Agriculture reforms - replace crop insurance with direct payments

I have blogged on multiple times about the problems with market-based insurance approach to address complex development issues. See this on the enduring seductive appeal of insurance for crops, health, and savings for the poor, and this on financial engineering in general as a meaningful poverty eradication strategy. 

This post discusses why health insurance is not only likely to be neither effective nor sustainable but also likely to end up weakening the public health system. 

Never mind, researchers including those from the likes of World Bank continue to believe in such simplistic but logically appealing PPP-type solutions. 

I had blogged earlier here about the problems and limitations of crop insurance. 

A report in Business Standard raises the inevitable problems with the latest crop insurance effort, PMFBY,

Several states feel the claims paid by insurance companies in comparison to the premium collected are quite low while their financial burden has increased manifold as they have to bear 50 per cent of the premium subsidy. The latest Central government guidelines which further capped the premium subsidy at 30 per cent in un-irrigated areas and 25 per cent in irrigated, also pushed the burden of running the scheme towards the states particularly in crops and areas that are risky... States fear that after the latest changes in PMFBY, their share of subsidy burden will increase as the Centre has capped its subsidy burden at 25 per cent and 30 per cent, while there is no such limit on them... Under PMFBY, farmers pay 2 per cent of the sum insured as their share of premium for kharif crops, 1.5 per cent for rabi crops and 5 per cent for horticulture and commercial crops... Bihar was the first state to opt-out of PMFBY, followed by West Bengal. Thereafter, Andhra Pradesh, Telangana and Jharkhand also moved out of the scheme. Punjab has never been part of PMFBY, while Gujarat has become the latest not to join the scheme. Madhya Pradesh, which is again a major state governed by the ruling party is also reportedly having second thoughts about the scheme.

Further, like with health insurance, crop insurance too suffers from all the classic problems of escalating premiums as the numbers of farmers shrink and their diversity narrows. And in this case, the consequences will have to be borne by the state governments as the residual payer of actuarial premiums, 

Once PMFBY has been made voluntary for loanee farmers as well, the actuarial premium for several crops in many areas tend to be on the higher side, which means if states want to participate in the scheme, they will have to fork out more in terms of their share of subsidy. At present, the actuarial premium in most crops is around 15-20 per cent, which insurance company officials said will easily go up to 25-30 per cent once fewer numbers of farmers participate in the scheme... Suppose the actuarial premium of a crop comes to 40 per cent in unirrigated areas. In this, the farmers share is capped at 2 per cent, while in the old format the balance 38 per cent subsidy is shared equally between Centre and states in the ratio of 50:50. However, from this kharif season (2020), while farmers share will remain at 2 per cent, Centre on its part will bear the subsidy only upto 30 per cent, which means 15 per cent in the 50:50 ratio. The balance, which in this case comes to around 23 per cent, will have to be borne by the concerned states, if it wants to implement the scheme.

This is the latest evidence on the limitations of crop-insurance approach to supporting agriculture. The PMFBY is likely to turn out to be only the latest in the long series of crop insurance programs that have struggled to realise its impact. 

Increasing productivity and supporting farmer incomes is a deeply complex issue (see also this). There has to be three legs to any meaningful initiative in this regard - investments in agriculture infrastructure, especially irrigation and storage; enabling reforms to ease frictions on backward and forward linkages for farmers; and a risk mitigation mechanism for farmers against the vagaries of both weather and markets.

Fortunately the government has recognised their importance and initiated measures on all the three fronts. The first two are now about implementation. On both sides, there are several precedents of failure to learn from and improve the effectiveness of implementation. And that's not going to be easy. I have blogged here and here respectively about them.

As regards the third leg, the government had chosen to go with crop-insurance. It may not have been the wisest choice. It may be time to acknowledge that, as NITI Aayog member Ramesh Chand has expressed on multiple occasions, plain simple direct transfers are the least distortionary and least expensive way forward on agriculture risk mitigation. Even with their implementation challenges, especially involving targeting to tenant farmers, they are superior to alternatives. But the design of their implementation should be left to states.

Update 1 (28.08.2020)

The evolution of agriculture market policies in Indian in recent years.

Update 2 (21.01.2021)

The problems with PMFBY.

Update 3 (18.02.2022)

Business Standard oped on PMFBY

The risks involved are too high, thanks to farming being a wholly outdoor activity, open to all kinds of natural hazards and attacks by diseases, pests, and stray animals. Claims are generally far higher than the premium collected by insurance companies. Besides, the compensation computed by insurers is often disputed by the beneficiaries. The farmers, too, are not keen to take insurance cover for their crops because they do not deem it financially rewarding. The claims sought by them are most often rejected by the insurers and, if accepted, the payment is usually too meagre and inordinately delayed... Farm insurance has, indeed, been beset with problems ever since it was first introduced in 1972. None of the dozen-odd schemes and insurance models tried and tested till now has proved successful. The PMFBY is no exception. It underwent a thorough revamp in 2020, when it was made voluntary for the farmers, instead of being mandatory for those taking bank loans. Trust deficit has been the biggest issue affecting the credibility of insurance as a means of hedging production risks in agriculture. This, in turn, is attributable to lack of transparency and a time lag in undertaking crop-cutting experiments to assess crop damage, the inadequacy of site-specific past data on crop yields to serve as a benchmark for computing losses, delays in paying states’ share of premium subsidy to the insurance companies, and procedural complications. Unsurprisingly, therefore, the area covered under the PMFBY has seldom exceeded 30 per cent of the total cropland, against the government’s target of extending it to a 50 per cent area.