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Building Agribusiness Risk Management System: Strategy and Stages of Development

Building Agribusiness Risk Management System: Strategy and Stages of Development

Roman Shynkarenko

Agricultural Insurance and Risk Management Consultant

Agricultural Insurance and Risk Management ConsultantMost Ukrainian experts in agricultural risks insurance rely in their works on an analysis of thepresent state of agriculture in Ukraine and on an overview of the insurance system adopted in theSoviet Union (e.g. insurance programs run by Derzhstrakh, the state-owned insurance monopolist).Some specialists have taken the trouble of analyzing insurance systems existing elsewhere, but amere replication of somebody else’s experience in Ukraine’s conditions is impossible for a numberof reasons. Analysis of international practices demonstrates that, as of now, no country in theworld can claim to have an effective, transparent, and independent system for hedging agriculturalrisks. There are countries which offer insurance of a limited number of risks, or where insurance isavailable only from private companies. In other countries, such as the USA, Canada, and Spain,the government spends a lot on insurance subsidies. Ukraine and other NIS countries need to findtheir own ways to design their systems taking into account limited financial resources,technologically outdated agrarian sector, and often underdeveloped system of agricultural producemarketing. Lack of analytical material with a comprehensive and practical approach to building asystem of agricultural risk insurance in Ukraine is why the Agribusiness Development Projectspecialists wrote this and other articles on the subject.This article aims to present an overview of options available for developing a system ofagricultural risk insurance. The author outlines the main principles underlying such a system, suchas the optional nature of insurance, rules of the government’s involvement in and interference withthe process of managing damage caused to agriculture by catastrophic risks. The government’sinvolvement in the creation of such a system may take a much broader range of forms thancurrently exist in Ukraine, and the author attempted to consider different forms of governmentalsupport. The overview is intended for use by stakeholders and experts involved in the developmentof an agricultural risk insurance system in Ukraine.Development Strategies and StagesHaving an agribusiness risk insurance system in place is a driving force for sustainabledevelopment of the agribusiness sector. Insurance – the transfer of risks to another party for aspecified fee – is just one of many risk management strategies, which should be used only once anagribusiness company has identified all risks it can potentially incur and has selected those itwould like to insure. Typically, insurable risks include bad weather conditions and the risk offalling short of profit targets. This article discusses the main stages of developing an insurancesystem for the agribusiness sector, and forms of governmental support available to agriculturalrisk insurance.Overall on a global scale, agricultural producers consider bad weather, price fluctuations andlegislative changes as the highest risks facing a company. Results of surveys undertaken by theInternational Finance Corporation in 2002 and 2003 show that agricultural businesses in Ukraineindicate that prices, changes in legislation, and weather conditions are major risk factors.Considering that the legal framework in Ukraine is not yet fully formed and market infrastructuredoes not yet meet the needs of agribusiness, insurance companies cannot be expected to have thecapacity to help the state manage such risks. Moreover, Ukraine’s insurance sector in its currentform cannot offer effective weather risk management tools.Agribusiness is an important part of almost any economy. Often the government provides supportfor both producers and insurance companies. The purpose of doing so is to develop an insuranceinfrastructure, standardize terms of insurance, improve quality of insurance services and to cut thecost of insurance for agribusiness users. International practices offer a variety of methods todevelop an agribusiness insurance system:

Insurers provide insurance services and receive no government support(Sweden);
Financial aid is provided to cover catastrophic losses (Germany, Italy, USA,Canada);
Government takes part in reinsurance pools (Portugal, Spain);
Subsidized premiums on some insurance products (hail, spring frosts etc. inSpain, France, Austria);
Subsidized multi-risk insurance programs (Canada, USA etc.)1.

