Growing credit-linked and stand-alone index-based drought insurance in Uganda
Marcel van Asseldonk, Joost van der Woerd and Eleni Vakaki explain how microinsurance is helping farmers to cope with years of drought. By courtesy of the Micro Insurance Network.
Low-cost, large-scale microinsurance can help to achieve Sustainable Development Goal (SDG) 13: Take urgent action to combat climate change and its impacts. Across Africa, emerging index-based insurance is getting better at claim handling, but direct sales to individual smallholders remain challenging. Scaling up requires cooperation with aggregators in the agricultural value chain including financial services (insurers, brokers, banks and microfinance institutions), as well as seed and fertiliser merchants, traders, processors and farmers’ organisations.
Scaling Up Micro-insurance in Africa (SUMAfrica) aims to demonstrate the viability of low-cost and large-scale index-based drought insurance in Uganda. The project compares different market channels (for example, creditlinked versus stand-alone insurance), and different index-based insurance products (such as generic or crop-specific products).
Agriculture insurance in Uganda is currently delivered through a consortium of Ugandan insurance companies (Agro-Insurance Consortium or AIC). The consortium aims to ensure cost-effective product development, insurance underwriting, claims handling, setting premium subsidies and reinsurance brokerage. It also sets an accredited premium rate for commodities covered under the national scheme.
Consortium members reach a wide range of clients through farmers’ associations, credit providers and, to a limited extent, direct sales. Using aggregators boosts efficiency and minimises distribution, premium collection and settlement costs: financial organisations provide creditlinked cover, while farmers’ associations offer stand-alone products to members. Loans from participating financial organisations come with compulsory insurance. The premium is integrated with the loan and eligible claims such as index pay-outs are deducted from any outstanding debt. However, stand-alone insurance for smallholders via farmers’ organisations is voluntary.
Index-based relative evapotranspiration drought coverage
Index-based insurance is cheap as it requires no on-site loss assessment. Pre-underwritten index products and real-time satellite-based loss monitoring ensure simpler, faster underwriting and claim handling.
In Uganda, index insurance is based on relative evapotranspiration (RE). Since evapotranspiration – the combination of evaporation and plant transpiration – is proportional to CO2 uptake, and consequently to plant growth and crop yield, RE is an accurate measure of drought and a suitable index for agricultural drought insurance, as well as being a better indicator of crop growth than precipitation. As such, the explanatory value of an RE index is also higher than a precipitation index for credit risk.
Spatially aggregated rates and pay-out calculations can be set to village, sub-county or district level. Importantly, spatially aggregated products are easier to understand for both smallholders and aggregators. With the product currently offered at sub-county level, the spatial basis risk (the difference between index measurements and actual losses) is kept at an acceptable level.
Since 2014, several RE-based products have been developed and marketed in Uganda, including crop-specific (Arabica and Robusta coffee, beans and maize) and generic drought cover. Crop-specific coverage is based on particular crop characteristics and drought sensitivity, whereas generic cover aims to provide general protection during the rainy seasons and thus is suitable for intercropped smallholder gardens. The index-based drought insurance schemes that are sold through the AIC consortium are designed and monitored by EARS Earth Environment Monitoring BV (EARS E2M), using RE time-series data from 1982 to date with real-time hourly data and drought monitoring at three kilometre ground resolution.
The Ugandan government subsidises 30% of the premium for commercial farms and 50% for small-scale farms, rising up to 80% in 33 of the most disaster-prone districts of the country, where premiums are higher. Basic premiums on all subsidised products are limited to 5% (10% in disaster-prone areas) to ensure affordable prices and adequate coverage, although farmers in higher-risk areas still have to bear part of the drought risk themselves.
In 2017, sales of both credit-linked and stand-alone index-based insurance reached approximately 45,700 smallholders across Uganda. Generic credit-linked drought index insurance is most widespread because it is compulsory and sold via banks with a large portfolio. Coffee insurance also performs well, and to a lesser extent, so do other commodityspecific products.
Direct sales to smallholders are a bigger challenge, so the project has collaborated with the National Union of Coffee Agribusiness and Farm Enterprises (NUCAFE), one of the largest organisations of coffee producers in the country, to try and scale up. Coffee is a valuable cash crop with a relatively well organised sector. NUCAFE is committed to helping provide drought cover to its members, with hub managers and field staff actively promoting and selling products. Farmers can pay their premiums in-kind out of their coffee harvest instead of finding the money up front. In addition, any insurance pay-outs are offset against payments for the processed coffee beans after they have been sold by NUCAFE on behalf of the farmers. However, this approach only works in more organised value chains where aggregators are closely linked to the producers and can leverage their organisational capacity and existing trust relationships.
Figure 3 (overleaf) provides an overview of index insurance sales in Uganda in 2017. The average sum insured was around US$1,750 for creditlinked and US$300 for stand-alone insurance, with average gross premiums of US$34 and US$18 respectively. Net premium rates before VAT for credit-linked and stand-alone insurance averaged 1.5% and 5% after subsidy. Variations in the basic premium largely depend on subsidy rates in different areas.
Good partnerships are essential for scaling up microinsurance in Africa. Microfinance institutions and banks benefit from linking credit and mandatory insurance, while insured smallholders have a better credit rating because they are less financially exposed. Financial institutions can increase their agricultural portfolio by reducing both absolute and proportional risk, which in turn should ultimately result in more competitive agricultural loans, better access to credit, lower interest rates and reduced collateral requirements.
Banks and other lenders have the power and the motivation to enforce mandatory bundles, while different incentives are needed to convince farmers to purchase stand-alone insurance products. A major challenge for these aggregators and for the agricultural sector in general is to increase awareness and understanding among smallholders about their risk exposure and the possible ways to reduce, transfer or deal with these risks.
Finally, government support is essential to drive the increased uptake of insurance in agriculture. Government subsidies in Uganda and some other African countries provide an effective incentive for farmers to deal with extreme weather risks and ultimately to help them build a more sustainable and resilient agricultural sector.
 Platform for Agricultural Risk Management, Agricultural risk assessment study, (Rome, Italy: Risk Assessment Uganday, 2015).
 Rosema, A., Huystee, J. van, Foppes, S., Woerd, J. van der, Klaassen, E., Barendse, J., Asseldonk, M.A.P.M. van, Dubreuil, M., Régent, S., Weber, S., Kara, A., Reusche, G., Goslinga, R., Mbaka, M., Gosselink, F., Leftley, R., Kyokunda, J., Kakweza, J., Lynch, R. and Stigter, K. FESA Micro-insurance: Crop insurance reaching every farmer in Africa. Scientific Final Report, Delft: EARS Earth Environment Monitoring, (Report Project no. 38, 2014) Scientific Final Report of Millennium Agreements Project no. 38 – p. 122.
 Von Negenborn, F., R. Weber, O. Musshoff, Explaining weather-related credit risk with evapotranspiration and precipitation indices, Agricultural Finance Review, 2018.