NOTES AgriculTurAl & rurAl DEvElOpmENT 41894 1st Annual Golden Plough Award for Innovative Project Design innovating to reduce risk: iSSuE 27 The case of livestock OcTOBEr 2007 insurance in mongolia Agriculture in Mongolia is dominated by livestock dzud have major effects on rural poverty, and many husbandry, which accounts for some 87 percent of the households that had entered herding during of agricultural Gross Domestic Product (GDP) and the 1990s were stripped of their principal assets. By which employs some 40 percent of the agricul- 2004, rural poverty had risen to 43.2 percent. tural workforce, providing rural households with Addressing the problem of such severe weather- an important but vulnerable source of income and related risk in an effective and sustainable way food security. Livestock's importance to rural liveli- posed a difficult challenge for the country and hoods increased dramatically during the 1990s with for the World Bank. The government endorsed a the transition from collectivized farming to family- program of improved pastoral risk management based herding. Between 1990 and 2000 the num- that includes activities from the community- to ber of herding households increased from 75,000 the national-level, including increased investment to 190,000 (World Bank 2005a). Mongolian herders in infrastructure, services, and hay and fodder are subject to catastrophic weather-related shocks, reserves. While these activities can be helpful in such as droughts, and the severe winter-spring the context of limited, low-level risks, they are colds known as dzuds. Between 1999 and 2002, a insufficient to prevent the kinds of losses incurred series of dzuds led to the loss of one-third of the in extreme dzud events, which bring about high national herd, seriously impacting national GDP. costs in the short- and long-run. Government inter- The levels of livestock mortality associated with a ventions, such as restocking programs, have been found to be expensive, inefficient, and likely to provide perverse incentives for herders not to take steps to lower herd mortality. The alternative of livestock insurance likewise revealed itself as fraught with problems, with past attempts proving unsustainable and susceptible to corruption. A new project that became effective in 2005, however, sought to address past failures and to establish the viability of a new form of insurance ­ index-based livestock insurance. ThE mONgOliA iNDEx- BASED livESTOck iNSurANcE prOjEcT The project is piloting insurance plans in three provinces, Bayankhongor, Uvs, and Khenti. It con- sists of five components. The first provides the ThE WOrlD BANk mechanism to pilot two index-based livestock different social groups, monitoring how the two insurance (IBLI) products: products are received, and in determining whether 1.The Base Insurance Product (BIP) is a commercial herders modify their behavior in response and, if risk instrument, sold and serviced by insurance so, how their behavior changes. The project's fifth companies, for which herders pay a fully loaded component supports the project implementation premium rate. It pays out when a district's (sum) unit in its management functions. mortality rates exceed a defined "trigger" per- The pilot experience will go far in demonstrating the centage--generally between 7 and 10 percent-- viability of the model and in guiding and informing depending on species and location. the project's expansion beyond its initial partici- 2.The Disaster Response Product (DRP) is a social pants. The lessons learned also suggest themselves safety net product financed and provided by as potentially replicable by other project teams, and government that begins payments at mortality as warranting the attention of other governments rates that exceed the exhaustion point of the BIP. that seek to manage the risks faced by livestock- Herders who purchase the BIP are automatically dependent communities. More specifically, the pilot registered for the DRP, on the same species is affirming the great practical importance of for- of livestock and at no additional cost. Those mulating an appropriate regulatory framework and herders who have not purchased the minimum of strengthening the country's statistical system for value BIP must pay a contribution to cover DRP livestock management. Providing support to insur- administrative costs. ance companies in developing linkages to interna- tional reinsurance markets and devising an effective public information, education, and communication campaign were also essential elements warranting careful consideration in project preparation. iNNOvATiON The problems with individual livestock insurance rendered conventional approaches based on individual losses ineffective and unsustainable in Mongolian conditions. It is unpopular among both livestock owners and insurance providers, subject- ing the latter in particular to transactions that are fraught with moral hazard and related--and often prohibitive--costs of verifying individual losses and determining their eligibility for coverage. The alternative of government-provided public livestock insurance would do little, or nothing, to offset The second component of the project entails a vari- these shortcomings, while the scale of the losses ety of targeted promotional and public awareness between 1999 and 2002 made it clear that govern- activities to foster awareness and inform stakehold- ment resources were, by themselves, insufficient to ers about the details of the two products and the provide for full catastrophic insurance. IBLI pilot. The third component supports the institu- Yet insurance itself remained recognized as an tional framework and capacity necessary to expand essential element of risk mitigation, and a logical the availability of the insurance products once the complement to other ongoing pastoral risk man- viability of IBLI instruments has been established. agement activities. Insurance clearly has the poten- The fourth component monitors a variety of stake- tial to protect herders from unavoidable losses, and holders during the IBLI pilot in tracking access by to mitigate the need for government-sponsored 2 re-stocking programs--if innovative solutions to anism like the DRP, the government has found itself the problems of moral hazard and high verification compelled politically to expose itself to the even costs could be identified. Any such innovations greater risk of compensating herders for livestock would necessarily spread the risks and costs more losses. The fiscal risk implicit in the DRP should, evenly among herders, the government, and the therefore, be weighed against this greater risk, commercial insurance industry. Involving the private which the government