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1. The client base of BASIX mainly consists of farmers, living in southern and central India, mainly in Andhra Pradesh. These farmers are often highly dependent on the income generated through harvesting their crop including rice, groundnut and jowar. The key expenses they need to cover are farming inputs, fuel, clothing, and food, of which food constitutes the highest amount for an average BASIX client1. Furthermore financing is very important for the farmers since most of their expenses had to be paid upfront, even while the final outcome of the crop was not known. Additionally clients faced significant weather risk, as irrigation was typically required but not available to them and thus crop yields were highly dependent on the strength of the monsoon. As a result of these circumstances, BASIX clients faced two key problems, namely financing their expenses such as farming inputs and secondly the high dependency on weather conditions, as these dictated the amount of income generated and subsequently the survival of their families.

In order to mitigate the risk clients often used one of two methods, either saving in order to liquidate assets in hard times or by borrowing from a local money lender in times of crisis (often at interest rates of 10% or more per month). In some circumstances the unavailability of funds to borrow in times of crisis was so significant that in 2003 Andhra Pradesh made the headlines as thousands of farmers committed suicide.

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2. A rainfall shock as defined as either, (i) a delay in the onset of monsoon and (ii) a significant shortfall in the amount of rain in the 90 day post-onset period,2 has an significant impact on the crop yields that farmers can attain and therefore significantly affects their welfare. The initial strategy of BASIX to mitigate these risks for farmers was implementing a multilevel insurance program. This program meant, that each farmer would pay an annual premium, of which a certain percentage would be kept in the villages account and the remainder in a multi-village account. As claims are made by the individual farmers, the group as a whole would decide whether to accept the claim or not. BASIX would then be liable for claims that exceed the multivillage account. The key problem with this first attempt at insuring the farmers against adverse weather conditions was, that it included a high level of administrative costs and subsequently a high premium, which many farmers were not willing to pay. As a result BASIX sought to simplify the system by developing other insurance products, that would allow for lower premiums for the end customer.

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3. Traditional insurance is a financial mechanism in the form of a contract or policy between two parties (the insurer and the insured) that aims to reduce the uncertainty of loss, or risk, by pooling small payments from a large number of insured so that the burden of losses among a few is distributed over many.3 As such traditional insurance provides the key benefit of sheltering the insured from the adverse effects of weather events. However the key problem with this insurance is that it is very costly to administer, as each individuals claim has to be evaluated individually by the insurer. Also adverse weather events often affect all individuals in a specific area thus leading to high levels of claims at the same time due to correlation. In traditional insurance both moral hazard and adverse selection are existent, as there is asymmetry of information which can be abused by the client. Index insurance has a defined threshold and a limit that establish the range of values over which indemnity payments can be made. The threshold marks the point at which payments begin. Once the threshold is reached, the payment increases incrementally as the value of the index approaches the limit.4 Index insurance on the other hand has got more simple information requirements as the specific thresholds for reimbursements are defined beforehand and thus payments are easily calculated. Also moral hazard is reduced, as the individual cannot make use of information asymmetry as in traditional insurance. Also the clear and transparent structure allows for lower
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administration costs in addition to the possibility of reinsuring the policies as the contracts are standardized. However despite its advantages the standardization comes at the cost of some individuals as basis risk is existent (losses might not be matched by payments). Also reliable data is necessary and often times difficult to attain. Also explaining the concepts of index insurance to often-uneducated clients can be very difficult. Furthermore just as in the case of traditional insurance, correlation risk exists and makes reinsurance necessary.

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4. Monte Carlo Simulation is a forecasting process during, which we create a significant amount of random simulations to predict the future and draw conclusions about the probability of different events occurring. This means that Monte Carlo Simulation allows us to get a reasonable range of different outcomes of a certain event and then attach probabilities to each of these occurring. In the case of weather insurance, Monte Carlo Simulation, would use historical data about rainfall during different periods of the year and then make assumptions about the underlying distribution of the amount of rainfall during specific periods. The model would then run a certain amount of simulations to find a representative sample of predicted rainfall during the growing period. It would then attach the corresponding pay-outs to these events and find an average cost of the contract for the insurance company. This can then be used to price the contract by adding a certain margin to the calculated expected cost. Therefore the model seems to be very attractive in terms of its predictive power and the ability to input a variety of different assumptions about the parameters of the relevant distributions. However it should be considered that Monte Carlo Simulation is only as good as the inputs that are used for the model, therefore not every result should be considered correct before consulting the relevant data.

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5. Given the data in Exhibit 4, we can estimate that the expected market size in all areas where BASIX operates could be around 38226 policies. This estimation relies on the fact that we would assume a similar population penetration as with the microloans we currently provide, then assume that 61% of the loans are given to borrowers working in the agricultural sector of the economy and 23% of those are living in areas in which the policy could actually be sold since weather stations are in close proximity to the client. As a result if we assume an average insurance price as calculated for the trial period of INR500, the total estimated market size for micro insurance would be INR19112768. Of this BASIX could earn INR75 per contract, while experiencing costs of INR10.83 per insurance sold. However here we make a very strong assumption, namely that every sales effort will result in a final sale. Given that the farmers want to insure against the adverse affects of weather, we can calculate the expected loss for each of the three phases and attach probabilities to these events. When we consider the new more transparent policy, it is clear that when using the assigned distributions (lognormal) and calculating the expected economic loss, that the expected loss to the insurance is INR103.454,5 which given that its sold for INR125 seems to be an attractive deal for the company. However given commission of 15% this comes to INR106.25 for the insurer and an expected profit of INR2.8 for each insurance sold. Additionally given this pricing the commission of INR18.75 allows BASIX to cover all its cost. So overall the insurance seems to be fairly priced and thus attractive to the client.

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6. The final question the case poses, is whether BASIX should sell the insurance given the new policy. First of all it is clear that given costs to sell the insurance of INR10.83 per contract and an income of INR18.75 per insurance sold, selling the product is clearly profitable. Furthermore considering that we estimated the market to be 38226 policies the total increase in net profit would only be INR302749 which given the current net profit of 3 million would represent an increase of 10%, an attractive undertaking. And it should be considered that in the context of a microfinance institution profitability is not everything, as BASIX has got a double bottom line, including both economic but also social factors. Especially since BASIX mission was a follows promoting a large number of sustainable livelihoods6, providing insurance for its customers should be seen as an integral part of their business and providing sustainability. Additionally BASIX wanted to innovate in the market and providing this insurance would clearly represent the ability of the institution to innovate, especially given the fact that such an insurance was a complete novelty for a developing country.7 Thus it can be summarized that the product should be provided by BASIX, since it will not only provide an attractive profit opportunity but is also clearly in line with their mission.

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Appendix 1.