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>> Crop Insurance

Gonzalo Chillado Biaus, Agriculture & Livestock Risk Manager with Munchener de Argentina Servicios Tecnicos SRL SystemAgro: Sustainable Crop Insurance as a Response to Climate Change

In this article, Gonzalo Chillado Biaus, Agriculture & Livestock Risk Manager with Münchener de Argentina Servicios Técnicos SRL, comments on some specific issues facing crop insurance, and offers details on “SystemAgro”, the tool offered by Munich Re.

1. Crop Insurance in the World

There are over 200 million hectares (494,210.76 acres) worldwide covered by sustainable crop insurance. Valuable experiences have been gathered for more than 35 years with this form of insurance.
Munich Re has sorted out the specificities of the systems that are of the essence to make crop insurance sustainable, and called these “SystemAgro”, the best practices in multiperil crop insurance.
The framework is given by a public-private partnership (PPP) that abides by the principles governing insurance. All conditions that are important for insuring agricultural crops and material for crop-yield insurance are regulated by law and other provisions. These include, for example, access to insurance, meeting the demand for insurance with suitable premiums or transparency in insurance terms and conditions and loss adjustment.
2. Climate Change, a Special Challenge

Our world is facing numerous pressing issues, with the financial crisis, climate change, energy and food security being amongst the most important. Agriculture faces mainly these three problems, i.e., it has always been (and will to an even larger extent be in future) amidst the tension existing among climate, financial markets, food and energy security. Scarce global stocks of agricultural raw materials, especially grains (note: in late 2008 the world’s stock of grains was of only 2 months), call for huge cooperation from the agricultural production sector in order to improve the global situation in the fields of food and energy. The increase in the world’s population to some 3 billion by the year 2050 will bring about a rising demand for agricultural raw materials globally, as well as a change in eating habits. The problem intensifies given the trend to reduce the useful arable land and to use agricultural raw materials for power generation.
The impaired access to credit facilities following the financial collapse also impacts agriculture throughout its economic cycle. Even if the financial crisis is overcome in a few years’ time, the global fear for insecure food supply will persist given the existing price stability and the delicate balance [to be stricken] between supply and demand. It is therefore necessary to strengthen private and public investment in sustainable agriculture. This is especially so because agricultural production is directly exposed to climate, especially to adverse weather conditions.
The social and economic impact in each country calls for comprehensive solutions. An interest case in point is Poland, where agriculture was affected by a serious drought in the 2006 spring-summer season, in response to which the Government compensated farmers with ad hoc payments but only for a part of the economic losses sustained. Together with farmers’ associations, the university and the insurance industry, the Polish Government therefore encouraged the purchase of insurance cover against natural perils through Crop insurance. At the root of this was a law to promote crop yield insurance which was enacted in 2006. The law provides for a subsidy of up to 50% of this insurance, as well as some fundamental regulations governing the role of the State in the multiperil crop insurance under the form of public-private participation.
Given the growing specialization of agricultural production, the impact that natural perils have on yield has increased. The climate change under way further strengthens this impact. Many scientific studies corroborate that climate change manifests itself in t he number and severity of extreme weather phenomena. This is especially true for heavy rainfall, heat and drought periods, as well as storms. The impact of climate change is more difficult to quantify in the case of extreme weather phenomena and the losses they cause, but it is possible for certain regions. Thus, there is some evidence proving that events followed by heavy storms (such as hail and downpour) are on the rise. Climate change is real (as evidenced by current measurements) and has intensified in recent years. In the last 100 years global warming is increasing at a pace of 0.7°C (33.26°F), but in Germany it is assumed to be 1.1°C (33.98°F), whereas in the Alps it is about 1.5°C (34.70°F).
Sea surface temperatures in the areas where tropical storms originate have increased by 0.5°C (32.90°F) globally since the early ‘70s on account of climate change, as illustrated by the graph below:
In this regard, it is worth underscoring that since the industrialization era (1750), global warming has been mostly the result of anthropogenic greenhouse gas emissions, and only a small portion is attributed to nature (intensity of sunlight).
The influence of climate change on extreme weather conditions and its consequential damage also manifest themselves in agricultural production and in crop insurance through the growing exposure to late frosts. Thus, within the framework of research work on climate change conducted at fruit plantations, it has been demonstrated an increase in the risk of late frosts for many fruit crops in Germany. The effect is an early blossoming, since winters are milder and shorter. Since the frost period, especially the date of the last spring frost, has not been analogously anticipated, the risk of frost damage increases. Frosts during the blossoming period is amongst the most hazardous events for fruit crops, and in extreme cases it may ruin the harvest for a whole year.
Labor has become intensified (because of mechanization and specialization) and has led to a growing demand for capital and investment alien to agricultural production. Consequently, there is today the need to offer growers additional security. Crop insurance (one of the best-informed insurance lines in terms of exposure to natural perils) may make an active contribution. The large cost of risk resulting from an increase in cat losses may only be controlled through a professional procedure implemented by all parties involved. We may then speak of a public-private climate partnership.
SystemAgro serves the primary purpose of facilitating farmer’s access to a smart management tool that allows them to strengthen their farming operations responsibly and by their own initiative.
3. The 4 Pillars of SystemAgro

