PētījumiInsurance and Risk Solutions in Agriculture: possibilities of designing an insurance model in LatviaKaspars Ummers, Nataļja Piroženko, Zintis Gaspaziņš, Latvijas Valsts agrārās ekonomikas institūts (LVAEI)
06.09.2005 The aim of the research is to identify and analyse agricultural insurance models in 5 European countries in respect of the insurable risks. The conclusions and recommendations of this study are intended to contribute towards development of agricultural insurance model in Latvia. The scope of the paper is to provide Latvijas Valsts Agrārās Ekonomikas Institūts with the review of agricultural insurance models used in 5 of the EU-15 countries (Germany, Netherlands, Italy, Spain, France). It has been decided to expand the research by reviewing the key risk management issues, its tools relevant for agriculture (insurance being one of them), summarize on the main CAP requirements as well as the EU regulations. This is because of the need of studying the possibilities of creating an agriculture insurance model for Latvia where we believe studying the context is vital. Main limitations of the study are the following: 1. The main difficulty was to obtain data for the analysis. There are various possible explanations to it: a) they are available in the local languages, b) there is a few models operating that involve the governments therefore there would be less requirements/incentives for making the information publicly available and hence there was a scarce of information available on the models; on the other hand, where there the significant involvement of the state, we found many useful information (Spain), c) the insurance models could be under development (see for some hints European Commission, 2001), therefore there would be little information available publicly, just for the reason the process of achieving an optimal solution was on its way . 2. Due to lack of publicly available information, as well as information provided by the official European organizations and Agricultural Ministries in European countries, this analysis could not be regarded as complete, but fragmented. Nevertheless it does provide a reach view on the trends as carrying on research on 5 countries it was possible to find information on nearly all relevant aspects of the objectives of this study. 3. For the purpose of making any conclusions about the hypotetical insurance model in Latvia this study is incomplete due to lack of the economic and political analysis of a European country that was selected for the research. ### Full formated text for convinient reading is available in annexed PDF file Pievienotie dokumentiReport PDFInsurance and Risk Solutions in Agriculture: possibilities of designing an insurance model in Latvia“Farming is all about risk and uncertainty whether your farm is big or small” Kaspars Ummers, Nataļja Piroženko, Zintis Gaspaziņš Riga 2005, Marsh SIA List of ContentsList of Abbreviations Chapter I Introduction 1.1 Introduction 1.2 Objectives of the Study 1.3 Scope and Limitations 1.4 Methodology 1.5 Main Findings Chapter II Risks and Crises in Agriculture 2.1 2003 Agricultural Year Overview 2.1.1 Projections for the EU-25 2.1 Farmers’ Perception of Risk 2.2 Categories of risk in agriculture 2.2.1 Risks related to production factors 2.2.2 Production Risk 2.2.3 Price Risk 2.2.4 Trends in risk exposure in the EU 2.3 Examples of Livestock Epidemics in Recent Years 2.4 Environmental Aspects Conclusion Chapter III CAP Reform / EU Regulations 3.1 CAP Reform 3.2 EU Regulations 3.2.1 Compensation of Direct Losses 3.2.2 Compensation of Consequential Losses Conclusion Chapter VI Insurance in Agriculture 4.1 Basic Requirements for Agricultural Insurance 4.2 Insurance 4.2.1 Types of Insurance 4.2.2 The Multi – Peril Crop Insurance Program (MPCI) 4.3 Re-insurance 4.4 Government’s Role 4.4.1 Fields of action for government 4.4.2 Public-Private Partnerships for the Provision of Agricultural Insurance 4.5 Risk Management Conclusion Chapter V Agricultural Insurance Models in European Countries 5.1 Spain 5.2 France 5.3 Italy 5.4 The Netherlands 5.5 Germany Conclusion Conclusions and recommendations List of AbbreviationsAI Avian Influenza BSE Bovine Spongiform Encephalopathy (also known as “Mad Cow” Disease) bn billion CAP Common Agricultural Policy of the EU CSF Classical Swine Fever CMO Common Market Organisations COM Common Organization of the Agricultural Markets EU European Union EU-25 European Union after the enlargement on May, 1st 2004 EU-10 New Member States of the European Union from May, 1st 2004 EU-15 Member States of the European Union before May, 1st 2004 Eurostat Statistical Office of the European Communities FMD Foot-and-Mouth Disease GAP Good Agricultural Practices HACCP Hazard Analysis and Critical Control Points ITL Italian lira MAFF Ministry of Agriculture, Fisheries and Food mlj million MPCI Multi-Peril Crop Insurance program OECD Organization for Economic Co-operation and Development t ton thsd thousand WTO World Trade Organization Chapter IIntroduction 1.1 Introduction Agriculture is the largest single industry in the world. With the world population currently estimated at six billion and growing by around 75 million people per year, its economic importance as a supplier of food, fibres and renewable raw materials is indubitable. All types of economic activity involve risk. These risks may take many forms. They may include risks relating to physical production, input and output prices, currency movements, institutional change, legal liability and personal circumstances. Agriculture is generally regarded as one of the more risky activities because of the price inelastic nature of demand and short run supply and its exposure to natural shocks. Global agricultural insurance premiums accounted for US$6.5bn in 2002, but at the same time only 20% of the worldwide agriculture production (crop and livestock) were insured . The highest market penetrations exist in North America for crop insurance due to high state-premium subsidies. Agriculture insurance has enormous growth potential in those markets where it is not yet developed. Over time, agriculture has developed into a complex and risky industry necessitating several insurance solutions. For example, livestock epidemics, such as epidemics of classical swine fever (CSF) and foot and mouth disease (FMD), can result in substantial losses for governments, farmers and all the other participants of the livestock production chain involved. Risk in agriculture is not only of concern to the individual farmer. It is also of importance to society as a whole, as risk-averse behavior of farmers can lead to an allocation of farm resources which is not efficient, resulting in a sub-optimal overall allocation of resources and consequently lower overall welfare. For example, risk-averse farmers might not adopt a new productivity-enhancing technology because of potential risk associated with it, which results in a lower increase in output that possible. Latvia’s accession to EU presents both opportunities and limitations towards developing it’s own insurance model. Help and assistance shall be available from the EU and in the same time various restrictions shall apply as regards to supporting the farmers by the government for the purpose of ensuring the common market. 1.2 Objectives of the Study The aim of the research is to identify and analyse agricultural insurance models in 5 European countries in respect of the insurable risks. The conclusions and recommendations of this study are intended to contribute towards development of agricultural insurance model in Latvia. 1.3 Scope and Limitations The scope of the paper is to provide Latvijas Valsts Agrārās Ekonomikas Institūts with the review of agricultural insurance models used in 5 of the EU-15 countries (Germany, Netherlands, Italy, Spain, France). It has been decided to expand the research by reviewing the key risk management issues, it’s tools relevant for agriculture (insurance being one of them), summarize on the main CAP requirements as well as the EU regulations. This is because of the need of studying the possibilities of creating an agriculture insurance model for Latvia where we believe studying the context is vital. Main limitations of the study are the following: 1. The main difficulty was to obtain data for the analysis. There are various possible explanations to it: a) they are available in the local languages, b) there is a few models operating that involve the governments therefore there would be less requirements/incentives for making the information publicly available and hence there was a scarce of information available on the models; on the other hand, where there the significant involvement of the state, we found many useful information (Spain), c) the insurance models could be under development (see for some hints European Commission, 2001), therefore there would be little information available publicly, just for the reason the process of achieving an optimal solution was on its way . 2. Due to lack of publicly available information, as well as information provided by the official European organizations and Agricultural Ministries in European countries, this analysis could not be regarded as complete, but fragmented. Nevertheless it does provide a reach view on the trends as carrying on research on 5 countries it was possible to find information on nearly all relevant aspects of the objectives of this study. 3. For the purpose of making any conclusions about the hypotetical insurance model in Latvia this study is incomplete due to lack of the economic and political analysis of a European country that was selected for the research. This paper limits its analysis to the main risks in agriculture, CAP reform and main EU regulations followed by the basic requirements for agricultural insurance and main insurance types, as well as the summary of the actual information pertinent to the country of research. 1.4 Methodology In order to achieve the purpose of the case study, the methodology that has been followed is shown in the below figure: Chapter two presents overview of agricultural sector in the European Union followed by the list of the main categories of risks, examples of livestock epidemics and environmental aspects. The main aim of this chapter is to show the importance of this research and to draw government’s attention to this problem. Chapter three discusses CAP reform and main EU requirements regarding insurance models in agriculture. This chapter explains the main principles that should be taken into account while developing agricultural insurance model. Chapter four analyzes main types and requirements for insurance and discusses the appropriate role for the government. The chapter ends with a short overview of main risk management tools which can be used as insurance’ alternative. Chapter five presents analysis of agricultural insurance models used in European countries, namely, Spain, France, Italy, the Netherlands and Germany. All the materials used in the research were either found in the Internet or provided to us by our colleagues from other Marsh offices. 1.5 Main Findings The agricultural insurance market in the European Union is undergoing significant changes. Support mechanisms protecting farmers from global market forces are being dismantled and governments become less and less involved in providing ad hoc disaster relief. At the same time private insurance companies are not able to satisfy all farmers’ needs due to lack of agricultural insurance products being available. Besides, severe weather conditions, recent outbreaks of livestock diseases and higher quality standards are also creating new agricultural risks. The complexity of this changing environment resulted in exposures that the EU’s traditional risk management tools are not able to meet growing requirements. In the light of all the points mentioned above it can be concluded that the only thing farmers could do is to work in close cooperation with the governments and private insurance companies in order to work out insurance model which will fit all the needs in the best way. Price risk and production risk are the two exposure categories that are significant to any agricultural community. Given the many new sources of price and production exposures, the market will be ripe for sophisticated insurance and re-insurance products and services that can help manage these risks. This study has a huge practical importance for the Latvian state institutions. Preliminary analysis of the existing agricultural insurance models combined with the EU regulations and future development opportunities of the sector gives our client the overall picture, while recommendations made specify areas for the next researches. Chapter II Risks and Crises in Agriculture Agriculture is generally regarded as one of the more risky activities because of the price inelastic nature of demand and short run supply and its exposure to natural shocks. This is the main reason why agriculture is one of the most heavily supported industries in both the European Union and throughout the developed world . Although agriculture accounts for just 1.7% of the EU’s gross domestic product and 4.2% of its workforce, it takes up half of the EU’s total annual budget. This accounted for €44.3bn in agricultural aid for 2003. 2.1 2003 Agricultural Year Overview The 2003 agricultural year was marked by lower production for both crops and livestock products, with the notable exceptions of milk and pig meat . This fall was partly offset by a fairly favourable price trend. Inflation allowed for, input prices were lower except for energy whereas agricultural prices were on the whole unchanged. Price rhythms were highly variable by sector and country but there were increases for all cereals, fruits and vegetables, wine, poultry and eggs, and falls for sugarbeet, potatoes, pigmeat and milk. Under these circumstances agricultural income rose very slightly for the Union as a whole (+ 0.9 % in real terms). The actual range by country was from -14 % for Germany to + 20 % for the United Kingdom. 