Natural Catastrophe Insurance – In Conversation with Mr. Ulrich Hess

By Vipul Sekhsaria, IFMR Holdings

In the below video we share a brief conversation with Mr. Ulrich Hess, GIZ. Mr. Hess is currently a Senior Advisor, InsuResilience Initiative at GIZ, and has worked extensively in the field of natural catastrophe risk insurance market. In the video he shares his insights on the impact of natural disasters on the livelihoods of households and the risks associated with it. He also talks about the challenges in designing a natural catastrophe insurance product and addressing issues associated with both inefficiencies and effective delivery of the product.


Developing the Natural Catastrophe Risk Insurance Market for Low-Income Households in India

By Vipul Sekhsaria, IFMR Holdings

Natural disasters leave behind them a tale of death and destruction that affects the economy on the whole and severely impacts communities, especially low-income households, which bear its brunt. While little can be done to prevent natural calamities like floods, cyclones, drought etc. from occurring, what perhaps can and should be done is how best households, especially the vulnerable ones, can mitigate the financial losses that such calamities have on their lives.

Flood & Drought Risk

In terms of number of people affected, India tops the list of 163 nations affected by river floods as cited by World Resources Institute[1]. Close to 76% of India’s 7,516 km long coastline, is prone to cyclones with over 40 million hectares (12 per cent of land)[2] being prone to floods and river erosion. Floods can severely disrupt livelihoods, especially in low-resource settings. Flooded households are affected by a plethora of adverse conditions including food insecurity due to crop failure or affordability concerns due to sudden price changes. Daily care of children is importantly challenged during floods as in worst scenarios all basic services become disrupted, including water and sanitation conditions, or the provision of basic community health and social services.

Like flood, drought in India is also a major disruptor of financial well-being with 68% of the country being prone to it in varying degrees[3]. It is difficult to provide a precise and universally accepted definition of drought due to its varying characteristics and impact across different regions such as rainfall patterns, human response and resilience etc. Last year (2016) more than 300 million people living in 256 districts were affected by drought after two years of sparse monsoon rains[4]. The latest findings suggest that while there have been alternate dry and wet spells over the past three decades, the frequency and intensity of drought years has been increasing – for instance Tamil Nadu was declared drought hit in January 2017 after it recorded the worst rainfall in 140 years[5]. What’s important to note is that while the direct effect of drought could be on the farmer and the agriculture economy, but due to its high incidence, the local rural economy also gets severely affected thereby expanding its impact base beyond the farm sector to rural labourers and small rural businesses.

Natural Catastrophe (Nat-Cat) Insurance

Given the fragile economic livelihoods of the underlying households that microfinance institutions and small business lenders serve, even significantly diversified originators typically have a large percentage of their capital at risk in case of a localised natural catastrophe, resulting in a higher cost of capital. This leads to either no catastrophe cover or cover that is unaffordable to people living on low incomes. Further a majority of households never have access to any insurance that protect their assets and livelihoods in the event of a shock. The existing PMFBY (Pradhan Mantri Fasal Bima Yojana – Prime Minister’s Crop Insurance Program) is a restructured Weather Based Crop Insurance Scheme covering only Farmers – it does not take care of many other rural customer segments like Labourers, Small businesses that form 60% of the rural population. Even for farmers it doesn’t provide the much-needed liquidity during the constrained circumstances of a natural disaster like flood nor any protection towards assets other than crops (example: house & contents, livestock, other small holdings). The PMFBY structure is also highly subsidised by the government (to an extent of 90% subsidy)[6], which is a good first step to drive adoption, but without an exit strategy, the long term continuance of subsidy always remain questionable.

India was the first developing country to pilot weather indexed insurance and, despite the recent spread of weather indexed insurance programs across the world, more farmers purchase weather indexed insurance in India than in any other country. However, despite the large public subsidy, as mentioned above, a significant majority of India’s farmers have remained uninsured largely due to issues in design, particularly the long delays in claims settlement.

In terms of product development, designing an Index Based Parametric Cover is somewhat comfortable at a portfolio level rather than at the individual level (micro level), since at a portfolio level, rate makers have access to more managed data of the spread and concentration of assets across the geography. The return periods of the calamities and the portfolio data make it possible to arrive at a commercial rate for the Index Based cover. Recent experience suggest that while products are available but they are also limited to perils like Earthquake which are usually perceived as low-frequency event affecting a much smaller geography in India and therefore are of lesser demand as against for Flood and Drought.

