# **1. Introduction**

This paper presents the background and rationale for the Index-based Livestock Insurance (IBLI) project in Mongolia. The Government of Mongolia and the World Bank signed a loan for this project in May of 2005. The first sales occurred in 2006 to cover the mortality of livestock for the first five months of 2007. Sales were greater than anticipated with nearly 10 percent of the herders purchasing the insurance in the first year. Of more significance, financial intermediaries offering loans to herders provided lower interest rates to those herders purchasing this new form of insurance.

The Mongolian countryside remains a herder-based economy. Agriculture contributes nearly one-third of the national GDP and herding accounts for over 80 percent of agriculture. Animals provide sustenance, income, and wealth to protect nearly half the residents of Mongolia. Shocks to the well-being of animals have devastating implications for the rural poor and for the overall Mongolian economy. Major shocks are common as Mongolia has a harsh climate where animals are herded with limited shelter. From 2000-2002, 11 million animals perished due to harsh winters ( _dzud)._ The government has struggled with the obvious question of how to address this problem.

In 2001, Government of Mongolia (GoM) requested assistance from the World Bank to address a problem that has plagued Mongolia for centuries – tremendous death rates in the livestock population. While the country had a social livestock insurance program during the communist period, several attempts to pass a livestock insurance law in recent years have failed. Based on the first involvement from the World Bank in 2001, Skees and Enkh-Amgalan (2002) recommended an index-based insurance program using mortality rates by species and _soum_<sup>_2_</sup> . This recommendation was motivated by significant concerns regarding moral hazard, adverse selection, and extreme monitoring costs that would accompany a traditional livestock insurance program in the vast open spaces of Mongolia. Another concern that was highlighted involved the potential for extreme loss exposure associated with any livestock insurance program in Mongolia.

Since the initial recommendations to implement index-based livestock insurance, a significant policy debate within Mongolia has been occurring about alternatives for insuring and financing the extreme losses associated with the death of large numbers of animals. Given the difficultly in finding solutions that would address both the social and market dimensions of this problem in a fashion that would not strain the state’s limited fiscal resources, GoM requested further research on this issue. The policy recommendations reported in this paper are a product of conceptual developments that have been ongoing inside the World Bank on agricultural insurance and the research that has followed for the GoM.

The core recommendations involve a combination of self-insurance by herders, market-based insurance and social insurance. Herders retain small losses, larger losses are transferred to the private insurance industry, and extreme or catastrophic losses are transferred to the GoM using a public safety net program. Given that this is a novel approach to a significant problem in Mongolia, the GoM was persuaded to begin a pilot program.

The proposed insurance program relies on a mortality rate index by species in a local region ( _sum_ ). The index provides strong incentives to individual herders to continue to manage their herds so as to minimize the impacts of major livestock mortality events; individual herders receive an insurance payout based on the local mortality, irrespective of their individual losses. The insurance would pay out to individual herders whenever the mortality rate in the _soum_ exceeds a specific threshold. Finally, a 33 year time series on adult animal mortality is available for all _soums_ and for the five major species of animals (cattle, horses, camels, sheep and goats).

> 2 In Mongolia a _soum_ is equivalent to a county and an _aimag_ is equivalent to a state or province.

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