All 4 pillars, also known by the acronym BLOC, are equally important. The moment one of them is missing, the system's stability is jeopardized. Pillars need therefore be reinforced through state regulations under the form of laws and provisions. Nonetheless, the configuration of these pillars is flexible. That is because taking into consideration the current structure of the farming economy and the insurance industry, SystemAgro may only act as a control tool at a farming-political level.
3.1 B - Backing: Subsidized Insurance Premium

B is the first cornerstone for finalizing the purchase of insurance and it has already been introduced in most countries.
When Government subsidizes premiums, it lays the first building block for [facilitating the] purchase of insurance. Without subsidies, insurance premiums for umbrella covers can hardly be paid or else deductibles are so high that only rarely do farmers actually get paid.
This may be attributed to the fact that loss events recur at shorter intervals than in other lines, such as fire insurance. The same happens with the territorial extent of the loss; by way of example, in the case of drought it is more extensive than for other perils. This translates into extremely high premiums.
Several examples from around the world prove that farmers only purchase crop insurance when Government materially subsidizes premiums. Subsidies for long-term guaranteed premium rates are also absolutely necessary for the stability and sustainability of any crop-yield insurance system. These should, like in the USA, be a reliable and constant component in Government’s general budget and be backed by legislation on the matter. This lies at the core of financial estimates made by both farmers and insurers. Thus, the Government may also budget for its expenditure on crop insurance.
It may also act smartly if it follows a comprehensive agricultural policy, i.e. if it ties premium subsidies to other instruments. By way of example, purchasing multiperil crop insurance is a requirement in the USA to become eligible to participate in other government promotion programs within the field of risk management.
3.2 L - Loss Sharing: Government sharing in Insured CAT Losses

L: Government’s sharing in insured cat losses renders the system stable throughout time and facilitates access to private venture capital.
As a general rule, Government provides assistance in the case of catastrophes, which can be offered on an ad hoc basis. This is the case with extensive damage caused by drought, floods and frosts. It is possible to achieve a significant density of insurance only if multiperil crop insurance is the cover of choice, with the assistance offered in case of catastrophes not competing with it.
The advantage of crop insurance vis-à-vis ad-hoc assistance lies in that upon occurrence of a catastrophe, the farmer has the legal right to receive some compensation for damages and the Government may turn to the insurance industry infrastructure and venture capital. Thus, distribution does not follow the “watering can principle” but, rather, the extent of damage sustained by the individual farmer is assessed and the indemnity is paid when the farmer needs it the most.
In the case of major catastrophes causing large losses, unless Government contributes to the claim, insurers have to pay a benefit that is several times higher than the premium amount received. In an extreme year, the technical cost for a period rises well above the real level, and farmers would therefore face dramatic premium increases. If premiums are not increased, access to private venture capital would be curtailed, and all of this would be the result of a single loss.
Crop insurance will always be available if the loss ratio is shared between the Government and the insurance industry, even after years with extremely high ratios. With its high insuring level, it is therefore a cost factor that farmers may foresee and that remains practically unalterable.
What was in this scenario the impact generated by the 2008/09 serious drought in South America? It was an extremely long and dramatic period and the damage to crops amounted to some 3.8 billion Euros in Argentina alone. As it was the case in affected neighboring countries (Uruguay and Paraguay), the total amount of benefits paid by insurers in Argentina was fivefold the premium amount collected on multiperil crop covers. The low market penetration of multiperil crop insurance and the little market share this cover has in insurers’ portfolio were the only reasons that prevented the situation of the crop-yield and crop-hail insurance market situation from aggravating further. In view of the growing demand for multiperil crop insurance in Argentina and the huge potential for drought damage, it is necessary for risks to be shared between Government and the insurance industry.
3.3 O – Open: Accessible to all Farmers

