Is the insurance cover sufficient? Dealing with the agricultural drought

At first glance, the above examples of ad hoc government activities seem like a good way to finance negative financial outcomes. Still, governments face an additional unexpected burden on the state budget and a lack of verification of the application of crop yields by farmers, leading to the ineffective public money spending. Hence, private insurance can be a way to better finance losses.

11 CEE / SEE countries became EU members in 2004-2013, following the CAP (Common Agricultural Policy), which also means subsidizing private agricultural insurance. However, the drought is poorly insured or not insured at all. Even though drought insurance is offered, there are many restrictions applied by insurance companies in terms of high deductibles, compensation sub-limits, types of crops or insured regions, etc.

Why is such a “low-risk appetite”? First, crop insurance was introduced into the CEE / SEE region by German, Italian and Austrian insurers who focused mainly on the risk of hail. Before the 2018 drought, farmers and insurers hardly anticipated the need for such protection. As a result, there is a lack of extensive experience of insurance companies in assessing the risk of drought and loss adjustment. Moreover, it is technically challenging to deal with drought loss precisely and quickly. This has a cumulative effect on large areas that require a good network of highly skilled claims experts.

At the same time, the drought is a very catastrophic threat that can exhaust the collected insurance premium for many years ahead. To ensure such a risk, an insurance company needs a sustained and waste risk portfolio to reduce the volatility of expected losses. This can only be achieved through decisive government intervention in the development of crop insurance.

Strong cooperation between the government, agricultural associations and the private insurance market (Public-Private Partnership) should create the most favourable drought insurance conditions for all interested parties. Farmers want to be well insured at the best price. The government wants financial relief on the state budget and effective targeted assistance for farmers. Insurance companies want a stable portfolio with long-term profitability.

In addition, drought insurance should be available to farmers, meaning that the government has to subsidize the insurance premiums and participate in the reinsurance loss layers. Moreover, crop insurance should be the precondition for the farmer to obtain other financial assistance. In many countries, such a measure is not so popular as such compulsory insurance can be considered a new hidden tax. However, in countries with developing insurance markets and a low insurance culture, it is a necessary step to establish a robust drought risk insurance mechanism.

Last but not least, the government should set strict conditions on when and to what extent it engages its resources in financial aid after the drought. Measures should be predetermined as a drought crisis response plan, but it does not look chaotic. On the other hand, a clear understanding of when and how the government is involved constitutes a  strict line between recovery of losses from public finances and the private insurance system. As far as EU members are concerned, such activities should follow EU directives stating that government intervention should not cause unequal opportunities in agriculture between EU countries.