3 RD MARCH 2009, KAMPALA, UGANDA

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1 INNOVATIVE NEW PRODUCTS WEATHER INDEX INSURANCE IN MALAWI SHADRECK MAPFUMO VICE PRESIDENT, AGRICULTURE INSURANCE 3 RD MARCH 2009, KAMPALA, UGANDA

2 Acknowledgements The Commodity Risk Management Group at the World Bank (Especially Erin Bryla and Joanna Syroka ) contributed to management of the pilot and the development of some slides in this presentation.

3 WHY WEATHER INDEX IN MALAWI Malawi Facts: Population: 12 million; 165th Human Development Index Food crop - maize; export crop - tobacco, tea, cotton, coffee, sugar One rainy season, November-April 45% of GDP comes from agriculture 87% of total employment is ag 64% of rural income is from agriculture Drought and Lending (2004/2005): Recovery rates for ag lenders in the range 50-70% Ex. One big bank that lost $110,000 to smallholders farmers stopped lending to those farmers Major government and donor lending program lost 50% of value over 5 years due to drought-blamed default and the program was discontinued. Microfinance institutions stopped lending

4 PILOT OBJECTIVES In 2004 the National Smallholder Farmers Association of Malawi (NASFAM) wanted to expand its operations and grow the Malawi groundnut market domestically and for export, but high risks from drought and high loan default rates deterred financing institutions from providing loans. The Pilot Program aimed to: Gives farmers the ability to mitigate drought risk Secure access to finance and inputs for improved production NASFAM training and higher quality seed will improve long-term production and revenues Protects both producer and loan provider from weather-related production risks Allowing banks to expand their lending portfolios in a managed way Gives insurers the opportunity to re-enter rural markets No regulatory impediment and reinsurance potential Little (and bad!) experience with traditional agriculture insurance Opportunity for NASFAM to expand its operations and grow the Malawi market domestically and for export

5 PRE-CONDITIONS Historical weather data & weather stations Length of historical record - 30 years or more Quality controlled, cleaned, enhanced Reliable ongoing collection and reporting procedures Third-party settlement data Ability to index risk Basis Risk or How good is this insurance? Mismatch between coverage and actual result How can it be minimized? Yield data that shows strong correlation with weather event Local insurance company willing to intermediate product

6 WHETHER INFRASTRUCTURE Malawi Met Office data excellent: over 30 years, few gaps, 21 primary synoptic stations (red) In addition over 200 rain gauges around the country which can be leverage. CRMG/Met Office installed 6 new automatic weather stations in 2008 World Bank installing new stations this year. Dense, high-quality network

7 THE GROUNDNUT PILOT Loans to cover seed, insurance premium and interest: Opportunity International Bank of Malawi Malawi Rural Finance Corporation Policies: Insurance Association of Malawi (seven companies pooled the risk) Premium: 6-7%, Max Payout per farmer: Loan Size given by bank Seed & Product Distributor: NASFAM: Groundnut in 2005, Groundnut & Hybrid Maize in 2006 Participants: Farmers all members of NASFAM clubs 2005: 900 farmers, 4 weather stations, sum insured $35, : 2500 policies, 5 weather stations, sum insured $110,000 Insurance Payout Payment details: Payout: channeled from insurance company directly to the bank; No Payout: farmers benefit from selling the higher value production

8 GROUNDNUT PILOT STAKEHOLDERS Club and NASFAM enter into sales agreement Club enters into contract with bank for insurance & loan Insurance purchased on behalf of clubs Farmers authorize the bank to pay NASFAM for the seed S t e p Insurance Association of Malawi Step 3 Step 7 MET OFFICE Seed distribution to clubs Money paid to NASFAM for seed Meteorological information distributed Payout from insurers to banks Farmers sell groundnut output to NASFAM NASFAM pays off loan balance to the bank Payment of any additional revenue from crop sale to club 8 Step 2 MRFC/ OIBM CLUB Step 6 Step 10 Step 4 Step 5 Step 11 NASFAM S t e p 9 Step 1