O: The legal terms and framework are applicable to all agricultural operations. All farmers benefit from the financial aid offered by the Government. This is achieved through an open approach to crop insurance. In other words, any farmer willing to purchase crop-yield insurance has the right to be admitted to the system.
SystemAgro therefore contributes to wide market penetration and becomes an efficient management tool at the agricultural policy level. Market penetration is above 80% of the crop area in the USA (taking the top 10 crops). This shows that a large number of farmers accept that Government directly manage transfer payments to the system in connection with this form of insurance. All natural perils likely to materially reduce the yield of US farmers are included under a multiperil crop insurance that offers wide coverage to all farmers. The stability and sustainability of this form of insurance is not only attributed to the Government subsidizing premiums and becoming involved in covering cat losses, but also to the sharing of insured perils at a regional level.
3.4 C – Central and Uniform: Central Structure and Uniform Insuring Conditions

C: A central structure is required to ensure the transparency and efficiency of the crop insurance system.
These systems were implemented in the past and were supported through subsidized premiums. However, after a few years they had to be discontinued because of insufficient premium rates and high loss ratios. These projects failed to serve the purpose of creating a sustainable risk management system, plus they ate up the financial resources without offering any benefits in the medium term. Experience shows that premiums that are suitable for the risk are extremely important given the frequency and territorial scope of damages caused to crop yield. It also shows that the competition in terms of premiums jeopardizes the survival of the newly introduced crop insurance. For crop insurance systems to develop sustainably it is essential that insurance terms and conditions, including premiums and marketing guidelines and loss adjustment, be consistent. Two reasons underpin this statement:
1. Only if premiums are suitable for the risk do they allow carriers to support loss payments. Otherwise, the system would collapse.
2. The Government has a legitimate interest in the assistance it offers (premium subsidization, loss sharing, development and management support) benefiting farmers and the agricultural sector in the long term. Therefore, firstly there is the transparent and efficient use of public sector funds.
A crop-yield insurance system must be based on a central structure that allows establishing, controlling and adapting uniform conditions for all parties involved “on the fly”. Its most outstanding roles are the following:
1. Enforcing the regulations provided for by law.
2. Permanently implementing and adjusting consistent conditions in order to manage SystemAgro.
3. Ensuring access by participating insurers.
4. Ensuring application of government support (premium subsidies, loss sharing).
5. Increasing efficiency.
A transparent structure has been created in the USA, Spain and Turkey for farmers, Government and the insurance industry, which operates resolutely and cost-efficiently and to the benefit of all parties involved.
Uniform conditions and a central structure are not a substitute for the insurance industry which, in addition to carrying the risk and playing significant marketing, management and servicing roles, also cooperates with the central structure with a view to optimizing both products and processes.
4. Proper Insurance is what Matters

Only if farmers are given a tool to individually manage risk will crop-yield insurance be sustainable and attain high market penetration.
Yield can be approximately determined and predicted only by using complex models. The amount and accuracy of data to be fed is time and work consuming in practice. To date, only quite precise graphical representations have been developed, which have been based on significant effort at a measurement level, and only for small spaces. This means individual assurance of farmers at premium rates that are suitable for the risk is quite limited in index insurance. Only individual crop insurance offers farmers what they expect: A reliable and suitable compensation in case they suffer a loss. This in turn leads to enhanced acceptance. In addition to information on the risk at a regional level, background information on the farmer’s yields is at the core of pricing and product design. In this case, it is worth making the effort of gathering the necessary data. If mean yield has been low in the last few years, then the insurance is based on the expected yield, which is statistically low. Nonetheless, if the farmer has obtained high yields in recent years, then there is also a high yield expectation as the year starts.
5. SystemAgro – Success Factors for Crop-yield Insurance

Generally speaking, five are the success factors characterizing SystemAgro:
�� Stability: SystemAgro has proven to be sustainable for the whole agricultural economy. The sectors that come before and after it also benefit from its value added.
�� Customization: SystemAgro is a flexible control tool for the agricultural policy that is customized to the farmer’s individual risk management and is integrated into a given country’s agricultural policy. Moreover, it respects the structure existing in the insurance sector.
�� Pluralism & Comprehensiveness: SystemAgro offers farmers the possibility to get insurance irrespective of the exposure, location or production.
�� Rating: SystemAgro ensures the farmer will have the liquidity so that he may not only have the necessary production means but also the financial strength to make investments towards the future, such as investing in new agricultural machinery, buildings or facilities. Farmers’ revenue stability translates into improved solvency and, therefore, into an improved credit rating.
�� Transparency: SystemAgro is arranged following a centralized approach. Thus, both Government and the farmer are informed of the subsidies and of the system applied in setting premiums.
The success of SystemAgro’s comprehensive approach lies in that the system inures to the benefit of all parties involved in this public-private partnership.
�� The farmer avails himself of a professional management tool to insure his individual risk.
�� The insurer becomes involved in the long term with the prospect of obtaining profitable results throughout time.
�� Government attains stability in the agricultural sector and has the support to face the climate change challenge through this private-public partnership for climate.
SystemAgro is a “win-win-win” situation.

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