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Innovative Approach from WSB Aims to Help Farmers Cope with Climate Change

By Wisconsin School of Business

February 1, 2016

WSB Risk and Insurance Ph.D. Adolph Okine develops pricing model to make agricultural insurance cheaper, promote innovation in developing countries

In the developing world, a single season of drought can lead to crop losses that threaten the livelihoods of tens of thousands of small farmers. While agricultural insurance could help, most traditional policies are too expensive. Groups such as the International Fund for Agricultural Development (IFAD) have sought to create index-based insurance options that pay out for losses based on an independent, objective measure linked to crop yield. But identifying that measure, finding the right trigger mechanism that recognizes the true level of risk while providing an affordable policy option, has been elusive.

Adolph Okine, a first-year doctoral actuarial science student in Risk and Insurance at the University of Wisconsin-Madison’s Wisconsin School of Business, has developed an innovative new model that uses data-based triggers to create index-based insurance options. His work has the potential to help farmers in Ghana and other developing countries cope with the impact of climate change and improve the stability of the agricultural industry that is subject to increasingly unstable weather patterns.

Okine, together with Askar Choudhury, James Jones, and Raquiba Choudhury of Illinois State University, used an innovative statistical approach to analyze data to find a trigger point that would initiate payment for crop loss through a simplified, index-based insurance policy that would be significantly more cost effective than traditional agricultural insurance policies.

“Index-based insurance policies can give farmers in developing countries the safety net they need to break the cycle of poverty that even just one year of drought and crop losses can cause,” says Okine, a Ph.D. student in Risk and Insurance at the Wisconsin School of Business. “Our goal was to bring stability to the practice of agriculture in the developing world by looking at rainfall data and finding a reasonable trigger that would signal payment for crop loss. We hope this model will lead to the creation of a fairly priced index insurance product to help farmers struggling to deal with climate change.”

Justin Sydnor, Okine’s advisor and an associate professor of risk and insurance at the Wisconsin School of Business, says, “There’s a great deal of excitement about the potential for index-based insurance policies to help mitigate the risks faced by farmers in developing countries. Adolph and his co-authors’ method of using data to identify a trigger point for index policies should be an important and practical step toward improving the quality of these plans. He is using cutting-edge statistical techniques to answer important questions in insurance.”

Changing weather patterns and reductions in rainfall have left farmers in the developing world especially vulnerable to crop losses. An affordable, index-based insurance product could be used as a tool to promote agricultural and rural development by helping farmers manage the risk of drought and crop loss, while providing an alternative method of funding disaster recovery assistance programs in areas that rely on agriculture.

Prior attempts to create index-based insurance products have considered triggers with arbitrary thresholds of rainfall, such as rainfall amounts below 10 percent of normal. But such triggers have not found the balance between recognizing the likelihood of risk and offering protection at an affordable price point. Okine’s innovative data-driven approach sought to find that balance by identifying a trigger using a clustering model for the districts examined in Ghana to identify a unique threshold for rainfall that is strongly correlated with crop yields in those areas.

Providing a viable means of insuring crop losses in Ghana and other developing countries can have significant impacts. In Ghana alone, farming represents 36 percent of the country’s gross domestic product (GDP) and is the main source of income for 60 percent of the population.

“There’s a great need for affordable crop loss insurance because weather shocks can trap farmers and households in poverty, and the risks associated with agriculture limit the willingness of farmers to invest in measures that might increase their production and improve their economic status,” says Okine.

Okine and his co-authors were recently honored by the Journal of Insurance Issues and The Center for the Study of Insurance Regulation with the Best Paper Award for “Drought Triggered Index Insurance Using Cluster Analysis of Rainfall Affected by Climate Change”.