The Journal of Risk Finance

A complete agro-financial service framework for emerging economies

Kunal Goel
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Kunal Goel , (2013),"A complete agro-financial service framework for emerging economies", The Journal of
Risk Finance, Vol. 14 Iss 5 pp. 490 - 497
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JRF
14,5 A complete agro-financial service
framework for emerging
economies
490
Kunal Goel
Department of Chemical Engineering, Indian Institute of Technology,
Received 7 April 2012
Revised 23 September 2012 New Delhi, India
29 January 2013
20 June 2013 Abstract
Accepted 24 June 2013
Purpose – The purpose of this paper is to propose a conceptual framework for a comprehensive
agricultural financial service to address the problems faced by the farmers and the insurance
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companies and to suggest the product delivery method to increase the acquisition rate of the product.
Design/methodology/approach – A theoretical framework is proposed based on the pros and cons
of various insurance services floated out earlier as well as the various risks faced by the farmers.
Subsequently, on the basis of the factors that affect the take up rate of insurance products, the paper
proposes an adequate delivery strategy.
Findings – An efficient integrated framework for risk management in agriculture has been
developed by interlinking various elements like price risk, yield risk and demand risk in addition to
providing additional advisory and credit services. Other services only cover one or two of these and
hence, are not adequate. Also, illiteracy of farmers is the main bottleneck that decreases the take up
rate and can be addressed by appointing agro-financial agents.
Practical implications – The frameworks proposed if brought into practice will lead to a holistic
agro-financial service and help in overall advancement of the agricultural sector and economy.
Originality/value – This paper would help insurance companies to come out with better insurance
products for the agricultural community that will be easier to administer and economically more viable
and thus fulfils the criteria for a holistic insurance framework.
Keywords Agriculture, Agro-financial, Crop insurance, Delivery, Price risk, Risk mitigation
Paper type Research paper

1. Introduction: risks in agriculture and criteria for risk management

Agricultural produce is subject to a variety of risks namely climatic, biological,
geological, market and man-made. There are two main approaches that are generally
used to handle risks: risk control and risk financing. Risk control can occur in several
ways: through the diversification of income sources, migration, use of hazard-resistant
technology and reduced consumption. Risk financing includes crop or weather
insurance and saving. It can also entail selling assets and obtaining loans from formal
or informal sources (Arias and Covarrubias, 2006).
There are two main type of risks that are faced and need to be considered: systemic
and basis. Systemic risk in agriculture is characterized by the presence of covariate
risk and is beyond the control of farmers. When one producer is hurt by an event, it is
likely that other producers will also suffer. It can be divided into yield and price/market
The Journal of Risk Finance risks. Yield risk (i.e. the amount of production) relates to the climatic, sanitary, and
Vol. 14 No. 5, 2013
pp. 490-497 geological risks that have a direct effect on agricultural production. Price/market risk
q Emerald Group Publishing Limited relates to market fluctuations in price and demand. Basis risk depends on the size and
1526-5943
DOI 10.1108/JRF-04-2012-0023 the heterogeneity of the unit of area chosen. Temporal component of the basis risk
 arises from the fact that the sensitivity of yield to rainfall varies over the stages of Agro-financial
growth. Spatial component of the basis risk reflects the fact that rainfall differs across service
locations even within the same region. Crop-specific component of the basis risk refers
to variation in planting times, duration of growing season, and sensitivity to rainfall framework
across different crops (Sinha, 2007).

2. Need for crop insurance 491

The agricultural risks along with how the farmers manage them impact farm income,
productivity, and access to credit. These risks among others could lower the farmers’
anticipated income and have negative effects on their standard of living, ability to
provide for themselves and their families, ability to build capital and ability to access
credit from lenders (Bryla et al., 2001).
While informal risk management techniques like crop diversification and
dependence on kinship and social institutions may be available to farmers, such
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strategies fail in the face of severe weather. Without formal mechanisms to manage
weather-related risks, agricultural households may invest less or may not adopt
profitable farming innovations (Sarthak et al., 2011). So, they resort to adopt a low risk,
low yield strategy which affects the overall production and hence the price levels. Crop
insurance can help the farmers to reduce the negative impact of various systemic risks
and to try out new innovations and better methods to increase the yield.
However, crop insurance has not been very successful in most of the developing
countries due to some problems with its framework and low adoption by the farmers
due to financial illiteracy and adoption of poor delivery methods. In this paper, we
examine the problems with the existing products in crop insurance and try to find out
different elements that may be used to develop a holistic framework for risk
management as well as for increasing take up rate.