More products for protection around Flood and Drought should also appear in the near future but cost of such solutions is yet to be evaluated. It’s worth mentioning here that, trigger of such portfolio level product results in a payoff to the risk originator (Micro Finance Institutions or similar) to cushion their own portfolio from delayed receipts of the loan repayments due to the stressed situation caused by the catastrophe. The challenge in this segment as it seems is that most originators who are already working on tight margins find it difficult to cover the cost of an earthquake protection product at a portfolio level and the high price still continues to be a dampener.

Designing a Nat-Cat Micro product

While the subject of Index Based Parametric cover is largely centred around loss of assets (whether fixed or movable), there has been very little or no work done so far as to protect the loss of Individual Income due to the incidence of perils like say, flood and drought, through an Index Based Parametric cover. The advantage of originating such cover is making the end consumer (micro level) ‘Nat-Cat-Resilient’.

The biggest challenge in developing the Nat-Cat Micro product is the absence of structured income data at the micro level. In absence of any close estimate of the different income profiles and the effect of Nat-Cat perils on this income, it is not possible to initiate the ratemaking of the risk – ‘Loss of Income’. Since the potential customers are mostly from unorganized sector, a great deal of primary research work will be involved in estimating the different income profiles of the constituent occupation classes.

To address this challenge we have undertaken a detailed primary research activity (details on which we will share in subsequent posts) to capture insights on the impact of natural calamities on income of rural customers, length of the impact as well as coping mechanisms. Joining in this detailed research work is a leading DFI (GIZ InsuResilience Direct Insurance Implementation Team) who has partnered with IFMR Holdings (IFMRH) in developing Catastrophe risk protection market along with weather based technical service provider based in India. In its current phase the goal of this project is to develop probability curves that can be externally assessed and then used to pilot differing approaches like the one detailed above as a “Micro Nat-Cat Product”. If successful, the aim would be to make these probability curves available to others to develop similar coverage and products to serve a much larger population in India.

As part of this blog series we intend to share insights from our research and interactions with expert stakeholders in subsequent posts.

[1] http://www.livemint.com/Politics/hjUVTrwyI0I4p4b4enBg1K/India-tops-list-of-nations-at-risk-from-floods.html
[2] http://www.worldfocus.in/magazine/disaster-management-in-india/
[3] http://www.ijesmjournal.com/issues%20PDF%20file/Archive-2017/Jan-Mar.-2017/4.pdf
[4] http://www.thehindu.com/todays-paper/tp-in-school/Reeling-under-dry-spell/article17052569.ece
[5] http://www.business-standard.com/article/economy-policy/ne-monsoon-worst-in-140-years-144-farmers-dead-tn-declares-drought-117011100782_1.html
[6] http://indianexpress.com/article/business/business-others/pradhan-mantri-fasal-bima-yojana-crop-insurance-plan-to-entail-rs-8-8k-cr-outgo/


Using Customer Information to take a Household Approach to Lending

By Shweta Aggarwal, IFMR Rural Finance

There has been a lot of stress on assessing a customer’s cash-flows before sanctioning a specific loan, for instance a home loan or a crop loan. However, there hasn’t been enough stress on assessing a customer’s cash-flows before sanctioning a Jewel or a JLG loan. What causes the discriminatory use of cash-flow assessments for the same household given the same provider? For the customer, in both cases he/she has borrowed money and has the responsibility to repay it in a given time period along with the added cost of borrowing (interest rate and processing fee etc).

In the KGFS-way of operations, we have designed a simple process that enables the institution to collect and store customer information and assess a household’s cash-flows before sanctioning any product, not only loans but also insurance, savings and investment products. Let’s go through this process step by step:

Step 1: Know Your Household

As a part of the KGFS model, each household in a KGFS service area (in the plains, typically a 5km radius around the branch with approximately 2,000 households) is enrolled. The enrolment process involves detailed collection and verification of household information ranging from occupation and income details of all members, household expenses, asset ownership and most importantly outstanding liabilities of each household member. This information is collected and stored in an online customer management system that is accessible to each member of the KGFS ground staff (henceforth: Wealth Manager).

Step 2: Cash-flow Assessment

With this information we arrive at the annual surplus available with each household. While each Wealth Manager is equipped to calculate surplus, as a cross-verification, this analysis is also available through the online systems. This is a household’s debt servicing capability (DSC) or amount of surplus the household has, as one unit, to service debt, buy insurance, save, invest and meet other short term/long term goals. After a thorough Wealth Management conversation, we shift towards a need specific conversation.

