The government of Uganda is promoting growth of its coffee industry by nearly 400%. Aiming to increase production of coffee from four million bags to twenty million bags, the government is investing in irrigation and subsidizing coffee seedlings to increase interest in growing coffee, a crop often seen risky by farmers because of the unpredictable nature of rainfall in Uganda. NUCAFE, the National Union of Coffee Agribusiness and Farm Enterprises, is promoting crop insurance as a tool to increase interest in growing coffee. Justus Lyatuu of The Observer, writes of NUCAFE’s foray into crop insurance.
Coffee is extremely reliant on moisture and rainfall to successfully grow and mature to a crop fit for harvest. A slight decrease in rainfall could cause mass coffee crop failure, leading farmers to stray from growing the risky crop. Nearly 65% of crop losses in Uganda are due to drought, and the farmers’ inability to accurately predict weather and effectively mitigate the risks associated with weather leads farmers to devote their resources to growing less risky and less valuable crops.
NUCAFE is encouraging farmers to grow coffee through the offering of crop insurance, which will function to reduce the risk carried by farmers from investing in the production of coffee. Farmers will pay 5% of their expected yield of harvest in the beginning of the grow, and in the event of crop failure due to weather events such as drought, the insurance policies will pay out to farmers near the expected yield of the harvest. Not only does this promote the growth of coffee by mitigating many of the risks of doing so, NUCAFE also will offer education and access to weather information from NASA to allow farmers to more accurately predict weather and mitigate losses from drought.
Index Insurance, How Can It Promote Increased Confidence in Risky Crops?
Index insurance is an emerging form of insurance beginning to become available to those in the agriculture industry, that offers policies to farmers based on weather indexes. Farmers will pay premiums to the insurer, who will in turn, pay out to the farmer in the event of weather conditions suitable for crop failure are met. For example, if the agreed upon conditions for the weather index insurance policy state that if below 15 inches of rain falls in the grow period, then the insurance policy will pay out to the farmer.
Pre-existing forms of crop insurance were structured so the farmer pays premiums to the insurer, and if the crop fails, then the insurance policy pays out near equal to the crop loss.
Index insurance has many advantages over standard crop insurance policies. Because index insurance uses publicly available data to determine if conditions for crop failure are met, transaction costs for index insurance are significantly lower than standard insurance, where claims often result in the insurer needing to inspect the farm themselves, increasing transaction costs. Lowered transaction costs are essential for financial products, and create suitable conditions for private insurers to exist in the marketplace as well as allowing small farmers to afford insurance. When transaction costs are minimized, the cost associated with the financial product is as close as possible to the cost to the insurer of paying out to policyholders. Not only does this increase potential profit margins for insurers, it keeps the cost of insurance low for farmers. Index insurance’s low transaction costs mean the product’s adoption might be possible without governmental and NGO financial support, which otherwise would be required to supplement insurers operating at a loss.
Index insurance protects insurers from moral hazard. With standard crop insurance, the policy may provide a better outcome to the farmer if the crop fails, tempting the farmer to intentionally sabotage their crop. They may have a policy that pays out more than the expected yield of their harvest, or they may be able to make the same amount of money with a failed harvest without having to put in effort to grow the crops. Because index insurance pays out when uncontrollable weather conditions are met, farmers don’t benefit from a failed harvest, it actually still serves the farmers best when they always strive for a successful harvest, since payouts aren’t determined with the outcome of the crop, but instead based on growing conditions.
Because index insurance determines if payout conditions are met based on weather data, it isn’t always effective in protecting the farmer from risk. If the farmer’s crop fails even when there has been 15 inches of rainfall in the grow season, the farmer has a failed crop and no payout from his insurance policy. If somehow the farmer’s crop succeeds when there has been less than 15 inches of rainfall in the grow season, he receives a payout even when his crop succeeded. So, while index insurance protects insurers from moral hazard, it often can result in ineffective risk mitigation for the farmers.
Index Insurance in Uganda
With the implementation of weather index insurance in Uganda for coffee farmers, coffee farmers can invest their resources to growing coffee without having to bear the risk of crop failure. Policies aimed to protect farmers from drought would pay out to farmers when drought conditions have been met. Since drought is the leading cause of crop loss in coffee agriculture, insurance policies that pay out when drought conditions occur mitigates the risk of low rainfall to coffee farmers, the largest drawback to growing coffee instead of safer crops.
Lyatuu, Justus. “Coffee Farmers Urged to Embrace Insurance.” The Observer. N.p., 10 Mar. 2017. Web. 11 Apr. 2017. <http://www.observer.ug/business/51694-coffee-farmers-urged-to-embrace-insurance.html>.
Hellmuth M.E., Osgood D.E., Hess U., Moorhead A. and Bhojwani H. (eds) 2009. Index insurance and climate risk: Prospects for development and disaster management. Climate and Society No. 2. International Research. Institute for Climate and Society (IRI), Columbia University, New York, USA.
Leiva, Oscar. Hands of María Del Socorro López López. Digital image. Coffeelands. Catholic Relief Services, 9 Nov. 2015. Web. 17 Apr. 2017.