with success in some cases, but to achieve this, it's essential that customers have a strong awareness and understanding of the product.
  • Governments aren't really on board, even though the product would increase economic growth. Noteworthy exceptions to this are the governments of Canada, India, and the United States, which subsidize premiums by at least 50 percent. However, such involvement by many governments in Africa, for example, would likely not be affordable.

These results are not new. It's just that the industry has not found compelling solutions to these problems.

It's no wonder weather-indexed insurance for low-income populations continues to limp along, even though it is one of the financial sector's greatest inventions (in this blogger's opinion). The best way forward for weather-indexed insurance is either providing it for free (which is why Shawn Cole advocates so strongly for public-private partnerships) or bundling both the price and the service with existing financial products. And ensuring that individuals sufficiently understand the products and their benefits, and that the products work well - i.e. making a claim or a complaint is as seamless as possible.

But I'd love to be proven wrong-do you know an example of a weather-indexed insurance that's working?

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About the Author

Sonja Kelly conducts and facilitates financial inclusion research at CFI, directing the CFI Fellows Program, developing frameworks to understand critical concepts like financial health and financial capability, and facilitating the Global Microscope research. She serves as research lead on many topics related to financial inclusion. In her own research and work, Sonja focuses on regulation and policy, the role of banks in financial inclusion, and especially vulnerable populations. Sonja has a doctorate in international relations from American University, where her dissertation focused on financial inclusion policy and regulation. She has previously worked at the World Bank, the Consultative Group to Assist the Poor, and Opportunity International. Sonja is currently a member of the board of directors of People Reaching People, and has held volunteer positions as president of the Washington DC chapter of Women Advancing Microfinance, and as president of the steering committee for Northwest Chicago Young Life.

Expanding access to finance for smallholders one lease at a time

27.03.2017Ashley Olson Onyango, Programme Manager, Agricultural Finance

This post was originally posted on the Rural & Agricultural Finance Learning Lab website.

In rural sub-Saharan Africa, working in agriculture tends to be an extremely labor-intensive job with high risk and low payoff. As a result, new generations of farmers and other entrepreneurs are often deterred from pursuing a career in agriculture. This leaves the agricultural industry with ageing farmers and declining agricultural production. One potential solution, however, is the mechanization of farming which can help decrease the need for hard, manual labor, while also improving production, household incomes, and livelihoods. A shift to tractors and other machine-powered equipment is part of a broader strategy to improve rural livelihoods and make agriculture attractive for new generation of farmers.

Although this shift may seem easy, the challenge is that tractors and machine-powered equipment are expensive - and access to finance is frequently cited as a key barrier to increased investment and productivity for smallholder farmers in sub-Saharan Africa. Farmers struggle to mobilize the resources required to effectively invest in their land without additional financial support, but at the same time, lack adequate collateral to access credit from financial institutions.

Financial Sector Deepening Africa (FSDA) and Nathan Associates recently published the Agricultural leasing market scoping study for sub-Saharan Africa, which directly tackles the barrier of adequate collateral. In fact, a key advantage of leasing is that it doesn't require collateral, since the lessor retains ownership of the asset for the duration of the lease contract. That being said, lessors still need to mitigate their risk by taking an initial down payment from lessees. Specifically, "in agricultural leasing, concerns around willingness to pay, crop failure, and asset depreciation all drive up the size of the initial payment required by financial institutions."

The required down payment on agriculture equipment typically varies by region and product. For example, in developed countries the required down payment is generally in the range of 10% to 20%. Compare this to developing countries, where the FSDA study found that in the eight reviewed - Ethiopia, Ghana, Kenya, Mozambique, Nigeria, Tanzania, Uganda and Zambia - downpayments generally range between 20% to 40% of the value of the asset. This is a threshold that is above what most smallholder farmers can pay - creating a significant barrier to accessing leasing products, which ultimately holds back demand.