Step 3: Need Specific Conversation

Now that we have a clear assessment of a household’s current financial position and future goals, it is easier to have this conversation. Let’s take a 4 member household with an annual DSC of INR 20,000 with two short-term needs highlighted during the Wealth Management conversation:

  1. Farmer getting ready for the next season of paddy needs INR 25,000
  2. Entire household worried about meeting current month’s daily expenses needs INR 15,000

As explained in the Paddy Financing blog-post we collect details about the farmers cropping cycle and calculate expected expenses and income from cultivating that season. Since the loan is for financing crop expenses of INR 25,000 (excluding 20% equity brought in by the farmer), net income should be sufficient to:

  • Meet the financing cost of taking the loan (interest + processing fee)
  • Contribute to proportional household expenses

If net income is more than sufficient, the loan is sanctioned and remaining income is added back to the household’s DSC. However, if net income is insufficient, the household has the option of digging into its current surplus but is made aware that the cost of taking a loan is now greater than returns earned from the activity. This approach aims at incentivising the household to engage in income generating activities to increase their annual DSC and gain access to higher ticket size loans.

Now, the household still has to meet its daily needs and requires INR 15,000. Given that the household has an unused DSC of INR 20,000 the household can take any of the generic purpose loans like JLG, Jewel or Personal loans from their local KGFS. In case annual DSC of the household was INR 10,000, the household would get the option of structuring a loan for INR 15,000 over two years. This would ensure the household has access to the much needed finance and at the same time is not over-burdened by stress of repaying the entire sum the same year.

This framework is still being refined and future work hopes to address:

1. Creating a liquidity buffer – Is the entire surplus available for servicing debt or should some be kept aside for unexpected circumstances?
2. Accounting for seasonality – Is there more surplus available in some months than others?

* – Graphic illustrations by Roshni Jesudoss, IFMR Rural Finance


Designing a financial product for paddy farmers

By Arun Kumar & Balajee GE, IFMR Rural Finance

How can we design a financial product for a farmer that is exactly suited to his requirement? The answer lies in understanding the utilisation of the product. So, it became clear to us that if we were to design a crop loan for a farmer, we had to understand the exact utilisation of the loan. This also meant we had to understand everything about the crop for which the loan would be utilised for. Which is exactly what we did.

Instead of designing a generic crop loan that any farmer could avail, we designed a very specific loan that only paddy farmers could avail. Here’s what we did:

First we studied the paddy farming cycles in Tamil Nadu, which included the seasonality, varieties and duration of the cropping cycle. Then we mapped the entire supply chain for the paddy farming activity, keeping the farmer as the focal point. This included:

  • Identifying the inputs and sources (Seeds, fertilisers, pesticides)
  • Costs associated with each of them
  • Costs associated with infrastructure such as electricity and water

We then mapped out the different activities of paddy farming over a timeline. Here’s what a typical paddy farming cycle looks like:

Based on a combination of our own primary research and various secondary data, we developed our own template to calculate the financing requirement to cultivate paddy. The inputs for the template are:

  • Size of land holding
  • Nature of electricity (free or paid)
  • Source of water (Borewell/bought/free)
  • Extent of mechanisation (Partial/complete)

Based on the combination of inputs, the template recommends an approximate cost of cultivation and a recommended loan amount. The template also recommends the disbursement to be made in multiple tranches (ideally 2).

The first tranche (60% of the sanctioned loan) is disbursed on Day 15 and the second tranche (remaining 40%) is disbursed on Day 45. The days were decided based on our interaction with farmers. The farmer could use the first disbursement to pay wage labourers for transplantation, purchase of fertiliser for first round application.

The second disbursement will help the farmer to meet the expenses he will incur during purchase of fertiliser for subsequent applications, pesticides, and will also take care of harvesting expenses (manual or mechanised).

As is usual in loans, the farmer is expected to bring in equity. This equity is deployed in the first few days of the cycle to meet the sowing expenses (seeds + labour).

The farmer will repay the loan (principal + interest) post harvest and sales.

We believe it is important to offer a credit product that is structured around the cash flows of the customer, making credit available exactly when needed and repayment when cash is available at the household. The exact timing helps in reducing the interest cost and also eliminates the uncertainty surrounding the credit availability.

This pilot is a step in that direction. Our pilot is underway in four branches of Pudhuaaru KGFS. We also aim to roll out customised loans for farmers growing other crops.

Track our progress and findings from the pilot on our Facebook page or via Twitter.


Consumer Finance Innovations in India

Nachiket Mor and Bindu Ananth were invited by Columbia University to share some of our thinking and work on consumer finance in India. In the talk, they explored the shift from a product-driven standardised approach to one characterised by customised sale of suitable financial services and the KGFS experience of doing this at scale.

Click here for presentation from the talk