3. Development of crop insurance

Crop insurance is cumbersome to administer and prone to losses. Claims ratio has been
around 500 per cent. Insurance companies feel that crop insurance is a liability and not a
profitable proposition at all. Estimating crop loss due to an unexpected weather event as
well as estimation of potential yield and actual yield is a difficult task (Venkatesh, 2008).
The traditional crop insurance approach has faced many problems in dealing with
moral hazard, adverse selection and high administrative costs. In addition, the
traditional crop insurance often requires significant subsidies, which puts pressure on
the government’s fiscal situation (Hess et al., 2002).
The various insurance schemes which have been tried in India are analysed in Table I.

4. Complete agro-financial service: a conceptual framework

Having a look at the agricultural risks faced by the farmers, we see that the major
systemic risks whose effect can be dampened by the purchase of crop insurance are
price variations, yield risk and other market risks such as demand.

4.1 Risk control

Mitigating price risk. The most significant mechanism to reduce the price risk faced by
the farmers is minimum support price (MSP) offered by the government. Sinha (2007)
states that the government follows an open ended procurement policy and there is no
 JRF
Scheme Basis Drawbacks
14,5
Individual indemnity based Individual loss assessment Asymmetric information
(CIRM Blog, 2010) High administration costs
Pilot crop insurance Homogeneous area approach High basis risk
(CIRM Blog, 2010)
492 Homogeneous area approach Homogenous area approach; Restricted coverage
based (Raju and Chand, 2008) linked to short term credit; Important commercial crops
limited coverage with maximum excluded
limit of Rs 10,000 Cross subsidization
Low premium to claim ratio
Area yield insurance (Skees et al., Average yield within a pre- Basis risk
2008; Barnett and Mahul, 2007) determined area Financial non-viability
Limited coverage
Moral hazard
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Income based (Sinha, 2007; Area yield cum support price Low coverage
Venkatesh, 2008) Restricted to wheat and paddy
Weather index based (Bryla et al., Weather index Basis risk
2001; Giné et al., 2008) Incomplete coverage
Table I. Complex claim calculation
Crop insurances and required
their drawbacks Lack of adequate data