Government bodies design insurance systems for the agribusiness sector in consultation withprofessionals involved in the commercial insurance sector, and normally this is done in severalstages outlined in this article. It is important to note that insurance systems are never static. Thesystems evolve, practices and mistakes get analyzed, and then governments in cooperation withinsurance companies try to find the best solution to design effective and affordable riskmanagement instruments. Such reforms have been carried out in Greece, Italy, Canada, USA andsome other countries. Adoption of the Common Agricultural Policy (CAP) and subsequent cuts inagriculture subsidies will shortly bring about striking changes in the insurance systems of EUcountries.Key Principles of Agribusiness Strategy and Insurance SystemThe need for government involvement. It is important to remember that there are no countrieswith 100% solid governmental support for agribusiness insurance and risk management. Not onlydoes government support entail costs for the national budget, but also more often than not it causesdistortions in the sector and often results in the mismanagement of funds (“rent seeking”).The voluntary nature of participation. Mandatory agricultural insurance has always beenperceived by producers as one more tax to pay, therefore it is important to provide for otherincentives in agribusinesses and to make insurance voluntary.Clear rules should be set for governmental involvement (assistance) in the case of catastrophicrisks. This kind of assistance should not be mandatory but establish clear eligibility criteria. Theallocation of such aid must be fair and free from administrative bias. In other words, everyone whohas sustained a loss and meets appropriate requirements should be eligible for indemnity.Overview of major insurance programsSingle risk insurance. Commercial companies have a proven track record of providing singleriskinsurance and insurance of a set of risks without any support from the government (e.g. hailinsurance).Multi-risk insurance. Such programs require thorough preparation and zoning. Oftengovernments have a number of ways to render support for these programs. Governmental supporthowever should not be used to push out commercial insurers from the market. The governmentmay support insurance products for strategically important industries and/or types of agriculturalproduce.Index insurance. This type of insurance is based on various indexes (weather parameters, yields,cattle epidemic etc.). This is a relatively new type of insurance available in some countries. It caneasily be supported by the government, since it requires lump-sum, low costs.Potential forms of governmental supportAll forms of governmental support that are listed below should be evaluated based on theireffectiveness depending on the situation in the country’s insurance sector, the goals and objectivesof governmental support, and consequently, their impact on the state budget. All of these forms ofsupport have their strengths and weaknesses.International experience demonstrates that it makes much more sense to introduce simple cropinsurance for specific risks, which the state budget can afford, rather than undertake large-scaleprograms with limited budget resources.Investments in infrastructure. The government funds the development of insuranceproducts, actuarial calculations, and installation of up-to-date meteorological equipment.Coverage of administrative costs. The government covers part of or all costs of theadministration/monitoring of agricultural insurance contracts. With this support, insurancecompanies will have the incentive to promote products which are strategically importantfor the government, as well as other commercial insurance products in rural areas.Subsidies to insurance premiums. The government reimburses a portion of insurancepremiums on separate insurance products for insurers in cases where agriculturalbusinesses cannot afford to pay for the actuarially grounded cost of insurance.Subsidization of payments on catastrophic insurance products. The government coversthe cost of catastrophic insurance products in full (e.g. loss of entire harvest due to acatastrophic event), where coverage is low. This form of governmental support is moreeffective than ad hoc payments in catastrophic events, improving the producers’ insuranceculture. Catastrophic programs are good for planning contingency reserves in a clear andtimely fashion.Involvement in funding catastrophic pools. The government forms and accumulates afund, either together with insurance companies or alone, to make payments from oncatastrophic risks. This form of assistance can help to identify clearly the terms on whichhelp is provided as needed.Involvement in/establishment of reinsurance pools. The government is involved in orestablishes reinsurance pools, from which funds are disbursed to insurance companies tocompensate clients for a loss they incurred. These companies can act as intermediaries forthe reinsurance of large risks overseas. Governmental involvement can help to speed theprocess of establishing a standard for insurance procedures and claim processing, and toidentify insurance priorities. Once financial stability and a sufficient level of reserves areachieved, the government may withdraw from pool management and limit itself tooverseeing operations. This helps to utilize governmental resources in a more efficientmanner without losing control of the situation in the sector.Financing/establishment of a service of independent underwriters and insurancearbitration. Parties in insurance sector frequently face controversial cases, and insurersoften have little opportunity to make sure that the amount of loss and compensation areassessed in an accurate and unbiased manner. Therefore the availability of independentexperts ensures stability of the insurance system and its credibility in the eyes of insurants.Agribusiness Insurance Development StagesAnalyze the Agribusiness SectorAt this stage, it is important to perform an analysis of the agribusiness sector, its opportunities,challenges, and improvement potential. It is necessary to determine the direction which it is goingto take and competitive advantages over other countries, and to outline main strategic sectors ofagricultural production from the standpoint of government policy and national food safety.It is critical to determine the share of primary agricultural production and processing in Ukraine’sGDP, maximum deviations, quantitative indicators of agricultural produce output in measurementunits (tons, liters etc.), as well as in national currency and USD. These data can help to assess thepotential need of the agribusiness sector for insurance products. It should be taken intoconsideration that insurance is one of many risk management strategies available, therefore not allagricultural and processing businesses will want buy insurance products. In the United States,where the government heavily subsidizes insurance premiums, only 20% of farmers are involvedin insurance programs, which provide insurance protection for 75 crops. In Spain, the governmentprovides heavy financial support for agribusiness and insurance companies, too, but only 31% ofagricultural firms choose to enter into insurance contracts. There companies