Structure Example

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UKRAINIAN AGRICULTURAL WEATHER RISK MANAGEMENT
WORLD BANK COMMODITY RISK MANAGEMENT GROUP Ul
rich Hess
Joanna Syroka PhD January 20 2004
UKRAINIAN AGRICULTURAL WEATHER RISK MANAGEMENT
WORLD BANK COMMODITY RISK MANAGEMENT GROUP IFC
PEP Ukraine Ulrich Hess Joanna Syroka PhD J
anuary 22 2004
Weather Index Insurance for Agriculture COM
MODITY RISK MANAGEMENT GROUP The World Bank 13
th October 2006
William J. Dick
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OUTLINE

• Overview of the Commodity Risk Management Group
  (CRMG), the World Bank
  
• Index-based Weather Insurance
• How to develop a Weather Insurance program?
• Extending the index concept to flood insurance

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CRMG Overview
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CRMG facilitates.

• Market-based Risk Transfer Products
• Weather index-based insurance
• Price risk management contracts
• New Applications
• Disaster risk financing
• Extension to new hazards
• Access to risk capital
• Access to global reinsurance markets
• Knowledge Transfer and Education
• Technical assistance in projects
• Publications and training workshops
• Existing Transactions
• India, Ethiopia, Malawi, Ukraine.

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CRMG global activities
2005
2002
2004
2006
2001
2003
Feasibility Study
Pilot Design
Pilot Implementation
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New Model Index-based Weather Insurance
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Motivation

• Traditional crop insurance
• Multi-Peril Crop Insurance (MPCI)
• Yield-based insurance is not sustainable
• Named peril Crop Insurance
• Damage-based insurance is viable for selected
  localised perils
  
• Main Problems
• Loss adjustment and farm level data
• Moral hazard
• Adverse selection due to asymmetric information
• High monitoring and administrative costs
• Often heavily subsidised
• Operationally difficult for small farmer
  agriculture
  

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Experience with public crop insurance
Financial performance of crop insurance

• Condition for sustainability
  
  
• (AI)/P
• Where
• A average administrative cost
• I average indemnities paid
• P average premiums paid

Source Hazell
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Index insurance

• Challenge
• Design an alternative, efficient and
  cost-effective crop failure insurance program
  that facilitates risk transfer and is feasible
  for small farmers in low-income countries.

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What are index insurance contracts ?

• An index insurance contract indemnifies based on
  the value of an index- not on losses measured
  in the field
  
• An index is a variable that is highly correlated
  with losses and that cannot be influenced by the
  insured
  
• Example indices rainfall, temperature, regional
  yield, river levels
  
• Index insurance contracts overcome most of the
  supply side problems of traditional insurance
  contracts
  

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Main characteristics of an index

• Observable and easily measured
• Objective
• Transparent
• Independently verifiable
• Able to be reported in a timely manner
• Stable and sustainable over time

Weather indexes can form the basis of an
insurance contract that protects farmers from
weather risk
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Payout structure drought protection
EXAMPLE OF PAYOUT STRUCTURE
Financial payout - increment per mm
Payout (unit per ha)
Deficit Rainfall Index (mm.)
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Index insurance Advantages and challenges
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How can index instruments be used ?
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The global market

• Deals transacted
• Argentina I Weather insured seed credit
• Argentina II Dairy yield protection against
  low rainfall
  
• South Africa Apple co-operative freeze cover
• India Approximately 250,000 insured against
  poor monsoon
  
• Mexico Crop insurance portfolio reinsurance
  through weather derivative structure
  
• Canada (Ontario) - Forage insurance with weather
  indexation
  
• Canada (Alberta) - Heat index insurance for maize
  
  
• Ukraine Winter wheat protection against weather
  risks
  
• Malawi Weather insurance pilot for groundnut
  farmers
  
• Ethiopia WFP Drought Insurance
• Under preparation
• Morocco Wheat yield protection against drought
• Zambia Maize yield protection against drought
• Nicaragua Bank-intermediated weather insurance
  for groundnut farmers
  
• Thailand Bank-intermediated weather insurance

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• How to develop a weather insurance program ?

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Developing a pilot program

• Identify significant farmer exposure to weather
• Quantify the impact of adverse weather on their
  revenues
  
• Structure a contract that pays out when adverse
  weather occurs
  
• Execute contract (with insurers and a delivery
  channel)
  
• Secure international reinsurance

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High Probability, Low Consequence Risks Vs.Low
Probability, High Consequence Risks
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The cropping calendar

• A rainfall index is normally split into 3 or
  more crop growth phases
  
• Objective maximise the correlation between
  index and loss of crop yield

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Maize Rainfall Index - example
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Index v. maize yield example
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Distribution and risk transfer

• Bank-intermediated weather insurance contracts to
  farmers
  

Global Reinsurance Companies
Reinsurance treaty
International
Insurance Company/ Syndicate
National
Contractual relationship
(risk transfer, services, operations etc.)
Agricultural Bank
Weather insurance contracts
Farmers
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Weather index insurance - summary

• The product is simple and weather measurements
  can be understood by farmers
  
• Basis risk can be reduced by increasing the
  density of low cost weather stations
  
• Low cost of distribution and loss adjustment
• Less specialist knowledge needed to underwrite
  the product
  
• The product is suited for catastrophe hazards
• The product is highly flexible and can multiply
  in the insurance market
  
• Reinsurers are interested to accept the risk

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Extending the concept to flood insurance
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The flood risk in Asia
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Flood insurance concept

• Design a flood index which can proxy losses
  caused to crop
  
• Rice is the strategic crop most exposed to flood
• Flood impact is dependent on variety, time of
  occurrence, depth, speed and duration of flood
  water
  
• Harness technology to support insurance
  underwriting and operations
  
• 2 key components for index design phase
• Flood modelling (FM)
• Agro meteorological modelling (AMM)
• 2 key components for operational phase
• Geographical information system
• Earth Observation (EO)

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Medium Risk Pricing Zone
High Risk Pricing Zone
LA1
LA2
LA4
Pasak River
LA3
LA5
Low Risk Pricing Zone
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Summary Combining the Technology Components
FM AMM
Design a flood index that proxies crop loss
FMEOGIS
Define flood risk zones and pricing the
contract
EO GIS
Loss adjustment for payout determination
according to the index
FM flood modelling. AMM Agro-meteorological
modelling. EO Earth observation. GIS
Geographical Information System.
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Remote sensing can measure flooded areas
Flood assessment based on SAR - Bangladesh 07/2004
Flood map
River gauges
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Challenges in indexing flood risk

• Types of flood risk
• River inundation flood
• Flash flood
• Typhoon induced flood
• Coastal surge flood
• Challenges
• Zoning for insurance purposes
• Defining macro or micro level insurance
  products
  
• Pricing flood risk
• Influence of flood management practices on risk
• Avoidance of anti-selection
• Simplifying the product
• CRMG is still in the research phase
• Thailand, Vietnam and Bangladesh