| Government vs Weather
The True Story of Crop Insurance
in India
Jennifer Ifft
Abstract
The government of India started offering widespread crop in insurance
in 1985, with the Comprehensive Crop Insurance Scheme. The CCIS
has been replaced by the National Agriculture Insurance Scheme.
The NAIS is considered to be an improvement over the CCIS, but it
has simply replaced one flawed scheme with another slightly less
flawed one. Government crop insurance has proved to be a failure
worldwide, but India seems to have ignored both its own failure
and the failure of other countries. The main flaws of the NAIS are
the goal of financial viability, its mandatory nature, its failure
to address adverse selection, arbitrary premiums, and the area approach.
Internationally, private crop insurance is not highly developed
but varied successful private programs do exist. Even if India withdrew
from crop insurance schemes, it could still support farmers through
an income guarantee or investment in infrastructure.
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Farmers face floods, drought, pests, disease, and a plethora of
other natural disasters. The weather is their greatest adversary,
something that can never be controlled by man. Yet, farming has
been in existence since the caveman turned his spear in for a hoe.
Farming has come a long way since then; nevertheless; farmers are
still at the mercy of the heavens. Crop insurance is a risk management
tool that farmers can use in today's agricultural world. For a premium,
farmers can pass their weather-related risk onto a third party.
Farmers in India have been subjected to publicly administered insurance
schemes since 1972. Every scheme has been flawed, yet the government
of India is still attempting to strengthen agriculture by protecting
its farmers from the weather.
India's failure at providing public crop insurance does not stand
alone. In both the developing and developed world, governments'
crop insurance schemes have run at huge losses while not delivering
an effective product. The inadequacy of such schemes is a well-established
fact. On the other hand, private insurance does exist in situations
where it is feasible and no subsidized insurance is offered. The
farmers stand to benefit even more from private insurance when there
are several competitors.
The government's most current crop insurance scheme, the National
Agriculture Insurance Scheme, has only been implemented since the
Rabi season of 1999-2000. Within five years the NAIS is supposed
to become financially sustainable, charging farmers premiums based
on actuarial rates and administrative costs. A data based analysis
of the NAIS is not possible, as data for only two seasons exists.
However, shortcomings of previous crop insurance schemes, general
trends of agricultural insurance in other countries, and inherent
theoretical flaws in the NAIS all point towards disaster.
The main flaws of the NAIS can be summarized as follows:
- Lofty goal of financial viability
- Mandatory for loanee farmers
- Adverse selection, in the case of non-loanee farmers
- Premiums do not equal Risk level
- The area approach
Show me the money!
The Comprehensive Crop Insurance Scheme, predecessor to the NAIS,
was implemented for 15 years, from Kharif 1985 to Kharif 1999. A
Ministry of Agriculture Publication, Background Note on Crop
Insurance, states that:
The Scheme had a positive and stabilizing influence on agricultural
production and productivity in respect of crops insured and is a
popular program particularly in those areas of certain States where
the risk factor in agriculture is relatively higher.
This "positive" and "stabilizing" influence came at a large cost.
The claims percentage (percentage of claims to premiums) was 572%.
The loss between premiums paid and insurance claims amounted to
184,446 lakhs, exclusive of administrative costs (five to seven
percent typically). Only four of the 22 participating states had
insurance charges greater than claims.
The CCIS only charged premiums of 1-2% percent, while claims made
were approximately 9% of the sum insured. Factoring in administrative
costs, participating farmers as a whole would have had to pay approximately
15% of the sum insured without the subsidy. The NAIS has premiums
of 1.5 to 3.5, varying from crop to crop. Although premiums are
higher than those of previous schemes, based on past experience,
they are still not high enough to cover claims.
Farmers growing commercial or horticultural crops covered under
the NAIS are supposed to pay actuarial rates. For all crops, the
NAIS is supposed to become financially viable within five years,
with yearly increases in premiums based on administrative costs
and actuarial rates. If the NAIS becomes financially viable, private
crop insurance would also be feasible. The effect of the opening
of insurance markets in India is still to be seen. However, if the
government stays in the crop insurance market private companies
will be discouraged from entry, especially considering the state
controls on almost every aspect of agriculture. Government controls
range from setting input prices to output prices, all of which distort
agricultural production. Therefore, any reform in crop insurance
will be most effective when accompanied by overall reform in the
agricultural sector.
