College Papers

UNIVERSITY OF NAIROBI SCHOOL OF ECONOMICS NAME

UNIVERSITY OF NAIROBI
SCHOOL OF ECONOMICS
NAME: MWANGI PETER
REG NO: X50/6629/2017
COURSE: MASTER OF ECONOMICS
PROJECT PROPOSAL SYNOPSIS
TOPIC: IMPACTS OF AREA/YIELD INDEX CROP INSURANCE ON FOOD SECURITY; CASE STUDY, NAKURU COUNTY-KENYA
IMPACTS OF AREA/YIELD INDEX CROP INSURANCE ON FOOD SECURITY; CASE STUDY, NAKURU COUNTY-KENYA
Introduction
Agriculture is naturally a risky business and farmers face a variety of risks and uncertainty including weather, pest, disease, input supply and market-related risks. Depending on agriculture as the main source of income exposes farmers to an uncertain income each year, of which is used for meeting expenditures. Since the prevalence of uncertainty and risk in agriculture is not new, key players in an agricultural sector have over the past-developed risk management mechanisms aimed at reducing and coping up with risk. Therefore, a key question emerged whether these traditional mechanisms are sufficient, or whether, public interventions, such as crop insurance, can provide a more efficient alternative.

Background
In Kenya, application of risk management mechanism in agriculture can be traced back from as early as 1930’s when the colonial government initiated the first agricultural insurance under the Guaranteed Minimum Returns (GMR) scheme. The objective of the scheme was to compensate farmers against unavoidable crop failure due to risks and uncertainty. In 1978, stakeholders scraped off the program due to misuse but in 2009, the private sector made efforts to revive the program by launching a scheme dubbed “Kilimo Salama” meaning safe farming. In 2016, the government of Kenya through the Ministry of Agriculture, livestock and Fisheries launched “Kenya Agricultural Insurance and Risk Management Program” to hedge small-scale farmers against risk of crop failure.

Over the past years, agriculture has been a big business in most of Sub-Saharan Africa (SSA), especially in Kenya both for small and large-scale farmers hence fueling economic growth. This therefore, provides a window for companies, institutions and firms to offer agricultural coverage in case of loss due to drought, floods, diseases and pests. Statistically in Kenya, agriculture for a very long time has been considered as the mainstay and contributes to about 30% of the gross domestic product (GDP) and about 60 percent of foreign exchange earnings (GoK, 2017). The sector also employs about 67% of the labour force in the rural area thus acting as a source of income for the household.

However, the sector faces sluggish growth due to lack of modernized application of technology as well as agriculture being rain fed dependent. These and other factors together with impacts of climate change such as floods, drought, emergence of new diseases and pests contributes to decline in production. Crop insurance plays an important role in in addressing the impacts of climate change by providing coverage on the crop failure.

Despite these noble efforts to revive the crop insurance industry, a gap of empirical evidence exists on the role crop insurance products plays in enhancing food security through increased productivity in agriculture. In order to address the aforementioned knowledge gap, the study employs a binomial logit regression model to assess the impacts of crop insurance program as well as the factors affecting awareness.

The profitability and soundness of the crop insurance program is therefore, by large extent determined by the knowledge of factors affecting farmers’ purchase of crop insurance. The availability of information has been the major obstacle towards the uptake of the crop insurance. Since different farmers have different risk associate with loss, they have different elasticity of demand of insurance product. Factors such as risk premium, information asymmetry (adverse selection and moral hazard), and elasticity of demand among other have an effect on crop insurance uptake.

