How Modi’s crop insurance scheme benefits private insurers far more than it does farmers

The Narendra Modi government launched the Pradhan Mantri Fasal Bima Yojana in 2016. It was advertised as incorporating the best features of earlier crop insurance schemes while removing all their shortcomings.

But as the first part in this series reported, after the scheme’s introduction, crop insurance coverage shrunk.

This second part takes stock of the extent of public funding for crop insurance and whether the money is being utilised efficiently for the intended purpose.

How was crop insurance funded in the past?

As any other insurance, crop loss insurance works on the idea of spreading risk across a large number of people exposed to the same risk – in this case, farmers.

Insurers consider the risk of crop damage in India to be high given the record of significant loss in foodgrain production once every three years. Unsurprisingly, premiums calculated on actuarial considerations – after a statistical analysis of past production figures – are also high. The average across India was 10%-15% of the sum assured for kharif or monsoon crops, with higher premiums in some areas and seasons. In 2016, for instance, it was 19%-21% for kharif crops in Gujarat, Rajasthan and Maharashtra.

Such high premiums are unaffordable for small and marginal farmers who constitute 86% of India’s farmer population. So, the state needs to step in with public funds to make crop insurance work.

India has tried two models of public funding of crop insurance.

Trust model: Farmers pay premiums to a trust which manages the money collected and settles claims. Premiums are set at rates farmers can afford. If compensation claims exceed the capacity of the trust to pay, the state steps in and makes good the deficit.

This model was used for the National Agricultural Insurance Scheme. Its premiums were fixed by the government at relatively low rates, averaging under 3.5% for kharif crops as a whole. A public sector entity, Agriculture Insurance Company, acted as the trust which collected premiums and serviced claims. If the company received claims for more money than it had, the central government, with contributions from the states, paid the rest.

Insurance model: An insurance company collects premiums and pays compensation. Premiums are charged based on actuarial considerations that spread the risk across the insured, minimise the residual risk borne by the company and allow it to cover overhead cost and turn a profit. Farmers pay a portion of the premium and the government pays the rest. But by paying actuarial rate premiums, the government and the farmers absorb most of the risk.

This model was used for the Modified National Agricultural Insurance Scheme and the Weather Based Crop Insurance Scheme. Premiums and claims were managed by insurance companies, which charged actuarially determined premiums, averaging 10%-11% for kharif crops across India. The premiums were paid partly by the farmers, partly by the government. To control its overall expenditure, the government defined caps for the premium rate (11% for kharif crops in the Modified Insurance Scheme) and the premium subsidy (75% for the same scheme). Insurers charging higher premium rates had to reduce the sum assured so that the overall government expenditure did not exceed the cap.

How does PMFBY funding differ from earlier schemes?

In 2015-’16, the National Agricultural Insurance Scheme accounted for 64% of the insured farmers and 70% of the sum assured.

The other schemes, based on the insurance model, not only had a much smaller footprint, most farmers enrolled in them had been compelled to take the insurance along with public sector loans.

Voluntary participation was virtually non-existent in the Modified National Agricultural Insurance Scheme while less than 3% of farmers were enrolled in the Weather Based Crop Insurance Scheme.

In 2016, all three schemes were replaced by Modi’s PMFBY, which adopted the insurance model with actuarially determined premiums, averaging 12%-15% for kharif crops nationally. The government fixed the premiums to be paid by farmers at rates similar to those of the National Agricultural Insurance Scheme and paid the rest with contributions from the states.

For insurers, the PMFBY was much more attractive than previous schemes. The limits on the sums insured and the premium subsidy provided by the government were relaxed. This meant insurers could look forward to doing potentially more business from higher sums assured and higher enrolment. Since the farmers would be paying low fixed premiums, the government would be largely footing the bill.

Where does money for crop insurance come from?

Before the PMFBY was introduced, crop insurance was largely funded by the government. In the last three years under the PMFBY, more than 80% of the overall spending has come from the public exchequer.

The table below shows the money paid in premiums by the farmers and the government for the last five years. The government’s expenditure is under two heads, premium contributions for all schemes and claims support for the National Agricultural Insurance Scheme, which existed until 2015-’16.