offer their clients 58insurance programs for agricultural crops, livestock and aquaculture. In Canada, where thegovernment covers 50% of insurance program costs, only half of all farmers buy policies frominsurers.Determine major risk types and risk factorsThis stage requires a general analysis of the agribusiness sector (a risk profile) by risk type andorigin. It is important to list the most serious risks, their potential effects and the recorded scope ofdamage. In addition, it is necessary to draw a risk profile of an average agriculture enterprise,including the level of agricultural technology used, production output, and models of financial andoperational management.The highest weather risks should be identified and distributed by country regions. A risk map likethis will help to make risk management programs more accurate and to design region-specificinsurance products. The collection and processing of statistical weather data are very important,and will be used later to design (determine) adequate insurance products, insurance rates andrequirements for insurance and reinsurance pools. It is best if weather data are available in anelectronic format, which makes them easier to work with and speeds the process of designing theappropriate products.Identify the market for agribusiness insuranceUsing sector analysis data, one can evaluate a potential market for insurance by sector, includinggrain crops, vegetables, fruits, vine-yards, livestock, the level of involvement (number ofinsurants) and an estimated cost of insurance. These data can be used to calculate an estimated costof insurance products depending on insurant involvement, the cost of setting up the system, as wellas the level and form of governmental support.Key partners, clients and users of insurance servicesBanks and other financial institutions, which provide loans to agricultural firms, form partnershipswith insurance companies in developing the insurance system. Solid insurance programs can lowercollateral requirements (in Ukraine, banks use the collateral ratio of 1:2 or 1:3, and more), and helpform stronger business relationships between finance institutions and agribusiness clients. Inaddition, it is necessary to analyze the existing forms of cooperation between financial institutionsand insurance companies and key products finance professional use (or would like to use).Evaluate the insurance sectorThis stage calls for an analysis of the insurance sector: the number of companies operating in themarket, the number of those involved with agribusiness, and the performance of insurancecompanies. It is important to give a critical look to insurance products available to the agribusinesssector and to gauge the needs of potential clients.The analysis of the insurance sector should also include an assessment of insurance demand andthe clients’ credibility. These data form the basis for formulating an agribusiness insurancedevelopment strategy and deciding on a model of governmental involvement and support.Assess the legal frameworkThis is necessary to identify existing policy challenges and to plan law-making activities in orderto create an appropriate regulatory framework to stimulate development of insurance.Once the conception of agribusiness insurance development is in place, it will be necessary tofinalize the changes and addenda to be made to existing legislation so as to ensure maximum legalsupport for innovative insurance products and measures in the sector. The majority of the CIScountries, such as Ukraine, Russia, Moldova and others, face regulatory barriers hampering thedevelopment and introduction of new insurance products, such as index insurance, based onregional index yields and weather parameters. Accordingly, government agencies and policymakers, using consulting support from insurance companies, may assist in ensuring the timelyadoption of regulatory documents necessary for the improvement of insurance business.Assess reinsurance potentialAn analysis of the reinsurance sector is important for making an adequately assessment of the riskbearingcapacity of the doemstic insurance sector, and the options and terms of reinsuranceavailable on international markets. The analysis can show what steps are needed to make sure thatinsurance rules and procedures on the domestic market meet reinsurers’ requirements.Assess and monitor the insurance systemIn developing the strategy, it is important to determine which insurance products are most suited tothe needs of the agribusiness and insurance sectors. Then it is necessary to decide which of themare the most profit-making and productive: the conventional (single risk and multi-risk) insuranceproducts or index-based ones. Index-based insurance is a new type of insurance, with some greatstrengths and specific weaknesses in comparison with conventional insurance. Some veryadvanced and successful agricultural firms need individually tailored insurance programs;therefore it is impossible to create an insurance product to meet the needs of all potential clients.However, standard products help to create basic instruments, which, if needed, may and will becustomized to meet the clients’ needs. Therefore, insurance experts and government officialsinvolved in the creation of agribusiness insurance system and planning government participation,should take into consideration other countries’ experience and their country’s potential and use allavailable information to produce a sound strategy.While implementing insurance system or large-scale insurance products, it is very important toinform potential insurants about new products and those existing in the market, as well as aboutinsurance procedures and terms. International experience demonstrates that the availability ofgovernmental support and initiatives in financing and insurance is encouraging for directors ofagricultural firms in improving their land use practices and increasing production. Another way isto improve the methodology of collecting statistical data and financial reporting among farmingbusinesses. All of these changes can contribute considerably to the improvement of businesspractices in agrarian regions by increasing financial stability and individual income levels both inrural area and across the country.The on-going monitoring and close scrutiny of insurance program outcomes can change or finetuneinsurance terms or insurance products. Taking such an approach can facilitate theemployment of funds from the national budget, if the government provides the financing, andthose of farmers who pay for their insurance. The government should invite insurance experts toperform the monitoring and analysis and hold consultations with representatives of insurancecompanies on a regular basis.We understand that the creation of agribusiness risk insurance is a large-scale and labor-intensiveprocess. Ukraine does not have a system of sound agricultural insurance as yet, but it is our hopethat, once the stages for the development of an appropriate insurance system are completed and aprofessional assessment of potential insurance products and forms of governmental support ismade, the government and the insurance sector in Ukraine will be able to build an agribusiness riskmanagement system capable of addressing complex issues facing the agribusiness sector.Bibliography:

