Bundling Drought Tolerance & Index Insurance to Manage Drought Risk

1. Bundling Drought Tolerance & Index Insurance to Manage Drought Risk Travis J. Lybbert & Michael Carter University of California, Davis Intl. Consortium on Applied Bioeconomy Research Ravello, June 2013

2. Three Basic Ideas • Risk and vulnerability as experienced by poor households is often complex and nuanced • Reducing household vulnerability requires an appreciation of these complexities • Promising agricultural technologies may be necessary but are rarely sufficient We illustrate these ideas using drought vulnerability and drought tolerance

3. The Smallholder Drought Burden • Drought may be a universal lament among farmers, but spatial drought heterogeneity is massive • A pure ‘subsistence burden’ is the exception rather than the rule • Poorly functioning or missing credit / insurance markets therefore amplify drought vulnerability • Drought events can harm the poor directly An obvious, ex post burden • The threat of drought is like a bully A hidden, ex ante burden Can outweigh the ex post burden!

4. Bundling Agronomic & Financial Innovation to Reduce Drought Vulnerability • Recent innovation in both drought tolerance and index insurance Investments, hype, hope…some results • In isolation, each has a limitation DT can’t tolerate extreme drought Full DII may be too expensive for many • Properly bundling the two may help resolve these limitations due to a natural complementarity

5. Drought Tolerance • Longstanding breeding objective…with new tools, renewed promise and high hopes • Massive private sector investments from Pioneer, Syngenta, Monsanto and others • New DT seeds being released

6. US Drought Tolerance Prospects • The reported average DT maize yield benefit in U.S. in 2012 was 5-10 bu/ac (5-17%) • This yield benefit is conditioned on drought severity and is therefore ‘stochastic’

7. Drought Tolerance For Smallholders • Public research and development funding has prioritized DT in a big way in the past decade • Drought as the universal lament of farmers Public-private partnerships (e.g., Drought Tolerant Maize for Africa, Water Efficient Maize for Africa, etc.) • But rich droughts and poor droughts are not alike * Sort of. † Maybe. ‡ Sometimes. *†‡

8. DT Benefits & the Nature of Drought Moderate Severe Extreme Moderate 50 bu/ac is the 90th percentile of maize yield in Ethiopia!

9. Non-Monotonic DT Benefits Reduce Value of DT to Smallholders and Slow Learning (Lybbert and Bell 2010)

10. Index Insurance • Championed recently as a promising alternative to conventional crop insurance • Contract tied to index that is correlated with individual outcomes to dodge moral hazard and adverse selection problems Basis risk and transparency tradeoffs • A growing set of experiences and rigorous evidence suggests that it may reduce both the ex post and the ex ante drought burden • Unlike DT, drought index insurance payouts are monotonically increasing in drought pressure

11. Index Insurance Experimentation • Rainfall China, India, Malawi, Nicaragua, Ethiopia • Satellite Mexico, Kenya, Ethiopia • Satellite + Rainfall Ethiopia, Kenya, Mali • Area-yield Peru, Ecuador • ENSO Peru

12. Drought Index Insurance (DII) Prospects • Will smallholders pay actuarially fair prices? • How sustainable will index insurance markets be? • In contrast to DT, the marginal costs of providing DII are high Beyond pilots public support for DII will be limited Financial and commercial viability critical for DII • Price elasticity of demand for DII is thus critical • Price has often limited uptake of index insurance

13. DT-DII Complementarity Net Benefit

14. Calibrating a DT-DII Product: Ecuador • Rainfed, drought-prone maize production in Guayquil (2001-2011) • Assume DT maize confers yield benefit of 20% at ‘optimal drought’, which fades with less/more severe drought pressure • Area-yield index insurance product calibrated and priced according to historic maize yield • How would a DT-DII bundle compare to DT and DII in isolation?

15. Traditional v (Stylized) DT Maize Yield Distributions

16. Yield-Earnings Profiles

17. What’s a bundled DT-DII product worth?Ecuador Calibration Results • Lessons from the “Biotech Yield Endorsement” pilot of USDA/RMA • Bundling with index insurance eliminates threat of audits and monitoring – but other implementation challenges remain…particularly in developing countries

18. In Summary… • All farmers fear drought, but spatial heterogeneity implies important differences in the drought burden • DT crops may partially lift the ex post drought burden, but drought will continue to ‘bully’ many poor households • Index insurance is promising but can be expensive – and is harder than DT to sustain through public support • A DT-DII bundle may resolve these limitations – now is the time to calibrate, experiment and evaluate • Improving food security will require more than a technocentric ‘build it and they will come’ approach – must appreciate the smallholder perspective on climate change adaptation and associated risks

19. Thank you