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Presentation at the ICAR Forum 2008 October 14, 2008, Bucharest

Presentation at the ICAR Forum 2008 October 14, 2008, Bucharest. Insurance of Climate Risk in Agriculture Martin Odening Department of Agricultural Economics and Social Sciences, Humboldt-University Berlin, Germany. Motivation. Strategies for Coping with Climate Risk. Mitigation. Adaptation.

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Presentation at the ICAR Forum 2008 October 14, 2008, Bucharest

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  1. Presentation at the ICAR Forum 2008October 14, 2008, Bucharest Insurance of Climate Riskin AgricultureMartin Odening Department of Agricultural Economics and Social Sciences, Humboldt-University Berlin, Germany

  2. Motivation

  3. Strategies for Coping with Climate Risk Mitigation Adaptation • Reduction of Greenhouse Gases • Immission Certificates • Crop rotation • New seeds • Irrigation • Crop insurance • Weather derivatives • CAT bonds Insurance

  4. Agricultural Insurance Systems

  5. Weather derivatives: Market Development million USD Source: PricewaterhouseCoopers

  6. Index-based Insurance / Weather Derivatives • no moral hazard • no adverse selection • no assessment of damage required (low transaction costs) • payoffs not only in case of extreme weather events Advantages of index-based insurance Disadvantages of index-based insurance • high basis risk • sometimes difficult to price • lower familiarity by users

  7. = rainfall at day t = reference level for minimum daily rainfall Weather Indexes for Wheat 1. Rainfall sum R2 = 0.22 2. Rainfall deficit R2 = 0.52 3. Rainfall and Temperature R2 = 0.85

  8. De-correlation function for precipitation in Brandenburg, Germany Rainfall deficit

  9. Revenue Distribution with and without Hedging Probability (€/ha)

  10. Overview about Practical Experiences with IBI 1 ENSO – El Nino Southern Oscillation is the index measuring the Pacific sea surface temperature

  11. Preconditions and Success Factors of IBI in Agriculture • Factors determining the demand for IBI • Risk exposure of the farms • Hedging effectiveness of the instrument • Risk attitude of the decision maker • (Non) Existence of effective alternative risk reduction instruments • Transparency of insurance products • Cost of insurance • Policy environment

  12. Preconditions and Success Factors of IBI in Agriculture • Factors determining the supply for IBI • Cost of insurance product development • Cost of delivery • Cost to control adverse selection and moral hazard • Cost of loss adjustment • Market potential and volume • Risk premium • Political, legal and institutional factors

  13. Indicators for the Potential of IBI in ECA Countries (1)

  14. Indicators for the Potential of IBI in ECA Countries (2)

  15. Factors Influencing the Potential of IBI in ECA Countries

  16. Portfolio Analysis for ECA Countries 2 4 Romania Bulgaria good Hungary Moldova Croatia Russia Kazakhstan Turkey Uzbekistan Preconditions for establishment of IBI Albania Azerbaijan Ukraine Serbia Kyrgyzstan Tajikistan Kosovo Georgia Armenia poor FYR of Macedonia Belarus 1 3 low high Demand for IBI

  17. Conclusions & Recommendations Weather constitutes one of the most important risk exposures in agriculture; it may hamper the economic development of the agricultural sector Farmers: awareness of risk and active risk management Insurers: supply of tailored and affordable insurance products Science: rigorous evaluation of existing pilot projects; design and rating of index-based weather insurance Governments/donors: • Improvements in legal and regulatory environment • Improvement in data collections • Assistance in product development • Knowledge transfer and educational efforts • Financial support for the coverage of catastrophe losses

  18. Willingness to pay for Weather Insurance in Germany

  19. Cost of Weather Insurance • actuarially fair price (= expected payoff) = 13.5% of the insured revenue • Premium loading = 20-25% surcharge on the fair price depending on the type of insurance • Insurance premium = fair price + loading = 16.54% of the insured revenue • WTA exceeds WTP => emergence of insurance market is unlikely

  20. Indifference Prices for a Put Option on a Weather Index in Different Regions in Germany (in €) Actuarially Fair Price Crop rotation in Brandenburg Thuringia Saxony

  21. Hedging Strategy Using Weather Derivatives Production revenue Profit Hedged position a) Futures Present index value Weather index on expiration Short future Production revenue Profit Hedged position b) Put-Option Strike Weather index on expiration Long put

  22. Methods and Data Sources Theoretical Analysis Experiences with IBI Success Factors / Preconditions for IBI Quantification Indicators Aggregation ‘Portfolio Matrix’ Data on ECA Pre-Assessment of Feasibility of IBI in ECA Recommendations for Donors / Goverments

  23. Securitization of Weather Risk insurance transaction securitization insurance premium weather bond price farm insurer investor principal & coupons recoveries compensation unconditional payment payment when weather event occurs

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