How Index-based Insurance will Restructure Agriculture in Kenya

The government has proposed to amend the Kenyan Insurance Act to introduce an index based insurance. This is a laudable move, that will facilitate uptake of agricultural insurance in the country

Index Based In
Index Based Insurance will facilitate uptake of Agricultural Insurance. Photo: Courtesy

By gatuyuriana journal

In the Budget Statement for the year 2018/19, Cabinet Secretary Henry Rotich made various policy declarations in relation to the insurance sector. One, was to do away with insurance brokers. Such a move will render multitudes in the industry jobless.

There was another thing. He has proposed to amend the Insurance Act to introduce an insurance system known as “Index-based Insurance.” This is applicable move. An amendment Bill to the Insurance Act has been published to actualize these policy proposals.

In your business class, you may have been taught. Key principles in insurance include risk, insurable interests and indemnity. It is the last one, where there is a problem. The Kenyan insurance sector is indemnity-based. In this, an insurer is only obligated to “return” the insured to their status before the occurrence of the risk insured.

Well, for tangible such as a car, it is easy because an insurer will indemnify, in cases of an accident, with another car with equal valuation.But what of circumstances where you insure properties like crops in a farm, and they are wiped out by calamity such as drought?

What do you indemnify? This is a challenge. An assessment of losses cannot be conducted before payment is made. This predicament has led to low uptake of agricultural insurance by farmers.

Again, indemnity insurance has other problems that have made it commercially unsustainable. One is “moral hazard”. Insured become more negligent in protecting their insurance against loss, since the insurance guarantees payment anyway.

There is also an issue of “adverse selection”, where more risk-prone individuals will self-select into the contract. Hence, like a boss, comes the alternative, the index-based insurance.

Index-based insurance is one under which the payment to the insured is based, not on the assessment of the insured’s actual loss, but on determined amount based on an objective and independent index.

In such a case, the index serves as a proxy for the actual loss. If you are a farmer for instance, and there is drought, the compensation may be based on expected yield.

For index insurance to work there must be a suitable indicator variable (the index) that is highly associated with the event being insured but is not prone to manipulation by either the insured or insurer.

For example, if one is insuring against animal feed scarcity, an indicator such as rainfall or forage availability may be suitable. The idea would be that rain failure during the rainy season, shortage of available forage, or a combination of the two would result in some level of livestock stress.

The insurer will thus make a payment when a geographic area based indicator that is highly associated with the risk outcome being insured against is triggered. This differs from traditional insurance which requires that the insurer monitor the activities of their clients and verify the truth of their claims on a case by case basis.

When this comes into force, we expect actuarial experts will have a boom in making determining of premiums that will be payable.

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