Journal Issue

Crop Insurance, Creditworthiness, and Development

International Monetary Fund. External Relations Dept.
Published Date:
September 1970
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Bernard Oury

THE FIRST reference to multirisk or all risk crop insurance appears to have been made by the American statesman and scientist, Benjamin Franklin, in 1788. In that year France suffered the loss of crops over much of the country due to a severe storm. When Franklin heard of this he wrote to one of his correspondents in France saying: “(It must have been a terrible tempest that devastated such an extent of the country. I have sometimes thought that it might be well to establish an office of insurance for farmers against the damage that may occur to them from storms, blight, insects, etc. A small sum paid by a number could repair such losses and prevent much poverty and distress.”1

About 110 years were to pass, however, before any organized effort would be made by an insurance group to do in the United States what Franklin had in mind for agriculture. Insurance on buildings and equipment, against specified risks such as fire, windstorm, and hail have been available to farmers for a long time from farmers’ mutual insurance societies and commercial companies, both in Europe and in the Americas. Insurance on crops, though only against fire and hail, and insurance on livestock are the oldest forms of insurance against agricultural risks. Yet these are not the most important single risks in agriculture. In the United States, several attempts were made around the turn of the century by private insurance corporations to write multi-risk or all risk insurance on crops. They failed because of the heavy liabilities involved. Such contracts were written against loss of income from the crops for any cause including prices; and price declines were, on the whole, more important causes of loss than crop failures.

Interest in crop insurance revived in the 1920’s. The International Institute of Agriculture, forerunner of the Food and Agriculture Organization, made studies on the subject. Aside from numerous schemes and proposals for commodity price stabilization through control or support of prices or production, commodity price stabilization by means of insurance was discussed in the United States as early as 1928. The first world survey of existing agricultural insurance systems was initiated in September 1937 by the Assembly of the League of Nations when it asked its Economic and Financial Organization “to undertake a study of systems of agricultural credit and insurance with a view to the elaboration of principles calculated to strengthen internal and external credit and suitable for adoption by countries contemplating a modification of their existing legislation.” A report on these systems by Louis Tardy was submitted and discussed in 1938.2 In the same year, crop insurance laws were passed in two countries, the United States and Japan; these created the first government-operated multi-risk or all risk crop insurance schemes in the world. These first two systems served as examples to many other countries, even though their development was not untrammeled.

Today, against the background of tremendous accomplishments of technology both on earth and in space, and the world food/population balance prospects in the not-so-long run, crop insurance assumes new and added importance. The possibility of stabilizing producers’ earnings and encouraging production in a large and essential segment of the world economy and narrowing the food gap through a powerful combination of appropriate technologies and appropriate financial techniques of crop insurance/re-insurance is itself of great importance for the masses affected. Furthermore, by helping to prevent, or to compensate for, losses arising from adverse supply-induced movements in producers’ earnings and avoid disruption of their development programs, it is relevant to the assistance which appears necessary in the future in order to ensure a reasonable hope of sustained and eventually self-sustaining growth in a number of countries.

Crop Insurance and Economic Development

Insurance, generally, has indeed become in modern times one of the major instruments of economic policy for stability and growth. Considered from the general point of view of development, crop insurance may be regarded as an instrument of partial mobilization and earmarking of savings, and, when compulsory, as an instrument of income redistribution among the farming community, and sometimes among the whole community, when there is some form of government support, in sharing the burden of the losses occurring in agriculture in times of distress.

When family labor is included in the calculation of production costs, multi-risk or all risk crop insurance may provide some of the elements of a minimum income guarantee scheme. When diversification from one or two major export crops toward import substitution or production of other export crops is a foremost goal, crop insurance with appropriate premium subsidies where needed may provide an incentive to increase production of domestic food or other needed crop, thus helping to redress a difficult structural balance of payments situation. As indicated earlier, stabilization of farm income also helps to keep the flow of farm supplies even, thus in turn helping to maintain, establish, and increase demand for industrial development. Crop insurance, therefore, can be conceived as part of a comprehensive program of incentives for development. This implies the existence of an extension service or some comparable means of helping the farmer by demonstrating to him practical means of increasing productivity. This may be by encouraging him to use better seed, fertilizer, irrigation, and other inputs and equipment, and to use appropriate credit terms so that he may purchase the necessary inputs. Effective implementation of crop insurance during the process of development would be conducive toward creating a food buffer reserve and promoting stability of food prices.

