Does index insurance really work for smallholder farmers?

Traditional insurance for smallholder farmers in low- and middle-income countries (LMICs) is prohibitively expensive. Serving rural and remote areas requires costly on-site visits to assess risks and verify losses. In addition, the information available to insurers about farmers' practices, and what they are exposed to, is limited, which drives the insurance cost up due to the higher premiums charged to cover the uncertainty. 

Smallholder farmers, however, are particularly vulnerable to a variety of risks that carry potentially severe consequences, such as devastating pest attacks and weather-related events. 

Unlike traditional indemnity-based insurance — which compensates farmers considering their individual losses — index insurance products pay out after evaluating a simple external measure, such as rainfall levels or average local yields. Their administrative cost is lower because insurance companies do not need to conduct field inspections to evaluate losses, which makes the assessment of the claim easier. It is why index insurance is often hailed as a breakthrough to boost agricultural investment. 

But despite years of experimentation, the uptake of the first generation of index insurance products — introduced in the early 2000s in LMICs — remains disappointingly low. Moreover, their positive impact seems to be inconsistent. 

Against this background, our study, Do index insurance programs live up to their promises? Aggregating evidence from multiple experiments, just published by the Journal of Development Economics, explores whether expanding access to index insurance can help farmers to boost their productive investments.

Our findings temper the initial enthusiasm. 
 

Wide variation in impact

We pool evidence from eight experiments that provide causal evidence on the impact of index insurance programs on productive investments in LMICs. Our research focuses on index insurance programs across Africa and South Asia that reflect a wide range of product designs and delivery models. The experiments include:  

• Three products based on rainfall that use weather station data. 

• Two focused on area yields that rely on crop-cutting surveys or buyer records. 

• Three that use a hybrid approach, weather station data and crop-cutting exercises.  

Some of the index insurance products above are crop-specific, others are more general. Pricing varies due to differences in actuarial value and subsidy levels. Most products are sold individually, though two studies feature group-based decisions. Coverage amounts usually depend on land size. Payouts are triggered by diverse indicators, such as dry spells, cumulative rainfall, or area yield averages. Take-up rates range widely, from 29% in Mali to 100% in cases where index insurance is offered for free. 

Our findings are the result of aggregating evidence from these experiments and assessing the external validity of their conclusions.  They show that access to index insurance generally increases agricultural investment, as seen in Figure 1. On average, farmers offered index insurance cultivate more land (+8%) and invest more in seeds (+16%), pesticides (+9%) and fertilizer (+8%).  
 

Figure 1. The average effect of index insurance on farmers’ production decisions

^{Note: This figure reports effects as percentage changes relative to the control group mean. It was designed by the authors of the paper.} 

However, these average effects mask wide variations. The impact of index insurance differs widely across studies, and adjusting for basic household characteristics does little to explain this difference. The effects on those who take up index insurance are larger, but even more heterogeneous. 

We also find considerable uncertainty when predicting the impact of index insurance in settings where it has not yet been tested. The range of predicted effects includes the possibility of having no impact, or a negative impact. For example, there is a 25% chance of adverse effects on fertilizer use.  
 

The potential of the next generation insurance products  

While sobering, our findings should not be interpreted as evidence that efforts to promote index insurance should be abandoned. In fact, our results confirm that index insurance has the potential to stimulate smallholders’ productive investments.  

However, the substantial uncertainty around positive impacts, and the evidence on the limited uptake of index-based products, calls for caution from governments and development agencies. Before investing in their widespread promotion, more research is needed.  

Nonetheless, recent innovations in the design and implementation of index-based insurance have raised hopes that newer products might address some of the challenges that limit the effectiveness of earlier versions. Research currently underway also strengthens the potential for a promising second generation of index-based insurance.     

For example, emerging products that leverage advances in remote sensing and digital technologies, such as smartphones, could help further to reduce transaction costs and the mismatch between payouts and actual losses experienced by farmers. For instance, by relying on pictures taken by farmers, Picture-Based Insurance offers the possibility of verifying losses at minimal cost. 

However, more evidence is still needed before index insurance can be confidently promoted as a cost-effective way to help smallholder farmers manage risk at scale.