procurement target. It buys whatever is offered for sale at MSP. Rice and wheat are the
two principal commodities where the government’s role is most pronounced.
Procurement operations for other crops are carried out only when the market prices
fall below MSP.
If the indemnity is based on MSP, it will make insurance subject directly to
government decisions, reducing the chances of this being a purely commercial
operation or of it being accepted as a WTO “Green Box” measure (Sinha, 2007).
Index based payouts. The problem associated with the index insurance is that there
is a high basis risk involved and the fact that it does not take care of other aspects such
as crop loss due to pests and other things not covered by the index. In this regard,
a combination of weather index and yield insurance should be offered using
normalised differential vegetative index (NDVI) and rainfall index in combination with
each other. It has been seen that techniques such as NDVI, thermal infrared (TIR), etc.
can accurately tell the amount of yield in a region through satellite images (Patankar,
2009) and reduce the basis risk to a large extent.
Mitigating sale/demand risk. Many food processing and other industries are directly
dependent on the agricultural produce. The insurance companies can target them as
well to take up crop insurance. To mitigate the sale/demand risk of the farmers, the
insurance companies could tie up with a government procurement agency (e.g. Food
Corporation of India (FCI)) and other agencies for procurement of the produce, which
may sell the extra produce, if there, in the international markets. They may also offer
procurement offer to the food processing and other industries as a part of their
insurance policy.
Advisory services. Since it has been seen that the take up rate of crop insurance
increases drastically as some more services are offered in combination, therefore the
insurance companies can offer advisory services to the farmers as an extra advantage.
 Providing advisory services for irrigation methods and other farming processes to Agro-financial
less informed farmers will not only make it attractive but also beneficial for the service
insurance companies as they will be guiding and overlooking the whole process.
Similarly, the provision of weather forecast data to the farmers will help the farmers framework
plan accordingly to mitigate any adverse impact and will result in greater number of
people taking up the insurance.
493
4.2 Risk financing
Credit facilities. The availability of finance allows farmers to raise money for various
purposes such as adoption of new technologies, buying fertilizers, better varieties of
seeds, making provision of artificial irrigation methods. These may help the farmers to
raise their yield significantly which would lead to an overall increase in the production
and would also benefit the insurance companies indirectly.
This supports the case in support of linking rural finance to crop insurance. Since
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the farmer would have purchased the insurance, he would be paying premiums
to the company and might also be involved in some agreement which may tend to
minimize his sale risk. In such a situation, the premium payments can be used by the
insurance company to protect against credit defaults that follow a risk event and to
offer lower interest rates after the risk event. Interest rate reductions could be given in
relation to the severity of the event. Such a measure is very likely to boost the sale of
crop insurance policies significantly as it offers an opportunity to the farmers for easy
credit availability.
Availability of agricultural inputs at lower prices. The insurance companies could act
as a medium for providing certain agricultural inputs like seeds, fertilizers, insecticides,
pesticides, etc. at lower prices to its customers by tying up with relevant industries and
procuring the inputs at factory prices. These can then be distributed to the farmers at
lower prices, thus, reducing the effective premium for the farmers. The insurance
companies, in fact, may be able to earn profits through this scheme (Figure 1).
Such an agro-financial service may offer several benefits. On a macro scale, it is a
step in the direction of financial inclusion, providing access to insurance and finance to
the farmers in small villages. It offers easy credit availability for the farmers, so that
they are able to raise enough money which may allow them to use better methods of
irrigation. This, along with the provision of advisory services and weather forecast
would lead to an increase in overall production. The provision of rural financing is also
expected to lead to low discontinuity in premium payments and hence, low policy
dropout. The use of combination of weather and yield indices would reduce the basis
risk and also increase the coverage against non-weather risks. The challenges with
these new services (advisory and credit) could be solved by tying up or acquiring the
relevant firms in that particular sector.

5. Delivery method
To identify the effective delivery methods for insurance services, we, first of all, need to
know the factors which affect the take up of insurance products. Giné et al. (2008)
assert that the take up rate depends primarily on the availability of liquid cash at the
time of the product marketing and familiarity with the product. Further, Makki and
Somwaru (2001) state that the choice of crop insurance contracts is influenced by the
level of risk, expected indemnity benefits from the contract, cost of insurance and
 JRF
14,5

494
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Figure 1.
Conceptual framework
for complete
agro-financial service

