Speeches & Transcripts

The Agricultural Insurance – a Risk Management Tool

October 14, 2008

Ladies and Gentlemen,

This morning, I would like to talk about risk management in agriculture. In particular, I would like to draw some lessons from international experience in dealing with risk management in agriculture that I believe are particularly relevant for Romania.

I would limit my remarks to three.

The first is that risk management in agriculture is important, and likely to become more so in the future, and that the tools to manage risk are many, with agricultural insurance being only one of them.

My second point is that experience with traditional, multi-peril crop insurance schemes throughout the world has been rather disappointing.  Romania should learn from these costly and ineffective policies, and avoid repeating similar mistakes.

My third message is that new tools, based on catastrophic insurance instruments, if used smartly in combination with already existing public policies and tools can be made very effective in managing weather and climate related risks facing Romanian agriculture. Let me elaborate a bit on each of these points.

Risk Management in Agriculture

Agriculture is inherently risky.  Because it is risky, it can have large negative impacts on agricultural income, on food security, and the capacity of the sector to develop, invest, and compete in particular among the large, commercial farm enterprises. As a result, governments and public policies have historically and throughout the world trying to address this problem.

Agriculture faces 3 broad sets of risks:

  1. Regulatory risk
  2. Price risk
  3. Production risk: weather (drought, floods, hail) and other natural risks (pest attacks, crop diseases, pandemics: Avian Flu).

Regulatory risk, derives from possible changes in agriculture policies and regulations, has come down significantly with the entry into the EU due to stable and predictable policies under the CAP.

Price risks made of price fluctuations continue to exist (witness the recent spike in world food prices), but the CAP – directly through its income support policies and indirectly through its support programs in market development and integration— and other tools (e.g., forward and futures markets, social assistance programs) have reduced those risks as well.

Production risks are very much here.  The succession of floods, droughts, pandemic (AI) over the last 5 to 6 years are a stark reminder of the importance of weather-related and other “natural” events. Climate change may induce more permanent changes to Romanian agriculture such as drier summers, and warmer and drier winters. It is also likely that climate change will make weather events more unstable, and catastrophic events such as floods and droughts not only more frequent but also more severe.  

How do you manage such production risks? There are both ex ante and ex post strategies:

  • Ex ante strategies are those strategies that allow you to reduce your exposure to production risks (crop diversification, changes in cropping patterns or seeds on the farm; or public programs: irrigation systems, agricultural extension services, pest management systems, preparedness to pandemics, adaptation to climate change), or those that allow you to transfer risks –in part or whole-- through risk-sharing mechanisms such as crop insurance.
  • Ex post strategies are those strategies that allow you to cope with the shock once it has happened.  Asset sale, re-allocate labor, take credit, migration are typical private responses.  Public responses include catastrophic or disaster assistance, and social assistance programs.

Summary: my key message is that there is a wide range of tools for managing weather-related risks in agriculture, and agriculture insurance and catastrophic assistance are some of them.  Some work better than others, and each have different objectives in mind –some to reduce exposure of farmers’ income to risk, some to share risks, some to cope with the shock after the fact. When setting public policies, it is important to be clear about the goals and objectives you are trying to achieve, and find the most effective way to get there; and to acknowledge that these various tools are not mutually exclusive, but can or need to complement each other.

Crop Insurance: Lessons from International Experience

Let me now turn to my second point, about learning from the mistakes and successes from elsewhere.

Crop insurance schemes have been implemented in many countries across the world, rich and poor. What have we learned?  What are the stylized facts, and lessons from international experience?

Such schemes, implemented both in developed and developing countries, often proved fiscally expensive for the respective governments, had a limited outreach to few farmers – typically, the large, commercial farms - and agricultural activities, and have not eliminated the need for disaster assistance. More on these lessons will be further presented in a later session.

In summary, the heavily subsidized crop insurance provided by governments elsewhere is both costly and questionable. Romania should learn from these mistakes. It should avoid introducing traditional crop insurance schemes that would require large fiscal resources, and, in a world of limited fiscal resources, take away resources from alternative agricultural risk management tools that would be more effective and better adapted to the structural characteristics of its agriculture and farming population.

Way Forward: New and existing tools and policies.

New tools are being added to the tool box which could help avoid the pitfalls discussed earlier. These new tools combined with improved other risk management tools, either ex ante (better irrigation systems, more adapted seeds, better flood prevention works, better advisory services) or ex post (e.g., more and improved funding for social assistance programs) would be powerful instruments to manage effectively risks in agriculture.

Index-based insurance products are part of the new tools being added to the tool box and they introduce two attractive features:

  • First and foremost, index insurance products do away with many of the problems (high correlated risks, asymmetric information, and high transaction costs) plaguing traditional crop insurance, hence making them more viable and less reliant on public subsidies. However, they introduce new ones such as basis risk.
  • Index insurance mechanisms make possible the layering of risk, and facilitate the transfer of risks, including that of CAT risks (low probability, high consequence losses) through markets instruments. I do not want to say much more about these new instruments, since this topic will be addressed in greater details by experts through presentations that follow.

Let me just conclude by saying that index-based insurance is potentially a new and useful tool that is being added to the tool box government of Romania has at its disposal to manage its agricultural risks better and more effectively. This new tool, alone will not solve all problems, but it can help solve important ones, and avoid repeating costly mistakes of others. This new tool can be smartly combined with other risk management tools, either ex ante (better irrigation systems, more adapted seeds, better flood prevention works, better farm advisory services) or ex post (e.g., more and improved funding for social assistance programs targeted at smaller and poorer farmers; financial coverage for contingent liability under disaster relief programs through CAT bonds or re-insurance mechanism) to provide the Government with powerful and cost effective instruments to manage risks in agriculture.