Climate Change and Crop Insurance: Experiences under a Risk Management Policy Perspective
A Presentation from the the FARMD Annual Conference: Price Volatility and Climate Change, Implications for the Agricultural Risk Management Agenda. Zurich, June 9-10, 2011
Jesus Anton. Senior Economist. Trade and Agriculture Directorate. Organization for Economic Co-operation and Development (OECD).
Different layers of risk, different responses
FARMD (September 2011) | The infrequency of catastrophic events cannot undermine the social damage that they cause. Risks are correlated and systemic, therefore, it is important to apply a holistic approach to risk management as well as the associated policies and strategic responses, said Jesus Anton, during his presentation at the 2011 FARMD Annual conference.
Anton, Senior Economist at the Trade and Agriculture Directorate of the Organization for Economic Co-operation and Development (OECD), emphasized the need to come up with effective instruments to manage risks, which therefore also require differentiated policy responses. For instance, it is not always the case that keeping the risk at the farmer level is a less efficient approach.
“We have to study from the point of view of institutional economics and transaction cost economics, and try to find which is the most efficient governance instrument to manage each of the types of risks,” said Anton.
In this sense, index insurance may improve efficiency compared to other instruments, (e.g. less crowding-out). But is it efficient enough to pass the cost-benefit test? Anton asked.
The reality observed is that subsidies on programs such as crop insurance are necessary to bring back the markets after a destabilizing catastrophe. This intrinsically implies the creation of policies. But is there a welfare gain to society by adding to the supply or demand of crop insurance? These gains would have to be measured and compared to their cost in order to justify these kinds of interventions, said Anton.
What have been learned from the experience of OECD countries?
There are several factors that delude the demand for insurance, therefore, providing the rationale for subsidies. Insurance subsidies, however, increase demand because insurance crowds-out other strategies such as diversification. In some OECD countries, such as Canada, even in the presence of a highly developed insurance market, subsidies are still present. When expanding insurance instruments, said Anton, good government policy is necessary, but it is essential to avoid subsidies beyond transaction costs and catastrophic layer.
In his presentation, Anton provided some insights on what works and what does not in terms of support to insurance programs. He emphasized information and governance as the most important factors than can effectively support insurance systems, for instance, public-private partnerships for information sharing.
Another thing to take into consideration is a clear definition of the boundaries for catastrophic risk - what is catastrophic risk and what is not - which should be covered by the government; in practice, however, it is difficult for governments to draw the line or clearly define what the layers of catastrophic risk are. Anton highlighted subsidies for normal risks, as one of the less effective ways of supporting insurance systems.
In developing countries, the situation is of course different, stressed Anton. For those countries the focus is not so much about stabilization of income, but more on food security. There are also local structures and other aspects that need to be taken into account when planning interventions in this field.
Climate Change and Crop Insurance
There is not a lot of information on the quantification of the impact of climate change in agriculture. The impacts are very uncertain and are context specific. This does not mean that climate change is not occurring, said Anton, it is occurring but there is a lot of uncertainty around it, and therefore, this creates difficulties in terms of establishing insurance programs.
Anton presented preliminary results on carried-out simulations, testing different climate change scenarios in specific locations, with and without adaptation strategies, and the expectations in terms of increasing demands for insurance. The preliminary results indicated that the impacts of climate change are very uncertain even under stylized scenarios. Small impacts could potentially increase index insurance demand, but the gains in terms of welfare are not very clear. Also, among the different types of insurance, index insurance is less likely to hinder adaptation.
However, the uncertainty around climate change impacts can create significant misalignments. If only the farmers don’t know that there is an increase on the variability, explained Anton, and only insurers are aware of this, then insurance would be too expensive and farmers would not buy it. On the contrary, if both are unaware and both misaligned, then big loses would occur and most likely these losses would be covered by the government, which is a reason enough to be careful and critical to reduce this kind of misalignments.
Anton ended his presentation by stressing the need to improve our climate chain analysis.