Abstract

The annual average affected area due to weather hazards accounted for 16.5% in China during the five-year period of 2014 to 2018. Flood, drought, hail and freezing disasters were the most common hazards; In 2018, the total loss caused by meteorological disasters in 28 provinces (autonomous regions and municipalities) exceeded 74 billion yuan.

The flood disaster in Henan drew the industry's attention to the development of China's weather insurance.

One feature of China's climate is its frequent meteorological disasters, which has significant impact on crop production. Between 2005 and 2010, the average productivity loss of grain caused by natural disasters was about 50 million tons, accounting for 10% of the total output. During the five-years period of 2014 to 2018, China's annual total sown area of crops was 135,754,000 hectares in average, with affected area accounting for 16.5%. Flood, drought, hail and freezing disasters were the most common hazards; In 2018, the total loss caused by meteorological disasters in 28 provinces (autonomous regions and municipalities) exceeded 74 billion yuan (Data source: China Rural Statistical Yearbook &wind).

Farmers who depend heavily on the weather become the most vulnerable group in the event of a meteorological disasters; Agricultural insurance is highly valued and incentivized by the Chinese government. As one of the effective means of agricultural risk management, agricultural insurance is an institutional arrangement for farmers to transfer the agricultural productivity losses caused by disasters and accidents to the insurer by paying premiums (Tuo Guozhu and Li Jun, 2005). Starting from 2006, the Chinese government issued 16 No. 1 Central Document and Related Opinions, which vigorously promotes the subscription of agricultural insurance and facilitates to improve its quality, efficiency, upgrade and transformation. The fast development of information technology goes in tandem with wide application of innovative technologies. To better serve agriculture, rural areas and farmers, the Chinese government and regulatory authorities have also incentivized the innovation in insurance products, such as index-based weather insurance.

As a new type of agricultural insurance, index-based weather insurance are more used to the disaster mitigation and prevention. Traditional agricultural insurance products takes crop yield or income as the insurance object, which often generate issues such as moral hazard (Knight &Coble, 1999), adverse selection (Goodwin, Smith, 2003) and large spatial correlation of disaster risk (the systematic risk in agriculture) (Duncan & Myers, 2000), resulting in dysfunction of commercial agricultural insurance market (Tuo Guozhu and Wang Guojun, 2002). The lack of objective, transparent, efficient and economic disaster loss assessment methods is the dominant technical reason for market failure. Due to the limitations of traditional agricultural insurance products, studies on index-based weather insurance have been conducted internationally since the 1990s.

Index-based weather insurance is an agricultural insurance product that calculates the payout based on meteorological data. It is to index the damage degree of one or several meteorological conditions (such as temperature, precipitation, wind speed, etc.) to the subject matter of crop insurance, so that each index has corresponding profit and loss. The insurance contract is based on this index. When the index reaches a certain level, policyholders will be given corresponding compensation.

Comparing with traditional agricultural insurance, index-based insurance has prominent strengths in preventing moral hazard, adverse selection and reducing insurance costs (Liu buchun, Mei xurong, 2010). This notwithstanding, its advocacy faces a myriad of challenges, such as low awareness, lack of data, non-inclusion in government subsidies and basis risk etc..

Through research data, field interviews and statistical analysis, the Chinese Academy of Financial Inclusion at Renmin University of China concluded that as one type of agricultural insurance, index-based weather insurance can function as an effective means of agricultural risk management in China, but its advocacy and adoption is constrained due to the immature supervision mechanism of multi-sectoral linkage and weak innovation power of insurance companies. One objective of this report is to explore how index-based weather insurance can support farmers in terms of disaster prevention, loss reduction and income increase, to help boost the development of Rural Revitalization under government's policy setting.

The Bottleneck and Potential of Agricultural Insurance

This survey explores the factors affecting the demand and supply of agricultural insurance by using cross analysis and multiple logistic regression econometric model. A total of 1156 farmers were sampled, including 159 in Jiangxi, 314 in Shandong, 77 in Sichuan, 202 in Gansu, 200 in Guangdong and 204 in Hebei. The majority of the surveyed farmers are engaged in crop farming(54%), followed by aquaculture (29%), and 4% are engaged in forestry and fishery respectively.

