Bundling Drought Tolerance & Index Insurance to Manage Drought Risk Travis J. Lybbert & Michael Carter University of California, Davis Intl. Consortium on Applied Bioeconomy Research Ravello, June 2013
Mar 28, 2015
Bundling Drought Tolerance & Index Insurance to Manage Drought Risk
Travis J. Lybbert & Michael CarterUniversity of California, Davis
Intl. Consortium on Applied Bioeconomy ResearchRavello, June 2013
Three Basic Ideas
1. Risk and vulnerability as experienced by poor households is often complex and nuanced
2. Reducing household vulnerability requires an appreciation of these complexities
3. Promising agricultural technologies may be necessary but are rarely sufficient
We illustrate these ideas using drought vulnerability and drought tolerance
The Smallholder Drought Burden
• Drought may be a universal lament among farmers, but spatial drought heterogeneity is massive
• A pure ‘subsistence burden’ is the exception rather than the rule
• Poorly functioning or missing credit / insurance markets therefore amplify drought vulnerability
• Drought events can harm the poor directlyAn obvious, ex post burden
• The threat of drought is like a bullyA hidden, ex ante burden Can outweigh the ex post burden!
Bundling Agronomic & Financial Innovation to Reduce Drought Vulnerability
• Recent innovation in both drought tolerance and index insurance Investments, hype, hope…some results
• In isolation, each has a limitationDT can’t tolerate extreme droughtFull DII may be too expensive for many
• Properly bundling the two may help resolve these limitations due to a natural complementarity
Drought Tolerance
• Longstanding breeding objective…with new tools, renewed promise and high hopes
• Massive private sector investments from Pioneer, Syngenta, Monsanto and others
• New DT seeds being released
US Drought Tolerance Prospects• The reported average DT maize yield benefit in U.S.
in 2012 was 5-10 bu/ac (5-17%)• This yield benefit is conditioned on drought severity
and is therefore ‘stochastic’
Drought Tolerance For Smallholders• Public research and development funding has prioritized DT
in a big way in the past decade• Drought as the universal lament of farmers
Public-private partnerships (e.g., Drought Tolerant Maize for Africa, Water Efficient Maize for Africa, etc.)
• But rich droughts and poor droughts are not alike
* Sort of.† Maybe.‡ Sometimes.
*†‡
DT Benefits & the Nature of Drought
50 bu/ac is the 90th percentile of maize yield in Ethiopia!
Moderate ExtremeSevereModerate
Non-Monotonic DT Benefits Reduce Value of DT to Smallholders and Slow Learning (Lybbert and Bell
2010)
Index Insurance
• Championed recently as a promising alternative to conventional crop insurance
• Contract tied to index that is correlated with individual outcomes to dodge moral hazard and adverse selection problems
Basis risk and transparency tradeoffs • A growing set of experiences and rigorous evidence
suggests that it may reduce both the ex post and the ex ante drought burden
• Unlike DT, drought index insurance payouts are monotonically increasing in drought pressure
Index Insurance Experimentation• Rainfall
China, India, Malawi, Nicaragua, Ethiopia• Satellite
Mexico, Kenya, Ethiopia• Satellite + Rainfall
Ethiopia, Kenya, Mali• Area-yield
Peru, Ecuador• ENSO
Peru
Drought Index Insurance (DII) Prospects
o Will smallholders pay actuarially fair prices?o How sustainable will index insurance markets be?
• In contrast to DT, the marginal costs of providing DII are high
Beyond pilots public support for DII will be limitedFinancial and commercial viability critical for DII
• Price elasticity of demand for DII is thus critical• Price has often limited uptake of index insurance
DT-DII Complementarity
Net Benefit
Calibrating a DT-DII Product: Ecuador
• Rainfed, drought-prone maize production in Guayquil (2001-2011)
• Assume DT maize confers yield benefit of 20% at ‘optimal drought’, which fades with less/more severe drought pressure
• Area-yield index insurance product calibrated and priced according to historic maize yield
• How would a DT-DII bundle compare to DT and DII in isolation?
Traditional v (Stylized) DT Maize Yield Distributions
Yield-Earnings Profiles
What’s a bundled DT-DII product worth?Ecuador Calibration Results
• Lessons from the “Biotech Yield Endorsement” pilot of USDA/RMA
• Bundling with index insurance eliminates threat of audits and monitoring – but other implementation challenges remain…particularly in developing countries
In Summary…• All farmers fear drought, but spatial heterogeneity implies
important differences in the drought burden• DT crops may partially lift the ex post drought burden, but
drought will continue to ‘bully’ many poor households• Index insurance is promising but can be expensive – and is
harder than DT to sustain through public support• A DT-DII bundle may resolve these limitations – now is the
time to calibrate, experiment and evaluate• Improving food security will require more than a
technocentric ‘build it and they will come’ approach – must appreciate the smallholder perspective on climate change adaptation and associated risks
Thank you