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Innovations in Agricultural and Natural Disaster Insurance

Published by:
Online Location
Publication date
Number of Pages
Type of Publication:
Articles & Journals
Focus Region:
Focus Topic:
Climate / Weather / Environment
Type of Risk:
Natural disasters
Type of Risk Managment Option:
Risk reduction/mitigation
Mario Miranda, Dmitry V. Vedenov
American Agricultural Economics Association (ASSA)

Agricultural production has always been a risky endeavor. Farmers constantly have to deal with unfavorable weather conditions, variability in prices of inputs andoutputs, livestock disease outbreaks, pests, etc. The uncertainty of future incomes complicates both short-term production decisions and long-term planning (e.g., expansion of production or capital investments in machinery and equipment). It also renders lending institutions less willing to provide loans to farmers, since the probability of default is relatively high. Although some forms of selfinsurance may be available to farmers (e.g., crop diversification or intertemporal income transfers), these have certain limitations and
ultimately reduce farm profits in the long term.

Of all risk factors affecting agricultural production and especially crop production, weather is typically the most significant. Weather phenomena are hardto predict (at least in the beginning of growing season) and even harder to mitigate against. Moreover,
since unfavorable weather conditions such as floods or droughts often affect large areas, the risks faced by different producers are correlated. The latter presents a stumbling block to traditional insurance, which is designed to pool a large number of small unrelatedrisks rather than handle widespread simultaneous (catastrophic) losses.

A portfolio of agricultural risks has a substantial systemic component, which cannot be diversified away. Reinsurance may provide
insurance companies with a way to share this type of exposure, but it is usually costly andnot always available. As a result, even if an insurance company offers a form of crop insurance, the rates are usually prohibitively high.This in turn decreases demand for such insurance andcontributes to adverse selection.

Traditionally, unwillingness or inability of insurance markets to provide affordable risk management mechanisms for agricultural crop production has prompted many governments to subsidize agricultural producers and/or insurance companies that offer agricultural
insurance (subsidized loans, pricesupport programs, tax breaks, subsidized reinsurance, etc.). Unfortunately, government support programs are often inefficient and come at high social cost (Skees, Hazell, and Miranda). The situation is worse for developing countries, where the government often cannot afford direct support of producers. A solution to the problem of managing agricultural risks may lie in risk securitization, an emerging trendwhich attempts to bring together insurance andfinancial markets.

This paper considers recent innovations in this area andd iscusses possible applications of new risk sharing mechanisms to agricultural insurance in the context of a developing country (Nicaragua).