1. Penetration rate of agricultural insurance is low; the real demand on agricultural insurance is not fully released

According to the survey, about 50% of the farmers have no agricultural insurance (Figure 1.1). As for the reasons, 43% of the surveyed farmers stated they had no knowledge of it (Figure 1.2). After detailed explanation of the content and function of agricultural insurance, they expressed interest to enroll. It can be observed that the advocacy of agricultural insurance in many rural areas is very scarce, and farmers lack the channel or initiative to gain information on agricultural insurance products.

When asked whether they would buy agricultural insurance in the following year if they don’ have any claim this year, 42% of the respondents turned it down. (Figure 1.3). Some farmers stated that if they didn’t claim any loss, they would feel that the insurance premium was wasted. The answer indicates their poor understanding of the insurance products, which has “protection” function instead of “for profit”. Regression findings also show that the education level of farmers is positively correlated with the demand for agricultural insurance products. Therefore, developing rural education and improving farmers' understanding on insurance products are conducive to the advocacy of agricultural insurance. In addition, improving farmers’ awareness and knowledge on agricultural insurance can help to release their real demand of the insurance products.

From the supply side, the lack of service capability at the grass-roots level is one of the main constraints for the low penetration of agricultural insurance. Take Gansu as an example, the research group learned that although Gansu Province has set the goal of "insurance, loss assessment and claim settlement to individual household" and established an operation mechanism that involves the joint participation of grass-roots staff, bank and insurance agents and service assistant in accordance with the principle of "one village and one room, centralized and unified and comprehensive service", yet from implementation perspective, Lanzhou Agricultural and Rural Bureau of Gansu Province admitted that due to the immature rural financial system, the shortage of qualified workers and personnel, agricultural insurance advocacy and service depends largely on insurance companies and grass-roots workers, resulting in a worrying "last mile" issue, which has an adverse impact on insurance promotion and underwriting.

2. Farmers show low satisfaction with the limited varieties and coverage of agricultural insurance products

For farmers who have subscribed agricultural insurance products, although most of them are happy about the products (90%), some respondents say that there is room to improve for insurance products in terms of coverage, claim settlement speed and price. "Low actual payout " (73%) and "low underwriting amount" (45%) are listed as the main roots of dissatisfaction(Figure 1.4). Currently, most policy-based agricultural insurance products in China can only cover the basic materialized cost of field crops, and are unable to provide a coverage for farmers' income; For many non-staple crops (such as vegetables and fruits) and aquaculture, corresponding insurance products are missing. These factors reduce farmers’ willingness to uptake the insurance products.

The speed of claim settlement is another major factor thwarting farmers' enthusiasm to be enrolled in insurance scheme. Farmers' income is usually at a low level and their ability to bear disasters is weak, therefore, if insurance companies fail to pay compensation in time, or if the process is lengthy , it will harm farmers' satisfaction and trust in the insurance products and reduce their willingness to participate in agricultural insurance. Therefore, formulating reasonable premium payment standards, enhancing service and ensuring the speedy underwriting and claim settlement process can motivate farmers' adoption in agricultural insurance.

From the supply perspective, insurers' lack of enthusiasm in underwriting is the main reason for low customer satisfaction. The setback of their enthusiasm is mainly due to the long-term operation loss, excessive regulatory intervention and the lack of intellectual property protection mechanism. Agricultural insurance has the attribute of "two highs", namely, the "high compensation rate" caused by natural disasters and market fluctuation risk and the "high cost rate" caused by extensive human and material resources required for underwriting and settlement of claims.

Therefore, it is difficult for insurers to gain commercial profits by selling agricultural insurance products. Despite government support, issues like direct intervention in business operation as well as conflict of interest among different departments hinder the development. Effective restraint and supervision mechanisms are missing for local governments, agricultural and animal husbandry departments and financial departments to participate in different roles of agricultural insurance sector. Therefore, fragmented management brings a negative impact on insurance companies' operation.

In addition, there are relatively few laws and regulations in China to support and protect the innovative insurance products and their development. Quite some agricultural products available are only different in form but homogeneous which can't meet the personalized needs of farmers; in the bidding process, problems like corruption can occur, which hurt market's fairness and transparency; IP protection law on agricultural insurance are yet to be improved and matured to facilitate the development of innovative products and expand the coverage of agricultural insurance.

