# **1. Introduction**

Agricultural risk management is an inherent part of the development and poverty agenda because it can contribute significantly to poverty reduction. In most countries, and particularly in developing countries, farmers’ income is highly vulnerable to numerous risks, especially the production risk commonly associated with weather related events. Such events cause significant income fluctuations, can be a major threat to farmers’ financial survival, and can be difficult to manage. The inherent instability of farm income has led governments to devise numerous agricultural income stabilization programs and policies, with crop insurance being among the most prevalent. A survey conducted by the Food and Agriculture Organization (FAO) in the early 1990s reveals that various types of crop insurance programs are present in more than 140 countries (FAO 1991). Most of them, if not all, rely heavily on government subsidies.

However, despite the prevalence of government subsidies, the overall financial experience of traditional crop insurance has been disappointing and, in many instances, disastrous. Low insurance penetration despite high premium subsidies, mostly captured by large farmers, consistent underestimation of the systemic component of production risk, poor financial performance with claims consistently exceeding premiums, inappropriate pricing methodologies, uncontrolled moral hazard, and adverse selection are a few of the key endemic problems that plague national agricultural insurance programs worldwide (Hazell, Pomarelda and Valdes 1986; FAO 1991; Anderson 2001)<sup>1</sup> .

Previous government efforts to develop viable national crop insurance programs have also been frustrated by the inherent lack of clarity regarding the objectives that, depending on policymakers’ view, range from providing social safety nets to risk management. As a risk management instrument, crop insurance, in addition to other financial instruments (savings and credit) and preventive activities, can play a vital role in enabling farmers to deal with production risk and help them to restore their business viability after crop failures. As a social instrument, crop insurance can protect poor farmers from the economic consequences of adverse production shocks, thus restoring their livelihoods.

In the early 1980s, the realization of these daunting challenges led the World Bank to withdraw from providing technical and financial support to government sponsored agricultural insurance programs. However, since the late 1990s, due to the dwindling government subsidies to agricultural producers in developing countries, there has been a renewed interest among development lenders in using agricultural insurance as an important risk management tool that can enhance the business viability of agriculture in developing countries. The emergence of a new generation of parametric and index-based insurance products, which to a large extent, manage to address the moral hazard problem, was another contributing factor that led to revisiting the potential role of agricultural insurance in these economies. The World Bank has initiated a series of feasibility studies on weather-based index insurance in several countries (including Morocco, Nicaragua, and Tunisia) but, until now, none of these innovative programs has been implemented on a larger scale due to the lack of a coherent integrated and practical agricultural risk management framework that could ground these types of instruments in the concept of _crops’ market viability_ – the main topic of this work.

> 1 Hazell, Pomarelda and Valdes (1986) provide a comprehensive analysis of crop yield risk management in developing countries. They investigate the role of public agricultural risk management policies in general and crop insurance in particular in dealing with the variability of farm income.

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