One recommendation to overcome this challenge is to establish a fund that would increase market access for financial leasing by reducing the credit risk of leasing companies. For instance, a fund could bridge the gap between what potential lessees are able to pay and what lessor's risk policy deems an acceptable down payment. If the lessee (farmer) can make a 10% down payment, but the lessor requires a 30% down payment, the fund could make up the difference by paying the 20% differential. The 20% would be paid directly to the lessor, so the lessor receives their full 30%. The lessee ends up only paying the ten percent that he or she is able to afford at that time. The 20% paid by the fund becomes a separate loan and with every lease payment from the lessee to the lessor, a percentage of that amount is paid back to the fund to cover the 20% loan.

A potential fund to make lease finance more accessible, as FSDA's report recommends, could address customers' needs for an innovative product that tackles the issue of adequate collateral for financial access. Furthermore, it could address the challenges that suppliers of such financing face by buying down some of the risk and making an entry into this sector more attractive. We might call this a "smart subsidy" that could be transformative if well designed and executed by strong partners (see Inflection Point for context on "smart subsidy").

To bridge the gap of finance and improve rural livelihoods, development financial institutions should ask themselves what role they can play in making this new form of finance accessible to the agricultural sector - promoting growth and mechanization for improved livelihoods through the fund. While leasing finance is just one piece of the puzzle, the country scoping sheds light on how to enter this space given the current state and where are the risks and opportunities.

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About the Author

Ashley Olson Onyango is the Programme Manager, Agricultural Finance at FSD Africa. Ashley has been working in the agricultural finance development sector across sub-Saharan Africa. Ashley previously spearheaded the development of a new lending portfolio with Root Capital, focused on domestic value chains and food security crops. After the launch, she managed the start-up of the portfolio and integration of the new portfolio into Root Capital's lending operations. More recently, Ashley has been consulting in the agricultural finance development sector with a number of clients and has joined the FSDA as a long-term consultant to manage its Agricultural Finance Programme. 

Message from the MFW4A Partnership Coordinator

30.01.2017David Ashiagbor

Dear Readers,

Let me begin by wishing you all a very happy and prosperous 2017, on behalf of all of us at the MFW4A Secretariat.

2016 was a rewarding year for MFW4A. We were proud to host the first Regional Conference on Financial Sector Development in African States Facing Fragile Situations (FCAS) in Abidjan, Cote d'Ivoire, jointly with the African Development Bank, FSD Africa, and FIRST Initiative. The conference attracted some 140 policy makers, business leaders, academics and development partners from over 30 countries, to discuss the role of the financial sector in addressing fragility. The conference has already led to several initiatives by MFW4A and our partners in the Democratic Republic of Congo, Liberia, Sierra Leone and Somalia. We expect to build on this work in 2017.

Our support to the Conférence Interafricaine des Marchés d'Assurances (CIMA), the insurance regulator for francophone Africa, helped them to secure financing of EUR 2.5 million from the Agence Française de Développement. The funding will help to expand access to insurance in a region where penetration rates are less than 2% - well below the average for the continent. We worked closely with a number of our funding partners to help define their strategies in Digital Finance and Long Term Finance. These results are a clear demonstration of how the Partnership can directly support the operations of its membership.

With the support of our Supervisory Committee, we took steps to ensure the long term sustainability of the Partnership. The approval of a revised governance structure which fully integrates African financial sector stakeholders, public and private, was a first critical step. The ultimate objective is to expand membership and build a true partnership of all stakeholders in Africa's financial sector.

2017 will be a year of transition for the Partnership. It marks the end of MFW4A's third phase, and the beginning of its transformation into a new, more inclusive partnership, with an expanded membership. We will focus on revamping our value proposition to provide more focused, needs based services with the potential to directly impact our current and potential membership. In so doing, we hope to consolidate MFW4A's position as the leading platform for knowledge, advocacy and networking on financial sector development in Africa.

In closing, I must, on behalf of all of us at the MFW4A Secretariat, thank all our funding partners, stakeholders and supporters, for your constant support and encouragement over the years. We look forward to working together to strengthen our Partnership.

With our best wishes for a happy and prosperous 2017,

David Ashiagbor
MFW4A Partnership Coordinator

Using Digital Finance in Agriculture: New Guide Launched by USAID

03.05.2016Christine Martin, Senior Digital Financial Advisor, US Global Development Lab

USAID recently launched the Guide to the Use of Digital Financial Services in Agriculture, a step-by-step guide to help our partners support access to and use of sustainable financial services in rural areas. This Guide is the result of an ongoing effort within USAID to understand how digital financial services (DFS) can support Feed the Future initiative's goals of increasing agricultural incomes and reducing malnutrition while simultaneously building out ultra-inclusive economic infrastructure.