2.1.1 Projections for the EU-25 Market projections for the main agricultural products in the EU-25 were established under a specific set of assumptions . These cover the outlook for the macro-economic environment, with a gradual recovery of EU economic growth and a strengthening of the US$ over the medium term. World agricultural commodity markets are assumed to show growing demand and trade. Trade policies are assumed to be governed by the Uruguay Round Agreement on Agriculture and no new multilateral trade agreement has been accounted for. All existing trade commitments are assumed to be met. The medium-term perspectives for the cereal markets appear moderately positive thanks to the impact of the CAP reform and the return to higher set-aside levels in combination with more favourable world market conditions. In 2003 cereal production dropped to 230 mlj t from 263 mlj t in 2002 owing to exceptional weather conditions . Lower mandatory set-aside combined with more favourable climatic conditions led to a sharp rebound in 2004 as total cereal harvest reached 285 mlj t, with 63 mlj t produced in the new Member States. Production in 2005 would fall to 261 mlj t, due to the return to higher set-aside levels and the introduction of decoupling in a number of countries. The EU meat sector came back to a more normal situation after the extreme market conditions of the past few years, when it was hit by the second BSE scare and the FMD outbreak in 2001 and the avian flu in 2003. The EU-25 beef and veal consumption recovered rapidly after the BSE crisis and was higher than production in 2003 for the first time in 20 years. It is expected to remain so over the projection period as production would decrease to around 7.6 mlj t by 2012, in line with the structural reduction of the dairy herd and the impact of the introduction of the single farm payment. A tight domestic supply and a steady demand are projected to keep beef prices at a relatively high level, attracting more imports entering at full duty, notably from South America. Overall meat consumption is projected to increase from 87.4 kg/head in 2004 to around 89 kg by the year 2012 . Pig meat, with a share of about 50%, is by far the most preferred meat by the EU consumers , followed by poultry, recording a share of around 27%, which has overtaken beef and veal since 1996. Income estimates have been compiled on the basis of these market projections and the financial perspectives for the EU over the period 2005-2012 (Table 2.1). These medium-term income projections display a rather favourable outlook as the EU-25 agricultural income would grow by 11.7% between 2004 and 2012 in real terms and per labour unit. This overall gain would however mask marked differences between the EU-15 and the new Member States. Whereas agricultural income in the EU-15 would show a rather modest development with a 4% growth over the 2004 - 2012 period, it is foreseen to exhibit a more pronounced and positive trend in the new Member States where it would rise steadily by 50.4% over the projection period (when assessed against 2003, i.e. before enlargement, farm income per labour unit in the new Member States would increase by 137%). Table 2.1 Assumptions on Micro-Economic Variables in the European Union, 2002 - 2012 European Union. Directorate-General for Agriculture (2005). “Prospects for Agricultural Markets and Income 2005 – 2012” (page 19). In general the agricultural share of GDP has been declining during last years in the EU-15. The share of the labour force engaged in this sector is declining due to farm consolidation (reduces by around 40% from 1990). More than half farms in the EU-15 are smaller than 12 acres, the largest farms in the EU (124 acres or more) account for only 8%. Analysis of age distribution of farmers shows that the largest group is 55 or older. The aging of the EU producer has sometimes been cited as a cause for either concern – too few younger people are taking up farming – or reassurance – the problem of surplus production will be solved by demographics as older farmers exit from the market (OECD, 2004). For a growing share of farmers, farming is a part time job. Many producers have some or considerable gainful employment outside the farming and depend on off-farm income (Eurostat data). This shows that farmers don’t consider this type of employment as stable and don’t put enough effort in farm development throughout the Europe. 2.2 Farmers’ Perception of Risk The extent to which farmers are confronted with different sources of risk varies across countries, regions, sectors and time (MAFF, 2001). Farmers’ perceptions of risk can furthermore vary according to such factors as age, size of farm, the availability of a successor, the costs involved, sources of indemnity and other factors (Barry et al., 1995; Hardaker et al., 1997; Harrington et al, 1999). Two empirical researches on Dutch livestock farmers and UK producers’ attitude towards risk are summarized below. Results from the Netherlands indicate that Dutch livestock farmers perceive risks related to output prices and animal diseases as very important (Meuwissen et al., 2000). In analyzing the farm and farmer characteristics relating to the perceptions of the sources of risk, it was found that the risk factor ‘financial situation’ was perceived to be more important by dairy farmers than by pig and mixed farmers (probably it can be explained by the fact that cheese is an important export product for the Netherlands). Furthermore, this risk factor was perceived to be more important by farmers with a relatively low gross farm income, a relatively low solvency ratio and by those with relatively large farms. Also farmers who considered insurance as an important risk management strategy perceived risks related to the financial situation as being very relevant. Risks related to ‘legislation’ and ‘production’ were perceived to be relatively less important by dairy farmers, and for both types of risks there was an inverse relationship with gross farm income: the lower the income the more important the perceived risks related to ‘legislation’ and ‘production’. A study on UK producers’ attitude to risk undertaken for the National Pig Association concluded that price and marketing risk (including currency risk) was the major source of risk for the UK pig industry, as might be expected given the characteristics of pig markets and the nature of the CAP pigmeat regime. Main conclusion from these two researches is that farmers are trying to control an event/risk impact (i.e. secondary factors), instead of controlling and minimizing primarily factors, which lead to price risk and unstable financial situation of the farm. At the same time farmers perceive risk differently, which mean that the success of insurance system depends on risk perceptions which vary between countries. 2.3 Categories of risk in agriculture Some risks have to be more explicitly taken into account than others. If potential losses are big, more attention has to be paid to the choice among the available alternatives, as the differences between the various outcomes may be significant. Some risks farmers have in common with other businesses, others are unique to farming. The most important risks can be classified as follows (Baquet et al, 1997; Commission of the European Communities, 2005; Green, 2002; Hardaker et al, 1997; MAFF, 2001; USDA 1999): 2.3.1 Risks related to production factors Human or personal risk refers to the death, illness or injury of the farm operator and/or its labour force and may result in interruption of business. In European Union basic coverage for personal risk is provided by sector specific or general social security systems. Additional coverage is available on private insurance markets. Asset risk is typically associated with fire, storm, theft, or other causes of loss and damage to buildings, equipment, animals or other agricultural production capital. Losses can be covered by business insurance. In the case of catastrophic events, public disaster aid at regional, national and/or the EU level may contribute to reduce losses and to restore investments. Financial risk refers to capital as a production factor. Rising capital interest rates, unfavorable changes in exchange rate or insufficient liquidity may jeopardize the financial stability of any enterprise. Currency risk relates to the revaluation or devaluation of the national currency. Revaluation/devaluation of the currency affects import and export demand and domestic prices for competitively traded inputs and outputs. Furthermore, for EU countries that are not within the EMU (United Kingdom, Sweden, Denmark and the EU-10), a revaluation or devaluation of the national currency affects the size of CAP support prices and payments since these are denominated in Euros. Liability risk is associated with any private or business activity. New technologies (e.g. genetically modified organism) or evolving legal obligations (e.g. food safety rules) may change the liability risk and the possible requirement for insurance or other risk management instruments. 2.3.2 Production Risk Production risks concerning agricultural output or yields are often related to adverse weather conditions (excessive/insufficient rainfall, hail, extreme temperatures), as well as to plant or animal diseases or pests. Livestock production is generally considered to be less affected by output variability than crop production, since in many respects the production environment is easier to control. Sanitary crises, however, may result in severe income losses. While risk may be associated with either a positive or a negative outcome, the assumption is always made that a crisis has significant negative consequences. A crisis is understood to be an unforeseen situation that endangers the viability of agricultural holdings, either at a localized level, across a whole sector of production or at a wider geographical level. In agriculture, a crisis may be caused by Natural disasters: drought, floods, excessive rain, frost, hail, storms, earthquakes, etc. Diseases and pests affecting animal or plant health or contamination in the food chain (e.g. dioxins); hazards aggravated by the increased movement of animals, trade in goods and global travel. Crises of this kind can seriously disrupt agricultural markets; livestock farmers, in particular, may suffer severe economic hardship. Economic (conjunctural) factors having short-term but significant effects on farm income. Unforeseeable disruption of market access caused, for example, by the unexpected closure of important export markets. Contrary to more long-term and often predictable structural problems, a crisis is characterised by an abrupt shock with high intensity negative consequences. However, a short-term crisis may result in long-term structural problems. 2.3.3 Price Risk Price risk is the risk of output prices falling and/or input prices rising after a production decision has been taken. In the agricultural sector, specific inelasticity of demand contributes to the increased volatility of agricultural commodity prices. Given the fact that prices do not follow clear trends, price volatility has often been used as an argument for income stabilization measures in agricultural policies. In the open markets, prices are generally more highly correlated across different regions than yields. All these risk elements can and do affect income, a key variable for agricultural policy. However, the different facets of risk may also be correlated in such a way that income risk is reduced. For example, low yields may be associated with high prices and vice versa, although trade liberalization makes this even less sure. Besides, the various risks are often interrelated. For example, the institutional risk of a change in price support has an influence on price risk. Likewise, imposing environmental restrictions has an impact on yield risk. Therefore, risks of all categories have an effect on the income situation of a farm household. 2.3.4 Trends in risk exposure in the EU Several trends in European agriculture affecting risk exposure of producers can be predicted with a fair degree of certainty (European Commission, 2001). Production risks are likely to increase further because of rising quality requirements, stricter rules for the use of inputs and medicines for animals, growing movement of people, animals, animal products and plants as well as because of climate change. Furthermore, trends towards greater agricultural trade liberalization and reduction of CAP market support increase price risk. Specialization in European agriculture is likely to continue, thus increasing both producers’ production and price risk. All developments taken together are very likely to result in EU farmers’ market income being more volatile than in the past. 2.4 Examples of Livestock Epidemics in Recent Years Epidemics in livestock, such as foot and mouth disease (FMD) and classical swine fever (CSF) may inevitably affect many farms at the same time (Asseldonk et al, 2003). FMD is the most contagious disease of cloven-hoofed animals (cattle, pigs, sheep, goats and all wild ruminants) and has a great potential for causing severe economic losses. Many countries are officially free of FMD (without vaccination), other countries vaccinate against the disease (preventive vaccination), and in some countries FMD is still endemic. In the EU preventive vaccination is prohibited since 1991. After 1991, FMD epidemics occurred in Greece and Italy (1993, 1994, 1996) and the UK, Ireland, France and the Netherlands (2001-2002). CSF is also a highly infectious virus posing a threat to livestock production. Natural hosts of CSF are domestic pigs and wild boar. Preventive vaccination was stopped in all EU Member States in the early 1990's (Westergaard, 1991). The absence of vaccination resulted in a totally susceptible swine population (Edwards et al., 2000). In the wild boar population CSF is still endemic in Germany and Italy (Fritzmeier et al., 2000). In the 1990's large CSF outbreaks (more than 40 farms infected) occurred in the Netherlands (1997), Germany (1993, 1994, 1995, 1997, 1999, 2000), Belgium (1994) and Italy (1995, 1996, 1997) (Laevens, 1998 and Asseldonk et al, 2003). The Netherlands. In the Netherlands alone losses from livestock epidemics from 1997-2003 accounted for more than 4.4 billion Euro (Asseldonk, 2004). The main reason for providing these data is to show the financial consequences of livestock epidemics, not to compare them between different countries. One year losses of even 10 mlj birds (one third of the lost population due to epidemics in the year 2003) will have substantial effect on the whole country, as farmers are not the only one to bear losses which will affect several future years as well. CSF (1997 - 1998) o > 10 million pigs o Government: 1.4 billion Euro o Private sector: 0.9 billion Euro o Consequential losses: 450 million Euro FMD (2001) o 250,000 animals o National economic losses: 1.4 billion Euro AI (2003) o 30 million birds culled o Losses: 270 million Euro Livestock epidemics can have large economic consequences not only for farmers but also for other companies of production chain in terms of direct losses, which are partially compensated by the government; and consequential losses, which are almost always borne by the farmers themselves if not insured privately . 