The role of insurance in building resilience against food and water shock

Protecting against natural catastrophes

Extreme weather events have been long understood and insured within the Lloyd’s market and across the global insurance industry. (Re)insurers have sophisticated models that determine the risk factors of weather events, which consider property damage, business interruption and more. However, the implications of climate change are extremely complex, as there are several factors at play. While climate change is happening everywhere, the impacts by region and peril could be quite different, with varying degrees of certainty.

Absolute climate-related insurance losses are increasing, and although climate analysis shows there has likely been an increase in the frequency of some events, like heavy precipitation, there are also other factors at play. The principal driver behind the rise in insurance losses has been an increase in exposure in disaster-prone areas, for example caused by rapid property development and higher property values. Economic factors including inflation and supply chain disruptions are leading to rising repair costs when damage arises, whilst social factors such as changing land use, urbanisation and new types of construction are all influencing vulnerability to extreme weather.

There also remains a significant climate risk protection gap, with estimates suggesting that a little over a third of the global economic losses caused by extreme weather and climate-related risks are currently insured. There is therefore significant scope for innovation to develop new solutions to help customers face this growing risk.

Parametric solutions have become a popular means of providing adequate cover to weather events of variable severity. These products have significant flexibility and can be adapted in circumstances where extreme weather events could affect businesses or governments to help remove excess volatility from cash flows. In particular, they can be suitable for buyers who are able to assess and accept the potential basis risk of suffering economic losses without the parametric trigger being met. Parametric products can also be offered to businesses in vulnerable communities or developing economies, enabling the rapid release of cash which may be needed to rebuild or, indeed, “build back better” after disasters occur.

The Lloyd’s Disaster Risk Facility (DRF) was formed to address insurance gaps around the world through development and provision of contingent risk financing solutions to mitigate the human and financial impacts of natural hazard and other catastrophic risks. Members of the DRF have supported a ground-breaking risk transfer mechanism for the International Federation of Red Cross and Red Crescent Societies (IFRC)’s Disaster Response Emergency Fund (DREF) in collaboration with Aon and the Centre for Disaster Prevention. This tailored insurance backstop ensures that swift and agile emergency funding is available to support life-saving assistance in vulnerable communities experiencing all kinds of disasters.

Lloyd’s, as chair of the Sustainable Markets Initiative Insurance Task Force (ITF) have partnered with the United Nations Capital Development Fund (UNCDF) to design and scale innovative insurance solutions that will deliver financial resilience against climate shocks in Small Island Developing States (SIDS) and Least Developed Countries (LDCs). Initially focussing on building and scaling solutions across Fiji and the Pacific Islands, the partnership will also seek to replicate the model in other regions, including Asia and parts of Africa. In addition, the ITF are collaborating with the Sustainable Markets Initiative’s Agribusiness Task Force to unlock a ground-breaking cross sector financial solution which aims to accelerate the global transition to a regenerative agricultural system.

Enabling sustainable and resilient agriculture 

Agricultural insurance is a large market, estimated around $33 billion in value, and there is still significant opportunity for growth and partnership in developing new products, particularly in an era when weather events routinely threaten vital harvests. Demand for agricultural insurance, or crop insurance, is growing in emerging markets, accounting for more than 75% of new business for the line. But agricultural insurance can also be risky, and insurers may be overexposed to losses if maximum loss potentials and wordings are not appropriately assessed. 

Premiums are often subsidised by local governments, meaning that the success of agricultural insurance sales and continuous protection is dependent on regular support from governments and public authorities. This is common in mature agricultural markets such as the US, Canada, India and more recently due to an increased commitment from the government following periods of severe drought, Brazil. When the commitment is long-standing, resilience is improved through stability and continuity for farmers, funding for new crop and technology trials for smallholder farmers, and incentivisation to practice sustainable farming.

Successful government subsidised schemes that are underwritten at Lloyd’s include the reinsurance support for US based insurance companies that participate in the Federal Crop Insurance Program, locally referred to as Approved Insurance Providers (AIP). AIPs execute a Standard Reinsurance Agreement (SRA) and/or Livestock Price Reinsurance Agreement (LPRA) with the Federal Crop Insurance Corporation (FCIC). Lloyd’s insurers provide reinsurance stop losses for AIPs to protect them from multi-peril crop commodity price risk.

Further East, the West Bengal (WB) Bangla Shasya Bima scheme which launched in 2016 uses a yield index approach, whereby the annual average yield of a crop in an area is sampled to form an assessment of indemnity. Other government initiatives include government owned agricultural insurance companies, such as in China and Morocco, offering multi-peril coverage directly to farmers and then seeking reinsurance cover from Lloyd’s.

Quick and accurate loss adjustment is a particular problem for supporting developing countries, especially as it can be economically unviable to hire adjusters and the process is exposed to moral hazard. Parametric products are therefore an increasingly common option for Lloyd’s syndicates to support; policyholders have the flexibility to define their own parameters, empowering them to obtain coverage that aligns precisely with their specific needs. For example, Zambia’s African Risk Capacity (ARC) drought insurance coverage aims to accelerate relief by providing of cash transfers and food assistance to drought affected and vulnerable communities. The scheme was put to the test when the ARC paid out $5.3m following the extreme drought during the 2021-2022 growing season, which left many parts of Zambia suffering from food insecurity^[1]. The World Bank sponsored De-risking, Inclusion and Value Enhancement of Pastoral Economies (DRIVE) scheme provides livestock farmers in the Horn of Africa with access to rapid cash in the event of a drought, allowing them to keep their core breeding stock alive. The scheme enables $572 million in private capital to cushion pastoralists across Djibouti, Ethiopia, Kenya, and Somalia from the effects of climate change related drought.

Crop insurance industry has had a long history of environmental innovation in agriculture such as the National Crop Insurances Services (NCIS) - the crop insurance research arm of NAU Country – to maintain an agronomic research programme that serves to improve and validate crop loss adjustment procedures in the U.S. for both state and federally regulated lines of crop insurance, including for new production practices like regenerative agriculture.

Learning lessons from this scenario, and from precent events, agricultural risk underwriters may look to review the growing risks to the sector and provide new products which could provide resilience in times of food shortages and price fluctuations. Insurers should be mindful that poorly designed or implemented subsidy scenes can lead to farmers assuming more risk than they need to, growing unsuitable crops or growing too many, possibly eroding soil viability, depleting water supplies, or driving up the price of insurance for others. Additionally, parametric products and technologically driven claims management systems are heavily reliant on data to be successful, therefore data enhancements, both in availability and quality, could be key to the longevity of these solutions. Finally, the impact to agriculture goes far beyond just damage to crops to encompass broader social vulnerability, especially in agriculture driven economies.

  ^{[1] https://www.artemis.bm/news/zambias-arc-parametric-drought-insurance-to-payout-us-5-3m/}