First Considerations When Setting Up Agricultural Insurance: System Approach Before Product Approach

In the discussion on agricultural insurance in developing economies it is misleading to look for the solution first at product level. With an insurance product alone

– either an index insurance product or an indemnity-based insurance product – the problem of lacking access to appropriate risk management tools in agriculture cannot be solved. This is why all the proposals for index insurance over the last few years have not solved the problem of a lack of risk management tools in developing economies. This is not necessarily due to the type of product, but to the failure to implement the appropriate framework that any insurance product needs. In other words, a system approach has to be pursued first, before determining which insurance product is appropriate. Such a system approach creates a suitable legal, institutional, and organizational framework in which insurance products and other risk management tools can function efficiently.

A successful and sustainable agricultural insurance system consists of three major components:

x Framework and structural aspects;

x Operational aspects;

x Innovation.

Only if these three elements are all present and implemented as effectively as possible will the system achieve a high acceptance level among the stakeholders, financial stability, and sustainability.

SystemAgro: Framework and Structural Aspects of Agricultural Insurance Systems

The framework and the structural aspects of sustainable agricultural insurance systems have been compiled systematically by Munich Re under the name of SystemAgro.[1] The key features and key success factors are:

x Ability to respond to the heterogenic structures in the agricultural production sector (e.g. large-scale, medium-sized and smallholder farms as well as different production sectors) and provide individual insurance solutions to each of them. Sustainable production methods and use of best-available production techniques are prerequisites of insurance. Cooperation with extension services might be beneficial;

x Agricultural insurance systems to be organized and financed as publicprivate partnerships between the state, farmers, and the insurance industry.[2] The role of these stakeholders is as follows:

○ State: legal and regulatory framework, definition of agricultural insurance as a part of national agricultural policy, agricultural insurance law, cofinancing of the risk premium and administrative costs, risk carrier for catastrophe losses, supervision of the system. To guarantee the long-term stability of the system, cross-party agreement on these elements is essential. Premium subsidies and state reinsurance for catastrophe losses contribute to keeping insurance terms affordable for the farmer, thus facilitating high market penetration and the stability of the programmed;

In developing countries, where state institutions sometimes have insufficient resources, some of these tasks might be assumed by international organizations. At the national level, the ministry of agriculture and the treasury generally intervene;

○ Farmers: financing part of the risk transfer by paying an insurance premium, retaining part of the risk in the form of a deductible or with index products as a basis risk. Applying site-specific and sustainable production methods and techniques in order to minimize production risks;

○ Insurance/reinsurance industry: risk carrier, marketing and administration of insurance policies, portfolio management and product development, loss adjustment. Especially in developing economies, where direct insurance companies are often short of risk capital, reinsurance arrangements are essential to maintain the solvency margins of insurance companies at an adequate level. Besides the much-needed risk capital, reinsurers operating globally also contribute expertise and international experience in setting up and managing agricultural insurance systems.

x Joint market approach by all insurance providers and risk carriers, e.g. in form of a coinsurance pool. In such a pool, all of the crop risks of one country or even several (smaller) countries are combined, thus creating a better spread of risk. This joint market approach includes market-wide uniform insurance terms and conditions that are technically sound and – if appropriate historical data is available – actuarially calculated. These uniform terms and conditions are approved by the state and then have to be applied by all insurance providers. This is an important factor in guaranteeing the sustainability of the system;

x Centralized technical entity run by the insurance industry, which bundles the technical expertise, maintains an extensive database, and carries out the loss adjustment;[3]

x Integrate financial institutions as well as agricultural input, output, and extension service providers (including cooperatives) in order to promote and market the insurance products cost-effectively.[4]

  • [1] For more information: munichre.com/systemagro.
  • [2] Traditionally, agricultural insurance was organized either privately by insurance companies without state involvement or by the state alone. State-run systems were very common in the socialist countries (e.g. Soviet Union, China, Mongolia, German Democratic Republic) until 1990, often organized as obligatory insurance (Wildermuth, 1998). By contrast, privately organized systems prevailed in nations with a market economy. However, until 1980 even the United States had a state run agricultural insurance system that was subsequently reformed into a public-private partnership system. As either purely privately or purely state-run systems have proved to be ill-suited if comprehensive multi-peril insurance is required in these cases, public-private partnership models are at the forefront of developments. Privately organized insurance is prevailing only in those countries in which single peril insurance, e.g. hail insurance, predominates.
  • [3] See section on “Operational Aspects of Agricultural Insurance Systems: Loss Management and Loss adjustment/administration.”
  • [4] See section on “Operational Aspects of Agricultural Insurance Systems – Distribution”.
 
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