3. Farmers' demand in agricultural insurance is highly correlated with their income level and components

Households income level determines to which extent they can afford the premiums. The regression results show that the higher the proportion of agricultural income in the total annual household income, the stronger the farmers' willingness to buy agricultural insurance product (Figure 1.5). This is because the higher the proportion, the less likely it is to choose other non-agricultural production methods. As the agricultural income directly affects families’ life quality, they are more vulnerable  with the shocks of agricultural risks.

That notwithstanding, the data show that some farmers whose agricultural income accounts for 90% of family income have even weaker willingness to join insurance scheme. According to the interview, this is mainly because these families have low income and have no spare money for insurance products. In addition, farmers' income components displays a certain impact on their demand for insurance. Families with a high proportion of stable salary income have low dependence on the income of agricultural operation. Thus, their willingness to buy agricultural insurance products is also weakened. Families with a high proportion of agricultural income rely more on the stability of agricultural operation and have affinity to invest in insurance products. Therefore, further developing the rural economy and improving the income level of farmers can lay an economic foundation for the effective advocacy of agricultural insurance.

4. Financial subsidies have direct impact on the demand and supply of agricultural insurance

Most agricultural insurance products available in China are policy-based, which receive high subsidies from central and local governments.

When asked whether they would buy agricultural insurance without subsidies, over half (53%) of the respondents gave a negative answer. The regression results also show that the governmental subsidy to agricultural insurance is positively correlated with the demand. It can be concluded that financial subsidies have a significant positive impact on the demand of agricultural insurance. In the stage of advocating new products, increasing the financial investment from government can effectively improve farmers' acceptability of agricultural insurance.

Relatively speaking, the business entity has stronger willingness to be insured. The research group has conducted interviews with two principals of Taicang vegetable planting base and breeding poverty alleviation workshop in Jiangsu, they have shown strong affinity to be insured, and all available insurance products have been purchased. They even proposed to pay higher premium to obtain broader coverage. The research concluded that the frequent interaction between business entities (such as vegetable planting bases) and farmers can play its role in driving farmers to participate in insurance scheme.

From the supply perspective, the lack of financial resources from local governments is one of the main factors leading to the insufficient supply of agricultural insurance. The central and local financial subsidies were the first driving force for the vigorous development of China's agricultural insurance in the past. However, in some regions, local agricultural pillar industries are non-crop vegetables and fruits, which are not included in the scope of subsidies. The financial resources at provincial level alone cannot meet the subsidy demand, therefore not widely implemented. Even if it falls within the scope of central financial subsidies, and many farmers have the willingness in insurance uptake, provincial and central financial subsidies are difficult to obtain due to the lack of supporting subsidy funds in the county, or the subsidy amount remans low, it negatively affects the enthusiasm of developing agricultural insurance in these regions.

5. The potential demand for index-based weather insurance is high

Farmers’ knowledge on index-based weather insurance product is scarce, yet the potential demand is huge. Among the surveyed samples, only 35% of farmers have heard of index-based weather insurance. The limited knowledge hinders their acceptance of the product. After being explained the detailed contents of index-based weather insurance, 56% of the respondents stated their willingness to subscribe; only 8% of the farmers still held negative attitude; the rest were uncertain of their buying decisions(Fig. 1.6). The main reasons for their unwillingness are "unclear premium" (38%) and "haven’t experienced production due reduction to weather disasters" (37%) (Figure 1.7). It can be concluded that the potential demand for index-based weather risk insurance is high, but insurers, governments and social training institutions need to vigorously educate the public and enhance their understanding of the scheme.

6. The new index-based weather risk insurance can form an effective supplement with the traditional agricultural insurance

Meteorological disaster is one of the main risks faced by farmers. Survey data show that 95% of respondents have suffered losses due to weather-related hazards. The meteorological disasters vary from region to region, mainly including flood (84%), drought (72%), hail (52%), wind (56%), snow (48%) and low temperature freezing injury (42%) (Fig. 1.8).

Index-based weather insurance is different from traditional agricultural insurance. The essential difference lies in that the claim of traditional agricultural insurance products is based on the measurement of the productivity of the insured farmland, while for index-based agricultural insurance, the claim is not only highly related to the output of the farm, but also depending on several indexed weather variables, such as weather events, temperature, precipitation, etc.