Who is insured?
The CCIS was mandatory for loanee farmers growing covered crops
and insured 100% of the crop loan. The NAIS is also mandatory for
loanee farmers growing covered crops in implementing states. The
indemnity is based upon the value of the threshold level for each
crop grown in a set area. The threshold yield is based upon a moving
average of the yield over past five years. Anyone remotely familiar
with agriculture would understand that five years yield data does
not accurately represent complex weather patterns. Additionally,
non-loanee farmers are allowed to participate in the NAIS, but up
to this point very few, except in Maharashtra, have chosen to do
so.
The CCIS was often criticized as being "bank insurance," and the
NAIS is no better on this count. Producers taking out loans have
no choice--if the state authorities decide to implement the NAIS
the producer must purchase insurance. Insurance is not the only
risk-management tool available to farmers in India. Diversification,
fragmented land holding, off-farm employment, and savings are just
of few of the options. Requiring loanee farmers to prove their ability
to manage risk is good business--forcing one option upon them is
not. Farmers with adequate risk management capabilities should not
be forced to purchase crop insurance in order to receive a loan.
Twenty-two states/union territories participated in the CCIS, while
only 16 are participating in the NAIS. Punjab and Haryana are two
of the leading agricultural states, but have yet to participate
in the CCIS or NAIS. Agriculture in Punjab and Haryana is less risky
than that of other states. However, one cannot assume that no demand
exists for crop insurance in these states, as no cropping system
is without risk. Three levels of indemnity do exist within the NAIS,
but three risk levels can in no way address the diverse climate
and agriculture in India. If premiums were based upon true risk
levels, farmers in any agricultural system could avail of crop insurance
if it fit their risk-management needs. If a farmer faces such high
risks that he cannot survive without subsidized insurance the cropping
system is not sustainable
Adverse selection can be observed when a group of farmers is offered
crop insurance at the same premium, as is often the case in government
administered/subsidized crop insurance. The worst farmers will avail
of the insurance, making claims unreasonably high. Publicly administered
crop insurance schemes worldwide have been largely unsuccessful
partially due to adverse selection. In India adverse selection can
clearly be seen at the state level, as Punjab and Haryana do not
participate in the NAIS. If adverse selection were unavoidable,
the entire insurance sector would not exist. History tells us that
private insurance has been better able to address the problem of
adverse selection. The NAIS makes insurance mandatory for loanee
farmers, so adverse selection is more apparent at the state level.
Non-loanee farmers have no obligation to purchase crop insurance
and will most likely follow the pattern of adverse selection. If
the NAIS can become financially viable, premiums would have to continually
rise due to adverse selection.
A yield "guarantee"
Farmers insured under the NAIS are not guaranteed indemnity for
their yield losses. The uncertainty that even insured farmers face
is due to claims/indemnity being based upon the 'area approach.'
The area approach was considered the only feasible way to administer
the CCIS. As expressed in a Ministry of Agriculture publication
an 'individual' crop insurance scheme is not possible in India for
several reasons, including "prohibitive costs due to huge requirement
of men and material" and "disputes over fixing guaranteed yield
and loss assessment." The NAIS is being operated under the area-approach
currently. In a few selected districts the "individual"
approach is being implemented on an experimental basis. Considering
past experience, the individual approach is not likely to suddenly
become a feasible option.
The "area approach" is operated under the results of
crop-cutting experiments. Each year a set number of plots with the
insured crops for a certain "area" are used as the indicators
of an individual farmer’s losses within that area. The unit area
can be as large as a Block/Taluka or as small as 4-5 villages (Gram
Panchayat level). The states implementing the NAIS are expected
to reach the Gram Panchayat level of implementation within three
years. Insured farmers receive indemnity based upon the difference
between the threshold yield and the yield of the crop-cutting experiments
in their area. Crop yields naturally vary even over small areas
and very localized natural calamities could occur. Situations easily
exist in which farmers would not be compensated for their loss under
the NAIS or farmers without insurable losses would receive payments
anyway. Loanee farmers forced to purchase crop insurance may not
receive payments for crop losses. The only attractive feature of
the area approach is that it reduces moral hazard. Moral hazard
occurs when an individual farmer purposely allows his yield to be
less in order to collect insurance premiums. The prevention of moral
hazard does not redeem the area approach from its inefficiency.