2.5 Environmental Aspects The success of agricultural management largely depends on meteorological parameters, such as temperature and precipitation distributions, and on the likelihood of extreme events, such as hail, drought and frost. These agricultural risks are likely to increase in certain areas owing to changing climatic conditions, e.g. increasing mean temperatures. In other areas, conditions for agricultural production may actually improve. The potential effects of climate change on agricultural yields and the associated risks can be separated into the following three categories (Table 2.2). Table 2.2 Different Levels of Climate Change Effects on Agricultural Yields and Associated Risks First order effects Change in meteorological parameters, e.g. temperatures, CO2 concentration Yield Second order effects Climate change Frequency/intensity of extreme events, such as frost, hail, drought Yield Third order effects Climate change Weather patterns, soil humidity, precipitation Populations of weeds, fungi, insects Yield Source: Ortloff, W. (1997). “Climate change and risks for agriculture: management implications for the insurance industry.” Thesis for the EAEME program “European Master in Environmental management”, September 1997 (page 3). The existing scientific literature on the potential effects climate change may have on agricultural production indicates great uncertainty. The climate change study condensed the available scientific data into several scenarios to outline potential developments in agricultural yields and related risks (Ortloff, 1997). These scenarios illustrate what might happen to agricultural production in Europe under climate-change (Table 2.3). Table 2.3 Scenarios of Potential Climate Change Impacts on Agricultural Production and the Associated Risks Scenario Affected Parameter Increase by 2020 Increase by 2050 Temperature effect - baseline - worst case mean temperature temperature variability frequency of frost events mean temperature temperature variability frequency of frost events 0.5 oC 5% 0% 1 oC 10% 20% 1oC 10% 0% 2.5 oC 30% 30% Hail - baseline - worst case frequency of severe hail events frequency of severe hail events 5% 10% 10% 30% Drought - baseline - worst case frequency of severe drought frequency of severe drought 10% 15% 20% 30% Pest / disease - baseline - worst case occurrence frequency for damaging levels occurrence frequency for damaging levels 10% 20% 15% 30% Source: Ortloff, W. (1997). “Climate change and risks for agriculture: management implications for the insurance industry.” Thesis for the EAEME program “European Master in Environmental management”, September 1997 (page 4). Another study (Hohl, 2004) examined a warmer climate impact on agricultural products in mid latitude regions (this region was chosen due to existence of large agricultural production areas). Main findings are the following: Increased CO2 level: higher yields at short term, less evapotranspiration, more weeds. Temperature increase: more droughts and heat waves, less frost, longer growth periods, and shorter maturation time. Intensified precipitation cycle: more convective rainfall and flash floods, longer dry periods, potentially more hailstorms, more erosion, decreasing soil moisture, less water available for irrigation. Sea level rise: salt water intrusion. Warm winters: better reproductive cycles of some insects. In the mid term reduced production in some areas is balanced by gains in other areas. In the long term drawbacks with shifts in agricultural production zones to higher latitudes. Developing countries are more vulnerable than developed countries (supply, demand, price setting, subsidies). In the same research Hohl pointed out that in the year 2003 economic damages in Europe after drought were estimated at US$ 13 bn. Figure 2.1 presents impact of the summer 2003 heat wave and drought in five European countries. Figure 2.1 Impact of the Summer 2003 Heat Wave and Drought on the Agriculture and Forestry in 5 Selected Countries Source: Hohl., R. (2004). “Extreme climate events and agricultural insurance.” MICE Workshop, October 2004 (page 5). Climate change represents a risk that needs to be taken seriously. Several climatic change studies show that the future will be bringing an increased frequency and severity in extreme weather events such as hail, drought and frost. At the same time main threats from climate change, namely, increased extreme and volatile weather events and insufficient capital, liquidity and rating problems create opportunities for insurance and re-insurance companies in innovative risk solutions. Conclusion Main conclusion from this chapter are as follows: 1) is that farmers are more concerned about secondary factors affecting their income/revenue, while ignoring primarily risk factors. Researches conducted in several old EU countries concluded that major risk factors, which are likely to cause catastrophic losses are almost always neglected by the farmers. The main suggestions are: The govermnent should provide farmers with more education and training about risk related issues in order to improve the risk awareness and thus change their attitude towards future potential losses and its mitigation. The government and insurance companies should work together with farmers to prepare for the changing nature of risks beforehand in order to eliminate or reduce consequences and work out a better solution. 2) In respect of changing climate and bad weather conditions, instead or in addition to traditional insurance solutions government and other institutions could consider weather derivatives that are risk transfer vehicles that pay pre-defined sums of money in the case of the weather conditions exceeding pre-agreed levels (see Lerner (2004a), Lerner (2004b), Marsh (2005) Mathematical modeling is required to develop the optimal solutions. 3) the risks that the agriculture faces are many and they tend to be very volatile; production risks against natural disasters and weather conditions is just part of the equation, therefore a more comprehensive approach in managing all of the risks could designate the role of insurance as a risk transfer mechanism in the context of the overall risk profile .Chapter III CAP Reform / EU Regulations 3.1 CAP Reform The Common Agricultural Policy (CAP) is a system of European Union agricultural subsidies which represents about 44% of the EU's spending (Wikipedia. The Free Encyclopedia). These subsidies work by guaranteeing a minimum price to producers and by direct payment of a subsidy for crops planted (see Appendix 1 for the whole list of sectors covered by the CAP). This provides some economic certainty for the EU farmers, ensuring production of a certain quantity of agricultural goods. Reforms of the system are currently underway including a phased transfer of subsidy to land stewardship rather than specific crop production from 2005 to 2012. Detailed implementation of the scheme varies in different member countries of the EU. History. The CAP developed during the late 1950’s and early 1960’s and was based largely upon the idea of providing agricultural subsidies through intervention in the markets . For each commodity covered, an intervention price is set that acts as a floor. If the market price falls below the intervention price level then the EU buys up any product offered for sale at the intervention price level. See Appendix 2 for the history of Cap reforms. Definition and Instruments. Among the European Union's policies, the CAP is regarded as one of the most important policy areas. Not only because of its share of the EU budget (almost 50%, decreasing over the years), the vast number of people and the extent of the territory directly affected, but also because of its symbolic significance, and the extent of sovereignty transferred from the national to the European level. The significance of the CAP, nowadays, is also portrayed by the fact that it is directly related to the Single Market and the EMU, two key areas in achieving the European integration . The objectives of the CAP, as set out in Article 33 of the EC Treaty, are: to increase agricultural productivity by promoting technical progress and by ensuring the rational development of agricultural production and the optimum utilisation of the factors of production, in particular labour; to ensure a fair standard of living for the agricultural community, in particular by increasing the individual earnings of persons engaged in agriculture; to stabilise markets; to assure the availability of supplies; to ensure that supplies reach consumers at reasonable prices. In order to attain these objectives, Article 34 of the EC Treaty provides for the creation of the common organisation of the agricultural markets (COM) which, depending on the product, shall take one of the following forms: common rules on competition; compulsory co-ordination of the various national market organisations; a European market organisation. The COMs were introduced gradually and now exist for most EU agricultural products. They are the basic instruments of the common agricultural market in as far as they eliminate the obstacles to the intra-Union trade of agricultural products and maintain a common customs barrier with respect to third countries. Three main principles, defined in 1962, characterise the common agricultural market and thus the COMs: a unified market: this denotes the free movement of agricultural products within the area of the Member States; for the organisation of the unified market, common means and mechanisms should be used throughout the EU; Community preference: this means that the EU agricultural products are given preference and a price advantage over imported products; also, the protection of the internal market from products imported from third countries at low prices and from considerable fluctuations in the world market; financial solidarity: all expenses and spending which result from the application of the CAP are borne by the Community budget. The EU governments gave careful consideration to the implication for CAP expenditures (OECD, 2004). They agreed that between 2007 and 2013 the overall ceiling for CAP expenditures under the common market organizations for the 25 countries will rise no more than 1% per year in nominal terms from the 2006 level. Once this ceiling is reached a “financial discipline” mechanism will automatically reduce the level of direct payments. 3.2 The EU Regulations Since the 1960s, the CAP has set all the rules, regulations, and support mechanisms for agriculture in all the Member States of the EU. Through such measures as export restitutions and import subsidies, CAP has assured the EU farmers a base price for their products and has shielded them from external competition. Over the last decade, the CAP system has become untenable both financially and politically. Critics cite such problems as the length of time it takes for compensation payments to be made, the discouragement of private insurance solutions, the disincentive for farmers to implement risk management methods, and structural weaknesses in the agricultural sector caused by CAP's production-based subsidies. These problems in combination with pressure both from within the EU and from external sources such as the WTO, world markets, and competing countries have forced CAP to implement reforms that will increase the EU's exposure to the global marketplace and new competitors. CAP support mechanisms remain in place for the time being. However, the progressive dismantling of these protective measures will expose European farmers to the full force of world market volatility, changing technology, restrictions on input, and new legislation. As an example of control measure, livestock production can be mentioned. Member states are obliged to apply the control measures laid down in the EU directives if an outbreak arises of so-called ‘List-A diseases’ (Appendix 4). The basis for these measures originates from the EU Council Directive 85/511/EEC and 80/217/EEC respectively. Measures include: 1) stamping-out of infected herds; 2) preemptive slaughter of contact herds; and 3) the immediate establishment of surveillance zones around such herds. In these zones, animal movements are restricted and to a large extent prohibited. After obtaining the EU approval, countries may take additional control measures such as slaughter of animals for reasons of animal welfare in areas with a movement standstill. Also, a more comprehensive pre-emptively slaughter scheme can be applied. Furthermore, all susceptible animals within a large area around the infected herds might be vaccinated (emergency vaccination, ‘ring vaccination’). Obviously, these livestock epidemics can have large economic consequences for farmers but also other various parties of the production chain in terms of direct and consequential losses. Therefore there must be strict rules for compensation obtaining and distribution of subsidies and other payments to the farmers. 3.2.1 Compensation of Direct Losses Direct losses comprise the value of the animals culled under depopulation and welfare control measures and the costs of organizational aspects such as the monitoring of farms in restriction zones (Asseldonk, 2003). Direct losses are partly compensated by governments (national and European). The veterinary budget of the European Union refunds 5% of the costs of compulsory and pre-emptive slaughter, 70% of the costs of welfare slaughter, and 50% of the organizational costs (Council Directive 90/424/EEC; Ministry of Agriculture, Nature Management, and Fisheries, 1998). The financing of the non-EU compensated part of the direct losses differs between the EU member states. In the Table 3.1 an overview of the current financing schemes is depicted, focusing on whether or not the primary sector contributes via a levy system (Asseldonk, 2003). Table 3.1 Direct Livestock Losses and the Contribution of the Sector Note: -: no levy, +: (partly) levy or compulsory insurance scheme Source: Asseldonk, M., Meuwissen, M., Huirne, R. (2003). “A risk financing model for livestock epidemics in the European Union”. Institute for Risk management in Agriculture (IRMA), Wageningen University, the Netherlands (page 6). Some Member States finance the direct losses entirely from the national budget. Others have set up some form of statutory system to co-finance the non-EU compensated part of the direct losses. These Public-Private financing schemes have a compulsory fund structure in which all farmers pay a levy. In case of co-financing to complement the public part, the amount that is financed by the sector can be proportional or non-proportional. 