Although many farmers have subscribed traditional policy-based agricultural insurance products, those products that use crop yield or income as the insurance subject encounter issues such as moral hazard and adverse selection risk. The objective, transparent, efficient and economic disaster loss assessment methods are still absent.

After the researchers explained in detail the measurability, objectivity, transparency, non-manipulative nature of the meteorological indexes, most of the surveyed farmers were convinced that index-based insurance could help them to mitigate the risks caused by weather disasters more effectively, and 61% of the respondents expressed their willingness to buy index-based insurance as supplement of the insurance policies they currently have.

Exploring Index-based Weather Risk Insurance

The Chinese government has put rural revitalization and solving issues of agriculture, rural areas and farmers to a strategic height, which brings great opportunities for agriculture industry, farmers and rural related insurance markets. Agricultural insurance ensures the smooth development of agriculture industry and food security. It is supported by government and enjoys favorable policies. As an innovative product, index-based weather risk insurance can effectively mitigate the risks caused by meteorological hazards and improve farmers' income. The successful promotion of index-based weather risk insurance requires the linkage of all stakeholders including the government, financial institutions, industry experts, insurance companies, hi-tech companies and agricultural business entities, so that all participants can form a joint force and build innovative digital agricultural insurance model with Chinese characteristics.

1. Side with existing financial products and innovate business model

Strengthen the insurance depth via innovative model of "basic insurance + additional risks". For example, it can be designed as traditional insurance and additional index-based weather risk insurance; When advocating policy-based insurance, sales person can also promote commercial employer's liability insurance and zoonotic insurance to farmers, leading growers and cooperatives, so that their capability to mitigate the risks can be improved. It can also enable the development of  traditional and innovative insurance products, which generates insurers' enthusiasm in operating agricultural insurance.

Carry out "agricultural insurance +" and realize the integration of agricultural insurance and other business lines. Agricultural insurance plays different roles such as risk prevention, leverage and credit enhancement. The proposal of Rural Revitalization Strategy empowers it to be more diversified, three-dimensional and integrated. Agricultural insurance and credit are important financial instruments to support and benefit agriculture industry. Strengthening the interaction between banks and insurance companies has practical guiding significance to resolve rural financial repression.

On the one hand, by leveraging agricultural insurance as a collateral, it can effectively alleviate farmers' the credit rationing and increase their credit availability and credit line; On the other hand, by relying on the expansion of rural credit, agricultural insurance can improve farmers’ income level, which will in return increase the demand for agricultural insurance products. Therefore, theoretically, agricultural insurance and rural credit can achieve interactive and coordinated development.

In the course of practice, Changfeng County of Anhui Province has developed a bank-insurance cooperative credit product based on the existing comprehensive insurance, to serve the local strawberry growers. It is found that Changfeng model effectively alleviates farmers' dual constraints of agricultural insurance and rural credit, and it stimulates financial supply and demand, and realizes the win-win cooperation among banks, insurance companies and farmers. Therefore, exploring the model of "credit + index-based weather risk insurance" to serve the "last mile" will help farmers to obtain loans, expand agricultural production, increase income and reduce the risk of poverty or return to poverty due to meteorological disasters. In addition, innovative models such as "order + insurance" and "order + insurance + futures" can also be further studied.

2. Break through pilot products and promote scale effect

It is difficult to achieve large-scale success with single index-based weather risk insurance product. Under the existing product system, the pilot of index-based insurance products must be innovative, yet the “novelty” greatly limits its operability and final effect, especially for the cultivated agricultural products.

At present, the available agricultural insurance products have covered wheat, corn, potatoes and other staple grains, open field and facility vegetables, as well as local featured l products with a wide range of planting areas such as herbs. Therefore, in the process of designing and promoting index-based insurance, we will face two main issues: first, it is difficult to find new products that have not been covered by existing agricultural insurance; Second, it is difficult for the new product to form scale effect and be commercially sustainable, which hinders the promotion of index-based weather risk insurance.

Trial on insurance for non-cultivated products and break through products portfolio. Besides cultivated plants type, index-based insurance can also play an important role in covering non-cultivated varieties. For example, the total output value of aquatic products in Guangdong province accounts for 21% that of agriculture, forestry, animal husbandry and fishery, but it has since long been heavily impacted by meteorological disasters such as typhoon, strong cold air and heavy rainfall. Unlike the insurance for cultivated crops, the existing agricultural insurance has not covered aquatic products on a large scale. The local agricultural development can receive a strong push by promoting index-based weather risk index insurance for aquatic products.