Justification
Climate change is a complex phenomenon that possess serious risks and uncertainty towards development and growth in agricultural sector through its productivity. The sector acts as a source of food for the country hence contributing to food security. Availability of food security provides for a healthy labour force, which in turn leads to increased productivity. Of late, agricultural production has declined due to impacts of climate change, which disrupts agricultural practice patterns such as planting and harvesting cycles linked to rainfall patterns.
These impacts can be mitigated through proper budgetary allocation as well as efficient design and implementation of policies. For example, the use of relevant programs such as crop insurance can help address these impacts. This is because use of insurance helps farmers hedge against risks associated with crop failure and adoption of relevant farm technologies at a lower risk. Crop insurance has not been adequately adopted by farmers in Kenya, although, it provide opportunities for sustainable livelihood. The research study will help the government in designing alternative ways of enhancing uptake of crop insurance products to boost food security. This is because food security provides for healthy labour for which in turn translates to increased productivity. Therefore, the research will aim at formulating relevant policies such as increased awareness, provision of subsidies and so on.

Main objective
To determine the impacts of area/yield index crop insurance in enhancing food security.

Specific objectives
To determine the contribution of crop insurance program towards food security.

To determine the opportunities and challenges linked with the uptake of crop insurance for food security.

To investigate whether household’s welfare determines the uptake of crop insurance.

To analyze relevant policy measures that can adopted to enhance viability of crop insurance programs for food security sustainability.

Farmers’ options to addressing risks
Most of developing countries highly depend on agriculture as the main source of food and livelihood but this sector faces declined production due to a number risks including;
Resource risks; these are risk associate to inputs such as labour, credit, irrigation water, seeds and fertilized among others
Production risks include pest, diseases and climatic conditions
Market risks includes prices and interest rate fluctuation in the market
Health risks are those related to sickness, death or accidents of the farmer, among others.

Asset and other risks includes theft, fire, war, land issues and so on
These risks and uncertainty in agriculture production seriously affect farmers. This forces farmer to develop hedging mechanism against unforeseen risks and uncertainty for crop production. Therefore, farmer responds towards this uncertainty and ricks through developing hedging mechanisms or strategies.

Risk-reducing Strategies
These strategies include crop diversification, income diversification, intercropping, and farm fragmentation among other options. Between individuals, a strategy of crop-sharing arrangements in land renting and labour hiring contracts can also provide an effective way of minimizing risk through sharing. Although these strategies can be quite effective in addressing many production and market risks, for the case of an average income, they are typically costly due to opportunity cost. For example, crop diversification is usually less profitable on average than crop specialization.

Risk-coping Strategies
These strategies are relevant in dealing with income losses once they occur. For example, in order to repay loans and to meet essential living costs in disastrous years, farmers may rely on new credit, the sale of assets, use of own food stocks, or temporary off-farm employment. In many rural societies setting, mutual aid or kin-support systems provide an important safety net for member households.

However, risk-coping strategies can also be costly. For example, the sale of assets such as land or livestock can leave the household without adequate productive assets for the future. Debt also has to be repaid, and interest rates charged by informal lenders are rarely cheap.
Most of agricultural risks are characterized with co-variability problem, which traditional risk-coping strategies cannot deal effectively with. For example, production and price risks affect nearly all farmers simultaneously within a small rural community. As a result, many farmers seek consumer credit at the same time, thereby driving up local interest rates.

However, covariability problem does not exist for all risks; for example, most health risks are independently distributed across individuals. In these cases, local risk-coping strategies can be quite effective. Therefore, for covariate risks, local risk-coping strategies need to be reinforced by risk pooling arrangements that cut across small rural communities. For this reason, formal banking and insurance institutions, plays a key role or provided solution since their portfolio can span different regions and even different sectors within the national economy.

Banks insurance scheme
Banks and insurance institutions provides loans to farmers but they are subject to loan risks such as default. Therefore, to minimize incidences of default, the institutions uses different ways such as:
Loan diversification
Build up personal relationship with borrowers to ascertain chances of default due to information asymmetry.

Interest rate adjustment to reflect risk premium and request of collateral
Agricultural insurance
This provides an opportunity for farmers to maximize profits, adopt improved but uncertain technology. Through this, there is increase in value added, increase in income and decline in poverty levels.

