Emerging Insight: Going beyond basis risk

Basis risk has always been central to discussions of index insurance contract design. At times, however, this has resulted in the evaluation of contracts based on whether they “triggered when they were intended to,” instead of whether they provided effective protection to clients.

The Facility’s recent meeting of the Global Action Network on Agricultural Insurance stressed the need to move beyond discussions of basis risk to a broader conversation about the value of index insurance products. But if we need to look beyond basis risk, what should we be measuring? Index insurance experts at the event identified several possibilities:

1. Timeliness of claims payments, claims ratio, ex-gratia payments, and number of complaints were identified as top indicators to track in order to quickly identify problem areas.
2. Clients’ willingness to pay can provide a point against which to measure value. If insurers are able to offer a product at a price that is at or below the price at which clients value that risk, it is likely to be perceived as good value by the client. But it’s also important to keep a close eye on client’s ongoing responses – renewal rates, although affected by many factors, can nonetheless provide an important clue to how clients perceive the value of a product.
3. Clients are keen on getting a cover that, besides giving a pay-out when there is a loss, can give them greater benefits (e.g., access to credit, better seeds or fertilizers, and more services) and is available from a trusted source. These elements are vital when considering the value of a product, even though they do not feature in the contract design.
4. Increasingly, those in the insurance for development community see the importance of measuring the client value of an insurance contract by the extent to which it helps a farmer maintain her income despite shocks. If a perfect product would allow farmers to maintain at least 75% of their normal income, we can ask how far a product is from that ideal. This is a broader measurement than basis risk, which simply asks whether the contract triggers relative to losses caused by the peril the insurance intended to cover.
5. The Facility’s PACE tool provides a way to assess client value holistically. The tool has recently been adapted for index insurance and used with the Sri Lankan insurer, SANASA.
6. The Global Action Network is exploring ways to combine the PACE analysis with more robust statistical analysis for a comprehensive analysis of client value and product quality.