incurred in full in the past. insurance industry on a commercial basis not only Conversely, unless there is a catastrophic event improves the financial sustainability of livestock early in the project, there may be insufficient data insurance, it also serves to strengthen the rural on the medium term economic and social impact of finance sector--a key element in the government any indemnity payments to permit the government strategy for diversifying the rural economy. to make an informed decision on the continuance IBLI is an innovation that satisfied these conditions of the DRP. Other critical sustainability factors thus and that addressed a variety of the flaws that ham- include the design of monitoring and evaluation pered previous approaches to livestock insurance in arrangements that will allow any difficulties to Mongolia. It is affordable to a very large number of be addressed early in the life of the pilot, thereby herders and does not reward poor livestock man- enhancing the overall quality of project design. agement. It is financially sustainable and profitable for private insurance providers, focusing squarely on the most significant sources of covariant risk. The approach explicitly defines and delineates the government's proper role, and purposefully inter- acts with other pastoral risk management, post- disaster assistance, and micro-finance initiatives. SuSTAiNABiliTy The sustainability of the BIP beyond the life of the project and its commercial expansion to the national scale is contingent on the decisions of private insurance companies, based on their experi- ence during the pilot and taking into account the relative profitability and future administrative costs of IBLI. Access to international reinsurance markets is another important factor that may well influence whether Mongolian insurance firms will continue providing coverage, and exploring channels of rEplicABiliTy such access is an important facet of the project. A precondition for an index-based insurance prod- The project's institutional capacity building compo- uct is highly correlated loss. While there is no direct nent seeks to increase the financial attractiveness precedent for IBLI, the use of area-based index of index-based insurance by strengthening the insurance for crop yields addresses a number of National Statistics Office, and other government similar problems to those facing Mongolian herd- agencies, in providing commercial insurance pro- ers. Many farmers, for instance, may experience a viders an enabling regulatory environment. crop failure from the same event at the same time, The DRP, on the other hand, is a social, rather than drought for instance. Individual insurance of crop commercial, product which in the event of a major yields also involves high monitoring costs and the disaster, may expose the government to significant risk of reducing incentives for farmers to adopt fiscal risk. Yet in the absence of a structured mech- drought mitigating farming practices. 3 Experiences with index-based crop insurance were more likely to purchase the insurance than in countries like India, Mexico, and the United more wealthy households, which are better able to States established a number of guiding principles withstand dzuds. that were incorporated into the design of IBLI in Indemnity payments made under the project are Mongolia. Sound financial and actuarial methods expected to be used for productive activities. These were introduced to encourage greater discipline include the replacement of livestock, and purchases within the project, and to transfer a proportion of goods and services to increase risk preparedness of risk to the international reinsurance market. and enhance livestock productivity. They would Regardless of whether the project determines that also enable insurance policyholders to pursue the IBLI is viable in Mongolia, a number of lessons alternative and supplementary livelihood strategies should be derived from the pilot that will be useful to other countries facing similar issues. that are stimulated by improved financial services in rural areas, including insurance services. EnvisagEd outcomE and povErty impact rEcognition The IBLI project is considered to be an `enabling' The project received the 2005 Golden Plough operation, promoting livestock insurance as one Award for Innovative Project Design based on its mechanism to enhance the livelihood security of contribution to the World Bank's rural development livestock-owning households by reducing their vul- strategy, Reaching the Rural Poor, and for its atten- nerability to catastrophic livestock mortality events. tion to sustainability and replicability. Accepting While not focused specifically on the needs of poor the Award on behalf of the project team and and marginalized people, it provides an opportu- Mongolian project managers and participants, task nity to ameliorate the social and economic impact team leader Nathan Belete noted that the pilot of severe weather events on herders' livelihoods, "is not only testing the viability of a new insur- thereby contributing to overall poverty alleviation ance product, but also piloting a disaster response in Mongolia. Surveys conducted during project program for highly catastrophic livestock mortality preparation found that poorer herding households events" (World Bank 2006). sourcEs Boldbaatan, Sh. 2005. "Mongolian Dzuds: How Herders are Reducing Their Risks ­ Strengthening Disaster Mitigation and Management Systems in Mongolia" in Know Risk. United Nations Inter-Agency Secretariat of the International Strategy for Disaster Reduction. Geneva. Mahul, Olivier and Jerry Skees. "Piloting Index-based Livestock Insurance in Mongolia" in Access Finance, No. 10, March 2006. World Bank Group. World Bank. 2006. "Agriculture and Rural Lending, Quality Up Sharply." World Bank Internal Communications, March 9, 2006. World Bank. 2005. Project Appraisal Document on a Proposed Credit in the Amount of SDR 5.14 Million (US$7.75 Million Equivalent) to Mongolia for an Index-Based Livestock Insurance Project. May 2, 2005. Report No. 32220-MN. World Bank. 2005a. "Mongolia: Sustaining Livelihoods in Areas with High Natural Disaster Risk" in Agriculture Investment Sourcebook. World Bank. Washington, DC. Nathan Belete is Senior Rural Development Economist in the East Asia Sustainable Development Department and Task Team Leader for the Mongolia Index-Based Livestock Insurance Project. The core Bank team for project supervision includes Andrew Goodland, Olivier Mahul and Gayane Minasyan. Gunnar Larson, who wrote this ARD Note, is a consultant for the Agriculture and Rural Development Department. tHE WorLd BanK 1818 H Street.NW Washington, DC 20433 www.worldbank.org/rural