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December 2014

Munich Re Agro Insurance Info

Knowledge exchange around the world. How can agricultural insurance systems overcome its deficiencies?

Dear Reader,

During the last year, the agricultural insurance community met several times to exchange lessons learned and to discuss future perspectives: Obviously, agricultural insurance that scales up within a proper PPP system is a means óf achieving food security. As Africa makes inroads towards a new coverage set-up, the USA is experiencing commodity price challenges.

USA: Challenges in crop-revenue insurance – The example of price risk in the US Federal Crop Insurance Program

November 2014. To this day, crop-revenue insurance – which protects farmers not only against yield losses but also against adverse price movements between planting and harvest – is only being offered in highly developed crop insurance markets, and then only with heavy public support in countries such as the USA. Evidence shows that governmental action has been instrumental in the take-up of revenue insurance, both by co-financing its costs, and by providing regulations and procedures for its successful operation.

Significantly, crop-revenue insurance has recently attracted a lot of attention, especially from insurers and reinsurers. Repeated and widespread revenue insurance loss payments over several recent years, coinciding with decreasing revenue insurance rates, have triggered discussions of how to adequately rate revenue risk. While there is ample experience with yield variability and a general agreement on how to rate it for insurance, the second risk component of revenue – which is price – is more difficult to quantify.

The US government entity responsible for the rate-making methodology is the Risk Management Agency (RMA), which is part of the US agriculture ministry. It has commissioned several studies that in principle confirmed the current practice of using financial market indicators, such as implied volatilities, to measure the expected volatility of commodity prices between planting and harvest. Other experts, however, have shown that implied volatilities as predicted by financial markets for major crops have correlated very poorly with actual price movements over the past decade. In reality, low-volatility years repeatedly resulted in years with steep price drops causing high insurance payouts, most recently in 2013 and 2014.

In the evolving discussion, Munich Re – which is an important reinsurer of the US crop insurance program – has taken an active role by offering its insights on the important rate-making issue. Munich Re suggests developing a technically sound solution for the market within the format of an open round-table expert panel, including participants from the insurance industry, government and academia. While no such panel has yet been created, the US government has offered all stakeholders in the public-private crop insurance program the opportunity to comment on the methodology currently applied. Munich Re and other stakeholders have taken this chance to contribute to the technical dialogue. The period for public comments ended on 29 October 2014, and the discussion is expected to be published on the RMA's website in due course .
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Germany: The Federal Ministry for Economic Cooperation and Development (BMZ) explores the linkage between agricultural insurance and feeding the world

November 2014. The aim of the Agricultural Insurance Conference that took place in Berlin was to promote a debate on the link between agricultural insurance and food security, and to explore how this link is relevant for future development efforts. The conference with the World Bank and IFC/GIIF (International Finance Corporation/Global Index Insurance Fund) as conference partner brought together food security and agricultural insurance consultants, development organisations, insurance policy makers and regulators, academics and representatives from the insurance and agribusiness industry to share their views and experiences.

Agricultural insurance obviously plays an important role, but it is not a stand-alone solution. It should be seen as providing the sustainability glue between loans, producing expertise, technology and market access. Conference participants also agreed that it is not only the insurance industry, agribusiness and agrifinance that need to develop closer connections. Governments also play an important role in making agricultural insurance valuable for food security. Co-finance of premiums is one central public commitment. As there is no value in waiting for each government to buy in, representatives of those governments that are committed to agricultural risk management will attract the most attention of development organisations and industry. The conference saw examples of required budgets for premiums co-finance being funded by development agencies.

The ultimate goal is to provide agricultural insurance for all producers who want to transfer risks. Munich Re has analysed the key success factors of agricultural insurance systems worldwide, and is very much in line with the developments aspired to at the conference.
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Mexico: Microinsurance conference gathers together experts on agricultural insurance

November 2014. The 10th International Microinsurance Conference held by Munich Re Foundation took place in Mexico City. Participants included representatives of insurance and reinsurance companies, international organisations, NGOs and development-aid agencies, as well as academics, policymakers, and supervisory regulators. The conference aimed to distil and disseminate information on key developments in the microinsurance market. Sessions challenged all stakeholders to recognise opportunities in the low-income market.