3.2.2 Compensation of Consequential Losses Consequential losses arise from business interruption, empty buildings, losses related to established restriction zones, emergency vaccination and price effect and are almost always completely borne by the farmers (and other participants of the production chain) if not insured privately. Consequential losses that arise at farm level can comprise one or more of the following categories (Asseldonk, 2003): Business interruption. Business interruption occurs because farm buildings become (partly) empty due to stamping-out and welfare slaughter or breeding prohibition, and stay empty until restriction zones are lifted. Losses related to established restriction zones. Farms in restriction zones face (long) periods in which animals (e.g., finishing pigs and veal calves) and manure can not be transported from the farm. These periods are characterized by animal welfare problems, extra feeding costs, and emergency measures for housing of pigs and storage of manure. Such losses will widely vary across farms and are therefore complicated to measure. Milk from dairy farms in restriction zones might be collected taking into consideration strict hygienic measures. Additional repopulation costs. These losses include extra costs of animal health problems. Losses from emergency vaccination. Given a situation, in which vaccinated animals are destroyed, losses might arise of the above categories (business interruption, repopulation costs). However, for reasons of social acceptability, the rendering of vaccinated animals is under debate. With future epidemics, meat and milk from vaccinated animals may be destined to the local market, which likely leads to extra costs and/or lower prices. Something similar may be applied to animals under welfare slaughter programs. Price effects. Livestock epidemics can have a rather severe impact on prices, especially meat prices. The impact depends on aspects such as the size of the epidemic (duration, size of restricted area), reactions of other countries (closure of borders, increased production) and whether vaccination is applied (which generally leads to long periods of export limitations). As farmers become less able to turn to CAP for protection, agricultural insurance programs should become increasingly desirable as a means of recovering losses. Conclusion. CAP guidelines have given each EU Member State great freedom in responding to its unique risks, with the result being a proliferation of products that differ considerably from state to state in terms of structure, coverage, complexity, and degree of state aid. However, despite the freedom regarding legislation, all the EU countries should adopt their models to the EU requirements. Chapter VI Insurance in Agriculture Crop insurance is the largest single agriculture insurance line . Global premium income exceeded USD 5 billion in 2003. Crop insurance is most developed in North America and Western Europe, whilst important agriculture production areas in Eastern Europe, Asia, Africa and Latin America are little insured. These are future potential growth areas for the agriculture insurance and re-insurance industry. 4.1 Basic Requirements for Agricultural Insurance In order for a risk to be insurable, two basic requirements have to be met: managing the adverse effects of “asymmetric information” and overcoming the implications of “systemic risks”. These two concepts are explained in the following box (Bokma-Bakker et al, 1999; European Commission, 2001; Harrington et al, 1999; MAFF, 2001; Skees at al, 1997; Skees et al 1999). Asymmetric information Asymmetric information relates to the problem that the buyer of insurance and the insurance company may not have the same information as regards the probability of losses occurring. Asymmetric information has two dimensions: Adverse selection occurs if those more at risk buy more insurance than others, without the insurance company being aware of this. A common tool insurance companies use to minimize adverse selection is to ask the insured to disclose any factors that may lead to above normal risk. Based on that information premium can be differentiated for different classes of risk. Moral hazard. In the case of insurance, moral hazard refers to an individual’s change in behaviour after having taken out an insurance policy. The change in behaviour results in an increase in the potential magnitude and/or probability of a loss. Opportunities for dealing with moral hazard and adverse selection are increasing. For example, insurers may link their underwriting criteria to objective criteria established for other risk management tools such as HACCP (Hazard Analysis and Critical Control Points), GAP (Good Agricultural Practice), and so-called ‘animal safety indices’. Systemic risk As opposed to risks like fire and burglary, systemic risks are dependent risks: a lot of people suffer a loss at the same time. Systemic risks result in many people making a claim at the same time with the effect that the premium paid into a pool are not sufficient to cover the loss incurred, which may threaten the solvency of the insurance pool. An example for systemic risks is price risk and currency risk. All producers suffer from price downturns at the same time. Measures insurance companies can take to deal with systemic risks include re-insurance, geographic spreading and the use of capital markets. Partly systemic risks include droughts, flood, etc. Another problem related to systemic risks, especially those risks with a low probability of occurrence (such as floods and droughts), is the human cognitive limitations related to low-probability, high-magnitude, risks: individuals typically have problems in assessing the probability of, or the potential magnitude of, catastrophic loss events. Because of such cognitive failure, the willingness to pay of individuals for insurance that covers such catastrophic events is less than the actual premium required for such insurance. Therefore, risks are insurable of the following basic conditions are fulfilled (Skees, 1997; Skees et al, 1999): Symmetric information. The insurer and the insured have (nearly) the same information as regards the probability distribution of the risk (the probability of a bad outcome). This is normally not the case, the main problems being moral hazard and adverse selection. Therefore, insurance solutions are only viable and can be offered at reasonable cost, if these problems can be adequately dealt with (see the box above). Independent risks. Risks should be (nearly) independent across insured individuals. If risks are systemic (dependent), special measures have to be taken in order to make insurance solutions viable (see the box above). Large number of exposure units. The law of large numbers allows an accurate prediction of average future losses and the calculation of the premium. Calculable chance of loss. In order to fix the premium rates, the insurance company must be able to estimate both average frequency and average severity of loss. For low-probability risks with potentially catastrophic outcomes it is difficult to fix a rate. Actual losses occurring must be determinable and measurable. Potential buyers of a policy must perceive possible losses as significant otherwise they will bear the risk themselves. At the same time, premiums must be economically affordable. Appendix 5 presents additional strategies to deal with asymmetric information and systemic risk. All the parties involved in agricultural insurance should further develop solutions to reduce problems described above. 4.2 Insurance Many agricultural risks are considered to be IN-BETWEEN RISKS, which are neither perfectly independent nor perfectly correlated (systemic), for example yield and price risk. Insurance solutions for agriculture also have to include provisions to deal with problems of asymmetric information (moral hazard and adverse selection). 4.2.1 Types of Insurance In the light of these considerations, the following types of insurance can be identified (European Commission, 2001; Meuwissen et al, 1999a): Yield insurance; Price insurance; Revenue insurance; Income insurance. Yield insurance is mainly feasible for crops. Livestock products in general cause yield measurement problems, due to the fact that output is produced at a very fast (e.g. milk) or a very slow pace (e.g. “production” of feeder calves) and because there are no clear, objective “harvesting” times (which increases the scope for moral hazard). However, not all crops have objective harvesting times, either. For such crops, for example horticultural crops in glasshouses, insurance is more difficult (Meuwissen et al, 1999a). Yields are normally insured for named (known) perils, such as hail, which allows the calculation of the probability distribution of a loss occurring, based on historic data. Insurance can be based on individual yields or area yields. In the first case, indemnities are paid, if the individual loss falls below a pre-determined trigger yield, whereas in the latter case a farmer would only receive a payment, if the area yield falls below a trigger yield (European Commission, 2001). When the yield insured is area-based, problems of moral hazard and adverse selection are less important. However, an area-based solution is only attractive, if yields are well correlated, otherwise the degree of risk reduction for an individual farmer might not be sufficient to make participation attractive. If individual yields are insured, solutions have to be found to cope with problems of asymmetric information (deductibles, checking of behaviour etc.). The availability of yield insurance can lead to a shift of resources to those products, for which yield insurance is available, as a consequence an increase in production levels and pressure on market prices are expected. Catastrophic losses as a result of natural disasters or epidemic diseases pose special problems for insurance. Natural disaster risk within a certain region is a highly correlated risk between the farmers of that region, with a low probability of very high losses. There are several reasons why it is difficult to develop insurance products to cover such risks (Skees, 1997): Systemic nature of the risk. If re-insurance or state guarantees are not available, the nature of the risks makes it necessary for an insurance company to charge high premium (which may make the product unaffordable for many farmers) and to build up substantial capital reserves. Insufficient relevant historical data available to calculate a sound premium due to the infrequency of such events. Crowding out by government providing ad-hoc disaster payments, which stifle the development of insurance products. As natural disasters, epidemic diseases have a systemic character and data concerning the outbreaks are rare (European Commission, 2001). In the case of animal diseases and as opposed to natural disasters, farmers can influence the chance of an outbreak of a disease by taking appropriate precautionary measures. Furthermore, state involvement is important with respect to both legislation and covering direct losses resulting from outbreaks of animal diseases (value of destroyed animals). As governments normally cover direct losses, losses which need to be covered are those resulting from business interruption (empty buildings), supply and delivery problems (because of movement restrictions) and repopulation (Meuwissen et al, 1999a; Meuwissen, 2000). The existence of private insurance products against epidemic diseases depends on relevant data availability for needed premium calculations as well as on sufficient re-insurance capacity or state guarantees. Price insurance is feasible only for those products, for which objective price data are available. To avoid moral hazard and adverse selection problems, loss assessment should be based on a price that cannot be influenced by the farmer (futures price, spot market price). The major obstacle for price insurance is the high correlation of prices, which is associated with a systemic risk. Generally, whether price insurance is offered or not depends on whether futures and options markets are available or not as well as on the availability of sufficient re-insurance capacity. If losses resulting from a loss of quality are excluded from coverage, then price insurance provides less protection for the farmer. However, including loss of quality may involve significant moral hazard problems, as quality depends to a certain extent on management decisions (Meuwissen, 1999b). Revenue insurance is a combination of price and yield insurance (European Commission, 2001). It has the potential advantage of being cheaper than either price or yield insurance, as the risk of a bad outcome is smaller (low yields may be offset by high prices and vice versa). Revenue insurance can be set up on a commodity-per-commodity basis or for a portfolio of commodities. The latter could again be cheaper for the farmer, because low revenues from one enterprise are likely to be partly offset by higher revenues from another (if the revenues are not positively correlated). However, such insurance would only be feasible if there is knowledge about the correlation between the different commodities. In order to offer a revenue insurance, an insurance company must be able to determine the joint probability distribution of price and yield risks and find solutions to overcome moral hazard and adverse selection problems. In addition, access to objective price and yield measures is needed. Income insurance is POTENTIALLY MORE ATTRACTIVE TO FARMERS THAN OTHER FORMS OF INSURANCE (e.g. yield, price), because it deals with losses affecting farmer´s welfare more directly (Meuwissen, 2000). It could be based for instance on net farm income of family workers (farm revenue including subsidies minus variable costs, taxes, depreciation, rent, interest and compensation of employees). However, for insurance companies this type of insurance poses considerable problems of moral hazard and adverse selection (European Commission, 2001). Potential losses do not only occur by accident but also depend on a large extent on how well a farmer manages his business. Furthermore, a farmer can easily manipulate certain elements influencing his income (e.g. compensation of employees, operating costs, inventories). These two factors make it difficult for an insurance company to calculate the probability distribution of a bad outcome and to fix a sound premium accordingly. 