9 THREE PHASE CONTRACTS Given a target premium and set pricing guidelines, and a required maximum payout per phase, red dots are calibrated to a simple crop water-balance model the FAO WRSI cross-checked against historical yields and local experts (blue dots) to minimize farmer income Value-at-Risk and maximize payout correlation to yields Payout ($) Payout ($) Payout ($) Deficit Rainfall (mm) Deficit Rainfall (mm) Deficit Rainfall (mm) PHASE 1 Sowing & Establishment PHASE 2 Growth & Flowering PHASE 3 Yield Formation to Harvest Sowing Window & Dynamic Start Date Cropping Calendar* * Cumulative 10-day rainfall is capped to prevent excessive rainfall impacting the phase-wise total

10 MAJOR PILOT ACHIEVEMENTS Unlocking credit facilities for smallholder farmers farmers formerly excluded from financial markets. Before pilot OIBM did not lend to agriculture, but now is using lessons learnt from project to expand lending book. Four other banks promised to unlock more than USD 10 million of credit if weather risk is insured. Access to high yielding seeds and fertilizers. Farmers interviewed indicated that they got an average of SIXTY 50 kg bags (by using hybrid maize seed) as opposed the usual bags. Improved sustainability for contract farming operations Sustainability of credit markets: Quantification of weather exposure Can expand lending in a managed way In case of another 2004/5 drought loans will be paid off Banks have flexibility to protect themselves either through marketing insurance directly to farmers or through a portfolio approach Expansion of the risk retention capacity through risk transfer to the international market

11 MAJOR PILOT CHALLENGES Side-selling leading non-weather related defaults. Basis risk Client education very few paying attention Inadequate weather infrastructure

12 TOBACCO SCHEME Loans to cover inputs: (20% Maize inputs) 2007/8 -Opportunity International Bank of Malawi /9 Opportunity International Bank of Malawi Malawi Savings Bank Malawi Union of Savings Credit Co-operatives Policies: 2007/8-20% local retention and 80% reinsured externally. 2008/9-5% retained, 80% reinsured. Premium: Around 5% (For 2533 farmers premium paid by OIBM) Participants: Farmers contracted by Alliance One and Limbe Leaf. 2007: 450 farmers, 2 weather stations, sum insured $308, : 2587 policies, 3 weather stations, sum insured $2,500,000 Insurance Payout Payment details: Payout: channeled from insurance company directly to the bank; No Payout: farmers benefit from selling the higher value production

13 DESIGN OPTION TWO TOBACCO CONTRACTS Weighted Cumulative Weekly Excess, E Sum (W *max(0, Y Weekly Cumulative Rainfall)) e.g. 1.5 * * * * * * 3 = 55 Total Contract Payout = max(0, D-85)*$1 + max(0, E 70)*$1 Max Payout $750 per hectare 85mm 90mm 85mm 87mm 95mm 83mm 80mm W 15 Nov 20 Dec 25mm W Transplanting Window & Dynamic Start Date 15mm 10mm 15mm Weighted Cumulative Weekly Deficit, D Sum (W * max(0, X Weekly Cumulative Rainfall)) 23mm e.g. 1 * * * * 10 = 37

14 CHALLENGES FOR TOBACCO SCHEME Premium of about 5% still viewed as too high. One bank pulled out last season due to this. Lack of weather station infrastructure. At least 4000 contracted farmers currently excluded due to weather infrastructure. Good news is that World Bank is installing some stations this year. How to get other farmers not under contract farming. Rumours of contract marketing. Have not yet experienced catastrophic weather to evaluate effectiveness of contracts.

15 2009/10 PROSPECTS Tea Cotton Soya beans Maize bundled with cash crops Paprika

16 CONCLUSION Weather Index Insurance is not a panacea but should be used together with other risk management tools that reduce risks along the whole value chain. Given that there are very few sustainable value chains, insurance market need to come up with affordable premiums rates that would be attractive for stand alone products