By António Sobrinho
Farmers must live with agricultural risks. Among them, meteorological risks may affect agricultural activity and farmers` revenues. There are several ways to meet agricultural risks and insurance is one of them. By insuring their crops, farmers transfer risk to a third party, limiting their losses. However, uncertainty is an important factor to be taken into account, as there is more and more evidence of climate change affecting standard weather patterns. In that sense, insurance can play an important role in influencing land use planning, as well as setting guidelines for an efficient use of natural resources.
Agriculture is a risky enterprise. It depends on numerous factors, some of them beyond human control. Nevertheless, one can consider three main ways to deal with agricultural risks, such as avoidance, prevention and assumption:
– risk avoidance seems to have a limited application as farmers cannot elude the uncertainties of weather (meteorological risks). It seems clear that avoidance is not the best way of meeting agricultural risks;
– risk prevention means the reduction of uncertainties through “improved facilities and techniques as well as organization”, as stated by P. K. Ray in his book “Agricultural Insurance (1981)”;
– risk assumption is a way to meet unavoidable risks through self-insurance or by transferring risks to a third party through insurance or speculation. While insurance offers protection in case of physical loss, speculation is basically a cover against probable loss of value.
Among agricultural risks, meteorological risks (e.g. excessive rain, hail, frost, strong winds, flooding, droughts, etc.) are under close surveillance, as extreme events are becoming more frequent and severe due to climate change evidence.
In Portugal, for instance, access to water is becoming a problem as hydric reserves have reached a critical point due to a severe drought and huge water demands as a result of the wild fires that have affected the country during summer 2017. This means that farmers and society as a whole require human intervention in order to cope with such demands and guarantee multiple usage of water through a judicious management.
Since a crop insurance system has been set up in the country on the 21st of September of 1979, farmers could insure their crops against several meteorological risks.
Risks covered by the crop insurance system at the time of its creation were as follows:
– extreme precipitation (above 10 mm in 10´);
– hail (solid precipitation as a spheroid);
– frost (ice deposits as a result of atmospheric water vapour sublimation, for several reference dates according to regional climatic characteristics of the country);
– strong winds (instant wind speed of above 80 km/h).
Along almost four decades, the Portuguese crop insurance system has been the object of several changes concerning risk coverage (e.g. more plants and risks) and some technicalities related to the production mode and claims, for instance. More information about crop insurance in Portugal can be found at the IFAP (Instituto de Financiamento da Agricultura e Pescas) website. Also at the website of ASF (Autoridade de Supervisão de Seguros e Fundos de Pensões), one can find information on legislation concerning crop insurance.
Nowadays meteorological risks apply to almost all cultures, although for some of them there are several constraints foreseen in the legislation. The Portuguese crop insurance system is highly subsidized through EU funds. Even so, most of the farmers consider it expensive and they do not transfer their risks to a third party.
Actually there are a few reasons that make insurance expensive: they concern claims assessment and administrative costs, for instance. When a risk occurs, physical damage evaluation should be performed by agronomists as a rule. This procedure is time consuming and represents a significant amount of money, and premiums become more expensive for the insured. Crop insurance does not attract as many farmers in Portugal as it should, basically due to the cost of insurance premiums.
Another way of risk transfer concerns speculation. Speculators “take upon themselves the chance of gain or loss through fluctuations in the value of certain commodities in the hands of producers, dealers or manufacturers”, as stated by P. K. Ray. This is much more a derivate product rather than an insurance product. Speculation, as described, is inexistent in Portugal.
The disruption of natural systems may cause serious prejudice to their sustainability. An example of that is the water diversion from the Douro water basin to the Spanish Levante, through the Tajo/Segura rivers, in order to irrigate orchards/gardens/golf courses in a semi-arid Mediterranean sub-region.
Such diversions affect the natural river flows and its biodiversity. Portugal, as a downstream country, suffers from the negative impacts of climate change as far as it concerns the water flows from its main international rivers (Minho, Douro, Tejo and Guadiana). Experts and politicians, both Portuguese and Spanish, should discuss the current situation in order to make decisions on an equitable basis, regarding quantity and quality of water flows on a daily scale.
Fundamental decisions have to be made in order to assess the limits of our natural systems. This means that fundamental choices have to be made in order to set up priorities for water resources management, including solutions that may require social consensus. For instance, the decision to build or not to build a dam as water storage will be of fundamental importance to the irregularity of rivers’ regimes due to climate change.
Insurance can play an important role influencing land use planning as well as setting guidelines for an efficient use of natural resources. This means that there should be incentives for farmers who decide to grow the most adequate species in less risk-prone areas, better adapted to topography, soil and water availability. On the other hand, an effort should be made in order to minimize the negative impacts on very small farms, on the use of poor farming practices, and on the access to subsidies and markets, for instance.
Besides the modalities above mentioned concerning risk assumption, a relatively new instrument known as weather index insurance (WII) is gaining ground, mainly in countries where weather networks are limited. The index should satisfy several properties (e.g. observable and easily measured, objective, transparent, independently verifiable, reported in a timely manner, consistent over time and experienced over a wide area).
As defined by the World Bank, the WII “is a simplified form of insurance in which indemnity payments are based on values obtained from an index that serves as a proxy for losses rather than upon the assessed losses of each individual policy holder”. This index has to be based upon an objective measure (e.g. rainfall excess or deficit), having a straight correlation with the crop yield.
An example of a pay-out structure for a hypothetical rainfall contract is shown on figure 2. There will be indemnity payment if rainfall is below 100 mm. Maximum indemnity (50,000 €) is payed to farmers when rainfall is below 50 mm.
WII is cheaper than traditional insurance due to its characteristics. This means that having done a previous study of the meteorological risks in order to define, for example, the risk profile, then it is possible to establish the layering of deficit rainfall risk by rainfall levels by risk retention, market insurance and market failure. Different parties could share the risk at micro, meso and macro levels and a pay-out structure for a hypothetical rainfall contract can be defined. There are no claims assessment and administrative costs are lower when compared to traditional insurance schemes. WII can be a useful instrument if well designed and managed.
In short, insurance could influence farmers` decisions regarding their options instead of running after any kind of subsidies aiming at the promotion of certain species. A well-managed crop insurance system, when compulsory for a large majority of the farmers, could reduce costs and become a valuable instrument for rural planning.
António Sobrinho is a PhD researcher at the Institute of Social Sciences, University of Lisbon (Doctoral Program for Climate Change and Sustainable Development Policies). email@example.com