We see at least four areas where DFS is making a vital impact by overcoming many of the challenges with traditional financial services that have left many rural communities unbanked or underbanked:

  1. Reducing the cost of delivering financial services outside of bank branches and urban areas, making these services (savings, credit, insurance, etc.) accessible and relevant to rural communities.
  2. Increasing the traceability of payments to reduce loss of funds and ensure proper accounting, which can potentially increase trust between various actors within the agricultural supply chain.
  3. Improving household resistance to financial shocks through savings and on-demand receipt of funds, which evidence shows helps to smooth consumption and maintain household nutrition.
  4. Creating new business models (for example, alternative credit scoring such as M-Shwari in Kenya which is providing very small, on-demand loans to customers based on savings behavior).

The approach we document in this Guide follows three broad steps for assessment: 

  1. Identifying the value-chain challenges;
  2. Assessing gaps and obstacles in existing services; and
  3. Assessing the maturity of the digital ecosystem in your area.

The Guide encourages the reader to walk through these steps without limiting his or her thinking, initially, based on gaps in the local DFS market. Rather, once the reader identifies opportunities, they can design interventions that integrate creative solutions and market facilitation to make these opportunities a reality, even in less mature markets, using the following four high-level intervention types:

  1. Utilizing digital finance along the value chain, the most immediate and direct way to use DFS in our programs;
  2. Organizing implementing partners around DFS solutions, in order to aggregate demand for services by working together with USAID and other development partners;
  3. Implementing other technology-enabled services in conjunction with DFS, which encourages the reader to look at the broader digital ecosystem and to integrate with other services that are relevant to smallholder farmers (such as mobile-enabled extension services).
  4. Market Facilitation, which recognizes the role that USAID, along with our partners, can play to stimulate the broad DFS market when key constraints, such as regulation or lack of adequate consumer protection are holding back use of services in rural areas.

One great example of the last intervention type which has seen great process over the past year comes from our Feed the Future partners in the Somali region of Ethiopia. Mobile money, although not widely available in the region, was identified as able to improve access to finance for livestock producers. Therefore, acting as a market facilitator, USAID supported Hello Cash to extend the services of Somali Microfinance Institution into hard-to-reach areas - creating the opportunity for customers to use mobile-based payments to transact, save, and increase access to loans, all of which will support the larger Feed the Future effort to build a reliable livestock market for Somalia and the bordering regions in Ethiopia.

In keeping with the Principles for Digital Development, this Guide is a dynamic resource that will be updated and improved based on your input and experiences in the field.

Please get in touch either through the comments section below or by sending an email to digitaldevelopment[at]usaid.gov. Whether it is related case studies, specific feedback, or ways that you're able to benefit from this Guide in your own work, we'd love to hear from you and to keep pushing forward our rural development goals together.

Appropriate Warehousing and Collateral Management Systems in Sub-Saharan Africa

14.12.2015Jonathan N. Agwe, PhD, Senior Technical Specialist, IFAD

Warehouse receipt finance (WRF) is an ancient financing technique that has been found on Mesopotamian clay tablets. WRF played an important role in the financing of agriculture and agricultural processing in the USA and Europe. It is widely used across the developing world - but mostly for the financing of import and export operations. In recent years, there has been much effort by governments of developing countries (supported by their development partners) to extend its use to national agricultural value chains.

So what's an agricultural warehouse receipt system (WRS)? It is a re-emerging financing system whereby agricultural commodity warehouses with qualified warehouse operators and collateral managers provide storage and collateral management services intended to facilitate access to warehouse receipt finance and other forms of commodity-based finance in favour of smallholder farmers.

