Regarding banana production, the strike is equal to 22.1 mt/ha and the actuarial fair price of this hypothetical coverage is estimated at 0.29% of the average yield.

Formally, the CRA crop yield is defined as _y_<sup>_CRA_</sup> = min( _y_ ,ˆ _y_ ) − _P_ .

ˆ ˆ ~ where _y_ is the actual yield, _y_ is the strike and _P_ = _E_ max( _y_ − _y_ 0,) is the actuarially fair catastrophe insurance premium.

The minimum business capital requirements adjusted for the catastrophic risk are presented below. The impact of the catastrophic risk on the amount of capital is significant, especially for the cocoa production which is more variable than the banana production. For instance, when the operating profit margin is 5%, the catastrophe coverage reduces the minimum capital requirements by 11.0% for cocoa and 3.4% for bananas. The value added created by the catastrophe coverage is higher for cocoa than for bananas because the former is more exposed to extreme weather events.

## **Minimum capital requirements (in % of average yields) for CRA crop yields**

||Averag<br>|e operating pr<br>|ofit margin (in<br>|% of average<br>|yields)<br>|
|---|---|---|---|---|---|
||5%|10%|15%|20%|25%|
|C|47.2%|45.5%|43.4%|35.7%|30.8%|
|ocoa|(-11.0%)<sup>a</sup>|(-9.2%)|(-6.0%)|(-10.5%)|(-10.6%)|
|Banana|16.6%|11.4%|3.6%|2.3%|1.2%|
||(-3.1%)|(-1.7%)|(-0.7)|(-0.6%)|(-0.2%)|

a Numbers in parentheses are the difference between the minimum capital requirements for CRA crop yields and those for (non-CRA) crop yields which are presented in Box 1.

## Source: Authors.

# **_3.2. Farmer’s Financial Profile_**

The farmer’s ability to absorb exogenous production shocks causing operating losses depends on his ability to raise sufficient resources to meet the costs until the next harvest season. These capital requirements can be met with either internal or external capital.

Liquidity can be obtained from utilizing the farmer’s internal capital resources, such as cash reserves (precautionary savings) or through the sale of less liquid assets (livestockor jewelry). Thus, it is his financial profile, and especially the structure of the farmer’s asset base, that determines his ability to absorb exogenous production shocks and maintain the business following crop yield shortfalls.

Market-based risk financing instruments can provide access to external sources of capital after the occurrence of a loss through insurance or contingent debt. In cases when the cost of this external capital is lower than the cost of the internal capital, access to this additional risk-absorbing capacity may enhance the viability of the farmer’s business or, in some cases, restore it. However, this additional risk financing capacity from external capital providers is costly, which limits its use to productive farmers involved in crop business activities generating a sufficiently high profit margin.

The role of external risk financing solutions as business enhancing instruments is illustrated in Figure 2. The efficient frontier for a farmer with no access to external risk financing tools is drawn for the expected return vs. return variability levels. Technology A generates low (expected) return, but it also exposes farmers to low production risks. On the contrary, technology B has a higher expected return but is riskier. Asset-poor but productive 8