EXPLAINER: What Index Insurance can do for Nigerian farmers

IFC and Africa RE recently announced plans to develop index insurance for smallholder farmers in Nigeria, and similar intention had been expressed by NIRSAL last year. But then, what does Index Insurance really entail?

According to the Global Index Insurance Facility Factsheet, insurance providers in Africa and other developing regions rarely offer the hazard insurance familiar to industrialized countries. Earthquake, flood, and hurricane victims often lose their homes in an instant, recovering none of their investment unless they are fortunate enough to be part of a donor-funded disaster relief program. Likewise, droughts can wipe out the crops that farmers rely on for income.

IFC, together with the International Bank for Reconstruction and Development (IBRD), also a member of the World Bank Group, has established the Global Index Insurance Facility (GIIF) to address this problem. GIIF takes an innovative index-based approach to insurance that aims to expand access to insurance products in developing countries, and particularly to farmers and people in agrarian communities.

With traditional insurance, a farmer insures crops for loss, so if 20 percent of crop yield is damaged, for example, the insurance company pays damages. This system creates moral hazard and requires that claims are individually checked for actual yield loss leading to high transaction costs and the frequent need to subsidize premiums. Results of this type of insurance are often poor for the insured and the insurer, and the complexities involved provide little incentive to expand such insurance provision into emerging or frontier markets where it is needed most.

Under an index-based insurance scheme, losses resulting from weather and catastrophic events are assigned values on a predefined basis, using an index. When one of those events is triggered the insured party receives an insurance payment according to the pre-defined payment formula. For example, insurance will be paid out in the event of drought as a result of less than an anticipated amount of rain, a wind storm of certain category, or an earthquake registering a certain Richter scale, occurring within a fixed distance from a location.

This innovative approach to insurance provision means that policyholders qualify for payouts as soon as the statistical indexes are triggered, without having to wait for claims to be settled in the traditional way. The insurance will pay if the index is triggered, irrespective of the actual loss.

The Global Index Insurance Facility (GIIF) is a dedicated World Bank Group’s program that facilitates access to finance for smallholder farmers, micro-entrepreneurs, and microfinance institutions through the provisions of catastrophic risk transfer solutions and index-based insurance in developing countries. Funded by the European Union/ACP, the governments of Germany, Japan, and the Netherlands, GIIF is said to have facilitated more than 4.6 million contracts, with $730 million in sums insured, covering approximately 23 million people, primarily in Sub-Saharan Africa, Asia, and Latin America and the Caribbean.

Providing access to finance for the vulnerable, insurance is an important element to poverty alleviation. Unfortunately, agricultural insurance and disaster insurance are either unavailable or prohibitively expensive in many developing countries.

Index insurance is an innovative approach to insurance provision that pays out benefits on the basis of a pre-determined index or loss of assets and investments resulting from weather and catastrophic events, without requiring the traditional services of insurance claims assessors. It also allows for the claims settlement process to be quicker and more objective.

CALEB OJEWALE