Drought Challenges - Chapter 13: Drought Risk Insurance

Elsevier, Current Directions in Water Scarcity Research, Volume 2, 2019, Pages 195-210
Daniel Tsegaia and Ishita Kaushikb

Preparedness for drought can reduce the often disastrous but preventable consequences of droughts on people's livelihoods and ecosystems. Risk transfer through insurance is one of the policy options for reducing vulnerability, especially for agricultural losses due to droughts. One of the recent innovations is agricultural index insurance. Rainfall index, Normalized Difference Vegetation Index, and area yield agricultural index are three of the most common indices used to build agricultural index insurance contracts. This chapter focuses on rainfall index which links insurance payouts to historical rainfall data from reliable weather gauging stations and relates it to crop and livestock losses. The system works in such a way that if the data show the rainfall amount is below the threshold, the insurance pays out. If implemented effectively, it has the potential to revolutionize access to formal insurance by smallholders. It has a drawback in that it depends on the availability and reliability of quality data, which is a significant challenge in most developing countries. But perhaps most importantly, index insurance is vulnerable to basic risk (the remaining risk from other rainfall deviations and from other hazards) such that insurance payouts do not match actual losses. Accordingly, the selection of an appropriate index is important not only to reduce crop and livestock losses due to low rainfall but also to minimize the basis risk.

Designing an innovative insurance product which addresses not only ex post drought impact but also reduces land degradation through adoption of appropriate ex ante strategies is crucial to forming holistic policies for reducing vulnerability to drought. To achieve the twin goals of land sustainability and resilience to drought, sustainable land management practices can be used as a condition or contractual obligation to provide a reduced or free premium to farmers who decide to participate in the insurance scheme. This chapter attempts to address the importance of designing such an innovative insurance product which does not only address drought impacts but also minimize land degradation.