Crop insurance has played a role in meeting the impact of crop yield risks in the Great Plains of the United States. This illustrates how crop insurance, where feasible, can be expected to be a major instrument of programs of development of rain-fed agriculture. This role has been further illustrated in Mexico. Hsieh 3 reports, for example, that the lack of irrigation facilities in most parts of the 116,000-hectare corn project in a highland rain-fed area with a considerable drought hazard, in the State of Puebla, would have constituted a serious deterrent to inducing additional expenditures by smallholders on farm inputs, if it had not been for the availability of the Mexican crop insurance program. Despite certain limitations of the latter, such as the small coverage (equivalent to only 1,100 kilograms of shelled corn per hectare) and high, though government-subsidized premiums, crop insurance was probably indispensable to achieving the rapid initial success of the Puebla project.

In addition to providing direct incentives, crop insurance may have some important catalytic effects that would also contribute to development. Lipton4 argues that it could contribute to the transformation of the structure of property relations as well as lead indirectly to a reduction in the birth rate of peasant families through an increase in security. There is little doubt that in many lower-income countries the tenant and the landless laborer will continue to defer to the landlord, the merchant, or the money lender until the government provides (1) substitutes for the old trade credit, (2) adequate employment, and (3) appropriate contact with officials. Such substitutes as crop insurance, loans secured against the harvest, and open employment opportunities, may be costly, “but it might be truly self-defeating to act as if such substitutes already existed and to ignore the effects on newly enacted agricultural legislation of the real, feudal power still prevailing at the grass roots.” Examples of such situations are many in the lower-income countries.

The predominance of large families in subsistence societies illustrates the insurance principle. Traditionally, a farm couple was well advised to have a number of children to ensure one surviving son; many children also mean availability of no-wage family labor as well as insurance against destitution in old age; today a smaller family will do. Many practices now standing in the way of economic progress similarly were attempts to provide built-in insurance. Among them are tenants’ preference for share-rents over fixed rents; borrowers’ preference for repaying in kind over repayment in cash; hoarding of marketable surplus, etc. Alternative sources of security, especially crop insurance, could contribute to overcome these obstacles.

Crop Insurance and Creditworthiness

One of the most important contributions of a good crop insurance system to development is its strengthening of the financial stability and soundness of farmers and hence their creditworthiness for borrowing funds needed for development. We should certainly expect that well-devised and administered systems of crop insurance would increase farmers’ creditworthiness. The ever-present element of risk in farming is a major consideration in establishing creditworthiness. When considering the extension of agricultural credit, primary attention may have to be given to the objectives of increasing domestic agricultural production and to improving farmers’ real income; yet, the repayment ability of applicants is always a major consideration in reaching decisions on loan applications. The matter of collateral is important too, but it stands next to repayment ability. In the financing of major crops the absence or presence of an insurance program is therefore often fundamental because of its implications for improving the ability of farmers to repay.

Less developed countries are currently faced with the challenge of rapid agricultural development within a context of generally declining world agricultural prices (except for a few commodities); it was generally the opposite for their counterparts of yesteryear, some 200 years or so ago, which are now among today’s advanced countries. The result in several developing countries has been a dramatic increase in farm output in recent years, but profits went only to a relatively few well-to-do landowners, while aggravating the financial position of a great many other peasants or farmers and their discontent. For example, Wharton 5 reports that studies conducted at the International Rice Research Institute indicate that whereas the total cash cost of production for the average Filipino rice farmer using traditional methods and varieties is about $20 per hectare, the cost rises to $220 when the new high-yielding variety IR-8 is grown. Although the yield may increase threefold leading to a net return four times greater than with traditional varieties, the farmer must have access to substantially greater credit to finance his operations.