Development of Farm Finance and Insurance System in Ukraine: Strategy Elements.Victoria Yakubovich, Agroaspect, Kyiv, 2002;
Development of Farming Sector Insurance: Choosing the way. Victoria Yakubovich,Agroaspect, Kyiv, 2002;
Government support of agriculture producers: Canada case. Victoria Yakubovich,Agroaspect, Kyiv, 2002;
State and prospects of development of agriculture risk insurance in Ukraine: analysis ofsurvey findings. Victoria Yakubovich, Agroaspect, Kyiv, 2003;
Multi-risk insurance. Farmer insurance government support programs in USA. VictoriaYakubovich, Agroaspect, Kyiv, 2003;
Market for current weather risk management tools and trends. Roman Shynkarenko,Agroaspect, 2003, Kyiv;
General principles of risk management in agriculture production and marketing. RomanShynkarenko, Agroaspect, 2003, Kyiv;
Risk Management Tools for EU Agriculture with a special focus on insurance. Report ofEuropean Commission, Agriculture Directorate-General, Directorate A. Economicanalyses, forward studies, evaluation. January 2001;
Risk Management in Agriculture: a discussion document, Executive summary. DEFRA,UK2001;
Selection of papers. Approaches to Income Risk Management in OECD Countries.Workshop on Income Risk Management. OECD, Paris. May 15-16 2000;
Selections of papers. Risk Management. Paving the Way Forward for Rural Finance. AnInternational Conference on Best Practices. Washington, June 2-4, 2003.

1 See Risk Management Tools for EU Agriculture with a special focus on insurance, January 2001.

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