Unpredictable weather patterns, exacerbated by climate change, pose significant risks for smallholder farmers, leaving them vulnerable to potential losses and income variability. These risks can impact smallholder farmers’ ability to meet financial obligations, including loan repayments. Compounding this issue, smallholder farmers often lack collateral and credit histories, making financial service providers (FSPs) reluctant to lend to them. As a result, these farmers remain largely excluded from formal financial services, limiting their ability to invest in their farms and improve their livelihoods.
Weather index insurance, a form of agricultural insurance that provides coverage based on predetermined indices, such as rainfall levels, temperature or soil moisture levels, can protect farmers against the financial consequences of adverse weather events. This protection can serve as an alternative form of risk mitigation, reducing the need for the traditional collateral or guarantees typically required. As a result, insured farmers can qualify for loans with lower collateral or guarantee requirements, ultimately enhancing their access to credit.
This blog explores how weather index insurance can help mitigate the risk of loan default and make farmers more creditworthy in the eyes of FSPs.
The conundrum of smallholder farmer financing
Access to capital is crucial for farmers to invest in inputs, equipment and labour, which can improve their productivity, climate resilience, and incomes. Despite the significant market potential that smallholder farmers represent, FSPs often shy away from serving this segment, perceiving them as high-risk borrowers. This reluctance stems from several factors, including:
- FSPs face challenges in accurately predicting smallholder farmers’ future cash flows due to limited data on their operations and incomes. Smallholder farmers often have irregular or seasonal income streams, which can make it difficult for FSPs to assess their creditworthiness and repayment capacity. Additionally, many smallholder farmers have little to no credit history or transaction records that FSPs can use to evaluate their financial stability and ability to repay loans.
- Many smallholder farmers lack traditional collateral, such as land titles or other assets, which FSPs typically require as security for loans. This absence of collateral makes it challenging for FSPs to mitigate the risk associated with lending to smallholder farmers, as they have limited recourse in the event of default.
- Agricultural production is inherently vulnerable to weather-related risks, such as droughts, floods or pests, which can significantly impact farmers’ ability to repay loans. Furthermore, smallholder farmers are exposed to market risks, including price fluctuations for their crops or livestock. These weather and market risks can lead to substantial income variability, which can put FSPs’ portfolios at risk of default.
Mitigating these challenges requires innovative solutions that can help reduce the risks associated with lending to smallholder farmers and enable FSPs to expand their reach to this underserved segment.
Leveraging weather index insurance to mitigate smallholder farmers’ risks
Weather index insurance can help protect farmers’ incomes against climate events, such as droughts or floods, by providing financial compensation when adverse weather conditions occur. By mitigating the potential impact of these risks on farmers’ livelihoods, weather index insurance offers a safety net that can cover financial losses and ensure that their ability to repay loans remains intact even in the face of adverse weather events. Consequently, this type of cover can help de-risk lending and make smallholder farmers more attractive borrowers for FSPs.
In the last decade, partnerships between insurance providers and FSPs have emerged to bundle weather index insurance with agricultural loans. While most of these partnerships are aimed at distributing insurance policies, the transformational impact on smallholder farmers’ access to loans is often overlooked.
In Mali, a partnership between insurance provider OKO and microfinance institution the Micro-Institution Income Growth (RMCR) Network – VisionFund Mali, demonstrates the catalytic role of bundling weather index insurance with loans on smallholder farmers’ access to credit. Under this partnership, Vision Fund Mali staff offer OKO’s weather index insurance policies to farmers applying for loans. Insured farmers who are members of a co-operative are not required to provide any guarantee, while insured non-members only need to provide 50% of the usual guarantee, alleviating a critical barrier for farmers’ access to loans. This collaboration has proven beneficial for all parties involved. OKO has increased its customer base, with 326 farmers insured by RMCR in 2023, representing 8% of OKO’s portfolio in Mali. RMCR earns a commission on each policy sold and is compensated for losses, with 100 loans partially repaid via insurance payouts that same year. Most importantly, access to loans has been improved for farmers. A recent survey conducted as part of the GSMA AgriTech Accelerator revealed that, among OKO customers who obtained a loan, a significant majority attributed their successful loan application to having OKO’s insurance policy.
