Towards new risk transfer solutions for the agricultural value chain
Agriculture and the entire food production value chain are greatly affected by prevailing global trends such as climate change and digitalization. (Re-) Insurers are leveraging their long lasting experience and technical expertise in various fields to develop new agricultural risk transfer solutions. These solutions are tailor-made and flexible and offer protection not only to farmers but to all players along the value chain.
Climate Change has already led to an increase in likelihood and in severity of adverse weather scenarios. For example an increasing number of agricultural regions are being threatened by drought conditions. These weather anomalies are challenging traditional agricultural practices and increasing the vulnerability of agricultural production.
Digitalization offers solutions to cope with this developments. It continuously increases the availability of data to steer and to optimize farm operations and to measure more accurately the production output and associated risks. On the other hand it often also leads to a higher number of interfaces and higher complexity of processes.
As in many other industries the ongoing Covid-19 pandemic shed a light on the potential fragility in food production supply chains, including the availability of agricultural workforce. Closed restaurants, schools and offices led to a reduction of demand for already produced food with no alternative markets. In particular Covid-19 highlights the threat of disease to livestock production.
In addition to all these challenges the farming and food sector is facing continuously increasing demand for food due to a growing world population and a significant change in diet like a growing demand for meat. Furthermore the social pressure towards the implementation of more sustainable practices in food production clearly rises.
The German word for food is Lebensmittel which in English literally translates to ‘resources for life’ and directly illustrates our strong dependency on a high level of functionality of the food production value chain. It emphasises the need to protect the different actors of the value chain from risks or mitigating their impacts.
By nature farmers are good risk managers. Amongst others the selection of appropriate varieties, right timing in planting and harvest, crop rotation or weed control form the basis of agricultural risk management until today. For events which cannot be controlled by management practices insurers started to complement the risk management with the foundation of the first hail insurers at the beginning of the 19th century.
Today well established agricultural insurance systems play an important role in many countries. They herby cover mainly field crops but also offer protection for livestock, greenhouses, forestry or aquaculture operations.
Given the importance of food security in general, agricultural production and the purchase of agricultural insurance is subsidized by many governments. These form of public investment also has a positive social impact in countries where a significant share of population works in the agriculture industry.
Whilst most traditional insurance schemes are designed to protect farmers, yield losses also pose a risk to other players along the entire food production value chain. Starting with input suppliers selling their products with payment due dates after harvest, exporters needing a certain minimum volume to cover fix costs, traders that have to fulfil forward contracts or banks issuing agricultural loans.
Parametric insurance solutions, if designed well, will play a major role in closing this gap. Besides the operational advantage of timely and transparent pay out in case of a loss, this is mainly due to two reasons. Firstly the increasing availability of suitable data and second the flexibility regarding the insurable interest.
The risk of crop shortfall is strongly correlated to objective and measurable parameters like precipitation, temperature, soil moisture or vegetation health. The technology to automatically capture those influencing factors, e.g. via remote sensing techniques, is advancing every day as are the knowledge and tools required to analyse the increasing amount of information.
(Re-)Insurers that are able to leverage their technical expertise and experience, e.g. in modelling climate or weather data and to successfully incorporate the support of data-technology and analytics providers will be at the forefront in providing innovative solutions.
In respect of the insurable interest, the basic concept of connecting a predefined pay-out mechanism to a predefined event or index value, allows for delinking the coverage from a physical asset. It therefore increases the flexibility and the number of possible applications. These range from agricultural insurance for smallholder farmer for which a traditional insurance approach is not feasible due to the high number of very small entities up to large corporate entities seeking to cover parts of their agricultural portfolio.
Parametric concepts can also be applied to traditional indemnity based agricultural insurance. For example identifying critical regions in respect of drought to support an efficient loss estimation process.
In order to leverage the real potential of parametric agricultural insurance it is essential to develop prudent, technically sound and transparent solutions. Contractual obligations of parametric coverage are wholly reliant on the underlying data, which means that a high standard of data integrity is required. Sufficient (historical) availability, its completeness and correctness are of utmost importance. Well established underwriting and risk modelling techniques such as trend evaluation or the treatment of severe events, which have not been yet observed, are especially relevant.
Existing deficiencies, e.g. basis risk, have to be discussed openly with potential customers. The most important success factor for parametric agricultural insurance, however, is the combination of data analysis with profound agronomical knowledge.
This is a promising environment for (Re-) insurers who bring together this broad spectrum of competencies in their teams and are able to include valuable input from their customers.