Life is full of random events that can cause sharp setbacks for financial security both on an individual or business level. In urban settings, the primary cause of such events tends to be health problems, car accidents or the death of a loved one. Over the past two hundred years, the developed world has built an intricate financial infrastructure in the form of life insurance, health insurance, home insurance, and a host of other insurance products to shield us from the unpredictability of daily life. The importance of such products towards the improvements of quality of life cannot be underestimated. Being able to insure against unforeseen events enables effective planning for the future and ensures that savings are not wiped out due to uncontrollable events. In the absence of such protection, financial security can vanish in an instant setting back years of work.
Dependency On Weather Outcomes In The Developing World
For well over 2 billion people who depend directly or indirectly on agriculture, one of the biggest sources of random risk in their life is the weather. The weather in particular especially refers to weather outcomes during key times of the year when the crops in their region need rainfall. This could be summer rainfall for Maize or spring rainfall for wheat or other weather outcomes dependent on the local crop in the area. Every few years, a drought or flood, which tend to be the biggest risks to agriculture, will cause crop losses. The local area may take years to recover from these losses as there tends to be a cascading effect going well beyond the immediate loss of income for the farmers growing these crops and such effects are felt far more deeply in developing countries.
- There is a much higher proportion of food insecure people who may be landless laborers or smallholders for whom the loss of food becomes the most immediate concern.
- Farmers with landholdings face the loss of income leading to debt increases and years in a debt trap.
- Crop failure in the region leads to loss of income for many supporting agribusinesses that rely on farming output to support their own operations like, flour mills, cocoa grinders, sugar mills, and many others. For these businesses, there is often little pricing power at the wholesale end of the supply chain. Prices of food items at grocery stores or prices being paid by multinational giants are unlikely to increase anywhere near local prices reflecting local scarcity. This is because generally speaking the global price of a commodity is where an agribusiness will tend to sell its crop and such prices reflect the global supply-demand balance. A local crop failure then tends to cause the rise in input costs but is commonly not large enough to cause output prices to rise. This lack of pricing power is a hallmark of most commodity businesses that developing countries tend to focus on leading to sharp reductions in income during stress periods.
- Crop losses also curtail feed for livestock businesses often leading to a culling of animals since livestock operations need a continuous source of feed to sustain operations. Culling of livestock or poultry in coordination leads to sharp reductions in price, hurting income in the present while crippling recovery later. Indeed, a sharp reduction in meat prices and a sharp rise in crop prices can often coincide with famine or severe crop losses.
The Role of Weather Insurance
To reduce the various impacts that weather can have on developing countries as well as enable a reduction in poverty, communities around the world need greater access to the types of insurance available in developed countries. New products such as parametric insurance, which make payouts based on objective data such as weather data make it possible to spread insurance availability to many new regions. Specifically, parametric insurance removes the burden of on-the-ground verification which plagues traditional insurance with onerous cost burdens and is open to fraud.
However, there are improvements that need to be made for parametric insurance to function effectively in developing areas such as data availability at a higher resolution. For example, if we initiate a parametric contract that pays based on the realization of drought, the policy will be much more effective if the rainfall measurement is tied to the local area of interest and not 100 miles away from where rainfall patterns can vary significantly. On this front, progress has been rapid with a range of satellite and station weather data being added in recent years along with internet-of-things (IoT) weather data networks being forged by private networks.
At Arbol, we believe weather insurance is a key solution for poverty alleviation in the developing world. Parametric insurance has been rising in popularity but its availability is still limited to specific areas and groups of farmers. To greatly increase availability in the developing world, we believe digital, decentralized contracts that bring together a host of agriculture entities and liquidity providers from around the world will be important to unleash capital and access for this crucial financial infrastructure.
Arbol makes automated payments based on weather outcomes using smart contracts and third-party weather data.
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