Insurable risk Not strictly insurable risk
quantifiable unquantifiable
Damage easy to attribute and value Damage difficult to attribute and value
Absence of moral hazard Presence of moral hazard
Intro contCrop insurance program acts as an alternative to relief measures. This is because it covers farmers against incidences of loss due to crop failure. Most of insurance are agreements marketed by private companies such as banks and insurance institutions.

Statistics shows that the penetration level of crop insurance in Kenya is low due to information asymmetry, which is evident through either moral hazard or adverse selection. For moral hazard, monitoring individual behavior becomes too expensive due to uncertainty. On the case of adverse selection, insurance pool contains more of high-risk individuals than of low risk individuals. The only solution to adverse selection is for the insurance companies to reduce exposure to large claims by limiting coverage or raising premiums, which in turn drives away low risk individuals.

Knowledge of factors affecting uptake;
Increase in premium rates
Cnacellation impact-negative if for low risk
Limited empirical attention………………………………….

In Kenya, climate change is already having an impact. There have been 12 serious droughts since 1990, with each one affecting some 4.8 million people (PDF). The average annual costs of the damage caused are estimated at some US$1.25 billion – with each drought reducing the country’s Gross Domestic Product by an average of 3.3 per cent.

The government of Kenya is keen to minimise the impact and cost of disasters to ensure the country can achieve its development goals. 
Finance has an essential role to play in reducing these costs – both before and after disaster strikes. Beforehand, investment can be used to reduce risk and increase resilience, for example through flood prevention schemes or crop insurance. After shocks occur, finance is also needed to fund post-disaster recovery and long-term sustainable development. Covering these costs demands an innovative approach to disaster risk financing (DRF). 
Risk management approaches 
The aim of disaster risk financing is to reduce the number of people affected by shocks (such as droughts), while also preventing the cost of such disasters having a negative impact on development programmes. 
Disaster risk finance takes many shapes in Kenya. Funding for DRF is allocated from Kenya’s national budget, as required under the constitution. Additional finance also comes from development partners, such as the European Union, the World Bank, the African Development Bank, China and Japan, and from the private sector and charities.

This finance is accessed through various funds (such as the National Drought Emergency Fund and the EU-funded Drought Contingency Fund) via targeted projects (such the World Bank’s Regional Pastoral Livelihoods Resilience project).  
Kenya is one of the countries taking part in the African Risk Capacity scheme, set up by the African Union (AU). This scheme was established to improve the capacity of AU member states to plan and prepare to respond to extreme weather events and natural disasters. Kenya has been buying premiums from the scheme on a seasonal basis, effectively buying drought insurance
Ahead of the 11th International Conference on Community-Based Adaptation, for which registration is available until 14 June, IIED is profiling national approaches to climate-resilient development in a series of blogs from members of the Government Group Network on Climate Change Mainstreaming.

Kenya also provides direct financial back-up through cash transfers as part of the Hunger Safety Net programme. This operates in four counties, providing up to 100,000 households with regular, unconditional electronic cash transfers of $25 every month. The instrument is designed to be scaled up and down in response to weather shocks.

Plans are also at an advanced stage to secure a development policy loan from the World Bank that would provide a Catastrophic Draw Down Option (Cat DDO) (PDF). This would provide a contingent line of credit allowing the government immediate access to funds in case of a disaster. If this plan goes ahead, Kenya will be the second country in Africa to obtain this kind of World Bank loan.

Kenya is leading on agricultural insurance  
Kenya is also a leader within Africa in promoting participation in the emerging agricultural insurance sector.

Households can join agricultural insurance schemes to insure against the risks of drought, including schemes aimed specifically at pastoralists and drought-prone regions, and some risk-prone areas are taking out insurance at the county-level. 
The Index Based Livestock Insurance scheme was developed in 2009 by the International Livestock Research Institute and insures pastoralists against the drought-related deaths of their livestock. IBLI has been financed through contributions from the UK’s Department for International Development, US Aid and the European Union.