Munich Re presented the Mexican way of insuring small farmers aggregated at municipality level. This CADENA model attracted the interest of the participants of the microinsurance community, as it overcomes the challenges of distributing agricultural insurance policies to farmers within a PPP.
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South Africa: FARMD organised conference on managing agricultural risks in a changing climate in Sub-Saharan Africa

November 2014. The objective of the FARMD conference (Forum for Agricultural Risk Management in Development) facilitated by the World Bank was to understand climate change and its implications for agricultural risk management in Sub-Saharan Africa. Experts discussed all elements of agricultural risk management, starting with adaptation and avoidance in production, looking into risks in the supply chain, the impact on policy-making for governments, and culminating in understanding the value chain of agricultural insurance. The insurance value chain consists of training in – and distribution of – insurance product design, including rate-making, risk, loss assessment, and risk sharing and risk layering.  

Munich Re participated in the panel discussion on risk transfer and coping mechanisms. The session highlighted the challenges in providing crop insurance in Africa: An insurance product has to be embedded in a nationwide agricultural insurance system. Besides challenges of distribution with low transaction costs, this means searching for smart product solutions where sharing of risk finance is divided between all stakeholders engaged in developing agricultural production in Africa. The stakeholders are the insurance industry and governments. They support the smallholder producers, and all together form a public-private risk-sharing partnership.
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Africa: African governments seek protection against negative impact of drought on their vulnerable population, and cede drought risk to Africa Risk Capacity (ARC) Ltd.

May 2014. Five African countries bought parametric insurance policies from the newly established ARC Ltd. in Bermuda. ARC Ltd. is capitalised by KfW (Germany’s Development Bank) and DFID (UK Department for International Development), and transfers risk to the market in order to build up a sustainable and independent risk transfer system. In its first year of operations, ARC Ltd. placed US$ 55 million with reinsurance providers. Munich Re furnishes ARC Ltd. with reinsurance capacity.

The individual parametric insurance policies are based on Africa RiskView (ARV) - a drought model developed by the UN World Food Program. Prior to joining Africa Risk Capacity, participating countries tailored ARV to their needs. This is a lengthy process, which ensures that risk assessment takes place and efficient risk mitigation mechanisms are found.  ARV is fed with remote-sensing-based rainfall data, water-sufficiency requirement index values, socioeconomic data and expected emergency relief costs for the affected population in a given country. As ARV also serves as an early warning mechanism, it becomes clear before the end of the season whether a payout will occur. If the early warning mechanism kicks in, a Final Implementation Plan (FIP) detailing the use of the payout has to be submitted. The FIP has to include a budget for an independent auditor who controls the use of the funds. Provided that a FIP was submitted, ARC Ltd. pays out no later than 17 days after the end of a season. The fast payout ensures efficient crisis mitigation. Research has shown that $1 paid at the end of a season following a bad harvest is worth as much as $4 paid a few months later when a food crisis has been allowed to evolve.

Basis risk is always problematic in non-indemnity-based insurance policies. However, in a trigger event ARC pays out on an aggregated (i.e. nationwide) level; thus locally occurring basis risk will be balanced out. Moreover, the payout is only provided if the government ensures allocation of indemnity to the affected people through a dedicated plan. The recipe for success of Africa Risk Capacity is the combination of risk assessment, contingency planning, implementation planning, risk transfer, and rapid availability of funds. As these elements as a whole make for a new innovative approach to drought risk mitigation and food security, Munich Re is addressing public needs and supports ARC in structuring expertise and capacity.
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Mexico: The ALASA Conference faces the challenges of agricultural insurance system in Latin America

May 2014. Agricultural insurance experts and representatives of various Latin American countries discussed the inter-linkage of public and private forces at the 13th ALASA Conference held in Puebla, Mexico. At this conference, ALASA and IICA (Inter-American Institute for Cooperation on Agriculture) issued a declaration on further process steps. They assessed that there is currently low interaction between public and private entities, and that one of the first steps has to be creating an enabling environment of legislation and regulation. Also, agricultural producers with the help of agribusiness should mitigate risks before transferring the remainder to the insurance industry. Next to information exchange between governments, producers and the insurance industry, data collection and management becomes a key collaboration field.

Munich Re presented the Mexican CADENA system. CADENA is an insurance coverage for small farming enterprises in case of disastrous weather events. Payouts are triggered on either weather-based or area-yield indexes. Premiums are paid by county administration and funded by the Ministry of Agriculture.
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We hope you have enjoyed this issue of Munich Re Agro Insurance Info Worldwide.
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