Risk Management: Helping Rice Farmers Cope with Risk

1. Risk Management: Helping Rice Farmers Cope with Risk Sumiter Singh Broca,Policy Officer, ESP Group2ndERAG Consultation onFormulation of a Rice Strategy for AsiaBangkok28-29 Nov 2013

2. Risks facing smallholder farmers in Asia • Food security is under threat from: • Population growth and demographic changes • Changes in food preferences with rising incomes • Instability in international markets • High and volatile prices • Land degradation and water constraints • Climate change and natural disasters

3. What is risk? • Definition: “Risks are undesirable fluctuations in consumption that are not perfectly predictable.” (Sinha & Lipton) • The key to determining who bears risk is finding out who will suffer a loss if something bad happens

4. Typology of risks • Poor, rural households face price/market related risks and non market-related risks: • Price/market related risks: • Price shocks • Non market-related risks: • Crop damage from weather or pests / disease • Death of livestock • Illness or death of household members • Loss of employment or self-employment • Natural calamities (drought, flood, fire etc.) • War and other forms of violence, e.g. crime

5. Strategies to deal with risk • Households can respond with a variety of strategies: try to keep income/consumption stable over time • Perhaps at low levels • Risk management strategies seek to minimize fluctuations in income itself • Risk coping strategies try to keep consumption stable in the face of income fluctuations

6. Strategies to deal with risk (cont’d) • Risk management strategies • Diversification of income sources • Negative correlation between incomes from different source • Examples: • Crop and field diversification • Diversification of income sources • Contractual arrangements e.g. sharecropping etc • Adoption of hardier varieties • Risk coping strategies • Insurance (crop, livestock, weather, health, life) • Savings and credit • Social protection / charity

7. Risk concepts (cont’d) • In practice two sets of strategies cannot be neatly separted • Key point: consumption can be (somewhat) stabilized, but only by accepting low return in exchange for low risk • Wealthy households: can choose more risky strategies and can therefore earn higher returns. • Poor households: forced to choose production technologies that are less risky but earn lower returns • Key point: Therefore policies to help poor rural households manage and cope with risk are also anti-poverty strategies.

8. Risk concepts (cont’d) • Some issues • Moral hazard: People may build houses in flood plains because it’s cheaper. Know that politicians will come to the rescue if house is washed away • Measuring risk: How to decide whether one household faces “more” risk than another, i.e. how to measure extent of risk faced by a household.

9. Vulnerability • “Vulnerability is the likelihood that at a given time in the future, an individual will have a level of welfare below some norm or benchmark.” Hoddinott and Quisumbing (2003) • The time horizon and welfare measure must be specified for the concept to be well defined • Can be defined at the individual or household level or even community

10. Measuring vulnerability • Vulnerability can be defined as: • Expected poverty (i.e. probability that someone will fall into poverty in the near future) • Low expected utility • Uninsured exposure to risk

11. Example: drought and rice farmers • Pandey, Bhandari and Hardy (2007): • Rice farmers in E India, SE Thailand and S China • Larger impact on farmers’ incomes in aggregate in India, less so in Thailand and China • Household level impacts were quite severe in all 3 regions • Eastern India: • Household incomes 24-58 % less in drought years, despite partial compensation from nonfarm income • Coping mechanisms: sale of assets, dipping into savings, borrowing

12. Example: drought and rice farmers • Farm households were unable to: • Keep income reasonably stable • Keep food and other consumption reasonably stable • Reduced number of meals and amount eaten • Even dipped into seed reserves in many cases • Incidence of poverty increased • More vulnerable groups included: • Small farm size • Farms in drought prone upland areas • Fewer working age family members

13. Example: drought and rice farmers • Conclusion: Evidence indicates serious impact of risk on poverty and malnutrition in rice farming households in at least some parts of Asia: • Risk management and coping strategies require resources which smallholders lack by definition • Therefore cannot protect themselves to the desired extent

14. Example: drought and rice farmers • Policies to help farmers implement these strategies are required • Agricultural research • Better technology design • Water resource development • Drought analysis and mapping • Drought relief and long-term mitigation • Drough forecasting and preparedness • Social protection • Crop insurance

15. Example of risk management: agricultural insurance • Does not eliminate risk but pools it • Spreads risk across an industry or economy and through time • Can help households and governments manage natural hazards • More efficient than credit and savings if financial market is little developed • Reduces credit default risk • Facilitates adoption of production innovations

16. Example of risk management: agricultural insurance • Conditions for successful insurance • Statistical independence • Symmetric information • Calculable expected frequency/magnitude of loss • Determinable and measurable losses • Significant potential losses and interest to insure • Limited policyholder control over insured event (moral hazard) • Affordable premiums

17. Example of risk management: agricultural insurance • Impediments to insurance • High administrative cost • Mismatch between preferences and willingness to pay • Inadequate legal/regulatory framework • Distorted incentives • Thin international reinsurance market for some kinds of insurance

18. Example of risk management: agricultural insurance • Lending to Agriculture • High systemic, market and credit risks • Slow return on rural investments • Low profitability of small-holder agriculture • Inability to offer guarantees due to low levels of assets • High cost due to geographical dispersion of clients • Insufficient knowledge about agriculture • Political interference

19. Example of risk management: agricultural insurance • Traditional Insurance Products • Single (named) peril • Multiple peril Actual physical loss or damage is measured in-field, and the claim is specific to that field/farmer

20. Example of risk management: agricultural insurance • Innovative insurance products • Crop area yield index insurance • Crop weather index insurance • Livestock mortality index insurance The claim is calculated based on an external index designed to reflect as accurately as possible the loss incurred by the farmer • Crop revenue insurance Protects insured parties from the consequences of low yields, low prices or a combination of both

21. Example of risk management: agricultural insurance • Conclusions • Insurance can only be implemented if insurance companies perceive profitable commercial opportunity to exploit in the medium term • Farmers must perceive that the premiums and expected benefits offers additional value • Insurance will be financially viable without the full support of re-insurers

22. Example of risk management: agricultural insurance • Conclusions (continued) • Essential to promote better on-farm risk management and risk coping strategies • Understand farmer risk attitudes better • Blend insurance with other financial products

23. THANK YOU

24. Specific objectives • Review of available evidence on types of risks faced by smallholder rice farming households in Asia • Analysis of impact on incomes / welfare of these households. • Analysis of risk coping strategies available to and adopted by these households and their dependence on socio-economic variables. • Analysis of the effectiveness of these strategies, together with a review of alternative strategies. • Based on above, recommendations for public policy measures to help these households cope more effectively with risk.