4.2.2 The Multi – Peril Crop Insurance Program (MPCI) Probably the most sophisticated agricultural insurance scheme currently in force is the Multi-Peril Crop Insurance (MPCI) program used in the US. The MPCI is a federally supported and privately delivered crop insurance system which allows the risk of crop failure and insufficient prices to be transferred from the farmer to an insurer along with supplementary cover options (Ortloff, 1997). The MPCI products provide a wide coverage for crop yield with only very few risk exclusions and typically carry relative high deductibles, varying between 15% and 50% of the insured crop value. Banks very often securities agriculture loans through crop insurance and request farmers to protect their future harvest with comprehensive MPCI policies, if loans for crop input cost have been granted. Since 1985 MPCI has rapidly developed in the US, Canada, Spain, Portugal and Israel. The main reason was increase in government subsidies . In 2003 the global MPCI premium income reached approximately USD 4 billion, which represents about 56% of the worldwide agriculture insurance program. Comprehensive crop insurance as provided with MPCI policies is a very good risk management tool for farmers to manage yield risks for the “open roof” plant production industry on a comprehensive basis. But, at the same time, the insurer needs to address certain serious underwriting problems attached to Multi Peril Crop Insurance: Asymmetric information relates to the problem that the buyer of insurance and the insurance company may not have the same amount of information as regards the probability of losses occurring. Anti-selection occurs, if high risk farmers buy more insurance than others, without the insurance company being aware of this. Moral hazard refers to an individual’s change in behaviour after having taken out an insurance policy. Availability of data. The development of crop insurance—although badly needed to support investments in agriculture—is often aggravated by limited availability of independent, reliable, risk data. Underwriting cost. Underwriting of MPCI products is expensive because it is very costly to develop location-specific underwriting information, establishing the infrastructure for widespread and continuous risk monitoring, as well as crop specific loss adjustment procedures. To reduce the high administrative and premium cost of traditional MPCI products, modern crop insurance solutions need to be based on indexes (area yield, rainfall, other weather perils, etc.). The establishment of a transparent index, which is highly correlated to the expected crop yield and based on reliable long-term data of an independent organization (e.g. a national meteorological office) is most important for any index-based crop insurance scheme. The American MPCI: a Model For The EU? Since the MPCI has proven itself in the US market, it may be worth considering a similar system for the EU. The pivotal question regarding the frame of an income protection scheme in the EU is whether each country should develop a program on its own or supra-national solution should be targeted. Another question is whether the EU is the appropriate body or should European countries join together to develop the program. Given the diversity of agricultural, climatic, economic and political conditions among European countries, the introduction of an insurance scheme with standard terms and conditions for the entire continent does not appear realistic. A more feasible option would be for an international body such as the EU to implement a framework on the basis of which each state would establish its own agricultural insurance system with specific terms and conditions. Within these national systems, the public authorities would provide re-insurance and actuarial support, allowing agricultural perils to be wrapped into insurance programs run by private companies. Within this scheme, the insurer examines a set of criteria (for example, farm’s production history) to allocate each farm to one of the three different pools (see Figure 4.1). The different risk levels in the funding system enable the insurer to take into account specific traits of risk. The greater the risk, the more assistance the government provides. One potential drawback of this system is that the state may no longer be prepared to participate in the program to the same extent if there are any significant changes in climatic conditions. Figure 4.1 Different Funds in the American MPCI System Source: Ortloff, W. (1997). “Climate change and risks for agriculture: management implications for the insurance industry.” Thesis for the EAEME program “European Master in Environmental management”, September 1997 (page 6). Other aspects to consider in developing a European multi-peril insurance system include drawing up an experience (bonus/penalty) rating system, defining a cover limit equivalent to a percentage of the average crop yield, an introducing state-of–the-art monitoring technology (satellite remote sensing) to combat insurance fraud. Furthermore, direct disaster payments must not be allowed to overlap with crop insurance schemes. 4.3 Re-insurance Re-insurance means transfer of some or all of an insurance risk to another insurer . The company transferring the risk is called the "ceding company"; the company receiving the risk is called the "assuming company" or "re-insurer." Re-insurance is valuable for insurer because it allows them to reduce their risk level. If an insurance company is concentrated on the risk in a particular geographic area, for example, then a disaster affecting everyone in that area may severely reduce the insurance company’s reserves. Without re-insurance premiums would have to be set at a very high level to build up enough reserves in order to cover potentially high losses. Two basic models for re-insurance dominate (European Commission, 2001): Proportional re-insurance (Quota share arrangements). Insurer and re-insurer share premium and risk. The re-insurer assumes an agreed-upon, fixed percentage of all the insurance policies written by a direct insurer. The quota determines how premium and losses are distributed between direct insurer and re-insurer. Non-proportional re-insurance Excess of loss: re-insurer covers up to a certain amount any part of a loss resulting from a single catastrophic event that exceeds an agreed deductible. Stop-loss: re-insurer covers up to a certain amount any part of a total annual loss that exceeds an agreed deductible. For the insurance industry, re-insurance is a further obstacle to setting up agricultural insurance products, since the capacity of the worldwide re-insurance market is limited. Therefore, the creation of insurance pools can be a solution for insurers to pass on/spread risk. A pool is set up by insurers to jointly provide insurance for certain risks (European Commission, 2001; Commission of the European Communities, 2005). Besides, in order to be financially viable, a re-insurance company has to diversify the risk it takes. This problem can also be solved with the creation of insurance pools. Typically, a re-insurer would cover a wide range of different risks in locations all over the world to reduce the variability in losses from its portfolio. The risks normally covered by such pools include: New, unknown risks; Catastrophic risks; Infrequent risks - the prediction of the total loss to be expected for a certain period is not possible (law of large numbers does not apply); Risks which can only be covered by applying special know-how. Advantages of an insurance pool include the following: Together, the members can provide maximum capacity. Risks can be spread more widely. The more risks can be spread, the less re-insurance is needed and the cheaper re-insurance therefore is; The pool can provide optimum safety (screening of applicants, solidarity clause, mutual coverage of risks); Fast exchange of information; Economies of scale. Two categories of pools exist: Co-insurance pools: insurers put together their individual capacities Co-reinsurance pools: a group of insurers (normally also including re-insurers) acts as re-insurer which covers a share of the members’ risks. The capacity a company contributes to the pool determines its share in receipts and indemnities as well as its share in profits and losses. 4.4 Government’s Role The overall objective of government involvement in agricultural risk management can be to help reduce farmers’ risk exposure (through diversification, sanitary and phytosanitary measures, price safety net) or help them cover losses resulting from risk exposure. Governments can either help to prevent/cover big losses or contribute in general to preventing/covering losses, whatever their size. 4.4.1 Fields of action for government There are basically four potential fields of action for government: 1. Legal framework for risk reduction (e.g. sanitary and phytosanitary legislation) or the establishment of markets for risk tools. For example, many catastrophes (epidemics) can be either prevented or magnified by government policies (or lack of them). Having government financially responsible for some losses might be an incentive for them to put into place appropriate hazard management measures (Cutler et al, 1997). 2. Market facilitations. Governments could help to create the necessary conditions for developing markets providing risk management tools. For example, they could provide information and training on risk and risk management tools for farmers. 3. Lowering the costs of risk management tools. As regards insurance, subsidies could be justified if an insurance product would be unaffordable for the farmers (due to systematic nature of the risk it covers or problems of asymmetric information). Possibilities include subsidies for insurance and re-insurance premium. Subsidies could also be justified on a temporary basis to encourage the development of market solutions. 4. Governments can also provide risk coverage themselves. For example by providing disaster aid payments, public insurance and re-insurance, or a specific safety net. Such approaches could be justified, if private markets for risk coverage cannot provide the necessary protection for all categories of farmers (missing or incomplete markets). Disaster Aid. Disaster aids are paid to help farmers to cope with losses from non-insured natural catastrophes (European Commission, 2001). A frequent argument in economic literature against ad-hoc aids relates to risk-awareness. If the farmer knows that he can get free ad-hoc disaster aid in the event of a natural disaster, he is less likely to take the corresponding risk into account in his decision-making. Furthermore, disaster aids potentially crowds out private initiatives. Another criticism, this time from the side of farmers, relates to the time-lag between the occurrence of a loss and compensation. A solution to this problem is sometimes seen in using the insurance industry to channel public money to the farmers, since it might be able to distribute compensation more quickly (due to its infrastructure and know-how). In the EU disaster payments are mainly maid by the Member States. The EU itself has 2 tasks. It participates financially in Member States’ sanitary and phytosanitary measures (budget 2000: 106.5 million Euro. The funds are mainly used for the eradication and animal diseases) and approves state aids by Member States. Approval is necessary to prevent possible distortion of competition between producers in different Member States . Safety net. A safety net in general is an instrument which allows farmers to smooth income over a longer time period, or to transfer money into an account in a high-income years while withdrawing it in a low-income years (European Commission, 2001; MAFF, 2001). Safety nets can be private as well as public instruments. For example, safety nets for product revenue and yield exist in the form of insurance in many countries, often supported or directly offered by the state. 4.4.2 Public-Private Partnerships for the Provision of Agricultural Insurance Governments could subsidize premium rates, administrative costs, and/or re-insurance (MAFF, 2001). In choosing a basis for a public-private partnership, it should be considered that: Agreements should not be too complex. Complexity may lead to rent seeking behaviour on the part of insurance companies and others. Moral hazard of insurance companies should be minimized. Moral hazard could manifest itself in, for example, insurers not properly underwriting their risks. Complexity and rent seeking behaviour are minimized by making the role of the government explicit and by using transparent parameters to measure the costs/risk (i.e. there should be no information asymmetry between insurers and governments). A public-private partnership for re-insurance, with the reinsurance contracts based on objectively established indices, such as area yields or rainfall, fits these requirements best. Moral hazard is minimized if governments reinsure only part of the risks underwritten by the insurers. There are two main ways in which governments might become involved in a public-private partnership: they could agree to provide some re-insurance coverage to insurance companies at zero costs, they could provide re-insurance at fully commercial rates. There are several arguments in favour of governments providing reinsurance at zero costs (Asseldonk, 2004; Barnett, 1999; Cutler et al, 1997; Hazell, 1992; Hennessey et al, 1997; MAFF, 2001) : Governments already provide disaster relief (for example in case of floods). Providing assistance through re-insurance seems more efficient, because disaster relief is very ad hoc and often involves problems of ‘who receives the money’. There are also considerable administrative costs incurred to set up special agencies to organize and provide the disaster relief. By providing re-insurance, governments can use the experience and capacity of insurance companies in dealing with moral hazard and adverse selection problems and in handling large numbers of claims. Governments already provide continuous payments to farmers (for example through price support). Providing assistance through re-insurance seems more efficient, because governments provide assistance when and only when farmers’ incomes are low and marginal utility is high. Individuals typically have problems in assessing the probability of, or the potential magnitude of, catastrophic loss events. Because of such cognitive failure, the willingness to pay of individuals for insurance that covers such catastrophic events is less than the actual premium required for such insurance. A modest subsidy for reinsurance might close this gap. Having the government financially involved may address a moral hazard problem in government behaviour: many catastrophes (for example losses from floods) can be either prevented or magnified by government policies (or lack thereof). Having governments financially responsible for some losses might be an incentive to put into place appropriate hazard management measures. Having the government financially involved may reduce political pressure to provide ad hoc disaster relief. There are also some arguments in favour of governments providing reinsurance at fully commercial rates (Asseldonk, 2004; Cutler et al, 1997; Lewis et al, 1996; MAFF, 2001; Priest, 1996; Skees, 1999). Governments can potentially provide re-insurance more economically than can private market re-insurers (assuming the private sector could provide the needed capacity). Governments have substantial advantages because of their deep credit capacity and their unique position as the largest social entity in a country. These advantages enable them to diversify claims intertemporally and to spread risks broadly. If farmers have to pay for their risk protection, the insurance scheme is really a risk management tool, not some form of income enhancement by the government. It is difficult to determine the appropriate role for government yet, therefore all the factors mentioned above should be taken into consideration while developing a new model in agricultural insurance, which would perfectly fit market, economical and political situation in Latvia. 