PMFBY: A Panacea or a Necessity for Protecting Indian Farming

Article by: Kolli N Rao, PhD
Source: Linkedin

In India, crop insurance has evolved to cover more areas and crops since the 1970s. The Pradhan Mantri Fasal Bima Yojana (PMFBY) was introduced in 2016 in place of existing claim subsidy-based models, and has now grown to be one of several government initiatives that provide farmers with some level of security when facing risky or uncertain circumstances.

PMFBY, which combines index insurance for widespread risks with indemnity insurance for localized risks, is among the most resilient global crop insurance programs. Even so, it has its share of drawbacks. As a matter of fact, there are several. In actuality, there is no insurance program that comes close to being flawless. Transparency and efficiency can be improved by learning from the experience.

A major criticism of PMFBY in the media and public discourse was that it resulted in undue profits being made by insurance companies, particularly those from the private sector. It is important to examine some of the most critical aspects of insurance and its implementation before determining whether or not the insurance industry profited from its business. In this article, we examine a few aspects:

PMFBY Experience:

In most public discourses and media reports of PMFBY performance, the full premium is presented on one side and only the claims paid on the other side. This is an inaccurate display for two reasons: (i) typically, the premium is booked on the basis of the farmers' enrolment at the beginning of the season; their claims would be known several months after the harvest. If someone reports in April 2022 about the 2021-22 season, the full picture of premium booked is available while the claim picture is incomplete. The yield data may have just been received for some crops, but not for all, and claims are still being calculated for Kharif (2021). Rabi (2021-22) season crops haven't even been harvested, so we can't talk about claims yet. This gives a distorted picture of the premium and the claims. Second, for any given year and more so for recent years, there are states where claims have been calculated but not paid. It is primarily due to a delay in receiving the government premium subsidies. Other factors, such as delay in receiving yield data, disagreements over yield estimation etc, may also delay claim payment. The second distortion occurs when the claim paid is compared to the premium booked (part of which is still pending for payment). The correct representation should be premium received Vs claims paid or premium booked Vs claims incurred, which most often gets missed while reporting.

The PMFBY industry level average claim ratio based on 2016-2021 performance is shown below:

Similarly, a distortion occurs when the premium surplus over claims is interpreted as profit. Many recent media reports automatically classify the difference between the premium and the claim as profit for the insurer. There are several costs associated with insurance. PMFBY administration is so intensive that 50-100 personnel (some on-roll, some off-roll) are deployed in each major district during key periods. Every block / tehsil must have an office, every state must have a call center, there are marketing and publicity expenses; service charges paid to CSC centres and banks for farmers' enrolment, crop loss survey & CCE monitoring costs, etc. Reinsurance, for instance, is a substantial external cost. An industry average break-even point for PMFBY is around 90% claim ratio for a company writing a premium of about Rs 2500 crore. Above that, insurers begin to lose money. Thus, only if the claim ratio is below 90% does the margin or surplus accrue.

Since 2020, eight of the originally empanelled 18 insurance companies have stopped writing crop insurance business, including both public and private insurers. There can be no doubt that this would not have occurred if the insurance companies had been making undue profits.

Claim experience of other Major Markets:

In several countries, agriculture insurance is used as a public tool. Among these are the United States and Canada in North America, Italy, Spain, France, Germany, Russia, etc. in Europe; China, India, Japan, South Korea, Thailand, etc. in Asia, and Brazil, Mexico, etc. in South America.

A number of these countries have supported agriculture insurance for decades. In order to compare the claim ratios, we are using the data from 2016, the year in which PMFBY was introduced. For the crop component of agriculture, the average and worst claim ratios are presented below:

Only Canada & Italy report higher average claim ratios vis-à-vis India, because both had at least one extreme event year during this period. Even without an extreme event year, India's claim ratio of 83% is reasonable and is also better than several other major countries.

How Insurance efficiency measured?

Insurance works on law of averages. Hence each year’s payout cannot be looked into in isolation. Rather an average over a cycle is the right way to look at it. Since we haven't experienced any wide-spread extreme event and had largely normal monsoon during this relatively short cycle of 6 years under PMFBY journey, India clocked a 83% claim ratio, that leaves little reserve with Insurers for a wide-spread extreme event in future. Rather a better way to measure the efficiency is to check if losses were compensated when farmers in individual districts / states suffered large losses. Yes, it did. The following are some examples of states since 2016.

In 2016, 2017 & 2018, Tamil Nadu experienced extreme droughts, resulting in claims of Rs 8397 crore against a gross premium of Rs 4085 crore. This represents a claim ratio of over 200%. Similarly, farmers in Maharashtra received compensation of approximately Rs 4500 crore due to heavy rains during the crop maturity / harvest stage in 2019. Similarly, several states (Chhattisgarh, Haryana, Karnataka, Jharkhand, Madhya Pradesh, Odisha, Telangana etc.) had experienced over 100% claim ratio in one or more years due to regional adverse weather events.

Climate Risk and need for Insurance:

We live in a time when the weather is more unpredictable than ever. There have been several dramatic changes in weather patterns over the past 10-15 years. Climate change negatively impacts major crop yields and associated insurance losses. It isn't just the change in precipitation, but also the increase in temperatures that affect crop yields, as it can affect photosynthesis, increase crop respiration, and increase pest infestation. Also, comparing the ranges of outcomes for the past severe drought of 2002, 2009 and 2015 leads to the conclusion that the probability increase is larger for more extreme events. As a result, crop insurance schemes like PMFBY will play an even greater role in the future.

Way Forward:

The governments monitor PMFBY implementation and introduces improvements from time to time in an effort to improve transparency and expedite claims payments. It currently insures less than 30 percent of the gross cropped area (which is less than half of what other key markets do), despite huge subsidies and a near-compulsory nature for loanee farmers. This requires concerted and coordinated efforts among PMFBY stakeholders to cover larger areas and farming communities. The Govt. of India initiating several technology-based measures both to improve transparency and expedite the benefits. This appears to bring back a few states that exited PMFBY a few years ago. 2023 could be a redefining moment for PMFBY.

Insurance is not a panacea, nor is it for crop production risks. However, globally, governments support crop insurance as part of financial risk management initiatives and for protecting the vulnerable farming communities from vagaries of climatic risks. With its flexibility for seasonality and coverage of wide variety of crops, farmer friendly method of threshold calculation (by eliminating two poor yields from the average), and use of new technologies, PMFBY can undoubtedly be an effective weapon in the risk management arsenal in mitigating the climate risk.