The Kenya Livestock Insurance Program is a government-run programme, launched in Turkana and Wajir counties in October 2015, with a goal to cover 14 drought-prone counties by 2017. In 2016, Marsabit, Isiolo, Mandera and Tana River counties joined the programme. Over $1.6million has been paid in premiums with a total sum insured of $10 million, benefitting 15,000 households.  The Kenyan government is planning to support the development of a voluntary livestock insurance market for pastoralists in these counties by subsidising premiums for those taking out insurance. 
The government also runs the Kenya Agriculture Insurance and Risk Management Program, which provides yield index insurance for semi-commercial maize and wheat farmers, with premiums subsidised by the government. More than 950 semi-commercial maize farmers have purchased insurance so far. 
Finally, Weather Index Insurance in Kenya has been subsidised by a range of international donors – which have provided $435,000 per year from 2014 to 2016.

Reducing risks, reducing impacts
While Kenya has made great strides in developing and participating in innovative schemes that manage climate and disaster risk, there is a massive DRF funding shortfall. So far Kenya has been able to mobilise around $188 million oer year in DRF. But this still leaves a gap of some $1.1 billion needed to protect vulnerable communities (PDF).

In addition, an inadequate legal framework, poor coordination, and a reliance on international donors mean that such protection is far from guaranteed.

What is needed now is more coordination across the various risk management schemes to ensure cover is targeted at the most vulnerable, and schemes are joined up to ensure all affected groups are protected. Interventions should also cover beneficiaries at all stages of the risk cycle – pre-disaster, during disaster, and post-disaster – to ensure sustainable recovery. 
The government’s draft policy on disaster risk management and the legislation currently being considered by the national parliament should be strengthened to improve coordination between different risk management instruments and ensure vulnerable individuals and communities get the protection they need.

A strong lead from the Kenyan government could also help secure the vital World Bank commitment on the Catastrophic Draw Down Option – and help close the $1.1 billion funding gap in disaster risk funding.

Crop insurance program
Evolution of agricultural insurance program can be as early as 1930’s when the colonial government initiated the first agricultural insurance and changes have been taking place.

Guaranteed Minimum Returns (GMR) scheme.
The objective of the scheme was to compensate farmers against unavoidable crop failure due to risks and uncertainty. In 1978, stakeholders scraped off the program due to misuse.

“Kilimo Salama”
In 2009, the private sector made efforts to revive the insurance program by launching a scheme dubbed “Kilimo Salama” meaning safe farming. This insurance was designed for Kenyan farmers to insure their farm inputs against drought and excess rain. The program targeted small scale farmers by providing insurance policies to shield them from significant financial losses when drought or excess rain are expected to wreak havoc on their harvests. In case of losses, all farmers were compensated depending on the extent of the drought as measured at their weather station.

“Kenya Agricultural Insurance and Risk Management Program”
In 2016, the government of Kenya through the Ministry of Agriculture, livestock and Fisheries launched this program to hedge small-scale farmers against risk of crop failure. The program addresses the challenges that agricultural producers face when there are large production shocks such as droughts and floods.

The program operates as a partnership between the government and private sector such as banks and insurance institutions. In addition, it aims at improving farmers’ financial resilience to shocks (drought, excess rain, pest and diseases) and enable them adopt improved production processes to help break the poverty cycle of low investment and low returns.

Reference
Goodwin, B. K. (1993). An empirical analysis of the demand for multiple peril crop insurance. American Journal of Agricultural Economics, 75(2), 425-434
Smith, V. H.,; Goodwin, B. K. (1996). Crop insurance, moral hazard, and agricultural chemical use. American Journal of Agricultural Economics, 78(2), 428-438
Chantarat, S., Munde, A. G., Barret, C. B., ; Carter, M. R. (2013). Designing index-based livestock insurance for managing asset risks in norther Kenya. Journal of Risk and Insurance, 80(1), 205-237
Olila, D. O., ; Pambo, K. O. (2014, March). Determinants of Farmers’ Awareness about Crop Insurance: Evidence from Trans-Nzoia County, Kenya. In Annual Egerton University International Conference (Vol. 26, No. 1)
International Conference (Vol. 26, No. 1)