Hence, farmers in less developed countries are currently bearing a relatively heavier burden of rapid credit absorption and consequently there is a larger amount of defaulting on repayment on the part of farmers suddenly stricken by adverse weather conditions. Governments are faced with disruption of development programs, balance of payments problems, and financial crises when the agricultural sector is stricken by adverse weather conditions. They then may have to turn to their international creditors to present them with moratoriums on their international debts.

Crop insurance and re-insurance may contribute to easing such recurring situations. In countries where it already exists, crop insurance often is closely tied in with credit. This is because banks and other credit institutions may be reluctant to lend money to a peasant or farmer whose only security is the crop he plans to raise. Crop insurance, used as collateral for loans, can help to overcome this reluctance to lend by improving farmers’ creditworthiness, i.e., crop insurance and credit are mutually reinforcing. However, the credit system must be adequate to needs: thus, crop insurance is not likely to accomplish very much if the proceeds to farmers are ultimately dissipated in repaying loans to small local traders and money lenders at excessively high rates of interest.

Much is to be learned from the early experiences of the U.S. Federal Crop Insurance Program. At its inception in the late 1930’s it had a very ambitious threefold objective, namely (1) the protection of individual farmers’ income against the hazards of crop failure, to enhance their creditworthiness, (2) the protection of consumers against shortage of food supplies and extreme prices, and (3) a measure of assistance to business and employment at large by stabilizing farmers’ buying power with a view to sustaining economic activity and growth. Thus, it was hoped in the United States, during the Depression, that a crop insurance scheme combining its effects with those of a commodity reserve scheme—both major instruments of the program established under the Agricultural Adjustment Act of 1938—would partially level out the economic effects of fluctuations in production, provide the farmer who suffers a crop failure with some income upon which to live, and in years of surplus prevent the added supplies from lending their full force to depressing the prices of farm commodities. The objectives of the U.S. crop insurance program had, however, to be later reassessed (1947) and emphasis placed on the promotion of the national welfare by improving the economic stability of agriculture through a sound system of crop insurance and providing the means for the research and experience helpful in devising and establishing such insurance. Nevertheless, this change of emphasis does not preclude that a well-conceived crop insurance program might in the years ahead play a major role in the stabilization of the economies of a number of countries.

Establishment of Crop Insurance Systems

The problem of crop insurance has many ramifications which must be considered within the context of a particular economy. In most lower-income countries, before proceeding with the design and implementation of any crop insurance system, a thorough examination of activities in the agricultural sector may be needed with a view to ascertaining whether the necessary agricultural programs and policies exist; if they do not, coherent new policies would be needed to provide a sound basis for such a crop insurance scheme.

A multi-risk or all-risk crop insurance scheme provides essentially a specified yield guarantee. Under most schemes in effect the maximum yield guaranteed per hectare does not generally exceed 75 per cent of the average yield computed for the period of reference (generally the five previous years); and in any case the amount of the indemnity is usually limited to the amount of expenditures committed to the insured crop. Under voluntary crop insurance the insurance has to be sold and in some systems the farmer may choose from among several options the amount of indemnity he wishes to receive per bushel or quintal and this amount is a major element in the calculation of the premium he will have to pay. Under compulsory crop insurance, a form of crop insurance generally advisable in less developed countries, there is necessarily less flexibility and the premium, which is lower due to a wider distribution of risks, has the characteristics of a compulsory levy. Nevertheless, in both types premium rates may vary widely between areas and between crops, depending on the risks, which are measured to the extent practicable by losses experienced in the previous years. The insuring of many kinds of crops in many areas brings diversification of risks. Even so, an important reserve fund is generally required as a cushion to spread the losses over several years.

The insured farmer will know the area designations of his farm or fields, the yield guaranteed per hectare, and the amount of the premium rate per hectare. Each year after planting he must report the number and location of hectares planted to the several crops insured under the crop insurance program. He reports any serious damage during the growing season and reports shortfalls and losses after harvest. He must keep records and evidence to prove the amount of his production. An adjuster, who might be a farmer, a retired farmer, a member of a village cultivation committee, or a government agricultural officer, inspects the farm, measures the stricken fields, verifies the production, determines the cause of loss and, if not caused by neglect, poor farming practices, or some other uninsured cause, helps the farmer to prepare his claim. It is important that the farmer be paid promptly after the loss is accurately assessed. Consequently, the legal and political status, as well as the structure and organization of the system, must be such as to assure the necessary rapidity in the functioning of the system.