The only way?
The NAIS has several shortcomings and its success is at best questionable.
However, the government could easily argue that farmers would otherwise
remain uninsured and that private insurance would not enter the
market. Options to the NAIS do exist that would help farmers, especially
in the long run.
The government has admitted that it lacks the resources to administer
a proper insurance scheme at the individual level. For various reasons
a second-rate scheme is deemed as necessary. A better option would
be an income guarantee not based upon yield, crop grown, or farm
size. Considering the various subsidies that are given to farmers
through various means--fertilizers, seed, price supports, etc.--an
income guarantee should not be an unfeasible option. Farmers need
to be able to respond to market forces and develop their own risk-management
tools.
History's lessons
Economists have proven that farmers stand to benefit from crop
insurance, even unsubsidized crop insurance. However, private markets
for crop insurance worldwide are not highly developed, except for
in a few cases. Skees (2000) documents several reasons for the underdevelopment
of private crop insurance. Subsidized crop insurance crowds out
private insurers and stifles innovation. Farmers are considered
to know their risks better than the government or the private sector,
so knowledge of agriculture is essential for insurers. The need
for information increases the cost of insurance. Agricultural risk
is unique--natural disasters can be widespread and are neither completely
independent nor correlated. Studies have indicated that farmers/decision
makers tend to underestimate the risk of damage by natural causes.
In the United States crop insurance is subsidized by the government
but administered through private companies. Hail insurance is not
subsidized, so most insurers offer hail insurance along with the
subsidized government policies. Rates are based upon the history
of crop losses due to hail in the county and competition also plays
a factor in keeping rates low. Adverse selection is not an issue
because companies set rates higher for high-risk areas. Moral hazard
is also less of a problem, as hail is a natural event. The multiple-peril
insurance subsidized by the government is considered to be too expensive
if offered without subsidies. A crop insurance agent from Midwest
estimated that over half of the farmers who purchase subsidized
multi-peril crop insurance also purchase hail insurance. The model
used for hail insurance can also be used for other natural disasters,
like drought, flood, and wind. The current subsidized insurance
program administered through private companies is relatively new.
This program is considered to be a significant improvement over
the previous unpopular programs administered by the government,
although it is not flawless. An option for the Indian government
is to administer its crop insurance program through private companies
and gradually phase out the subsidy. This option could best be used
for a "transition" period. Initially subsidizing premium
rates for crop insurance offered through private companies would
give the private sector incentive to enter the agricultural sector
and time to gain experience before the withdrawal of subsidies.
Crop insurance in South Africa was started in 1929 when a group
of farmers started a pool scheme. Subsidized multi-peril insurance
was offered for some time, but for the past fifteen years no subsidies
have been given. Hail is the main peril covered and many other perils
are also covered. Historical data and past claims play a role in
determining the premiums and damage assessment is the biggest challenge
for crop insurers. Crops at different stages are affected differently
by hail, making knowledge essential for insurers. There are several
players and new ones are continuously targeting this market. Several
crops are covered, including maize, wheat, sunflowers, and citrus
fruits. The South Africa case illustrates how private individuals
can offer crop insurance that is beneficial to farmers and how crop
insurance can still exist after subsidies are withdrawn.
In Canada crop insurance was administered through an area approach,
similar to that of India. Research from 1995 by Turvey and Islam
indicated that the area approach was not only inequitable but also
inefficient. The empirical research from 537 farms confirmed the
belief that individual crop insurance is better in terms of risk
reduction, but premiums would also be higher. The area approach
in Canada was concluded to be inequitable, as benefits were not
fairly distributed. The most benefits to be accrued would be by
the farmers with yields closest to the average. The crop insurance
in Canada was voluntary at this time, unlike the NAIS. Adverse selection
would be less of a problem at the individual level when insurance
is mandatory. Cross-subsidization would be more of a problem, because
the better farmers having to purchase insurance would indirectly
subsidize the worse farmers.
