1. World Bank Group Agricultural Risk Financing in Low and Middle Income Countries: Challenges and Opportunities Olivier Mahul Senior Insurance Specialist Financial Sector Operations and Policy Department World Bank Global Conference on Insurance and Reinsurance for Natural Catastrophe Risks, Istanbul, December 8-9, 2005

2. World Bank Group 2 Why The World Bank is interested in agricultural production risk management n High exposure of low income countries to weather risks (drought, floods…), pests and diseases n Lack of insurance and other risk management tools n Costly government ad hoc schemes n Need of innovative approaches to deal with the covariate nature of agricultural risks Rainfall and economic performance in Andhra Pradesh

3. World Bank Group 3 Previous attempts to protect farmers have not been financially viable n Failure of Universal Multiple-Peril Crop Insurance t All universal multiple-peril crop insurance programs are subsidized and/or delivered by governments t Poor financial performance t Extremely expensive t Essentially government social programs for farmers t Private insurance markets mainly act as agents Crop Insurance Premiums and Indemnities in the United States

4. World Bank Group 4 Country Agricultural Risk Management Model Country Agricultural Risk Management Agri-business segmentation Social vs commercial insurance Traditional farming sector Emerging farming sector Commercial farming sector Agricultural risk assessment Risk identification Probabilistic agricultural risk model Agricultural risk financing Risk layering Insurance index Insurance pool Insurance and rural finance Institutional capacity building Data management Regulatory/supervisory framework Information and education Technical expertise

5. World Bank Group 5 Why Agricultural Risk Financing is Important? n Agricultural risk financing t Is an integral part of agricultural risk management often underestimated t Brings an economic perspective on risk through price discovery (vs. physical mitigation) t Introduces discipline into the efforts of governments, insurers, farmers to reduce risk t Encourages pro-active risk management n But risk financing is NOT the panacea t Risk financing deals only with the residual production risks that cannot be managed using cost-effective mitigation measures (vaccination, irrigation…) t Underdeveloped agriculture cannot be developed or restored by the introduction of risk financing programs

6. World Bank Group 6 Risk financing instruments should be promoted n Reserves t Covers low severity, high frequency events t Viability depends on opportunity cost of capital n Contingent credit t Stand-by line of credit drawn down immediately after a pre-defined disaster t Annual commitment fee n Indemnity-based insurance t Loss specific t High deductible/high administrative costs n Index-based insurance t Payments based on an index (e.g., rainfall level, hurricane intensity, area yield losses) t Quick disbursement t Lower transaction costs t Imperfect coverage (basis risk)

7. World Bank Group 7 …To offer a comprehensive risk financing strategy to farmers Reserves Probability of Occurrence 20-30 years 3-5 years Ex post government assistance Contingent credit Insurance 5-7 years

8. World Bank Group 8 n Agricultural sector in Turkey t 35% of employment t 13% of GDP t 6% of exports n Agriculture insurance in Turkey t About 9 companies (out of 55 non-life insurers) offer agricultural insurance t Hail insurance, greenhouse insurance, livestock insurance t Agricultural insurance premium volume less than 0.5% of total non-life insurance premium volume Agricultural insurance should be promoted …

9. World Bank Group 9 Through innovative insurance contracts TriggersAdvantagesDisadvantages Indemnity n No basis risk n Delay time to calculate loss claims n Moral hazard/adverse selection Parametric Index (weather, satellite, etc.) n No moral hazard n Lower administrative costs n Higher start-up costs n Possibly more liquid n Quick claim settlement n Basis risk n Appropriate network in place n Complex actuarial modeling Aggregate loss Index n No moral hazard n Lower administrative costs n Possibly more liquid n Long delay time needed to verify final aggregate loss numbers n Basis risk, but smaller than parametric triggers Modeled-loss Index n No moral hazard n Lower administrative costs n Higher start-up costs n Possibly more liquid n Reliance on “black box” approach n Complex actuarial modeling

10. World Bank Group 10 Government Support Int’l capital and reinsurance markets Agricultural Insurance Pool Domestic Insurance Companies Farmers/Herders Government Structured Relief International Donors Development Banks Through National Agricultural Insurance Pools Rural Banks/MFIs

11. World Bank Group 11 National Agricultural Insurance Pool n Main Objectives t Provide affordable and effective insurance coverage t Ensure that farmers will receive full indemnity payments that are due t Insulate the domestic insurance industry from agricultural catastrophic losses n Main features t Act as a center of technical excellence t Provide the insurance industry with incentives to collaborate on the integrity of the program t Ensure efficient local retention by pooling non-retainable risks t Access the international reinsurance market at better terms by providing a more diversified portfolio t Limit government fiscal exposure n Examples t Spain: AGROSEGURO t Mexico: Fondos and AGROASEMEX

12. World Bank Group 12 Country Agricultural Insurance Program Farmer’s self- retention Catastrophe Coverage Base Insurance Coverage Agricultural Insurance Pool Reserves Seed Capital Insurance premiums Government budget backed by World Bank Contingent Debt Facility Loss frequency 5-7 years 20-30 years Int’l reinsurance Government reinsurance of last resort

13. World Bank Group 13 Premium subsidies should be targeted Expected loss Frequency of loss Severity of loss Operating costs Start-up costs Underwriting costs Loss adjustment costs Delivery costs Reserve load Risk capital (loss variance, correlation, etc) Cost of capital Return on equity