Appropriate legislation is needed to establish the bases for a sound scheme and to create the crop insurance agency to carry it out. Multi-risk or all-risk crop insurance schemes are usually operated by a government-sponsored agency. Credit institutions and farmers’ organizations might, however, in some instances contribute to capital needs. Nonetheless, in most countries, financial support has to be provided by the government in the form of participation in the reserve fund and possibly of subsidization of the cost of premiums to farmers.

Of course, difficulties are to be expected in establishing a crop insurance program in lower-income countries. They should not be underestimated, but they are not insuperable as time passes. In view of the current shortage of basic agricultural statistics in most of these countries, preliminary experimentation on a small but appropriate scale would be essential to build an adequate actuarial basis for a crop insurance scheme. The objectives of a pilot scheme would be (1) to study the technical aspects of crop insurance so that suitable features could be tested in terms of their relative effectiveness and popularity and to evolve a suitable actuarial grid; (2) to develop the appropriate machinery for efficient administration of the scheme and factor out the costs of the various operations; (3) to develop programs for educating farmers, farm organization leaders, extension workers, and agricultural officers in the technique of crop insurance and to demonstrate its workability; and (4) to train a nucleus of skilled personnel for possible future generalization of the scheme.

Pilot schemes would, however, in their nature, be limited. Thus, because crop insurance is closely connected with prevailing local conditions, a pilot crop insurance scheme would best be confined to limited areas in a limited number of villages. A pilot scheme should be confined to a few major crops. The data for demarcating homogeneous risk areas should, wherever possible, be obtained from village revenue records showing frequency of crop losses over a period of years, land revenue revision records, data on yield of crops, soil fertility, and agroclimatic factors. A compulsory scheme would have several advantages. On the other hand a pilot scheme, if further consideration convinces a country to go ahead, should be operated for a sufficient number of years in order for it to yield adequate information on which to base conclusions.

Financing of Crop Insurance Schemes

The financing of sound crop insurance programs, varied as they might be as to crops insured, amounts of coverage, premium levels, and degrees of appropriate government subsidization, if justified, would not, however, appear to raise insuperable problems. I am well aware that in dealing with areas and peoples of different nationalities and cultures, methods usable in certain places may not be suitable in others. Ultimately, however, the major financial problem is twofold, namely (1) the size of the domestic crop insurance fund and how it should be provided for, and (2) the easing of the financial stress upon domestic finances through some form of external re-insurance, either total or partial.

On the problem of domestic financing, it should be made clear that crop insurance programs can be initiated only in countries, or states or provinces thereof, with a sufficient agricultural and institutional structure. This prerequisite being met, and where the principle of development assistance is recognized and applied, appropriate arrangements might then be made to enable eligible countries to use, for instance, unused Public Law 480 accumulated balances on some matching basis with domestic resources to put together reserve funds. Noteworthy features of U.S. P.L. 480 are indeed its provisions for local currency sales and for granting or lending substantial portions of these accrued funds to the recipient country. The World Food Program of utilizing agricultural surpluses to meet food deficits may also generate counterpart funds that could likewise be merged under appropriate terms in a recipient country’s agricultural insurance reserve fund.

