Climate change and the impact on agricultural insurance

By Jutta Drewes, agricultural specialist: underwriting Hulisani Mukwevho, agriculture graduate Munich Re

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Jutta Drewes
Hulisani Mukwevho

 

In many ways, the effects of climate change are arguably already apparent in the insurance industry. This is particularly the case in agricultural crop insurance, where cover is offered as hail (with some extended perils) or multi-peril crop insurance (MPCI). MPCI covers drought as a peril; therefore, its sustainability is the most threatened by climate change due to the incidence of drought.

With a multitude of global climate prediction models, the climate predictions for sub-Saharan Africa are dire. Temperatures are expected to continue increasing throughout the region and rainfall patterns are declining dramatically in southern Africa while increasing in East Africa. Figure 1 shows the change in annual (top), summer (middle) and winter precipitation for two temperature scenarios: warming of 2° and 4°C by 2100, named RCP26 (left) and RCP85 (right) for sub-Saharan Africa by 2071‒2099, relative to 1951‒1980.

For the sub-Saharan subcontinent, the possible climatic effects are:

  • Higher temperatures, particularly in the inland subtropics
  • Increased frequency of extreme heat events
  • Increasing aridity
  • Changes in rainfall (rainfall in southern Africa is predicted to decline dramatically while increasing in East Africa). 

A sea-level rise of one metre is also being predicted by the end of this century.

Figure 1. Source: Serdeczny, O, Adams, S, Baarsch, F, Coumou, D, Robinson, A, Hare, W, Schaeffer, M, Perrette, M, and Reinhardt, J 2016.

 

For South Africa, these predictions are particularly ominous for the Western Cape, where the effects of the previous drought are still felt in the fruit industry.

Climate change contributes significantly to agricultural risks through the increased uncertainty of weather patterns. Farmers are faced with higher production risk as climate changes. While there are other manageable production risks, weather risk cannot be managed and must be transferred. Insurance has become an important risk management tool for hedging against the implications of climate change.

In South Africa, we can see the volatility in the crop insurance portfolio performance (as shown in figure 2). MPCI is the cover which includes drought and the severity of drought losses is evident. Hail volatility is less extreme but loss ratios are still high in some years. Insurers and reinsurers are losing money and this is not sustainable since crop insurance will become scarcer and more expensive.

 

Figure 2: South Africa crop insurance loss ratio. Source: Munich Re Analysis

 

Way forward

For insurers and particularly reinsurers, diversifying risk portfolios across different regions is an important strategy to reduce the overall exposure to climate risk. This strategy is used to avoid the concentration of risk.

Product innovation in the crop insurance space is urgently required to ensure the sustainability of the sector. Index covers have become one of the preferred ways of achieving this because their lower cost of distribution allows for higher market penetration and wider spread of cover. Index covers are based on compensation triggered by the deviation from the threshold of a proxy such as weather, mainly rainfall or temperature. Assuming insured farmers within the same geographic area experience similar weather impacts and have similar traits, when a payout is triggered, farmers are all compensated according to the agreed rate. On-ground conditions on the farm do not influence the claim process hence loss assessment is not necessary. The advantages of index insurance covers include lower moral hazard and lower risk of adverse selection.

Integral to more advanced and sophisticated index cover development is digitisation through the Internet of Things. By improved technology of in-field ground sensors and the parameters that can be sensed remotely with drones and satellites, the indices developed will mimic the individual farmers’ loss experience more accurately.

Munich Re plays an important role in developing products which are suitable for farmers in various countries in Africa by providing technical skills necessary for sustainable product development. Being involved in index insurance, Munich Re has several success stories in countries such as Rwanda, Kenya, Malawi, Zambia Nigeria and Uganda. We are known for our global market presence and knowledge and continuously seek new opportunities to innovate and develop reliable crop insurance products.