Insurability of Agricultural Risks

Agricultural insurance covers systemic risks such as drought, cyclone, epidemic diseases and wildfires, which have the potential to cause large-scale losses and make risk trans-fer for insurers to reinsurance and capital markets a necessity. Further, loss distributions of agricultural risks are often non-stationary and require special statistical treatment. Adverse selection has been a key issue in agricultural insurance and has been addressed through government premium subsidies to increase the affordability and penetration of  insurance,  improved  methods  to  determine  premium  rates  through  risk  classifica-tion, and the introduction of waiting periods before covers incept. Moral hazard is typically addressed through loss-sharing structures, increased monitoring and multi-year policies

Insurable Interest

For insurance to be recognised as such, insurance regulators request the demonstration of an insurable interest, which is the financial interest a policyholder must possess for a legally enforceable insurance coverage. Further, insurable interest is required to prevent speculation and gambling. In case of a lack of an insurable interest, insurance regula-tors tend to classify the product as a financial product.

Insurance or Derivative?

Insurance  and  derivatives  can  be  based  on  the  same  type  of  product  (e.g.  a  weather  index)  that  has  very  similar  risk  transfer  benefits  but  with  an  execution  form  that  involves entirely different regulations, accounting practices, tax implications and legal constraints. Under insurance law, the policyholder must have an interest in the subject matter of the policy and obtain some financial benefit from the preservation of the sub-ject matter or sustain a pecuniary loss from its destruction or impairment when the risk insured against occurs. In contrast, derivatives simply base payouts on the performance of an index and are therefore not associated with any physical loss and can be bought for speculative purposes. In practice, most insurance policyholders have an exposure (and  therefore  an  insurable  interest)  and  index-based  insurance  products  have  been  developed in a way that highly likely losses are indemnified.In agriculture, weather- and area-yield insurances do not require the prove of loss of the policyholder as claims are settled directly on weather and yield data. Usually, insur-ance  regulators  accept  these  products  as  insurance,  particularly  if  the  payout  occurs  to  individual producers (micro-level risk transfer) and premiums are government-subsidised. However, index-based insurance for agribusinesses could be seen by regulators as finan-cial instruments rather than insurance and new products often require a legal opinion and regulatory approval.