In modern insurance practice, re-insurance is generally a necessity, and re-insurance for crop insurance schemes would be essential for most developing countries. Through re-insurance, the insurer having accepted a risk that is beyond its own means, will cede part of the risk to another insurer. This is particularly the case in the insurance of high risks requiring sizable reserves, as is multi-risk or all risk crop insurance. The re-insurance of crop risks is not new. It has been practiced commercially for a long time for selected plantation crops, such as coffee, tea, and sugarcane. Private underwriting of crop risks may be authorized in a country with re-insurance protection being available from the government. This is illustrated by a little known and never used provision of the U.S. Federal Crop Insurance Act. A government-sponsored underwriting of crop risks may be authorized with reinsurance protection being secured on the commercial market. This is illustrated by the Mauritius Sugarcane Insurance Scheme and the Puerto Rico Farm Insurance Scheme seeking re-insurance (total or partial) on the international market. In 1957, the U.S. Federal Crop Insurance Act was amended to permit the U.S. Federal Crop Insurance Corporation to provide reinsurance for crop or plantation insurance in Puerto Rico when such re-insurance is not available from private sources at reasonable cost. This provision was used for the first time in 1968, but the larger share of the re-insurance was even then obtained from commercial sources. A central government may authorize state or provincial government underwriting of crop risks with the central government standing behind state or provincial schemes through re-insurance. An example of this is provided by Canada where multi-risk or all risk crop insurance was introduced in 1959 with provision for each province which so desired to establish its own independent provincial crop insurance corporation, these being in turn re-insured at the federal level. The’ Canadian scheme also has the peculiarity that it is voluntary, with the Government of Canada subsidizing 25 per cent of the cost of premiums to farmers and paying one half of the administrative costs and the provincial government the other half. Provincial governments in some cases also subsidize a portion of premium costs. The experience in Canada where the Federal Government assists the provincial governments in the development and operation of crop insurance plans, separated provincially, could be quite relevant to large countries with a decentralized administrative structure. It could be quite valuable also in any study toward establishing an international crop insurance system.

In any sound development strategy the functions of prevention and of assumption of risks are closely associated. The objectives are first to tame the environment so as to make nature yield more than it would otherwise do through sound agricultural development projects of one kind or another, and then to provide insurance protection against damages which cannot be avoided. The appropriate balancing of these objectives is at the center of the effectiveness of long-run agricultural development aid credits, some of which are made available for 50 years or so, a time span over which any agricultural development project is liable to be repeatedly disrupted by heavy losses due to adverse environmental conditions, notably weather, the risk probability of which can generally be calculated. (Even irrigation projects are not immune to weather risks.) Crop insurance and re-insurance might provide some of the necessary criteria on the basis of which several of the countries concerned could be eligible for and rapidly receive more effective assistance. The possibility of channeling a portion of the resources committed each year to multilateral aid soft lending operations through the reserve fund that an international crop insurance/re-insurance scheme would require, and thus ultimately to eligible countries in proportions consistent with the importance of their agricultural sector and their self-help efforts, deserves careful examination. So does the possibility that an existing soft loan multilateral aid fund could be made to fulfill the role of such international crop insurance corporation through annual allocation of a portion of its resources for this purpose, and the collection of appropriate re-insurance premiums. In such studies it should be borne in mind that a portion of the substantial indemnities to be paid out by such international crop insurance schemes could be paid in surplus commodities.

An international crop insurance corporation would operate by re-insurance rather than by direct insurance. Hence, it would undoubtedly require the crop insurance legislation, plans, and contract provisions of interested countries seeking re-insurance protection to be working on a sound basis, and their agricultural development programs and policies to be developing so as to become appropriate to their needs and coherent in purpose and method.

I hope it will be clear from what I have written that the introduction of crop insurance schemes is possible only in countries where a suitable governmental, institutional, and administrative framework exists; that even in such countries it requires careful preparation and exploration by means of a pilot scheme; and finally that crop insurance provides no panacea. What it does offer is one possibility, which needs to be further examined, of stabilizing agricultural earnings and thus promoting development.

Neas, E.C, Antecedents of Crop Insurance in the United States, Lecture given at the Central American Seminar on Crop and Livestock Insurance, Mexico, October 1966.

Tardy, Louis, Report on Systems of Agricultural Credit and Insurance (submitted by) League of Nations, Geneva, December 14, 1938.

S.C. Hsieh, On the Puebla Project, Mexico, Asian Development Bank, Manila, 1970.

Michael Lipton, “Strategy for Agriculture: Urban Bias and Rural Planning,” in P. Streeten and M. Lipton, Editors, The Crisis of Indian Planning: Economic Planning in the 1960’s, Oxford University Press, London, 1968.

Clifton R. Wharton, Jr., “The Green Revolution: Cornucopia or Pandora’s Box?” Foreign Affairs, Vol. 47, No. 3 (New York, April 1969).

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