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Managing Agricultural Production Risk Innovations in Developing Countries Report No. 32727-GLB Managing Agricultural Production Risk Innovations in Developing Countries June 2005 The World Bank Agriculture and Rural Development Department © 2005 The International Bank for Reconstruction and Development / The World Bank 1818 H Street, NW Washington, DC 20433 Telephone 202-473-1000 Internet www.worldbank.org/rural E-mail [email protected] All rights reserved. Rights and Permissions The material in this work is copyrighted. Copying and/or transmitting portions or all of this work without permission may be a violation of applicable law. The World Bank encourages dissemination of its work and will normally grant permission promptly. For permission to photocopy or reprint any part of this work, please send a request with complete information to the Copyright Clearance Center, Inc., 222 Rosewood Drive, Danvers, MA 01923, USA, telephone 978-750-8400, fax 978-750-4470, www.copyright.com. All other queries on rights and licenses, including subsidiary rights, should be addressed to the Office of the Publisher, World Bank, 1818 H Street NW, Washington, DC 20433, USA, fax 202-522-2422, e-mail [email protected]. CONTENTS Acronyms and Abbreviations .....................................................................................................................................v Preface and Acknowledgments................................................................................................................................ vii Executive Summary....................................................................................................................................................ix 1. Introduction .............................................................................................................................................................1 2. Risk and Risk Management in Agriculture...........................................................................................................5 RISK IN AGRICULTURE: STRATEGIES AND MECHANISMS...........................................................................................6 3. Developed Country Approaches to Agricultural Risk........................................................................................13 CROP INSURANCE PROGRAMS IN DEVELOPED COUNTRIES ......................................................................................13 WHY THE EXPERIENCE OF DEVELOPED COUNTRIES IS NOT A GOOD MODEL FOR DEVELOPING COUNTRIES ..........17 4. Innovation in Managing Production Risk: Index Insurance .............................................................................19 INDEX INSURANCE ALTERNATIVES..........................................................................................................................19 BASIC CHARACTERISTICS OF AN INDEX...................................................................................................................19 RELATIVE ADVANTAGES AND DISADVANTAGES OF INDEX INSURANCE ..................................................................21 THE TRADE-OFF BETWEEN BASIS RISK AND TRANSACTION COSTS .........................................................................21 WHERE INDEX INSURANCE IS INAPPROPRIATE ........................................................................................................22 5. New Approach to Agricultural Risk Management in Developing Countries ...................................................25 ROLE OF GOVERNMENT ...........................................................................................................................................25 POLICY OBJECTIVES ................................................................................................................................................27 CONSTRAINTS IN AGRICULTURAL RISK MANAGEMENT...........................................................................................28 RISK PRINCIPLES: LAYERING AND THE ROLE OF INDEX INSURANCE........................................................................30 ADDRESSING THE MARKET INSURANCE RISK LAYER ..............................................................................................31 MARKET FAILURE LAYER........................................................................................................................................34 POLICY INSTRUMENTS .............................................................................................................................................35 INDEX INSURANCE AS A SOURCE OF CONTINGENT FUNDING FOR GOVERNMENT DISASTER ASSISTANCE AND SAFETY NET PROGRAMS..........................................................................................................................................38 6. From Theory to Practice: Pilot Projects for Agricultural Risk Transfer in Developing Countries...............41 NICARAGUA: A SEVEN-YEAR INCUBATION PERIOD ................................................................................................43 MOROCCO EXPERIENCE...........................................................................................................................................45 INDIA: PRIVATE SECTOR-LED ALTERNATIVE AGRICULTURAL RISK MARKET DEVELOPMENT ................................46 UKRAINE EXPERIENCE.............................................................................................................................................49 ETHIOPIA: ETHIOPIAN INSURANCE CORPORATION AND DONOR-LED EX ANTE DISASTER RISK MANAGEMENT ...50 iii MALAWI AND SADC: WEATHER RISK TRANSFER TO STRENGTHEN LIVELIHOODS AND FOOD SECURITY ...............54 PERU: GOVERNMENT-LED SYSTEMIC APPROACH TO AGRICULTURAL RISK MANAGEMENT....................................56 MONGOLIA: WORLD BANK CONTINGENT CREDIT FOR LIVESTOCK MORTALITY INDEX INSURANCE.......................57 GLOBAL STRATEGY: THE GLOBAL INDEX INSURANCE FACILITY (GIIF) .................................................................59 7. Potential Roles for Governments and the World Bank......................................................................................61 GOVERNMENT ROLES ..............................................................................................................................................61 WORLD BANK ROLES ..............................................................................................................................................63 References ..................................................................................................................................................................67 Tables Table 2.1 Risk Management Strategies in Agriculture..................................................................................................7 Table 4.1 Advantages and Disadvantages of Index Insurance.....................................................................................23 Table 5.1 Risk-Transfer Strategies ..............................................................................................................................33 Table 6.1 Summary of Case Studies............................................................................................................................42 Table 6.2 Reasons for Buying Weather Index Insurance in India ...............................................................................49 Boxes Box 2.1 Asset-Based Risk Management........................................................................................................................6 Box 5.1 Reinsurance....................................................................................................................................................26 Box 6.1 India Impact Assessment ...............................................................................................................................48 Box 7.1 Examples of Potential World Bank Investment Lending Projects to Facilitate Risk Management ...............65 Figures Figure 2.1 Independent versus correlated risk .............................................................................................................10 Figure 3.1. Crop insurance premiums and indemnities in the United States ...............................................................15 Figure 4.1 Payout structure for a hypothetical rainfall contract...................................................................................20 Figure 5.1 Framework for governmental agricultural risk management policy formulation.......................................27 Figure 5.2 Average April—October rainfall for 13 weather stations in Malawi .........................................................31 Figure 5.3 Histogram of simulated SADC drought events ..........................................................................................34 Figure 5.4 The government-sponsored DOC as risk transfer product between national and international risk markets ...........................................................................................................................................................................36 Figure 7.1 Potential Impacts of Natural Hazards.........................................................................................................62 iv ACRONYMS AND ABBREVIATIONS ACP Africa-Caribbean-Pacific APF Agricultural Policy Framework of Canada APH Actual Production History ARD Agriculture and Rural Development Department of the World Bank Group BASIX Livelihood Promotion and Microfinance entity of Andhra Pradesh
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