3. Strengthen the market's understanding of index-based weather risk insurance and promote the capacity-building of local service departments

It is difficult for grass-roots staff to obtain up-to-date knowledge training in insurance, which results in the weak advocacy of the insurance products. Although the government attaches importance to and actively participates in the pilot work of agro-meteorological index-based insurance, the challenges remain. During the interview, the governmental leaders from Gansu Province and Guangdong Province stated that although the work on developing agricultural insurance has certain achievement, the problems are not to be ignored. For example, issues like unbalanced work progress, mismatched ability and responsibility of grass-roots staff, inadequate financial knowledge training still exist.

The person in charge of Pacific Insurance in Yuzhong County, Lanzhou mentioned that they are responsible for the 268 administrative villages, which are geographically dispersed and they are severely understaffed. Due to geographical dispersion, the capacity-building of personnel also encounters great obstacles. It is difficult for grass-roots staff to receive effective insurance and financial knowledge training, such inadequacy hinders the advocacy and promotion of innovative insurance products.

Strengthen the financial capacity-building for groups with poor financial literacy and ability, such as government workers (especially grass-roots staff), as well as farmers, so as to release the real demand for agricultural insurance (including index-based weather risk insurance). From the demand side, the empirical results show that there is a significant positive correlation between farmers' education and awareness of agricultural insurance and their demand for insurance.

In the surveyed samples, only 35% of the farmers had heard of index-based weather risk insurance products, but as the information is inadequate, most of them had no purchase interest. That notwithstanding, after researchers explained to them in detail about the coverage and claim settlement processof such products, about 56% of the respondents said they are willing to subsrcibe, and 61% of the respondents believed that such  insurance could be an effective supplement to the existing traditional agricultural insurance products.

It can be concluded that improving farmers' financial literacy can effectively release the potential demand for index-based insurance, and can help them better mitigate agricultural risks. From the supply side, the interview results show that the grass-roots staff in local government and insurance companies encounter difficulties to obtain effective training, which harms their qualifications to promote index-based insurance. Therefore, capacity-building needs to be further strengthened.

4. Establish index-based weather risk insurance database for digital empowerment

Index-based insurance product design requires data collection on long-series historical weather, claim and farmers' crop yield to set up the correlation between weather index, crop yield and compensation standard. Therefore, the accuracy and rationality of data collected are directly related to the rationality of pricing, as inaccurate data leads to pricing deviation and claim basis risk.

However, information on farmers’ basics and agricultural disasters is difficulty to collect. One reason is that China's agricultural and rural informatization development lags, much of such information is either absent or biased.

For example, through the field investigation in Qingyuan City, Guangdong Province, the project team found that due to the serious fragmentation of farming lands, the large number of farmers and the heavy underwriting workload, and many farmers are guest workers in major cities, it takes much effort to collect data and signatures. Farmers’ data tend to be incomplete and inaccurate. For example, it can happen that the replacement of forest tenure certificate is not timely updated, or the insured area is inconsistent with the actual area, or the insurance contract is inconsistent with that of certificate.

On the other hand, most of the existing information is scattered and filed by government departments. Due to different institutional and departmental interests as well as data security considerations, information on agricultural insurance is unlikely to be shared and utilized.

The Guiding opinions on Accelerating the High-quality Development of Agricultural Insurance in 2019 proposed to "increase investment and continuously improve the informatization development for agricultural insurance", to accumulate data and information in this sector. At the same time, it is required to "gradually integrate the agriculture related data and information of financial, agricultural and rural, insurance supervision and management, forestry and grassland departments and insurance institutions, dynamically grasp the relevant information of insured farmers and their production and operation ", provide support and services for agricultural insurance, and "prevent fraud and defrauding financial subsidy funds from the source".

Therefore, it is particularly important for the government to support in building meteorological observation stations, statistical investigation teams and meteorological databases, such actions can effectively promote the development of index-based weather risk insurance.

[This report is exclusively published by Caijing magazine authorized by CAFI of Renmin University of China. The article is based on the research results of the digital Agrometeorological index insurance project launched by the International Finance Corporation ("IFC") in China in 2019 with the support of the UK prosperity Fund]

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