premium subsidy. The above studies also bring out other factors affecting the farmers’
participation which include weather conditions at the point of purchase, “advice from
others” (Giné et al., 2008) and trust in the insurance agent.
Keeping all these factors in mind, a delivery strategy may be proposed. First,
agro-financial correspondents well versed in financial aspects and having an agricultural
background need to be appointed. Every agent would be appointed for a maximum of
five villages so that he could devote adequate time to each. The first strategy should be
to explain the product to the village officials, influential people and progressive farmers,
who will then function as motivators and would inform other households about the
product and the official marketing meeting to be held some days later.
At the marketing meeting, interested households should be identified and personal
visits to each should be made, explaining in detail about the product and its benefits.
We propose that such marketing meetings and visits be strategically timed, so as to
clash with periods of low rainfall (when the farmers would be wary of risks) and at
the time when the farmers would have adequate liquid cash (typically a little after the
harvest when the farmers would have sold the produce or before the start of the
monsoon season).
Also, younger and educated people should be the first to be targeted as they can
understand the product relatively easily and can then educate others. Furthermore, it
would be beneficial to have the same agent over a longer period of time for a particular
area, so as to build trust among the farmers.
These agents would also provide advisory services in the context of how to increase
the yield, which seeds to use, which fertilizers and insecticides to use, better cropping
practices, etc. Also, prompt and adequate help would be provided to procure the
 payout, avoiding hassle for the farmers. In addition, the agents would also provide the Agro-financial
relevant meteorological updates to the farmers and advise them about any necessary
measures needed to be taken, if need arises (Figure 2).
service
Apart from the role of the agents, regular marketing strategies would also pay a key framework
role. Television ads, print ads and radio ads are excellent forms of insurance
marketing. An innovative way can be a “mobile office”. The agents can travel in vans,
horse carriages, etc. and advertise over mounted loud speakers. Tying up with NGOs 495
can also be a good way to spread the message. One must also realize that there are
several industries dependent on agriculture like livestock products, food processing
industries, vineyards, etc. These can well lead to indirect sales if effectively dealt with.
Separate agents need to be appointed to look into this matter, who will approach them
and educate them about the need to have weather and crop insurance.
It is noteworthy that the appointment of agro-financial agents is a challenging
task, for the fact that the agents must be well versed in both finance and agriculture as
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well as be amiable and able to gel with the rural population. Thus, it needs to be taken
up carefully and meticulously. Moreover, the various governmental and industry
regulations must be kept in mind when designing the insurance product and delivery
method.

6. Conclusion
This paper has been able to determine the various elements that need to be considered
while designing an agricultural insurance product and thus, has proposed a holistic
framework for the same. The framework proposed would take care of the problems
faced both by the farmers and the insurance companies and can act as a basis for new
product development in the agricultural risk management domain.
Moreover, to increase the take up rate of the new insurance products, an integrated
and comprehensive novel delivery framework has been proposed with the main
emphasis on agro-financial agents. The author believes that the implementation of
the proposed delivery would usher in a new era in the insurance domain and would
increase the take-up rate manifold.

younger and
advisory
educated people
services
first target

Prod. explaination to
Agro-financial Agents marketing meetings personal household
officals/influential people/
visits
progressive farmers

Figure 2.
prompt help meteorological Framework for delivery of
in payout updates and
process advice
insurance through
agro-financial agent
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Further reading
Cole, S., Tobacman, J. and Topalova, P. (2008), “Weather insurance: managing risk through an
innovative retail derivative”, Technical Report, working paper, Harvard Business School,
Boston, MA.
Gine, X. and Vickery, J. (2006), Weather Insurance in Rural India, World Bank, DECRG,
Washington, DC, April 26.
Krub, K.R. (2009), Group Risk Crop Insurance, Farmers Legal Action Group, Inc., Saint Paul, MN,
September.
Lennep, D.V., Oetomo, T., Stevenson, M. and De Vries, A. (2004), “Weather derivatives: an
attractive additional asset class”, Journal of Alternative Investments, Vol. 7 No. 2, pp. 65-74.
 Rejesus, R.M., Goodwin, B.K., Coble, K.H. and Knight, T.O. (2010), “Evaluation of the reference Agro-financial
yield calculation method in crop insurance”, Agricultural Finance Review, Vol. 70 No. 3,
pp. 427-445. service
Turvey, C.G. and Kong, R. (2010), “Weather risk and the viability of weather insurance in China’s framework
Gansu, Shaanxi, and Henan provinces”, China Agricultural Economic Review, Vol. 2 No. 1,
pp. 5-24.
Vandeveer, M.L. and Young, C.E. (2001), “The effects of the federal crop insurance program on 497
wheat acreage”, Wheat Yearbook, Economic Research Service/USDA, WHS, Washington,
DC, March.

About the author

Kunal Goel is a final year student at IIT Delhi majoring in Chemical Engineering and a minor in
Business Administration. Kunal Goel can be contacted at: [email protected]
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