4.5 Risk Management The way of managing risks and the extent to which different types of risks are managed depends on such factors as a farmer’s degree of risk aversion, the costs involved, the relative size of a risk, the correlation of the risk with other risks, other sources of indemnity, a farmer’s perception of the nature of risk, and a farmer’s income and wealth There are the majority of risk management tools and strategies (European Commission, 2001), for example: ¬On-farm strategies concern farm management and include selecting products with low risk exposure, choosing products with short production cycle, holding sufficient liquidity or diversifying production programs. Several researches conducted found out that European agriculture is not adopting the strategy of diversification. Between 1975 and 1997, the share of non-specialized farms fell from 32% to 17%. Risk-sharing strategies include concluding marketing and production contracts, vertical integration, hedging on futures markets, participating in mutual funds and insurance. Diversification through increasing the share of income from sources outside agriculture. Eurostat data suggest that this type of risk management strategy is widely used in the European agricultural sector. Ideally, markets should provide a wide range of risk management tools. The most important markets for risk coverage are futures markets and insurance markets: Futures markets help to reduce short term price risk and at the same time increase price transparency. In the EU, futures can be traded on five exchanges and traded volumes are still relatively low. The development of futures markets in Europe has been hampered by CAP-induced price stability. As price volatility on the European markets is likely to increase with possible further trade liberalization, the conditions for the development of futures markets and other market-based risk management tools are expected to improve. Production risk can be covered by insurance if the risks are as little correlated as possible across insured individuals (independence of risk) and if farmers and insurance companies have similar information concerning the effective risks involved (symmetry of information). The classical example of such an insurable risk is hail. Mutual funds are a special case of insurance. Mutual funds are owned by the participants and cover losses of members either through money already available in the fund and/or through an additional collection among participants. Conclusion Market support, direct payments and diversification in the framework of the CAP have a major impact on farmers’ risk, even if their main goal may be income stabilization and not risk reduction. In particular, the price support mechanisms play a role in reducing price risks for key products. The EU measures explicitly targeted at production risk include sanitary and phytosanitary measures as well as guidelines for Member States’ disaster aids and insurance subsidies. The perspective of rising risk-exposure in Europe raises the question whether the EU has a role to play in risk management, which goes beyond its current role. This question has to be examined in the context of the fact that the core CAP instruments have an impact on farmers’ risk exposure, as mentioned above. It also has to be remembered that specific risk management policies cannot replace income support policies. The goal of risk management policies is not income support but only to reduce fluctuations of income or its components. Risk management instruments cannot reverse long-term income trends. Chapter V Agricultural Insurance Models in European Countries Agricultural insurance models are not unique in Europe. Main differences are in coverage and public sector involvement. For example (European Commission, 2001): Greece has a predominantly public system. The state, through its public insurance organizations, collects compulsory contributions, administers the program and guarantees coverage of losses. Therefore, the role of the private system is limited. Spain and Portugal have “public-private partnership” systems, where the state plays a key role, providing both premium subsidies and re-insurance. The private insurance industry is integrated into the system; it takes care of program administration and contributes to covering a share of the risk. Italy, France, Austria and Germany have systems of agricultural insurance, which are predominantly private. The four countries differ significantly with respect to subsidies for insurance premium. While Germany is not providing any premium subsidies, Italy grants considerable amount of premium subsidies to the farming sector. Due to difficulties with getting relevant and valuable information regarding agricultural systems/models used in different European countries, analysis provided below will not be complete and decision-making based. Another drawback of this analysis, as was mentioned above, is absence of at least pure economical and political analysis , as the proper choice of agricultural insurance system primary depends on these two factors. This chapter is structured by the key insurance parameters in order to provide a comparable analysis of agricultural insurance models used in European countries. 5.1 Spain Spain has a rich experience in agricultural insurance. Different systems with a varying degree of involvement of the state were tested between the 1920s and the 1970s. Overall success, however, remained limited and participation rate disappointed. The current system is built on that experience. It was set up in 1978 and continues to evolve (Burgaz, 2000; Agroseguro, 1999; Stoppa, 2000; Forteza, 1999). The Spanish system does not distinguish between risks in agriculture that can be insured by the private sector and risks where – because of market failure – the state has to step in. All insurable agricultural risks are covered by the private sector and all types of policies are subsidized by the state. Three different types of policies are on offer: Policies which cover only one type of risk (exceptional); Policies which cover multiple risks; Policies which provide coverage for all risks beyond ate farmer’s control (“all-risk”). Most policies are of type “multiple risk”. Traditionally multiple-risk policies go even beyond climatic risks and also cover risks like fire (European Commission, 2001). As of 2000, a new type of policy is on offer for various crops, which covers multiple climatic risks (seguros de rendimientos). Insured objects and risks covered In 1999, farmers could choose between 58 different types of policies. All crops can be covered at least for the most important risks. Of the 58 types, three cover animal products and five cover marine cultures. Objects Type of cover Risks Crop frost, hail, floods, fire, excess of rain, drought, hot or violent wind; Forestry Livestock diseases Marine Aquaculture Types of Insurance Coverage in Spain Nominated risks Integrated risks Yield Risks Defined and specified according to lines Climatic adversities (multirisk) Climatic adversities Guarantees Percentage of damage Difference between the guaranteed total harvest and real total harvest obtained Difference between the guaranteed total harvest and real total harvest obtained Yield Free fixing Fixed by area, crops and varieties Fixed individually (historical data) Premium Fixed for each area, crop, species and varieties Fixed by area, crops and varieties Fixed individually Assessment For each plot Compensation between plots (hail and fire by plots) Compensation between plots (hail and fire by plots) Source: Marsh internal resources. The involved parties Policies can be taken out by individual farmers or by groups of farmers (cooperatives, professional organizations etc.). Participation in the system is voluntary: Farmers – by underwriting an insurance policy; Insurance companies – by joining AGROSEGURO. Cooperation between parties The Spanish system does not distinguish between risks in agriculture that can be insured by the private sector and risks where – because of market failure – the state has to step in. All insurable agricultural risks are covered by the private sector The system is based on an intricate partnership between the private and the public sector (European Commission, 2001). The main role of the private insurance companies is to take care of program administration and contributes to covering a share of the risk (see Figure 5.1): ENESA (Entidad Estatal de Seguros Agrarios), an organism attached to the Ministry of Agriculture, Fisheries and Food. Its president is the under-secretary of the Ministry and its director is appointed by the Minister of Agriculture. In its two main bodies all stakeholders of the system are represented. The tasks include the elaboration of annual plans for agricultural insurance, in which the technical framework for the system is laid down (level of subsidies, insurable yields, minimum cultivation standards, deadlines for subscribing to insurance policies etc.), the subsidization of the insurance premium (together with the regions, i.e. Comunidades autonomas) and the control of implementation of the insurance plans. Furthermore, ENESA is acting as arbiter in all cases of disputes. AGROSEGURO (Agrupación Española de Entidades Aseguradoras de los Seguros Agrarios Combinados), a pool of sixty private insurance companies which participate in a system of co-insurance. According to this system, the companies share the total risk underwritten in a given year by all members in proportion to their participation in the equity of AGROSEGURO. AGROSEGURO, on behalf of its members, assumes the day-to-day running of the program, i.e. fixing and collecting premium, assessing losses, paying compensations, controlling farmers etc. CCS (Consorcio de Compensación de Seguros), a public enterprise with own resources, operating as a re-insurer (under the control of the Ministry of Economy). Re-insurance by CCS is obligatory. For a graphic presentation of the system see Figure 5.1 (based on Stoppa, 2000). Figure 5.1 Agricultural Insurance System in Spain Source: European Commission (2001). “Risk Management tools for EU agriculture with a special focus on insurance.” Working document, January 2001 (page 46). In operative terms and for any given year, ENESA takes the lead in publishing the annual plan. On the basis of the framework set out in the plan, AGROSEGURO fixes the detailed conditions for all insurance products, in particular the regionally differentiated premium rates which vary according to risk exposure and also include administrative and re-insurance costs. Once the conditions for the various products are set, they are then commercialized through the networks of the insurance companies which are members of the pool of AGROSEGURO. Obligatory re-insurance is provided by CCS, additional private re-insurance is provided by private companies for viable lines for coverage going beyond the level provided by CCS. The re-insurance CCS provides is non-proportional to the premium to be paid for re-insurance. In 1999 total receipts by AGROSEGURO amounted to 307 mlj Euro, of which farmers paid 155.8 mlj Euro and the state 151.2 mlj Euro. In the same year, administrative costs of AGROSEGURO amounted to 11.7 mlj Euro. Subsidies from the state and the regions are paid out by ENESA and channeled through AGROSEGURO to the insurance companies. Public subsidies amount to up to 41% of the premium (45% in the case of the new multiple climatic risk policies). Role of the Government State plays a key role, providing both subsidies and re-insurance. In case of natural catastrophes, the state does not make any disaster payments, since the agricultural insurance scheme covers almost all perils which possible can threaten income from agricultural activities. Premiums are subsidized by the government (between 20% and 44%). Advantages and disadvantages of the model Advantages of the system for the public administration: The government is in position to establish in advance the budget set aside for the provision of aid different agricultural catastrophes. The government is able to reduce both its economic contribution and its political involvement. Indemnity is directly proportional of the damage caused. The wide range of policies on offer is considered to be one of the main reasons for the program’s success in terms of high overall participation rates (In the year 2000, about 30% of Spanish producers participated in the system and about 30% of crop and 10% of animal production were covered) Advantages of the system for the farmers: The policy holder receives indemnity proportional to damage suffered. Indemnity is paid out to the holder within approximately 60 days after harvesting and the adjustment have been made. The farmer can invest more in his land as he is better protected against unpredictable weather conditions. His solvency rating improves with regard to financial system Weaknesses, as perceived by official Spanish sources, include the fact that there are important actuarial imbalances for certain products and regions, certain deficiencies in the day-to-day running of the programs and the fact that not yet all risks are insurable for all products. The question of efficiency of the system is not addressed by official sources. Timing Spain has a rich experience in agricultural insurance. Different systems with a varying degree of involvement of the state were tested between the 1920s and the 1970s. Overall success, however, remained limited and participation rate disappointed. The current system is built on that experience. It was set up in 1978 and continues to evolve (Burgaz, 2000; Agroseguro, 1999; Stoppa, 2000; Forteza, 1999). 5.2 France Apdrošināmais, objekts, riski Objekti Seguma veidi Riski Lauksaimniecības objekti ārpus telpām Valsts palīdzība dabas katastrofu gadījumos par lauksaimniecības objektiem (tā nav apdrošināšana!) Neapdrošināmie riski (saskaņā ar 1982. gada 13. jūlija likumu) Manta (īpašums): dzīvojamām vai komercuzņēmumu, rūpniecības vai lauksaimniecības uzņēmumu ēkās, mēbeles (motorizēti transporta līdzekļi, materiāli, lopi kūtīs un raža klētīs). 