Is all this public money being utilised efficiently to achieve the desired outcome? One way to find out is by assessing how much of it actually reaches the intended beneficiaries.

Where is this public money going?

Before 2016, insurers retained less than 12% of the government funding of crop insurance schemes for any season while the rest reached farmers. This changed dratically with the advent of the PMFBY.

The chart below shows the portion of public funds retained by the insurers after settling claims of the insured farmers during successive kharif seasons. Kharif season accounts for two-thirds of the sum assured in a year and data for it is available till 2017 unlike for rabi season. “Routed to farmers” is the money given to the farmers over and above the total amount of premiums collected from them.

Reviewing the data for 2015, the year before the PMFBY was rolled out, is quite instructive. It was a year of severe drought. The bulk of the crop loss claims were settled under the National Agricultural Insurance Scheme, which accounted for around 70% of the sum assured. The government paid out most of the claims since they exceeded the Agriculture Insurance Company’s capacity to pay. Almost all the money paid by the government, therefore, went to the farmers.

Under the PMFBY, the government pays over 80% of the total premium amount. Of this, the insurers retained about 44% and 23% in the last two kharif seasons – a sum of Rs 9,500 crore.

Is the PMFBY model superior to the earlier ‘trust model’?

The Modi government has tried to respond to criticism that the PMFBY has enabled the insurers to make windfall gains.

The agriculture secretary claims the PMFBY model is superior to that of the National Agricultural Insurance Scheme as the government no longer carries liability for “unlimited claims” that could result in huge payouts in case of a major drought.

This argument does not hold. Insurance companies have far lower capacity to absorb risk than the government and must minimise their risk. They use actuarial rates to decide premiums so as to spread risk across the insured, in this case the farmers and the government. High risk equates to high premiums.

There may come a year when the payouts to the farmers are higher than the premium amount collected. But, when cumulated over several years, the premium amount collected on actuarial basis must exceed the payouts and overhead costs, enabling the insurers to make profits. The government is now spending more money over several years on actuarial rate premiums than if it just provided claims support when needed as in the National Agricultural Insurance Scheme.

Actuarial rate premiums allow private insurers to particpate in the PMFBY. This was not possible in a scheme of the trust model. So, is the new model more advantageous for farmers?

The usual argument in favour of private service providers is they are compelled by competition to be more responsive to customers. This argument is not valid for the PMFBY as there is only one insurance provider in any area – so the farmer has no choice. This means that competition is not driving improvement in service metrics. It is left to the government to cajole or threaten insurers for something as basic as timely settlement of claims.

The entire infrastructure used for insurance in rural India belongs to the public sector, from rural bank branches offering insurance and collecting premiums to the state machinery determining crop yields and measuring crop losses. Reports suggest private insurers have hardly any “boots on the ground” and farmers find it difficult to reach them for grievance redress. It is not clear what value private insurers add as an intermediary between the government and the farmers.

Who benefits from PMFBY?

Currently, the government pays 80%-85% of the premiums to make crop insurance affordable for farmers. This means the PMFBY essentially runs on public funds. The quantum of public expenditure is huge, more than Rs 47,000 crore in the past two years during which only 25%-30% of the crop area was covered.

Private insurers use public infrastructure extensively to advertise the PMFBY, enrol farmers who have taken crop loans, collect premiums, settle claims, specify the sums assured for various crops and estimate crop losses.

Clearly, having a trust to manage the crop insurance programme would lead to a far more efficient use of scarce public resources than working through private intermediaries and paying for their overheads and profits. Comparing the experiences of the PMFBY and the National Agricultural Insurance Scheme bears this out.

This begs the question: what was the Modi government’s key consideration when it designed the PMFBY? Was it ensuring relief for stricken farmers or business to corporate insurers?

This is the second part of a two-part series on the Pradhan Mantri Fasal Bima Yojana.

Read the first part: Modi’s ambitious crop insurance scheme is failing. Here are the hard facts

Kannan Kasturi, an independent researcher, writes on matters of public interest and public policy.