Multi-peril crop insurance in Australia: barriers and opportunities

The Agribusiness Bulletin

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Multi-peril crop insurance in Australia: barriers and opportunities

Agriculture is an industry that operates in the most volatile environment. Despite the volatility, the sector contributes $56 billion per annum to the Australian economy. The significant contribution of agriculture suggests that farmers have been able to successfully manage their risks using a range of risk management tools. One such tool is agricultural insurance.

In this article, we discuss the current status of the multi-peril crop insurance market, an on-farm risk management toolkit much talked about by successive governments and industry groups in Australia. The article touches on the barriers that prevent it from growing and the opportunities for higher uptake, concluding with some comments on the outlook of this market in the near future. 

Multiple peril crop insurance (MPCI) provides coverage against a range of perils that affect crop production within a single policy. It covers perils currently excluded from other named peril insurance, including drought, excess rainfall, wind, and wildlife damage. MPCI products were first introduced in 1974 and again in 1999, however, they were limited to Western Australia and discontinued after one season.

There are currently only a handful of providers that offer MPCI products¹.  The policies are limited to winter crops, such as wheat, barley, oats, triticale, lupin, and canola. The combined value of these crops in 2015-16 was $10.3 billion, representing 18% of total agricultural production in Australia.

While named peril insurance has a high uptake of over 75% by farmers, multi-peril insurance is relatively newer and its uptake to date is low as demonstrated when looking at the apparent uptake by NSW farmers for winter crops (see Figure 1).

(Figure 1. Estimated insurance take-up rate by agricultural commodity | Source: Food and Agriculture Organization, , 2009; IPART, 2016; ABS, 2017 | Note: * MPCI insurance rate estimated using Independent Pricing and Regulatory Tribunal (IPART) estimates for the number of policies undertaken for the 2015-16 season compared to the number of NSW agricultural businesses that list crops as a major land use (13,562 businesses))

Barriers to a bigger market

The previous failed attempts to launch MPCI products, and the current low take-up rates in Australia highlight a range of barriers.

• High premiums relative to traditional crop insurance and other risk management strategies by farmers is the key reason for low adoption of MPCI products. For instance, MPCI premiums are typically in the range of 5%-10% of the crop value², compared to 0.55%-3.5% for named peril insurance³.
• Systematic risk refers to a risk that affects a significant number of policy holders simultaneously. Weather-related events covered under MPI such as drought or excess rainfall, are likely to affect a large number of farmers simultaneously.
• Adverse selection refers to a situation when higher risk farmers are more likely to take out an insurance policy for a given price compared to lower risk farmers. To account for the higher risk profile of participants, insurers must increase the premium prices. With higher premiums, relatively lower risk farmers tend to drop out of the program.
• Moral hazard occurs when the policy holder changes their behaviour and increases their exposure to risk when insured. In agriculture, this can include farmers changing their production practices to something more risky as a result of being insured. Difficulties in distinguishing losses caused by adverse events or poor farming practices can lead to additional costs for the insurer.
• Lack of data and underwriting skills: the insurance industry lacks detailed climatic information to accurately assess the exposure of an occurrence and estimated duration for an insured event. At the same time, there are very few specialist underwriters in Australia.
• Lack of awareness: given that the product is relatively new in Australia, farmers may not have sufficient information about MPCI and how it can fit within their broader risk management strategy.
• High upfront costs include financial costs (e.g. upfront fee for policy assessments) and non-financial costs (e.g. detailed farm records required). This may act as a barrier to finding out more about MPCI products for cash constrained or time poor farmers.
• Government policies in the form of concessional loans or grants for farmers following natural disasters may provide a disincentive to take up insurance.

Opportunities

Despite the long list of barriers, there are examples of disruption that bring optimism for further MPI market development.

• Risk diversification: given the success of MPI in Europe and elsewhere, insurers might be able to diversify risks by pooling Australian exposure with European exposure. The geographical as well as seasonable differences will help alleviate the systematic risk barrier.
• Better access to data: the internet of things, drones, satellite and technology will increase farm level data and help reduce information asymmetry, hence the adverse selection and moral hazard issues.
• Changing farm business model: if widespread merger and acquisition activity occurs, Australia could go from a predominantly ‘owner-operator’ model to a ‘corporate-tenant’ model. Bigger farming corporations with a diversified portfolio of properties and enterprises would have deeper pockets to take out MPCI.
• Product innovations to meet requirements of Australian farmers will also ensure greater adoption, and a more sustainable MCPI product. For instance, this could include requiring policies to be taken out across multiple seasons to ensure that the risk is manageable for insurers.
• Right government incentives such as tax incentives or incentives for financial institutions that lend to farmers who take out MPCI.

“Where to go from here?”

The allocation of risks among farmers (self-insure or mitigate risk through adopting preventative measures), insurers (third party risk transfer) and the Government (risk bearers to meet social goals) would determine whether the MPI market will further develop or not. Disruption within agriculture and elsewhere in the economy will cause a realignment of the balance between self-insurance, risk mitigation and risk transfer and, hence, changes to who bears the risk. A market subsequently will develop to provide price signals to encourage an efficient allocation of risk.

Authors

Nga Nguyen and Christine Ma

References:

1. Includes Latevo underwritten by Assetinsure (2014-16), CropSure underwritten by Lloyds, PrimeGuard underwritten by Allianz Australia (2015- ), ProCrop underwritten by CGU (2015-), and SureSeason (2016-) underwritten by Lloyds.

2. Deloitte Access Economics (2015), Scoping Study on Multi-Peril Insurance and its application to Agricultural Industries in NSW.

3. National Rural Advisory Council (NRAC) (2012), Feasibility of agricultural insurance products in Australia for weather-related production risks.