1) Materiālo zaudējumu apdrošināšana 2) Valsts palīdzība dabas katastrofu gadījumos par mantu (nav apdrošināšana!) Apdrošināmie riski tādi kā: uguns, zibens, vētra, krusa, un tml. Neapdrošināmie riski (saskaņā ar 1982. gada 13. jūlija likumu), piem., īpaši stipra vētra, cikloni, plūdi Lauksaimniecības objekti. Valsts palīdzība pieejama attiecībā uz riskiem, kas nav apdrošināmi (neapdrošināmie riski saskaņā ar 1982. gada 13. jūlija likumu), ja izpildās zināmi priekšnoteikumi. Manta. Ja bojātais vai zaudētais īpašums: nebija apdrošināts pret zaudējumiem, tad izpildoties zināmiem priekšnoteikumiem var tikt piešķirta palīdzība no “dabas katastrofās cietušo palīdzības fonda” attiecībā uz zaudējumiem, kas cēlušies no neapdrošināmiem riskiem; bija apdrošināts pret zaudējumiem (piemēram, pret ugunsgrēkiem vai dažādiem riska faktoriem), tad atlīdzību izmaksās apdrošināšanas sabiedrība gan attiecībā uz apdrošināmiem riskiem, gan arī “neapdrošināmajiem riskiem”. Iesaistītās puses Lauksaimniecības katastrofu palīdzība paredzēta lauksaimniekiem, kuri cietuši ārkārtīgi liela mēroga neapdrošināmus zaudējumus. Nacionālais lauksaimniecības garantiju fonds. Apdrošināšanas sabiedrības. Valsts pārapdrošināšanas sabiedrība “Caisse Centrale de Reassurance”. Pušu sadarbība Lauksaimniecības objekti. Nacionālais lauksaimniecības katastrofu garantiju fonds sedz lauksaimniecības objektu zaudējumus, kas atrodas ārpus ēkām (telpām). Lai varētu saņemt kompensāciju no šī fonda: cietušajam jābūt apdrošinājušam pret ugunsgrēku ēkas un to saturu, Ražas zaudējumu gadījumos, ja izmaksas par jaunu sējumu izveidi un ražas zaudējumiem, ko var ciest šī aizstājošā lauksaimniecības kultūra kopā ņemot pārsniedz robežas, kas noteiktas 1980. gada 15. aprīļa starpministriju rīkojumā (27 % un 14 %). Kompensācija nevar pārsniegt 75 % no zaudējumiem (skat. dekrētu Nr.79-823, izdotu 21.09.1979) Fonds nenodrošina kompensāciju: ja runa ir par krusas, vētras postījumiem tad tie ir apdrošināmi riski un arī pret tiem ir jāveic apdrošināšana. Zaudējumu atlīdzību par šiem riskiem līdz ar to fonds nenodrošina. Par riskiem, kas uzlūkojami kā apdrošināmi Francijas apdrošināšanas tirgus praksē. Manta: “Dabas katastrofās cietušo palīdzības fonds” atsevišķos gadījumos piešķir kompensāciju, ja īpašums nebija apdrošināts pret zaudējumiem. Apdrošināšanas sabiedrības izmaksās atlīdzību par līgumā paredzētajiem apdrošinātajiem riskiem, tai skaitā par dabas katastrofu neapdrošināmajiem riskiem saskaņā ar likumiem , piem., (saskaņā ar 1982. gada 13. jūlija likumu, kā arī 2000. gada 13. novembra likumu Comité Européen des Assurances, 2005), piem., īpaši stipra vētra, cikloni, plūdi Apdrošinātājiem šīs saistības tiek uzliktas ar likumu, ka visi, kas apdrošina mantu pret uguni un citiem riskiem, saņem apdrošinājumu arī pret nepadrošināmajiem dabas katastrofu riskiem. Prēmiju likmes un apdrošināšanas segums ir noteikts ar likumu. Apdrošinātāji var izvēlēties veikt šo risku pārapdrošināšanu valsts pārapdrošināšanas sabiedrība “Caisse Centrale de Reassurance” (Comité Européen des Assurances, 2005) Valsts loma Valsts izstrādā un ar likumu palīdzību uztur modeli palīdzības sniegšanai katastrofu gadījumos (tai skaitā attiecībā uz lauksaimniecību), kā arī regulē apdrošināšanas sabiedrību darbu attiecībā uz obligāti ievērojamām normām apdrošināšanas līgumos. Lauksaimniecības objekti. Lauksaimniecības katastrofu birojs nodrošina metodiku kompensējamā zaudējuma aprēķināšanai. Nodrošina palīdzības izsniegšanas procedūru, pieņemot pieteikumus zaudējumu atlīdzībai, kā arī lemjot par atlīdzību un to veicot. Departamenta lauksaimniecības un mežu direkcija ir pareizas lauksaimniecības nelaimju procedūras norises garants. Kā tāda tā veic sekojošo: Piedāvā mērus, kas pieņemami katastrofas gadījumā un konsultē prefektu par tiem; Izstrādā prefekta rīkojumu projektus attiecībā uz lauksaimniecības katastrofām; Piedalās informācijas ievākšanas misijā; Kalpo kā Departamenta ekspertīzes komitejas sekretariāts; Nodrošina katastrofu dokumentu pakešu izpēti un izskatīšanu; Pārrauga lietu izpētes un kontroles kredītus; Sastāda informācijas ievākšanas misiju; Sasauc Departamenta ekspertīzes komisiju; Vada Departamenta ekspertīzes komisiju; Sastāda prefekta ziņojumu (atskaiti), kas tiks nodota lauksaimniecības ministram; Nodod ekspertīzei dokumentu paketes (lietas), kuras tas (tā) vērtē kā strīdīgas; Veicina jebkuru rīcību, kuras mērķis ir nodrošināt cietušo iesniegtās informācijas kontroli. Nacionālā lauksaimniecības katastrofu komisija ir konsultatīva instance visos jautājumos, kas saistīti ar lauksaimniecības katastrofām. Tā sapulcējas savā kārtējā sesijā vidēji vienu reizi trimestrī. Tā pieņem lēmumus par lauksaimniecības katastrofas rakstura atzīšanas pieprasījumiem. Kad Nacionālā lauksaimniecības katastrofu komisija ir pieņēmusi labvēlīgu atzinumu par iesniegto pieprasījumu, šis atzinums tiek tālāk izvērsts starpministriju rīkojumā Lauksaimniecība /Finanses /Budžets), kuru īsteno Departamenta lauksaimniecības un mežu direkcija un kas ļauj katastrofā cietušajiem, kuri atbilst nosacījumiem, saņemt zaudējumu kompensāciju. 5.3 Italy 1. Insured objects and risks covered Object Coverage Risks All PD Hail, allied perils (frost, wind, dryness, sun scorching for a limited number of crops and few communities, varying from year to year) Fruit trees PD diseases Private Insurance: Hail, allied perils (frost, wind, dryness, sun scorching for a limited number of crops and few communities, varying from year to year), diseases and damage to fruit trees. Disaster Aid: Excessive rain, flood, windstorm, frost, rime, hail, drought (only in communities where these risks/crops are not insurable) (investment grants, subsidies, exemption from taxes/duties or rebates of taxes/duties). Funding: Private insurance: subsidies for hail, frost, wind and dryness (redefined each year); Disaster aid: public funds. Involved parties Overall system In Italy, private sector insurance companies run agricultural insurance, but there is a considerable amount of financial aid by the public sector. (28) Insureds are individual agricultural undertakings or groups thereof located in areas which the competent regional authorities have declared affected by a natural disaster or exceptionally adverse weather conditions. Cooperation between parties Crops (45) The defence consortia (set up on the basis of Law 364 of 25 May 1970 and Law 590 of 15 October 1981, as amended by Law No 185/92) may, on behalf of their members (if those members do not act directly), take out insurance contracts to cover losses caused by adverse weather events or animal or plant diseases. The insurance contracts must be concluded with individual insurance companies or with insurance companies participating in consortia in accordance with Commission Regulation (EEC). The insurance companies must be authorised to cover instances of hail. Farmers may choose between three types of contracts: (a) compensation for the damage caused to specific crops by hail, ice, frost and other adverse climatic events (individual climatic events affecting individual crops); (b) compensation for the damage caused to a holding's facilities and specific crops by all adverse climatic events affecting the value of production beyond the normal business risk. The contract may also concern losses due to plant diseases, if strictly related to adverse weather events, and to animal diseases (several weather events affecting individual crops or structures). This type of contract may also include damage to quality; (c) compensation for the damage caused to a farm's primary crops by all adverse weather events if the level of damage exceeds the normal business risk (various climatic events affecting more than one crop or structure). What is the role of the government? Overall system State aid is available for excessive rain, flood, windstorm, frost, rime, hail, drought in communities where these risks/crops are not insurable. Farmers are compensated for the damage to agricultural production or the means of agricultural production resulting from natural disasters, adverse weather conditions or animal diseases. (24) There are comprehensive set of aid measures designed to compensate farmers for the damage to agricultural production or the means of agricultural production resulting from natural disasters, adverse weather conditions or animal diseases. (26) Also, there is aid towards the payment of insurance premiums (also defined as passive forms of defence). (25) The resources to compensate farmers for the damage suffered as a result of these events are provided through a national fund known as the National Solidarity Fund (Fondo di solidarietą nazionale) , which allocates to the individual regions the sums necessary to compensate farmers. (29) In order to be entitled to the aid, the undertakings concerned must have suffered production losses equal to at least 35% of their gross saleable production, with the exclusion of livestock losses. The calculation of the damage may also include the losses due to previous natural disasters which hit the same holding and the same crop during the same marketing year. (33) Damage to infrastructure and land improvement works. Any damage which may be attributed to negligence, insufficient maintenance, natural deterioration, or normal seasonal conditions is not entitled to compensation through the Fondo di solidarietą nazionale. The exceptional nature of the event must be proven by irrefutable technical data substantiated by official weather detectors. They must be compared with the data of previous years over a sufficiently long and statistically significant period. (36) The holdings which meet the requirements above may benefit from the following types of aids: (b) ‘First aid’ measures On the basis of the information contained in the abovementioned circular, it is possible to infer that these aids are granted where significant damage has occurred and for specific situations of need requiring prompt intervention. One-off contributions to partially cover the damage suffered by farmers and to pay for the costs incurred are made in the following situations: a per hectare contribution in the case of crops which were partially or completely lost, a contribution of up to 40% of the damage suffered for the loss of live stock and up to 30% for the destruction of dead stock, a contribution up to ITL 5 million for urgent repairs to rural buildings, a contribution up to ITL 50 million for the restoration of infrastructure serving agricultural holdings, a contribution up to 100% of costs incurred for the collection, sheltering and feeding of the livestock only for the emergency period and for no longer than six months in any event, a contribution of up to 90% of costs incurred to offset the damage to production. (b) A contribution of up to ITL 3 million to direct growers and farmers whose main occupation is farming. This amount may be increased up to ITL 10 million for farms where damage has occurred to specialized protected crop facilities. The aid may reach 80% of eligible expenditure and is designed to enable farmers to restore their working capital (capitale di conduzione). As an alternative to this type of aid, farmers not having farming as their main occupation may qualify for five-year-long soft loans. (c) Soft-loans of a duration of five years to enable farmers to continue their operations during the year in which the event took place and the following year. The loan granted may also cover the loan installments falling due the year in which the event took place, provided they are not extended for more than 24 months. (d) Ten-years soft mortgages for the recovery, restoration and conversion of structures in the holdings which were damaged by the event, including damage to trees, greenhouses and road facilities on the holding. As an alternative to this measure, the holdings may benefit from grants of up to 80 % of the actual costs incurred in the case of small holdings, 65 % for medium-sized ones and 50 % for large holdings. The aid may be granted for the recovery and repair of premises, land, trees, repair and replacement of agricultural equipment, plants for the storage and processing of products; purchase of seeds and the restoration of stocks. (e) Five-year soft loans for processing and marketing cooperatives and producer groups recognised under Community legislation which have suffered a fall in income due to a reduction in the products supplied by members who were affected by the events concerned. The reduction must be at least equal to 35% of the average production supplied and marketed over the preceding two years. Only a reduction in the quantities supplied directly due to a decrease in production caused by a natural disaster or like event may be taken into account. Any reduction due to other factors such as changes in the operation of cooperatives, changes in the number of their members or different agricultural practices cannot be taken into account. Moreover, the aid cannot be granted to those cooperatives which purchase from market suppliers, other than their members, more than half of the overall amount processed. The amount of the soft loan may be up to the fixed operating costs and for no more than the percentage reduction in income. (f) Special contributions for the storage of citrus fruit and for the distillation of apples and pears which cannot be marketed may be granted to cooperatives and groups of fruit and vegetables producers. (g) The Regions may also provide up to 100% aid for the restoration and repair of road networks and water works. (47) the State contribution to eligible insurance expenditure (that is established using parameters for each type of guarantee, product and municipality which are fixed yearly by Ministerial Decree on the basis of statistical insurance data) cannot exceed 50 % of the costs actually incurred for the payment of the premium (65 % in areas of high climatic risk, which are to be defined by Ministerial Decree). The aid has never been granted for more than 50 % of the cost of the insurance premium and that the increase for areas of high climatic risk had never been applied. The State contribution to the actual costs sustained generally ranged between 30 % and 40 %. Livestock program (39) The State contribution may be up to 50 % of the costs actually borne by the support fund. (41) The decree provides for aid measures for agricultural undertakings affected by foot-and-mouth disease, classical swine fever, African swine fever, vesicular stomatatis or pleuropneumonia. Only agricultural undertakings that are members of a ‘consortium for the defence of production’ and who report the number of animals they have by March 30 of each year, agree to pay their membership contribution and agree to satisfy all hygiene and sanitary provisions for the protection of the stock farm may benefit from the aid. The contribution may not exceed 40 % of the gross saleable production which could have been obtained from the slaughtered animals. For each year and livestock head, the decree fixes the value of the gross saleable production. The contribution (within the 40 % limit) takes into account the farm's fixed costs and whether the animal was registered in a stud book. The overall contribution is proportional to the waiting period of the farm which cannot be longer than six months for cattle and three months for pigs, sheep and goats. The State contribution is paid to the consortia only after approval of the final accounts upon presentation of the relevant applications to the competent regional authorities. Crops (42) A contribution up to 80 % of eligible expenditure may be provided to invest in initiatives — even pilot ones — to actively protect holdings (crops) against adverse weather events. A case in point is the installation of special nets against hail. The beneficiaries of the measures are protection consortia which are also responsible for the