New Approaches to Agricultural Insurance in Developing Economies

Joachim Herbold[1]

Providing appropriate risk management tools for agriculture is a key challenge for agricultural development. Agricultural insurance systems play a vital role in that process: they provide structured cover against natural perils and legal entitlement for indemnification for the farming sector. As such, they serve as collateral for agricultural loans and provide a safety net for investments. Agricultural insurance systems have been successfully implemented in recent decades, though mostly in industrialized countries. All of these systems are based on public-private partnerships; only these have proved to be successful and sustainable, whereas purely private or purely state-organized systems have failed. This article illustrates why agricultural insurance systems based on public-private partnership will also lead development in developing countries and emerging markets, and elaborates upon the key components of such systems.

World agriculture is facing the challenge to provide sufficient high-quality food, raw materials, and energy to a growing world population. According to the United Nations' Food and Agriculture Organization (FAO), there is a need to increase agricultural production (food, feed, renewable primary products) globally by

1.6 percent annually until 2015 and thereafter by 1.4 percent until 2030.[2] Greater investment in agriculture will be necessary to meet this challenge.[3] Though high

agricultural commodity prices are helping to finance these investments, financial institutions will also have to make a significant contribution by providing finance and risk transfer solutions.

Agriculture is confronted with a series of risks: political risks, market risks, contamination risks,[4] and natural risks. No other economic activity has as large an exposure to natural risks as agriculture. This is due to production being in the open air, its high dependence on sufficient and timely water supplies, and its susceptibility to pests and diseases. With appropriate management practices[5] risks can be reduced, but not eliminated.

Losses due to extreme weather events are therefore a common phenomenon, especially in crop and grassland production. The majority of these losses – estimated at 70 to 80 percent – are attributable either to lack of rain or excess of moisture (either rain or flooding). The rest is mainly due to frost, hail, and windstorm. Accurate data on crop losses caused by adverse climatic conditions are limited to countries with crop insurance systems established for decades, such as the United States or Canada (see figure 1).

* “Other” includes but is not limited to: cold wet weather, frost, wind, flood, cold winter, insects, hurricane, hot wind, irrigation failure, aflatoxin, wildlife, erosion and fire.

Fig. 1. Losses per peril in the MPCI programmes in the USA and Ontario, Canada Sources: Rain and Hail, 2011; Agricorp, 2011

According to the projections of climate scientists, climate change can increase the variability of weather patterns in many regions; and increase the frequency and severity of extreme climate events. This implies increased frequency of heat stress, droughts, and flooding in particular, as well as modified risk of fires, and pest and pathogen outbreaks. The negative effects will be more pronounced in low-latitude countries than in the rest of the world.[6] This puts farmers in such countries that rely heavily on the agricultural sector particularly at risk of suffering additional losses.

Smallholder farmers in developing countries are particularly vulnerable. This is due to various factors:

x Production often in more exposed areas, e.g. disadvantaged and mountain regions, marginal land;

x Shortage or lack of financial means to invest in risk-reducing measures,

e.g. irrigation, drainage, frost prevention;

x Limited access to loans;

x Limited access to inputs to improve production techniques, which might have risk-reducing effects.

The livestock sector is more exposed to epizootic diseases than to climatic risks. There is a high risk of epizootic disease outbreaks being spread over a wide area and consequently causing high economic losses. Prominent examples of such outbreaks are foot and mouth disease (FMD) in the United Kingdom in 2001[7] and in South Korea in 2010–2011,[8] as well as avian influenza in Asia since 2003.[9] Though such large loss events have relatively long recurrence periods, the loss potential is huge.

In many developing economies,[10] farmers retain the risk of crop losses and epizootic diseases irrespective of the size of their farms. Their risk management mainly consists of diversifying their income sources by planting a variety of

crops and breeding cattle. They have hardly any risk-transfer tools, which in turn limits the availability and range of agricultural production finance offered by banks. This situation has not changed with the development of microfinance and microinsurance[11] over the last decade. Thus, neither microfinance nor microinsurance have made their way into the area of agricultural production. Although this is not surprising, many people are unaware of the fact because rural microfinance/insurance is normally aimed at rural households and not crop or livestock production specifically. Therefore, the development of sustainable risk management systems and tools – one of them being agricultural insurance – will be a key topic in future agricultural development strategies as well as in climate change mitigation strategies.

  • [1] Senior Underwriter Agriculture, Munich Reinsurance Company.
  • [2] See BMELV (2008).
  • [3] The FAO report “How to Feed the World in 2050” for instance states that total average annual net investments in developing countries would have to amount to US$83 billion in order to achieve the required increase of 70 percent in food production by 2050 (FAO, 2009).
  • [4] Contamination due to biogenic factors (e.g. mycotoxins in cereals), chemical residues/ substances or radioactivity.
  • [5] E.g. site and variety selection, crop rotation, soil preparation, fertilization, pest and disease management, sanitary measures.
  • [6] For more information on this topic and the impact of climate change on agriculture refer to IPCC 2007. See also IAASTD, 2009; FAO, 2009.
  • [7] One of the worst FMD outbreaks worldwide. Animals culled: 6 million (4.9 million sheep, 0.7 million cattle, 0.4 million pigs); losses to agriculture and the food chain: €3.6 billion; government compensation for slaughtered animals and payments for disposal and clean-up costs: €2.9 billion (DEFRA, 2004).
  • [8] The worst ever FMD outbreak in South Korea. As of 24 March 2011, 3.3 million pigs and more than 150,000 cattle had been culled (Asiaone Health, 2011).
  • [9] These outbreaks were caused by viruses of the H5N1 subtype. As of June 2007, 62 countries around the world had reported H5N1 in birds. During these H5N1 outbreaks more than 250 million birds were destroyed or died and the direct economic costs for affected countries exceeded €8.8 billion (WHO, FAO, both undated).
  • [10] Developing economies comprise emerging markets and developing countries.
  • [11] Microfinance/microinsurance is defined as finance/insurance designed for low-income people/businesses not served by typical social or commercial insurance schemes.
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