A 1997 study by Sakurai and Reardon indicated that there was an
unmet demand for formal drought insurance in Burkina Faso. Burkina
Faso is a part of the West African Semi-Arid Tropics (WASAT) and
experiences frequent drought. Much of the farmland in India is in
the semi-arid tropics. The demand for drought insurance was found
to decrease in households with higher overall incomes or more self-insurance.
The authors suggest that crop insurance alone is not sufficient;
that policy and programs that supports self-insurance, such as micro
credit or increase of off-farm employment, are also important. Perhaps
in India public funds and government policy would be better aimed
at strengthening self-insurance mechanisms, while leaving crop insurance
to the private sector.
Moving forward
The value of crop insurance, private or subsidized, is much debated
by academics and policy makers. The concept of index-based contracts
for natural disasters in place of crop insurance has been recently
introduced. Farmers would purchase a contract and be compensated
when a certain event or natural disaster occurs. Rainfall contracts
are one example. Rain is relatively simple to monitor and the history
of rainfall in most areas is well known. Farmers would be compensated
if the rainfall in an area would go below a set level, with varying
levels of payment depending upon the level of rainfall. The faults
of this approach lie in its similarity to the area approach. However,
the benefits are significant, including reduction of moral hazard,
adverse selection, and transaction costs (Skees 2000). This alternate
model could be adopted as an improvement over the NAIS but would
still deter the private sector from entry into crop insurance.
Private crop insurance can be observed worldwide, even though it
is not highly developed. Private crop insurance has tended to cover
more specific risks and not cover management-related risks. These
insurance policies offered must fit needs of farmers and be beneficial--otherwise
they would not exist. This is not necessarily the case with government
sponsored crop insurance. Private insurance works in a wide range
of countries for a wide range of agricultural activities. Insurance
programs vary from tropical plantation crops in Latin America to
tree crops in the USA. (Gudger 1991)
The NAIS will not fix the ills of Indian agriculture, nor will
any other grand insurance scheme planned by the authorities. Private
crop insurance may or may not develop if all government crop insurance
is abolished. Abandoning insurance schemes does not mean abandoning
farmers. Farmers could be given an income guarantee not based on
yield, price, or area planted. Even now an income insurance scheme
is being considered in India. Investment in agricultural infrastructure/research
would be more equitable as opposed to subsidies to crop insurance
and may yield more long-term benefits. Farmers deserve the chance
to farm on their own. They know the weather better than anyone—it
is their greatest foe and their greatest friend. The government
should stop trying to play God and help farmers help themselves.
References
- Blank Carter & McDonald, "Is the Market Failing Agricultural
Producers Who Wish to Manage Risks," Contemporary Economic
Policy, July 1997
- Government of India Publications: Background Note on Crop
Insurance, Rashtriya Krishi Bima Yojana, Salient features
of the National Agricultural Insurance Scheme, Crop Insurance
in India, Operational Modalities of the NAIS, Statewise Progress
of CCIS from Kharif ‘85 to Kharif 1999
- Gudger Michael "Crop Insurance: Failure of the Public
Sector and Rise of the Private Sector Alternative" Risk in
Agriculture: Proceedings of the Tenth Agriculture Sector Symposium,
November, 1991
- Hazell P, Pomareda C & Valdes A, Crop Insurance for Agricultural
Development: Issues and Experience, (Baltimore: John Hopkins University
Press, 1986)
- Interviews with: Abigidit Sen, Sharad Joshi, Madam Devan,
NABARD Officials, Stanley Metz, US Crop Insurance Agent via-email,
Ministry of Agriculture Officials, Ivan van Rooyen, Crop Insurance
Executive (South Africa) via e-mail
- Morduch Jonathan "Between the State and the Market:
Can Informal Insurance Patch the Safety Net?" World Bank
Research Observer, August 1999
- Sakurai Takeshi & Reardon Thomas, "Potential demand
for drought insurance in Burkina Faso and its determinants"
American Journal of Agricultural Economics v. 79 no4 (Nov. 1997)
pp. 1193-207
- Skees Jerry "A Role for Capital Markets in Natural Disasters:
A Piece of the Food Security Puzzle," Elsevier Science, May,
2000
- Turvey Calum G and Islam Zahirul, "Equity and Efficiency
Considerations in Area versus Individual Yield Insurance" Agricultural
Economics, Volume 12, Issue 1, April 1995, Pages 23-35
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