Weather Index-Based Livestock Insurance

This paper focuses on estimating the causal effects of index-based livestock insurance on poultry production among pastoralists in the Borena zone of southern Ethiopia, using four rounds of household level panel data. Exploiting randomization of extension treatments to purchase the index-based livestock insurance, and using a fixed effect model and standard Tobit model analysis, our result shows that households who purchased an index-based livestock insurance contract in at least one sales period are more likely to keep a greater number of poultry than those who never purchased in either sales period.

This positive and statistically significant correlation result implies that the insured household may keep a relatively higher size of poultry to reduce residual risks that are not covered under the insurance policy. Since the insured households are protected against the systematic risk of herding, they may stock a relatively higher size of poultry bearing in mind that they will have a relatively lower burden of risks and the risks in poultry production are relatively easily affordable. Moreover, the insured may prefer to insulate their consumption by selling poultry and poultry products from fluctuations in income instead of using their insured livestock as a buffer stock.

The world’s ever-growing population and economy is fuelling a huge demand for livestock products. This growing demand also presents an immense opportunity for households who engage in rearing, processing, and/or marketing livestock or livestock products (Delgado, Rosegrant, Steinfeld, Ehui, & Courbois, 2008). However, frequent and concurrent risks related to weather variation such as flood, drought, and typhoons are the most prevalent hurdles to the sector especially in the developing world.

Ethiopia is one of the developing economies often cited as a prime example of a highly vulnerable country in Africa to future climate-related risks. Although agriculture is the mainstay of the country’s economy, it is exposed to climate extremes and variability in rainfall, causing a stubborn effect on the economic growth (Conway & Schipper, 2011; Dercon, 2004). Thus, weather risk management is an urgently top issue in order to meet the growing demand for livestock and/or livestock products.

In the absence of formal agricultural insurance markets, rural households primarily rely on short-term traditional risk coping mechanisms, such as borrowing money, asset off-take, reducing consumption, informal risk-sharing strategies, and/or peripheral aid (Norton et al., 2014; WFP, 2010). According to Nigus et al., (2018), however, these strategies are potentially costly and inefficient to cope with systematic risks. Indeed, they could be ideal instruments to prevent idiosyncratic risks (basis risk), but do not provide adequate protection against covariate risks(Morduch, 1999; Nigus et al., 2018a).

To solve such problems, researchers and development institutions have innovated the Index-based livestock insurance (IBLI) in recent years, and it is deemed as a feasible, modern risk coping strategy (Boucher and Delpierre, 2014; Conway and Schipper, 2011; Dercon, 2004; McIntosh et al., 2013; Miranda and Mulangu, 2016). The insurance is a new and promising risk hedging instrument against livestock mortality that would often happen following a catastrophic drought.

In practice, IBLI is designed to settle losses based on a meteorological index that is calibrated to be highly correlated with actual losses. However, it is not calibrated at the individual farm level and is exogenous for the insured households. To calculate indemnity payments, vegetation condition is tracked by the Normalized Differenced Vegetation Index (NDVI) using remotely sensed satellite data. As a result, it has an advantage over traditional insurance by reducing transaction costs, eliminating moral hazard, information asymmetry, and adverse selection because farm inspections are not necessary.

In Ethiopia, this meteorological index-based insurance was introduced in mid-2012 as a pilot project in the Borena zone. This initiative was coordinated by the International Livestock Research Institute (ILRI), implementing partners Oromia Credits and Saving Share Company, and Oromia Insurance Company. Collaborative organizations included Cornell University, University of California, University of Sydney, Syracuse University, The Institute of Developing Economies (IDE)-JETRO, USAID, JSPS Grant-in-Aid for Scientific Research, The Australian Department of Foreign Affairs and Trade, and CGIAR (Ikegami & Sheahan, 2016; Jensen, Barrett, & Mude, 2015; Takahashi, Ikegami, Sheahan, & Barrett, 2016).

However, a major drawback of IBLI is the prevalence of residual risk or basis risk. Livestock other than camels, cattle, goats, and sheep, including poultry, are not covered by an index insurance product. This situation creates demand for an additional mechanism of risk protection (Cecchi, Duchoslav, & Bulte, 2016). In the presence of idiosyncratic risks and uninsured livestock, poultry production could contribute substantially to increasing income and reducing malnutrition among rural and urban poor. Poultry production is an interesting tool to respond rapidly to income shocks if included in rural development strategies. Raising and stocking poultry are also more rapid and easy than that of major livestock, respectively, as it has a high reproductive rate (Reta, 2017).

The poultry systems, thus, typically have imperative livelihood roles for poor households with very minimal input levels. Chickens feed themselves by scavenging from the backyard of the households (Alemu, Degefe, Ferede, Nzietcheung, & Roy, n.d.; Reta, 2017; Tarawali, Herrero, Descheemaeker, Grings, & Blümmel, 2011). Thus, their economic value in supporting the income of the pastoral household could be significant.

However, the introduction of IBLI against mortality of major herds could affect the poultry rearing behavior of households in either direction. To the best of our knowledge, no empirical research exists addressing the relationship between IBLI and uninsured poultry production. We, thus, estimate the effect of IBLI on poultry production in this paper with a hypothesis that the effect of IBLI is equal to zero.

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