Farm Insurance in Australia – What Should Farmers Know?

For more than a hundred years, nations across the world have executed crop insurance programs. Multiple types of threats including drought are covered by most of these programs. And it’s also true that for more than a hundred years, these programs have seen failure. None of them is commercially practical. All are sponsored and several have proven too pricey for governments to afford. Typically nations that continue to finance agriculture also finance their crop insurance programs.

The crop insurance program in Canada has a loss ratio of up to 3. This means that the covers provided by insurers along with the program’s administration costs are thrice greater than the premiums paid in by farmers. Even the US program has a loss ratio similar to this and at present funds 67% of premium for farmers who buy insurance against yields less than 50% of average. Japan and Brazil suffer loss ratios of more than 4.5. Of late, the European Union examined insurance while reforming its Common Agriculture Policy. Almost distinctive among its trading partners and competitors, Australia has been reluctant to directly fund farm programs including farm insurance.

The practicality of multi-peril crop insurance in Australia has been examined by three studies. The Industries Assistance Commission in 1986 gave recommendation against a crop insurance program. The Multi-peril Crop Insurance Project in 2000 inferred that crop insurance was not viable without government funding. The Multi Peril Crop Insurance Task Force in 2003 performed a thorough analysis for Western Australia, the biggest and most dependable wheat producing state in Australia. If crop insurance is possible in the country, it will be in the state of Western Australia. However, the Task Force ‘saw no future for multi-peril crop insurance without considerable government subsidisation of premiums or countersigning of risk’.

Do any prospects exist in Australia insuring against drought? To anyone’s surprise, the answer is yes. There are chances of success for financial markets where governments have seen failure. Throughout the world, techniques for the management of financial risk are being extended into weather risk management. Climatic derivatives are provided by global financial organisations to insure against too little or too much rain, or too cold or too hot temperatures. Weather derivatives are at the base of yield index contracts as a substitution of crop insurance. The Task Force further made two more recommendations:

1. Decide what government can do to help in:
• Establishing necessary infrastructure for climatic derivative products
• Building independent, trustworthy data collection, and
• Enhancing the knowledge of growing products and finding their potential value to farmers
2. Think upon how government could help in building a suitable model on which a relevant index for farmers can be based that has a powerful relationship to the crop performance in Western Australia.

While pilot projects have been initiated in some developing as well as transitional countries, Australia is a distinct laboratory to experiment with yield index insurance and weather derivatives. It consists of a well-designed financial sector and commercially feasible scheme won’t be crowded out by government subsidies. Subsidies may entice crop insurance providers and any insurance broker to North America; but the advantages of expanding their portfolios will entice them towards Australia.

Markets for Risk

With so many letdowns over nearly a century, why does crop insurance still exist on the political agenda? The answer is that markets are being unsuccessful to give a required service for farmers and governments must rectify the failure. An important service given by insurance and financial markets is risk-sharing. Effectively the risk is moved to people who are in a better position to manage it and it is spread all through the economy. People who bear the risk get a payment of risk premium for their service. Farmers get the advantage of more ability to be entrepreneurial, more access to available credit and adopt more speicalisation and new technologies and efficiency in production.

Probably there is a considerable demand for crop insurance; however the insurance sector is not able to provide it.

Multi-peril Crop Insurance

Farmers want to buy insurance and insurance providers want to sell it to them. But for multi-peril crop insurance, moral hazard may be the smallest problem. But farmers and insurance providers can undermine a farm insurance contract. E.g. farmers may miss to spray for pests or fertilise. Or they may fail to check that the harvester is working properly. This side of moral hazard is normally handled by coverage levels. The insurance provider will cover a part of the production e.g. 65%. The remaining 35% is covered by the farmer and still he gets an incentive to grow a good crop. However, if the season is bad, production may definitely decline below 65% and the farmer be paid for 65% of an average year irrespective of how badly the crop yields. To confirm that farmers take care for the crop, insurance providers use an election percentage of about 70%. In the event of a total crop failure, a farmer will get 70% of 65% i.e. 45.5% as an indemnity payout. If it’s 50% normal, he’ll get 70% of 15% i.e. 10.5% as an indemnity payout added with 50% for selling the crop, thereby giving a total of 60.5%.

The contract can even be subverted by the farmer by selling the crop to a neighbour and filing an insurance claim. But this is prevented by assessment of crop done by insurance adjustors before harvest; but it’s an expensive and time-consuming process that increases the transaction costs. The contract can be subverted even by insurers by not keeping enough reserves or not reinsuring and being unable to pay the indemnity claims as promised. In such a situation, farmers have a little recourse.

Two important kinds of information are known by farmers but not insurers. First is the average yields. Second is the variability of yields. Surveying farmers can assess the likely demand for insurance. This is tougher to do than to say. Australian farmers are not experienced with farm insurance and will need help to learn about it and decide how it suits their portfolios. In this regard, MGA Insurance can help them. Watch the following video how they can be of help.

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