Interlinking Weather Index Insurance and Credit to Improve Agricultural Productivity in Rural Ethiopia

Photo credit: IFPRI via Flickr

Rainfall variation is a major source of income and consumption risk among smallholder farm households. One way to help farmers deal with weather risk is through weather-indexed insurance policies, which pay sums of money to farmers when extreme weather events like droughts or floods occur. Researchers are examining the effect of combining weather index insurance with input loans on fertilizer and modern seed use, as well as livelihood outcomes for smallholder farmers in rural Ethiopia.

Policy Issue 

Rainfall variation is a major source of risk to smallholder farm households’ income and spending. Weather risk may influence farmers to underinvest in fertilizer or improved seeds and miss out on opportunities to increase their income. In fact, fertilizer use in Africa is about 12 times lower than in other developing regions and modern crop usage is about five times lower than in Asia. One proposed method of dealing with weather risk is weather index insurance (WII), which pays out sums of money to farmers when extreme weather events occur (e.g., excess rainfall, drought).

When WII products have been directly marketed to farm¬ households in developing countries, demand has typically been quite low. One potential explanation is that low adoption is linked to poor access to credit or savings, meaning that farmers often have difficulty finding enough cash when it comes time to make these purchases. Offering credit may allow farmers who want but cannot afford insurance an opportunity to insure their crops and take on additional risks.

Context of the Evaluation 

Agriculture is the main productive sector of the Ethiopian economy. It accounts for a little under 50 percent of the gross domestic product (GDP) and provides employment for 80 percent of the population. Ethiopia’s agricultural sector is almost entirely rain-fed and consists of an overwhelmingly smallholder farming system accounting for over 95 percent of the cultivated land. The average farmer in 2012 held 1.2 hectares of land and about 55 percent of all farmers held less than 1.0 hectare. Rainfall in many parts of Ethiopia is highly erratic, with major drought events occurring every four to five years on average. Weather shocks severely affect low income smallholder farmers and are a contributing factor to a cycle of poverty and food insecurity.

The product offered in this study insured the cost of inputs (fertilizer and improved seeds), which amounts to about 1000 Birr (US$75) per-timad (one quarter of a hectare) for the average smallholder farmer. Local weather stations that register low rainfall triggered insurance payouts. The indexes were optimized for the specific crops grown in the region surrounding each weather station (e.g. teff, maize, sorghum, and wheat).

Details of the Intervention 

Researchers examined the effect of combining loans with weather insurance on the use of fertilizer and improved seed varieties in Ethiopia. Specifically, researchers studied the obstacles to providing and pricing insurance and the rate of agricultural technology adoption among smallholder farmers. As part of the study, villages (“kebeles”) were randomly divided into three groups:

  1. Stand-alone Insurance (17 villages): Farmers were offered and able to purchase the standard weather insurance product. Researchers randomized price at both the village level (0-70 percent discounts) and individual level (0 or 20 percent discount).
  2. Credit & Insurance (17 villages): Farmers were offered the same insurance product with the same randomized subsidy structure, but policies were presented as “state-contingent loans”—meaning that in the event that the insurance product triggered, the loan and interest did not need to be repaid. If the insurance product did not trigger, then the loan plus interest had to be repaid.
  3. Comparison (15 villages): Farmers were not offered either product.

In the first year of the evaluation, the potential clients were surveyed and asked how much they were willing to pay for weather insurance products, while in the second year, they were offered a policy, and the surveys recorded whether they purchased the insurance.

Results and Policy Lessons 

While the study is still ongoing, preliminary results suggest that there are profitable opportunities for increased fertilizer use among farmers in the study, yet significant weather risks and limited access to cash or credit constrain farmers in making these investments.

Researchers found a large difference between stated and actual demand for weather insurance. Prior to being offered insurance, 62 percent of farmers stated that they would buy the product, and on average farmers were found to be willing to pay the actuarially fair cost. However, when offered the actual product, demand was lower, and significantly influenced by the availability and amounts of the subsidy vouchers. The preliminary results suggest that that promotion and subsidy will be necessary for a more widespread adoption of weather index insurance. Given that most states in Ethiopia are now moving away from subsidies for inputs, finding innovative ways to pull private credit into smallholder agriculture and to protect farmers from weather-related risk appears to be particularly important.

These results reflect only the first sales year of a multiyear pilot, and in future years, researchers will examine the effects of the insurance and credit products on input use and yields.