actual implementation of the projects. Aid at a rate of 50 % may also be granted for the running and maintenance of the equipment installed thanks to earlier contributions. The active protection projects may be financed only if they prove to be economically viable compared to the corresponding forms of passive protection. It is up to the Ministry for Agriculture to establish the minimum thresholds below which active protection projects are not considered economically viable. Timing Other Italy spent the biggest amount of money among the EU-15 countries (appr.4 mlj Euro) to compensate producers for crop losses in the form of disaster aids from 1988-1997 (European Community, 2001). On the contrast, Spain spent around 1.5 mlj Euro, Austria – 108 thsd Euro. 5.4 The Netherlands Insured objects and risks covered Objects Type of cover Risks Crop, plants in greenhouses (siltumnīca) greenhouse policy - material damage and consequential loss fire, storm, hail, snow, power outage cattle consequential loss Brucellosis, BSE, Contagious Bovine Pleuropnemonia, Food and Mouth Disease, Rinderpest, Tuberculosis and Vesicular Stomatitis breeder broilers consequential loss MG and Salomonella Involved parties Overall system. Netherlands has a voluntary system of agricultural insurance, which is predominantly private – based on the offerings of the insurers - non-governmental entities. Breeder boilers program. Mutual insurance scheme, which means that the farmers are insureds and the insurer for themselves (mutual scheme). Livestock program. Besides, in respect to the direct losses of livestock due epidemic deceases there is a scheme whereby the government manages the public fund from which the losses are paid. The bank guarantees the sufficient amount of levies to the fund (Asseldonk et al, 2003). However, in respect of the consequential losses the Netherlands has a private scheme. Cooperation between parties Overall system. The insurance contracts are governing the cooperation between the insureds and the insurers. Livestock program. Regading direct loss compensation the farmers and the Ministry of Agriculture have agreed on a system where a bank guarantee is supplied and producers will have to pay the levy mainly after the epidemic. The amount of the levy will depend on the actual cost of the epidemic. Within this system the government can withdraw capital from a private bank to (co-) finance actual losses. Any capital provided by the bank is paid back by the primary sector through additional payments over a certain time horizon. Rearding the consequential loss the additional coverage (only available for cattle) is either a proportion of the insured sum of the culled animals (ranging from 10% up to 30%), or is based on the duration of business interruption (in some policies a limited period). In general, the indemnification is based on the number of cows that die or are culled. Covered perils are Brucellosis, BSE, Contagious Bovine Pleuropnemonia, Food and Mouth Disease, Rinderpest, Tuberculosis and Vesicular Stomatitis. Thus, economic losses as a result of only movement standstills do not trigger indemnity payments and coverage is only provided for cattle and not for pigs, poultry and sheep. Timing Other Following the epidemic of CSF (classical swine fever) in 1997, the Dutch government has decided that the farmers must pay a larger proportion of the costs of any future epidemic and a system has now been put in place whereby pig producers will have cover for up to 227 million Euro per five years (the same holds for the cattle sector). Currently participation level in the consequential loss insurance is less than 10%. 5.5 Germany Insured objects and risks covered Objects Type of cover Risks Viticultures Property damage (PD) Hail (long tradition), frost Sugar-beet quality Sugar content Potatoes quality content in starch storm, frost, rainfall (only for big farms in Eastern Germany) All affected Consequential loss Fire Animals Material damage, consequential loss Epidemic diseases, accidents Forestry Material damage Fire, storm Source: Asseldonk et al, 2003; European Commission, 2001. Involved parties Overall system. Germany has a voluntary system of agricultural insurance, which is predominantly private – based on the offerings of the insurers - non-governmental entities (European Commission, 2001). Livestock program. Besides, in respect to the direct losses of livestock due epidemic deceases there is a mandatory scheme whereby the government (administrative council) manages the public fund from which the losses are paid. However, in respect of the consequential losses the Germany has a private scheme “Entragsschadenversicherung” (Asseldonk et al, 2003). Cooperation between parties Overall system. The insurance contracts are governing the cooperation between the insureds and the insurers. Livestock program. The program is run by an administrative council that decides the level of the levy etc. The administrative council is made up of farmer and ministry representatives. The levy varies between species but more importantly is varied according to the needs of the fund. The compensation payments are made from the available funds and the Ministry of Agriculture will pay for the costs if the fund runs out of money. The input of the Ministry will however be repaid over the following years and this is usually why the levy increases after a disease outbreak. The levy is only used to co-finance the Community Veterinary measures following a disease outbreak. It therefore only pays for the slaughter of animals that have to be killed under EU Veterinary measures. “Ertragsschadenversicherung” indemnifies farmers against the full range of consequential losses as one of the coverage options, including those resulting from movement standstills. The indemnification is based on the difference between the actual gross margin after the loss event and the insured gross margin, taking into account a deductible, and a covered period of 12 months. Losses as a result of movement standstills are indemnified with a percentage of 50%. The insureds need to have accurate accounting records of three years. The premium is a percentage of the insured sum, which is based on the value of the livestock and the gross margin per year. The farmer chooses, within a certain range, the value of the livestock. The standard gross margin differs between the performance levels. Participation level of dairy cows is over 50%, cattle 30%, sows 42% and hogs 23%. Insurance for sheep is not available. Insurance for poultry will not be prolonged (current participation <5%). All private insurance excludes direct losses that are met by the public sector (Asseldonk et al, 2003). Hail insurance (Lutzke, 2005) • Hail insurances have long tradition in Germany and are available for all crop plants and specialized cultivations. • Private insurance which covers losses in quantity as well as in quality. • The amount insured is calculated from the expected value harvested per hectare under normal conditions. • Premium level depends on possible exposure to loss due to hail in the respective area. • For more information please see: www.hagelversicherung.de What is the role of the government? Livestock program. The German program is set up by national legislation but each Bundesland is responsible for running the program. The Bundeslander draw up the detailed rules of the application (Asseldonk et al, 2003). The government will pay for the costs in advance if the disaster funds run out of money. The input of the government will however be repaid over the following years. Therefore, after an outbreak of an epidemic disease, the levy usually increases according to the needs of the fund (Asseldonk et al, 2003). According to Lutzke (2005): • Function of this governmental fund is to grant aid, compensation and other support to farmers in case of animal diseases. • Mandatory membership for all owners of animals like horses, cattle, pork, sheep and poultry. • Obligation to report the number of animals to the ministry in the respective area and to pay a certain annual amount of money depending on the number and sort of animals. • Fund covers expenditures for immunisation or other preventive measures. • Compensation for ordered slaughtering after outbreak of animal disease. The veterinary budget of the EU refunds the 50% of the costs of compulsory and pre-emptive slaughter, 70% of the costs of welfare slaughter, and 50% of the organizational costs as per 90/424/EEC (Asseldonk, et al., 2003). Overall system. Governent is not providing any premium subsidies (European Commission, 2001). Timing Other Participation level of “Ertragsschadenversicherung”dairy cows is over 50%, cattle 30%, sows 42% and hogs 23% (Asseldonk et al, 2003). Insurance for sheep is not available. Insurance for poultry will not be prolonged (current participation <5%). Conclusion Spain is at the very forefront of agriculture insurance in Europe, successfully running the Agroseguro pool for 25 years, by involving the government in supporting the scheme very much. High participation rates are achieved. In respect of the livestock insurance, mandatory systems have been developed and supported by the state. Where it happens in can be concluded that the voluntary business interruption coverages are available. Figure 5.2 Level of Participation and Coverage for Private Voluntary Insurance Schemes Source: Asseldonk, M., Meuwissen, M., Huirne, R. (2003). “A risk financing model for livestock epidemics in the European Union.” Institute for Risk management in Agriculture (IRMA), Wageningen University, the Netherlands (page 11). General conclusions and Recommendations Even in the 21st century, agriculture crop production remains a high-risk “open-roof” industry. It faces several weather and disease risks, which are very difficult to control with on-farm risk-management techniques. Since soil and climatic conditions can differ tremendously nationally and internationally, farmers must consider tailor-made, local risk management strategies, including risk avoidance, risk identification, risk assessment, risk control and risk financing. In order for a risk to be insurable, some basic requirements have to be met, the most important of which are: managing the adverse effect of “asymmetric information” and overcoming the implications of “systemic risk”. The most common way of managing risk in traditional, labour-intensive, agriculture production systems is through risk diversification. However, the opportunity costs associated with risk management techniques are high and do not allow optimal utilization of the resources available. In contrast, modern industrialized agriculture is characterized by specialization, high capital investment and low labour intensity. Production risks in modern, industrialized farming are usually higher than in traditional farming because of specialization and capital intensity and therefore can be only partially absorbed on-farm. Risk transfer solutions through modern, appropriate insurance coverage are required. Three conclusions from existing public-private systems of agricultural insurance are: Firstly, initiatives have to be based on a “bottom-up approach” in order to be successful. Insurance products have to be tailored to the needs of farmers which vary among countries and regions. Secondly, a system has to be given time to develop. With growing experience, it can become more tight to the farmers’ need (regarding both products and risks covered). Thirdly, strong and close public surveillance is needed in order to avoid growing complexity leading to unjustified rent-seeking and losing track of the original purpose of providing insurance. Insurance solutions should be primarily developed at the Member States level. In addition to the need for a “bottom-up approach”, two further reasons support this conclusion: Insurance could increasingly replace national ad-hoc disaster aids. This would stabilize expenditure and reduce negative effects of disaster aid (e.g. delayed payments, discouraging private risk management and encouraging irresponsible management decisions). Member States are best placed to target public funds spent in the framework of such systems to certain groups of farmers, reflecting specific needs. A cautious role regarding the EU’s involvement beyond its current involvement is therefore advocated. The EU might have a role where production risks are to a large extent systemic (probability of high losses in any given year), which prevents insurance products being offered on the market or makes them very expensive and therefore commercially inviable. A private solution for this problem could be for insurance and re-insurance companies across Europe to jointly cover such risks by creating insurance/re-insurance pools. The EU could accompany such a process by providing the appropriate legal framework, where needed. The issue of risk-pooling across regions and commodities is equally relevant for farmer-owned mutual funds. In the long term, a more substantial involvement would be possible under two conditions: Firstly, an instrument would have to fit into the overall policy-mix of the CAP. Essentially, this would require that there is no overlapping with other instruments addressing the problem of risk exposure in agriculture. Secondly, sufficient funds would have to be made available. Providing re-insurance (especially covering losses above a certain level) would address the most often cited obstacle for the development of insurance systems, i.e. potentially catastrophic losses. If such re-insurance were provided, more insurance companies would offer insurance for the coverage of risks potentially resulting in catastrophic losses. The EU Member States have developed different systems (models) to cope with risk exposure in the agricultural sector. Analysis provided in this study is worthless due to lack of connection with economic and political situation in the country. Main recommendation for Latvia would be to create its own model based on the CAP requirements. However, other countries’ experience should be taken into account in order to avoid mistakes. In general, main recommendations are: Find appropriate insurance in the EU-15 market due to several reasons: o The EU-15 insurance companies are more experienced in agriculture sector and provide more opportunities to chose the best insurance product/package; o Costs of insurance will be less due to geographical diversification which leads to lower systemic risk. Main drawback of this option is that only standard offers could be available, which do not take into account local market conditions and requirements. Three Baltic States, namely, Estonia, Latvia and Lithuania, could develop insurance pools to provide the best offer to their farmers, taking into account local market requirements. This option is mush cheaper compare to the situation when only local companies offer agricultural insurance for farmers. 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