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06

Feeding the future 

Open-access content Wednesday 5th June 2019 — updated 5.50pm, Wednesday 29th April 2020

Dr Roman Hohl discusses the key achievements and challenges of the fast-growing agricultural reinsurance industry

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While production increases are required to feed a growing global population, continued specialisations will inevitably lead to higher risk and risk transfer needs to insurance, reinsurance and capital markets. However, the dynamic nature of biological systems and the potential for catastrophe losses make underwriting, pricing and transferring agricultural risks highly complex. Specialised expertise is necessary in order to understand exposure and risk in this fast-growing insurance segment.


Growing need for risk management

Agricultural production has undergone enormous growth since the 1960s, involving vast structural changes. These changes have included specialisation and verticalisation, boosting efficiency and global reach. Today, the production of key staples such as corn, rice and soy is geographically concentrated: for example, the largest 10 corn-producing countries provide 79% of global output, with the three most important markets alone contributing 39%. The ratios for rice, meanwhile, are 86% and 29% respectively. Global trade but limited market access in low-income countries has made the global food system highly vulnerable to production shocks from natural disasters, pests and diseases. Along with commodity markets, agricultural reinsurance has been instrumental in supporting the growth of production through risk transfer, provision of safety nets and collateral for lending.


Fast growth in developing markets

The transformation of public insurance programmes into private-public partnerships (PPP) in many markets, along with the recognition of agricultural insurance as an allowed form of government support under World Trade Organisation rules, has translated into significant growth. While the global agricultural insurance premium stood at $10.2bn in 2006, it had grown threefold to $30.8bn by 2017. The largest 10 markets produce nearly 90% of the global premium (Table 1). Most of the recent growth comes from emerging markets, which only accounted for $2.4bn (24% of the total premium) in 2006 but reached $14bn (46%) in 2017. Covering mainly smallholders, China and India alone generated a $10.8bn premium volume in 2017, compared to $250m just 11 years earlier (Table 1). 

In 2016, 25% of the global premium ($7.2bn) was ceded to reinsurance markets, dominated by a few reinsurers with dedicated agriculture teams. Driven by high growth and risk diversification from other insurance lines, most reinsurers underwrite agricultural risks - but often with limited expertise.

Table 1

 

 

Download PDF to see table.


Complex risks and high diversity of products

Over time, a wide range of products has developed to cover crops, livestock, aquaculture, equine (pleasure horses) and bloodstock (racing horses), forests, and greenhouses. Agricultural insurance products include indemnity-based products that rely on dedicated specialists for on-site loss adjustment; index-based (or parametric) products that use indices derived from crop yield data, weather data, satellite measurements (such as vegetation indices) or crop model outputs that directly relate to production losses; and hybrid products that use a combination of index-based triggers or government-declared disasters with indemnity insurance. Indemnity products are the most common (86.5% of the 2017 global premium) and prevail in production systems with larger farm sizes; they are the main products for most livestock, forestry and aquaculture risks. Index insurance is mostly used in smallholder systems and macro-level risk transfer with government entities and agribusinesses, and are increasing in importance (13.5%).

The most advanced insurance products, as used in North America, cover farm revenues, farm income or gross margins against production and market risks, and require prices from commodity futures markets. For example, US livestock and milk producers, and since recently, Chinese pork operators, obtain an indemnity in case the gross margin, expressed as a function of traded feed components (mainly corn and soybean meal) and future markets livestock prices, is below a pre-agreed value below which the producer incurs a financial loss.

 

Private-public partnerships

Initially, most agricultural insurance programmes were either private sector initiatives that covered idiosyncratic risks (such as crop hail) or public sector programmes that included systemic perils (such as drought or flood). During the past 30 years, most public programmes were transformed into PPPs as the financial burden increased - particularly for crop insurance - and private insurers offered additional distribution capabilities and underwriting experience. In most countries, agricultural insurance has become an integral part of the national disaster risk management framework, and PPPs benefit from government premium subsidies and, in some cases, reinsurance. Private-sector insurance products often coexist with PPPs or are the only form of insurance in markets without government support, providing coverage for additional perils or costs that are not publicly compensated (such as business interruption following epidemic livestock diseases).

 

Index insurance in India

With a production system dominated by smallholders in different climate zones, India developed area-yield indices (AYI) insurance in the 1970s and tied insurance to bank loans. Although AYIs induce basis risks, in that yield measured in an administrative area does not necessarily correlate with farm yield, the advantages outweighed the high costs that would otherwise be associated with indemnity insurance. The initial scheme operated under social welfare aspects and was reformed into an actuarial-based programme under a PPP to reduce the growing fiscal burden. The current AYI scheme, often called the Modi scheme, is expected to reach a premium volume of $4.2bn for the 2018-19 year - a significant increase from $850m two years before. With the importance of agriculture for the current government, and the aim to cover 50% of all farmers during the next five years, the scheme is expected to grow to $7bn.

For special crops where crop yield is highly variable and depends on management practices (such as horticulture), insurance is based on multiphase weather indices. A particularity is that the state governments tender crop insurance business to the insurers to obtain the best terms, creating high fluctuations in insurance portfolios over time. 

 

Government-powered insurance in China

After several attempts to establish public sector programmes, agricultural insurance started growing substantially in China after 2007, when the central government allocated substantial premium subsidies and provided binding terms and conditions. China's agriculture system is dominated by smallholders, with most farmers deriving income from activities other than farming. To reach a large number of smallholders, China took advantage of its administrative organisation, where village heads enrol farmers for insurance and public-sector employees support loss adjustment. Insurance terms are typically set at province level, and different franchises and deductibles apply for named perils. The allocation of insurance business is negotiated between the local government and the insurers, which operate as either province-based specialists or national non-life insurers. 

In 2018, 215 million farmers in China were insured, covering close to 75% of the cultivated land and with a premium volume of $8.6bn. The government is planning to consolidate farms to increase productivity and reduce reliance on imports, so insurance products are likely to cover more complex risks, such as market risks, through revenue insurance. Additionally, specialised sectors such as aquaculture might benefit more from government premium subsidies.

 

Future developments

Agricultural insurance is likely to continue developing as a function of production systems, average farm sizes, government policies and agricultural finance initiatives, so will differ in developed and developing markets. More frequent and severe natural disasters and water scarcity are likely to cause large-scale food system supply shocks, which will increase demand for regional risk pooling and risk transfer to reinsurance and capital markets. The agricultural insurance industry will benefit from improved technology (eg precision farming and permanent crop monitoring) and efficiency in administration (eg digitisation and blockchains), distribution (eg smartphones) and loss adjustment (eg drones).

Actuaries play an important role in quantifying risks in a sector that is both prone to structural changes and significantly affected by climate change. Catastrophe risk modelling concepts are necessary to complement actuarial analyses, particularly in high-growth markets with little experience data. The increasing availability of satellite data, re-analysis  models and crop-growth models will facilitate the structuring of improved products, particularly in the fast-growing developing markets. A more frequent exchange among all stakeholders, meanwhile, should close the knowledge gap between insurers and reinsurers, as well as between academia and the industry.

 

 

Dr Roman Hohl is an author and independent agricultural risk transfer specialist at www.agriculturalrisktransfer.com

 

This article appeared in our June 2019 issue of The Actuary.
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