A system of drought insurance for poverty alleviation in rural areas

This report provides tools for the development of crop insurance combined with micro finance to help smallholder farmers break out of the poverty trap. Although insurance is a well-established means to manage risk, crop insurance schemes have only rarely been implemented in the developing country, smallholder context. Consequently, many farmers seek to minimise their risks, at the same time reducing the potential for bigger profits as a result of lower investment in inputs, for example.The document centres on a case-study in Nicaragua, where many smallholder farmers grow drybeans, a crop sensitive to rainfall variation. The authors develop a "weather index" in order to reduce the complex relationships between drybean yield and climate variation into a single figure. They then convert this figure into a payable index, which consists of generation of the weather data, a simulation of crop yields based on the weather information, and finally estimating the minimum rainfall needed for a successful harvest at fixed periods during the growing season. Combining this with spatial data, soil varieties, and by breaking up the growing season into discrete units, a crop risk model is developed.The authors propose two possible insurance systems. The first allows farmers to determine the yield deficit needed for an indemnity payout, the second provides a fixed "trigger" value. Whilst the former allows farmers to choose the level of risk they are prepared to accept (and thus also the cost of the insurance premium), the latter is easier to formulate.The document emphasises that the success of a financial instrument for smallholders is dependent on the mechanisms put in place to ensure accessibility. Microfinance organisations (MFOs) that already have good contacts with small-scale farmers and offer related products are an obvious choice. Nonetheless, the paper comments that MFOs may be limited in effectively managing and distributing weather-insurance, and warns that links with experienced insurers and reinsurers is essential.Consultation with farmers revealed that they quickly grasped the concept of weather insurance, and they quickly became enthusiastic. They provided valuable input into the administrative and operational aspects of such a scheme, and endorsed MFOs as ideal local insurance agents.