The Role of Government and Markets in Ex Ante Crisis Risk Management in Agriculture Dr. Jerry Skees The H.B. Price Professor of Policy and Risk University of Kentucky and President of GlobalAgRisk, Inc.
Let’s be clear – the risk for this part of my presentation are linked to industrial farming systems … Small farms require early detection – quick payoffs to clean it up and then much lower payout rates as more losses are exposed
For financing problems on small farms a check off system is likely superior to insurance – bad information hurts the entire industry – it is an industry collective good problem (Sumner)
As more sophisticated techniques are used, safety protocols (HACCP-like) solutions become essential for both risk-mitigation and risk crisis management
Society will be involved in regulating to assure that safety standards are followed or litigating to provide incentives to assure that when problems do emerge everyone in society can become the regulator through the courts
More hazard and adverse selection -- firms still have incentives to hide information
Improved underwriting requires more monitoring and more cost
Must use principles of co-insurance and deductibles so that agent still has risk of being hurt if they cause a problem
Some past experience suggest that some insurance companies still do a very poor job of monitoring and underwriting
Conclusion for Insuring Food Safety, Animal Disease, and Environmental Problems
Insurance markets can change behavior in a positive fashion – or they can create more risk taking and even more problems
Challenge for insurers is to insure only random risk and not BAD management
Pressures from Government in changing property rights and imposing regulations can complement both the demand and the use of appropriate insurance solutions
Natural Hazard Risk Sharing for Agricultural: Product Design for Weather and Index-Based Insurance Traditional response to natural hazard risk and resulting income vulnerability in agriculture has been either post hoc disaster aid or ex ante multiple peril crop insurance. Heavily subsidized – the mixing of market and social goals has made crop insurance budget intensive and the target of criticism in trade negotiations. And yet, crisis risk management usually implies a role for government. Needed: Innovation in our risk sharing models
Asymmetry around best estimate due to measurement error, differences in record length, record reliability and completeness
Asymmetric information (moral hazard) contributes to loss probability ambiguity for insurance products
Result: Higher premium loads relative to well specified risk (Kunreuther et al., 1995)
Expectations of Loss Function Vary Between Buyer and Seller Classic problem in pricing -- Both buyers and sellers of risk management instruments must agree about underlying risk for a market to evolve
Can cognitive failure be addressed by removing the tail risk?
Leads to decision errors in risk management and creates a wedge between supply and demand for insurance and insurance-type products, especially for risk that are infrequent.
Parametric disaster assistance for low probability events:
Lower load over the remaining distribution
Larger probabilities are easier for consumers to grasp
individual farmers (US, Canada, India, Brazil – area yield insurance / India – rainfall insurance )
Microfinance / rural banks (Peru – COPEME)
Importers for food security (WFP – Food security)
governments for disaster aid (Mexico- Fonden)
Irrigators in a irrigation valley (Mexico IDB project)
Herders based on mortality in an area (Mongolia)
traditional crop insurance providers to serve as localized reinsurance
Banking institutions to protect their loan portfolios
Blending Exchange Markets and Insurance Markets
Are weather trades real enough to obtain efficient pricing? Or have we moved to a world of tailored insurance products where the risk are retained by large reinsurers?
The market trades would give more efficient pricing in theory
Without counterparty risk, hard to swap the risk
However, with tail risk, one is still looking at heavy loads for ambiguity and traditional methods for pricing an insurance product!
Layering Risk for Effective Policy severity frequency Retained by the Individual and Banks! Insurance Sector offers layer with Global Reinsurance for Pooled Country Risk Government offers ‘Free Catastrophe Insurance’ to cover ambiguity risk layer
Layering the Risk with Index Products Let x = the weather or indexed event The individual retains and manages the risk An insurance market holds this risk Government pays for this level; social solution
Layering Risk Severity Frequency Self-retained Insurance Reinsurance Gov’t Assistance NGO/Donor Community
Must separate market and social function more distinctly.. Using flat premium subsidies or gov’t to share risk of products that require diligent underwriting of individuals will be subject to significant abuse and cost
Key – pool risk with index insurance inside the market --- sell off the tail risk --- allow for dynamic trading of the pooled index risk