The Feed the Future Enabling Environment for Food Security (EEFS) project recently launched an analytical guidance document identifying the enabling environment factors that drive animal source food (ASF) market system success in terms of economic growth, resilience, inclusiveness, and improved nutrition. The guidance document organizes findings into three interconnected categories: supply-side factors, marketing factors, and financial services factors.

The first installment of this four-part blog series provides a general overview of the guidance document and how the findings can benefit USAID decision-making. The second installment summarizes the supply-side factors in the enabling environment for ASF market systems, and the third installment examines marketing factors for ASF system success. This final installment summarizes factors in the enabling environment that support financial services for ASF system success.

Overview

For producers and processors of ASF products to increase productivity and meet end-market specifications, they must improve their practices and technologies. These actors, however, face challenges related to liquidity and mortality risk that reduce their investment incentives.

Improving the enabling environment for livestock enterprises to access credit will expand liquidity for operational costs (working capital) and capital investments needed for productivity gains. Additionally, insurance products can limit the downside risk associated with animal mortality, effectively support system-wide resilience, and provide investment incentives for livestock producers and processors.

Access to Credit

It is well-known that access to credit in the agricultural sector is far more limited than in other economic sectors with higher degrees of formality, more reliable revenue streams, and more immovable tangible assets. In the livestock sector, primary producers face additional challenges related to the high upfront costs of acquiring initial animal stock, as well as the need to finance operations without revenue until an animal is sold, such as through a fattening enterprise.

There are various forms, or domains, for livestock credit, ranging from formal commercial sources and informal/traditional schemes to value chain financing arrangements.

Formal Livestock Credit

Formal credit for livestock and crop-based enterprises alike rely on a real property law and a secured transaction law, which enable lenders to manage default risk, thus incentivizing the supply of credit. The enabling environment for livestock credit in particular also relies on a secured transaction law that sufficiently covers movable assets such as livestock, as well as a well-functioning movable collateral registry to ensure multiple liens are not placed on a single animal/herd.

In addition to commercial lenders, an alternative formal channel for credit in the livestock sector includes public sector lending programs. However, EEFS’ research found little practical evidence of sustained success or impact from these credit sources, and that they often fail to reach stated target borrowers most in need.

Informal Livestock Credit

Where formal sources of credit are limited for livestock enterprises, informal schemes have demonstrated some success. For instance, a “heifer-in-trust” arrangement is an in-kind loan of a live animal from producer to producer. Under these models, a female animal is loaned from a producer with an established herd to a younger startup producer until they may establish a herd. Often, producer groups are used as the mechanism to facilitate the transfer, and offspring may be distributed across group members. Informal credit arrangements such as these are naturally more appropriate for small-scale producers, but are unlikely to satisfy the growth requirements of more commercially oriented producers.

Value Chain Financing for Livestock Enterprises

Value chain financing arrangement are those in which credit is extended based on future transactions rather than securitized assets. Typically, a buyer helps facilitate producer credit by entering into a formal forward purchase arrangement, which can be used as the collateral by a formal financial institution to have confidence in the borrower’s ability to repay a loan. These arrangements may also be facilitated with in-kind loans, where a buyer extends inputs, such as animal feed, to a supplier in exchange for an agreed forward purchase price.

In these arrangements, production risks are shared between the producer and buyer; however, there are often perceived or real risks of one party failing to execute their end of the agreement. The enabling environment can therefore support the functioning of value chain financing arrangements through a dependable formal contract law, which is consistently enforced, so that both parties are protected against counter-party risk. Donor-funded support can facilitate these arrangements initially by providing partial loan guarantees, as well as in the design and negotiation of forward purchase arrangements between parties.

Access to Insurance

While agricultural insurance overall remains limited in least developed countries, livestock-based insurance is particularly limited, accounting for only 10 percent of overall agricultural insurance premiums. [1] The evidence of success of livestock-related insurance products has been limited for several reasons, including implementation complexity, high costs, and lack of understanding among producers.

An insurance scheme in India for dairy cattle demonstrated the challenges of complexity. For instance, payout required an animal postmortem report (paid by the producer), slow release of claims, and refusal of insurance companies to provide coverage for cattle that were not part of a government distribution scheme. This scheme failed to achieve commercial sustainability. [2] More recently, a study in Ethiopia demonstrated the challenge of covering operational cost to achieve commercial sustainability, as one-third of livestock keepers were unwilling to pay just 4 percent of animal value as an insurance premium. [3]

Technology is now helping to reduce complexity of claims process, costs, and fraud. For instance, dedicated mobile apps and microchips now enable animal identification and remote claims processing. The USAID-funded Mobile Solutions Technical Assistance and Research (mSTAR) project has identified opportunities where digital access can improve livestock-based insurance.

Index-based insurance products are increasingly popular, as they reduce both information asymmetry and transaction costs. These products insure against objective measurements of covariate events, such as droughts, and often pay out without need for proof of animal mortality. Despite advancements in the index-based approach, challenges remain, and commercial sustainability has been elusive. For instance, the Index-Based Livestock Insurance (IBLI) program in East Africa found that many Ethiopian livestock producers were not familiar with the concept of insurance, and many expected premium payments to result in annual payouts regardless of the weather and/or animal mortality. [4]

Overall, EEFS’ review found that public, donor, and/or impact investor support in the form of producer awareness and education, premium subsidies, access to reinsurance, operational assistance, and producer access to animal health services are critical elements of establishing successful livestock insurance programs in developing country contexts.

Key Takeaways

Financial services are a critical tool to enable and incentivize producers to increase investments in new technologies and practices. Two primary financial services of need for livestock enterprises are credit and insurance.

Credit can increase producer liquidity for working capital and/or capital investments and may be accessed through formal commercial channels, informal/traditional channels, and/or through value chain financing. Formal commercial channels often require a formal legal framework for securitized movable collateral to stimulate credit supply. Informal/traditional channels which often extend in-kind loans can be leveraged through horizontal coordination mechanisms such as self-help producer groups. Value chain financing requires a consistently enforced contract law that will enable forward purchase agreements as collateral and reduce counter-party risk between suppliers and buyers. 

Insurance products can reduce the risks of livestock production, effectively providing a floor or safety net for producers, and thereby increasing systemic resilience and increasing incentives for new production-level investments. While sustained commercial success of livestock-based insurance in developing countries has been limited, the advancement of mobile technologies and index-based insurance products are reducing implementation costs and complexity. Initial introduction and establishment of livestock based insurance products are likely to be more impactful where producers are linked to animal health services, premiums are subsidized, and producers are sufficiently sensitized to how insurance works. 

References

[1] Dick, W.A and Wang, A. “Government Interventions in Agricultural Insurance,” Agriculture and Agricultural Science Procedia 1 (2010): 4-12, https://doi.org/10.1016/j.aaspro.2010.09.002.

[2] Shenoy, G. V. and Raju, K. V., “Management and Effectiveness of Cattle Insurance under IRDP,” Journal for Decision-Makers (1990), https://doi.org/10.1177/0256090919900204.

[3] Bishu, K. G. “Risk Management and the Potential of Cattle Insurance in Tigray, Northern Ethiopia,” PhD Thesis, University College Cork, 2014, https://cora.ucc.ie/handle/10468/1550.

[4] Takahashi, K. et al. “Experimental Evidence on the Drivers of Index-Based Livestock Insurance Demand in Southern Ethiopia,” World Development 78 (February 2016): 324-340, https://doi.org/10.1016/j.worlddev.2015.10.039.