ACRE Africa, another insurance provider, has partnered with major mainstream banks and MFIs in Kenya, Tanzania and Zambia, to bundle weather index insurance with microfinance loans offered to farmers. In the event of an adverse event the insurance payout is directed to the FSP to reimburse the outstanding loan, and any excess amount goes to the smallholder farmer. The safety net provided by insurance serves as a substitute to the collateral that banks typically require, making it easier for farmers to access loans. In East Africa, collateral requirements are most often in the form of title deeds. However, since land is primarily inherited and shared among multiple family members, individual farmers rarely possess their own title deeds, making it difficult for smallholder farmers to be considered for loans. By replacing the need for collateral with insurance, bundling weather index insurance with loans allowed close to 70,000 farmers across Kenya, Tanzania and Zambia to access the financing they need to invest in their farms and improve their productivity.
Considerations for scaling bundled insurance and credit products
Bundling weather index insurance and agricultural loans presents multiple advantages for FSPs, insurers, and smallholder farmers. While FSPs reduce their portfolios’ exposure to weather-related risks, tap into an untapped customer segment, and increase revenues through insurance commissions, insurers benefit from increased adoption and premium volumes. Smallholder farmers gain from improved access to credit, and enabling investments in farm productivity and climate resilience.
However, despite the potential benefits, this approach is still far from being mainstream. Many financial institutions remain cautious. Albert Dah, Agricultural Finance Director at MFI Advans Cote d’Ivoire, acknowledges that while this approach mitigates climate-related risks, producers also face other types of risk, such as market risks. “We are open to investigating bundling our agricultural loans with weather index insurance because we believe it has potential. But it doesn’t remove all the risks farmers are exposed to,” explains Dah, emphasising the need for comprehensive risk management. Advans Cote d’Ivoire is currently piloting a combination of area-yield and weather index insurance with insurance provider Pula to provide a multi-layer cover for both smallholders and the MFI.
Insurance policy pricing is another limiting factor for FSPs when it comes to offering bundled credit and insurance products to smallholder farmers. Insurance premiums can be high due to a shortage of professionals with the expertise to accurately assess and price agricultural risks, limited capacity to underwrite agricultural microinsurance products, high distribution costs to rural and remote areas. High insurance premiums can make the bundled product unattractive or unaffordable for farmers, defeating the purpose of improving access to credit. Insurers must balance adequate coverage with manageable costs for their target customers. Subsidies from governments or insurers can help make the product more affordable but may not be sustainable in the long term. Innovative business models should be explored further.
Finally, to scale bundles of weather-index insurance and loans, properly training credit agents to sell insurance is essential. Poorly trained agents can lead to customers being unaware of their insurance coverage, not understanding their policy, or not having their inquiries and concerns properly addressed, resulting in poor customer experience. Ongoing education and capacity building should be prioritised to ensure staff can effectively explain the value of bundled products, address concerns, and guide customers through enrolment, ultimately building trust, increasing uptake, and contributing to successful weather-index insurance scaling.
Conclusion
Weather index insurance offers a promising solution to the challenges of smallholder farmer financing. By providing a safety net against weather-related risks, insurance can help mitigate the financial uncertainties associated with agricultural lending. When used as a form of risk mitigation in the loan assessment process, weather index insurance can lower the guarantees required for farmers to qualify for loans. This, in turn, can improve access to credit for smallholder farmers, enabling them to invest in their farms, increase their productivity, and build resilience against climate change.
Despite the potential benefits for insurers, FSPs, and smallholders, bundling weather index insurance with agricultural loans remains uncommon across markets. To take this approach to the next level, stakeholders must collaborate to develop innovative business models that provide affordable, multi-layered coverage, while also investing in capacity building and awareness-raising initiatives to ensure all parties understand the value and mechanics of these bundled products.
The GSMA AgriTech Accelerator is funded by the German Federal Ministry for Economic Cooperation and Development (BMZ) and supported by the GSMA and its members.