If financial service providers have a warehouse receipt finance product that is accessible to farmers, then such a product gives qualified farmers the flexibility in timing their sales. Instead of selling their commodity to meet immediate cash-flow needs at peak production season when commodity prices are generally at their lowest levels, the farmer can store their commodity in a qualified warehouse and postpone selling to a later date when prices are supposed to be higher. The farmer then uses the commodity in storage to pledge as collateral for a loan which is used for the immediate cash-flow needs. From the financier's perspective, warehouse receipts, when used as collateral, can facilitate lending to farmers. Warehouse receipt finance also makes it possible for processors to fund the stock they need for their operations throughout the year and for exporters to optimise the timing of their expected sales. In addition, it gives international banks a way of bringing loans to customers at interest rates that tend to be lower than those offered by local banks.

However, there are some pros and cons of WRS within the context of the smallholder farmer. WRS could strive better under conditions of some form of guaranteed higher future prices compared to the usual low prices experienced during the peak harvest season. Hedging instruments to reduce the risk of adverse price movements include contractual arrangements like futures or exchanged-traded and forward or private agreements. However, these kinds of price volatility risk management mechanisms are a little more sophisticated at smallholder value chain level, leaving the price-taker farmer vulnerable to marked-to-market speculation. Whatever the case, the difference in prices at harvest season and time of sale must be able to cover the full cost of warehousing plus interest paid on the loan taken to respond to immediate cash-flow needs at harvest. Yet, WRS has proved difficult, partly because local financiers - the most logical candidates for financing national and regional agricultural trade flows - are usually unfamiliar with the WRS approach and they are also wary about the adequacy of commodity pricing mechanism, political, legal and regulatory conditions that surround its use.

What about a one-size-fits-all WRS for the smallholder farmer in Sub-Saharan Africa (SSA)? 

An investigation in the situation on the ground in nine SSA subject countries (Burkina Faso, Cameroon, Côte d'Ivoire, Ghana, Madagascar, Mozambique, Niger, Senegal and Uganda) identified bottlenecks to the wider use of various forms of WRS and formulated proposals for action. The investigation arrived at technical and legal recommendations, some of which are quite country- and context/commodity-specific, while others could be generalized, albeit with caution. The investigation came up with four main types of WRS, with the first type as the most appropriate for SSA smallholder, and the other three as a little more advanced at this time for the SSA smallholder who is yet to produce commercial volumes to be able to tap into such more advanced WRS types. However, one or two or all three of the other types or in some combination thereof, is the direction in which commercially-oriented SSA smallholder ought to be heading towards. The four types are:

  1. Type A for community inventory credit for smallholder farmers: This type is often supported by microfinance institutions (MFIs), which re-finance their operations with commercial banks. Stocks are normally held under a double-padlock arrangement in community stores or domestic buildings, with the keys to one lock held by the producers' organisation (PO) or group of farmers, and the other by the MFI.
  2. Type B for private warehouse receipting: This system provides financing against commodities stored in a private warehouse under the control and responsibility of a collateral manager (CM). This can include a field warehouse, where the goods are held in the borrower's store, which is temporarily leased to the CM.
  3. Type C for public warehousing: This system provides financing against commodities stored in a public warehouse. This is a warehouse that is open to depositors from the general public; it does not mean that the warehouse belongs to the State; indeed most public warehouses are privately owned.
  4. Type D for lending against the security of current or future production: In this case, the funding agencies lend against a documented security representing current or future production. This is the typical; system depicted under the value proposition for warehousing discussed above.

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This blog is adapted from AFD/CTA/IFAD-PARM co-publication on warehouse receipt finance in Africa. For the detailed study, please, click here:

http://publications.cta.int/en/publications/publication/1855/ http://publications.cta.int/en/publications/publication/1856/ http://publications.cta.int/en/publications/publication/1857/

About the Author

Dr Jonathan N. Agwe (DM) is one of the Senior Technical Specialists in Inclusive Rural Financial Services in the Financial Assets and Markets (FAME) Cluster at the Policy and Technical Advisory Division (PTA) of the Rome-based International Fund for Agricultural Development (IFAD). Prior to joining IFAD, Jonathan worked as Operations Officer in the Washington-based World Bank's Department of Agriculture and Rural Development for 13 years. And before joining the World Bank, Jonathan worked over 12 years, developing private and public sector programs for smallholder and commercial agricture in Cameroon.Jonathan N. Agwe has a cumulative work experience over 29 years and holds a Doctor of Management (DM) degree in develeopment management from the University of Maryland University College, USA.  

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