Weather risk management and agricultural finance

By Bob Aston

Many farmers in most parts of Kenya are exposed to severe income losses due to weather calamities such as drought, floods and extreme high or low temperatures. Rural smallholder farmers are the ones who are mostly vulnerable as most of them are unable to adapt and mitigate against the adverse effects of climate change.

The frequency and intensity of extreme weather arising from climate change has been on the rise over the years. Many rural smallholders’ farmers have been rendered vulnerable as they often face serious crop failures, income losses and livelihood collapse due to extreme weather events. Bad weather is a serious risk for low-income farmers whose livelihood depends on the natural resource base.

A farmer tending to his tomatoes

It is clear that farmers can only increase their ability to adapt to climate change by undertaking active risk management. Losses due to too much rain, too little rain and excessive heat or cold can be mitigated by using appropriate weather risk management tools.

The increase in extreme weather is highlighting the ability of the financial service to spur climate change adaptation particularly through insurance. Although agricultural weather risk products are growing in importance, most farmers are reluctant to voluntarily pay for insurance.

The correlation between crop volume and both seasonal and regional variability in weather can result in a successful yield or a financial disaster. This indicates that insuring crops against weather risk is extremely important.

One of the agricultural weather risk products that has been growing in importance is Index based insurance. This is an innovative financial product that allows individual smallholder farmers to hedge against agricultural production risks such as drought or floods.

An example is drought-index insurance, which reduces the financial risk of crop failure. This can go a long way in protecting farmers, agro-processors, rural banks and financial institutions, input dealers and others from extreme weather conditions.

Another common type of index based insurance is weather based index insurance. This is an attractive approach to managing weather and climate risk because it relies on weather data and there is no need to track yields, crop or financial losses.  Weather based index insurance can help farmers invest in new technologies even in the face of increasing drought and floods. It is also less expensive to administer since contracts are uniform and no on-farm inspection or loss assessment are required.

Another risk management mechanism involves providers accepting labor that contributes to climate change adaptation as payment for insurance premiums. This can be done by allowing subscribers in drought prone areas to work on projects that build resilience to climate change. Financial institutions and agricultural officers have also been urging farmers to purchase drought resistant seeds that can be resilient during irregular rainfall seasons.

Many micro insurance services for farmers have payouts structured on indexes registering weather that is likely damaging for land and crops. Micro insurance can also provide a weather-linked safety net so that crop failure does not affect the livelihood of farmers.

Farmers' capacity to repay loans is directly correlated to their yields but extreme weather conditions coupled with lack of crop insurance can result in massive crop failures which can lead to many farmers defaulting.