14. World Bank Group 14 And comply with WTO agreement n Annex 2, para. 8 t Eligibility for such programs shall arise only following a formal recognition by government authorities that a natural or like disaster (including disease outbreaks, pest infestations, nuclear accidents, and war on the territory of the Member concerned) has occurred or is occurring; and shall be determined by a production loss which exceeds 30 percent of the average of production in the preceding three- year period or a three-year average based on the five-year period, excluding the highest and lowest entry. t Payments shall compensate for not more than the total cost of replacing such losses t Where a producer receives in the same year payments under this paragraph and under paragraph 7 (income insurance and income safety-net programs), the total of such payments shall be less than 100 per cent of the producer’s total loss.

15. World Bank Group 15 Government Action Plan n Information and education t Reduce widespread lack of insurance culture n Enabling legal framework t Provide incentives for selling and purchasing agriculture insurance t Index-based products as insurance products n Institutional structure t Define the role of stakeholders (farmers’ groups, government, domestic insurance industry, international reinsurance industry, etc.) n Data management t Build an efficient data management system n Technical expertise t Contract design, ratemaking, underwriting n Financial support t Facilitate access to international reinsurance markets, t Governments as reinsurers of last resort

16. World Bank Group 16 World Bank ongoing activities n Kazakhstan t Refinements and implementation of the Crop Insurance Law n Ukraine t Area yield insurance n Morocco t Rainfall insurance n Tanzania, Uganda t Rainfall insurance delivered through MFIs n China t Agricultural insurance program n South Asia t Avian Influenza n India t Improving the National Agricultural Insurance Scheme n Mongolia t Index based livestock insurance n Etc.

17. World Bank Group 17 Livestock Insurance in Mongolia n The animal husbandry in Mongolia represents 87% of agricultural GDP and 30% of total GDP n 11 million animals lost in 2001-2002 due to severe weather conditions (dzud) n Livestock size in 2003: t 23 million heads (83% sheep and goat) t About USD 1 billion of value

18. World Bank Group 18 Index-Based Livestock Insurance Program n DRP : Social insurance t Monetary compensation in case of extreme catastrophic events t Herders pay small fee t Funded by GoM and donors t Voluntary participation n BIP : Commercial insurance t Sold by approved commercial insurers t Regulated by GoM t Herders pay a commercial insurance premium t Voluntary participation Disaster Response Product Base Insurance Product Retained by Herders and Banks 10% mortality 30% mortality 100% mortality

19. World Bank Group 19 Livestock Insurance Indemnity Pool Herders’ self- retention Disaster Response Product Base Insurance Product Livestock Insurance Indemnity Pool Government reinsurance stop loss GIC Herders’ insurance premiums net of reins. prem. Reinsurance premiums World Bank Contingent Debt Facility Loss frequency 15-20% 3-5%

20. World Bank Group 20 Pilot Program (2005-2009) in Mongolia BayankhongorKhentiiUvs # animals1.2 mm1.4 mm1.5 mm Value at risk (US$)33.5 mm55.3 mm43.8 mm Average AL (% VaR)5.7%4.7%5.1% Std AL (% VaR)7.1%3.3% Uvs Bayankhongor Khenti Key objectives n Test the product design n Learn if herders will buy the insurance n Learn if insurance companies have an interest in selling and the capacity to manage this unique insurance

21. World Bank Group 21 Probabilistic agricultural risk assessment model Production losses Stochastic normal & drought events Historical weather Hazard Module Simulated Weather Generator Vulnerability Module Crop Yield Model Planting Area Model Economic Module Direct loss model Indirect loss model Crops Soil Mgmt. Macro- economic data Direct & indirect economic losses n Customized from rapid onset disaster modeling framework n Probabilistic drought risk assessment model t Hazard module t Vulnerability module t Economic module

22. World Bank Group 22 Drought risk assessment in India State of Andhra Pradesh

23. World Bank Group 23 Revisiting crop insurance in India n Current NAIS t 13 million farmers insured t Low insurance penetration rate (< 15%) t Area-yield approach t Financially unsustainable (average loss ratio >500%) t Delays in indemnity payments (up to one year) t State Government and Central Government pay losses in excess of premiums on an ex post basis

24. World Bank Group 24 Moving to a market-based approach n Objectives t Design effective and affordable insurance products u Area yield insurance u New insurance product –Weather-based insurance –Satellite-based insurance u Double-index insurance –Early payment based on weather/satellite index –Adjusted payments based on area yield index t Put the scheme on an actuarial path u Sound ratemaking methodology t Develop a Corporate Risk financing strategy u Portfolio risk management strategy u Access to international reinsurance u Role of the Government

25. World Bank Group 25 Conclusion n Public-private risk financing t Public-private partnerships in risk financing (e.g., agricultural insurance pools) can support the development of domestic insurance markets n Creation/improvement of specialized agriculture insurance programs helps to t Boost insurance penetration t Increase industry’s technical sophistication t Build up additional domestic claims paying capacity t Reduce government exposure to agricultural catastrophic risks n World Bank support t World Bank can provide technical and capital support to national agricultural insurance programs by working together with governments and private insurance/reinsurance markets