Agriculture Risk Transfer and Models

number1Indemnity-based risk transfer based on yield

For medium to large-sized farms, the actual yield is determined by an expert loss adjustor at farm level. The loss is determined by comparing the actual yield with the expected yield by multiplying the yield short fall with the area planted and the pre-agreed or the actual commodity price.

As yield reduction is the result of many factors and perils, all perils are insured as it is nearly impossible to reconstruct precisely the impact of one peril from the yield reduction.

The insurance of yield reduction is often called Multi Peril Crop Insurance (MPCI) and if volume risk (yield reduction) and commodity price risk is insured jointly, this is referred to as Revenue Covers. For the commodity sector if volume risk and commodity price risk is covered, this is known as Contingent Price Options.

Examples
USA, Canada, Brazil
Beneficiaries:

  • Farmers
  • Cooperatives

Risk Transfer:

  • Insurance

number2Indemnity-based risk transfer based on mean damage ratios

Losses are determined by trained loss adjustors based on visual inspections in terms of a mean damage ratio determined over the affected field(s). Loss adjustment needs a large number of trained experts and to overcome this constraint, aerial photography from unmanned aeroplanes is used, as for example in China, to extrapolate loss extents over wider areas with punctual loss adjustment on the ground. Under this product, specific perils such as drought, flood, typhoon, frost, fire, hail or fire are insured with different insurance terms (rate, franchise, deductible) per peril and crop type.

In countries with predominantly large farms, this product is offered at farm level, whereas in countries with smaller farm sizes (e.g., China), the product is sold at village level.

Examples
China, South Korea, Australia, New Zealand, Europe, Argentina, Mexico, USA (hail only)
Beneficiaries: Farmers

  • Cooperatives

Risk Transfer:

  • Insurance

number3Index-based risk transfer based on yield

For small farms with exposure from the commodity sector in various sub-regions, losses are calculated from actual yields over a certain area (e.g., commune, county or district) from government resources compared to the expected (insured) yield of the same area. The yield reduction is then multiplied by a pre-agreed or the actual commodity price and the area planted. As yield reduction is the result of many factors and perils, all perils are insured as it is nearly impossible to reconstruct precisely the impact of one peril from the yield reduction.

Under this product, all covered risks in the area benefit from a payout relative to the covered area per insured risk.

Index-based insurance introduces basis risk which arises through imperfect correlations between the index and the actual losses at farm level. Consequences of basis risk are that farmers may not receive compensation when they have suffered effective losses or vice versa. In order to design a yield index, yield volatility has to be examined intensively in terms of weather impacts and other factors such as changes in farm management practice and such as seed and fertilizer application.

This product is increasingly used by the agriculture supply chain to manage exposure from adverse weather conditions which impact production levels and margins and government entities can equally benefit in protecting their disaster funds from the impact of natural disasters.

Examples
India, Vietnam, parts of Africa (pilots) Beneficiaries:

  • Farmers
  • Cooperatives
  • Agriculture banks (loan default risk)
  • Agriculture funds (investment risk)
  • Processors, traders and logistics companies (business interruption through production shortfall)

Risk Transfer:

  • Insurance
  • Derivatives

number4Index-based risk transfer based on weather parameters

For small farms with exposure from the commodity sector in various regions, weather proxies such as rainfall, temperature, relative humidity and wind measurements from ground weather stations are used to quantify losses within well-defined areas. A trigger in terms of a weather parameter is defined for each crop growth stage and perils such as deficit/excessive rainfall, heat days/cold spells or disease days are determined. A payout is triggered if the actual weather parameters are below/above the triggers after which each unit (e.g., millimeter of rainfall) is compensated by pre-agreed monetary amounts.

Under this product, all covered risks in the area benefit from the payout with the difference in the payout only being the size of the individual planted area. Perils can be selectively covered as long as the weather parameters can explain most of the observed yield volatility. However, perils such as hail, river flooding and landslide cannot be covered as they are not measurable at weather stations.

Similar to yield based index insurance, weather based Index insurance also introduces basis risk which arises through imperfect correlations between the index and the actual losses at farm level.

Examples
India and parts of Africa (pilots) Beneficiaries: Same us under Index-based risk transfer based on yield Risk Transfer:

  • Insurance
  • Derivatives