The current debate on agricultural insurance

In an international context characterized by increasingly liberalized markets and pressure from the WTO (World Trade Organization) to dismantle agricultural policies, in particular the American and European systems, we can observe a multiplication of insurance schemes designed to limit the negative effects induced by extreme price volatility.

At a time when all the players of the agricultural sector are being called upon to make proposals for the future structure of French and European agriculture, WOAgri proposes to take a look at insurance systems envisaged by France, Europe and the United States and examine their relevance1.

In France, crop insurance has been the subject of debate, especially in the Senate2 . It is a system that has been used for more than thirty years in Spain where it has proven its value, but has only just been set up in France. Thus, coverage for climatic events that affect farmers is still handled for the most part through compensation under the system of agricultural disasters. This compensation, which is paid after total or partial destruction of a crop due to climatic events, is paid by the FNGCA (Fonds National de Garantie des Calamités Agricoles), which was institutionalized in 1964, and other related systems (disaster or consolidation loans, overhead relief, exceptional aid…).

Now the French government would like to rationalize expenditures and promote a more preventive risk management system: crop insurance. In keeping with the Spanish model, they hope to rapidly shed responsibility for financing agricultural disasters in favor of public aid for subscription to private insurance policies. Introduced in 2005, this aid represented 35% of total insurance premiums and had already incited 20% of farmers to subscribe to comprehensive climatic insurance. If, for the moment, most of these contracts concern field crops (34% of field crop land is insured), we can observe that the crops most sensitive to climatic disasters, specialized farms like vineyards and orchards, are not widely covered yet.

Today, after a nearly three-year experimental phase, the organization and extension of this system are being discussed. The level of government and local participation, the question of reinsurance- will the government serve as guarantor for the insurance companies in case of a major disaster?- or the choice between mandating or simply encouraging farmers to subscribe to insurance, are all points that need to be cleared up in the coming months. In fact, risk and crisis management will be a major theme in the upcoming agricultural debates, on a national level but also on a European level with the next “Etats Généraux agricoles” (European States General) organized by the European Ministry of Agriculture. The upcoming review of the CAP and the reforms currently being carried out by the Common Organization of agricultural Markets (COM) is encouraging professional bodies and governments to construct new tools for managing risks. They could be of interest to EU authorities and provide a new approach to the CAP. The 2013 horizon and the reduction of subsidies programmed on the agenda of the WTO negotiations seem to indicate that crop insurance will play an increasingly important role over the coming years in both France and Europe.

In the United States, crop insurance is a tool that has been used for many years. With the review of the American agricultural policy (Farm Bill), public debate is currently focused on setting up income insurance.

The efficiency of the system, set up in 20023 , of countercyclical payments triggered when market prices fall under the adjusted target price has been in fact called into question. Focused on prices, it does not directly take into account variations in yield and area cultivated which are also determining factors for revenues. Triggering of aid is therefore not really adapted to farmers’ needs, especially those of the most modest among them. Thus, when yields are low, the system under-compensates farmers. On the contrary, when yields are high, the system compensates them too generously.

The USDA4 , therefore proposes to replace the system of guaranteed prices by another one based on revenues that would take into account both variations in prices and yields5. Countercyclical payments, under the new system, would be triggered when the national revenue calculated according to surface area (and not only the market price) drops below the reference level defined for each crop. The two other dimensions of aid for farmers are also concerned by this proposed reform: the amounts spent in the form of direct payments would be increased by 5.5 billion (in favor of young farmers) and the method for calculating marketing-loans6 would be changed.

A system of countercyclical payments, based on revenue, is comparable to those presented by agricultural organizations (such as the dominant union, the American Farm Bureau Federation, and the National Corn Growers Association) and think tanks (The Chicago Council on Global Affairs and The American Farm Land Trust). Senator Tom Harkin, chairman of the Senate Committee on Agriculture, Nutrition & Forestry, also put forward a proposal at the end of June that supports this view, in favor of reducing direct payments by 5.2 billion dollars, made possible by the review of eligibility for subsidies.

A congressional team, made up of Senator Richard Lugar and Representatives Ron Kind, Jeff Fake, Joseph Crowley and Dave Reichert, has also come up with an interesting alternative for reforming the Farm Bill. In their proposal entitled Food and Agriculture Risk Management for the 21st Century Act (FARM 21)7 , they transform the Farm Bill from a system based on subsidies (which for the most part distort the market) to a system based on a risk management account. According to this new program, American farmers will continue to receive subsidies, but these will be reduced progressively over a period of five years and will mostly serve to fund an individual account managed jointly by the farmer and the Department of Agriculture. These funds could be used for investments or to subscribe to private income insurance and solve cash flow problems. After a transition phase between the current system and the system promoted by this bipartisan congressional group, American farmers would only be able to rely on these risk management funds and their income and crop insurance policies to cope with price volatility.

While the main proposals for reform (by the USDA or the bipartisan group led by Ron Kind) have already been rejected out of hand by a subcommittee on agricultural issues within the House of Representatives, the debate on the Farm Bill is going to continue until a final vote planned for the end of the summer of 2007.

The European Commission also seems willing to consider new tools that provide basic coverage for drops in income: a communication from the Commission to the Council, dated March 9th 2005, has already recommended the creation of new systems (such as insurance against natural disasters, support for mutual funds) as a complement to the rural development programs already available. On the other hand, because the European Commission deems that security systems are already in effect for the most risk-sensitive markets, it excluded the possibility of introducing a general clause providing a “safety net in case of a market crisis” for all common market organizations, which will soon be regrouped within a single CMO.

II. Insurance may be necessary, but is it sufficient?

The development of insurance tools is evidence of the specific risks that farmers must deal with. Indeed, a farmer cannot guarantee, when sowing his crops or during the season, the quantity or quality of his harvest, or even the price he will receive for it. This is a far cry from the control over endogenous and exogenous factors that the industrialist enjoys. On the contrary, he can precisely control the quantity at the end of the production line and vary it according to changes in demand and competition. He can control the quality of his products throughout the process and knows pretty much what the retail price will be: he therefore has much more power to manage possible risks.

If climatic events are the most commonly cited risks, they are not the only ones, by far, that influence prices of agricultural products. There are also endogenous risks, due to malfunctions in agricultural markets (in terms of fluidity of information and competition in particular), that are just as important.

This last point is fundamental in the current debate because it represents one of the foundations of the legitimacy of agricultural policies. If an exogenous risk is insurable, an endogenous one is not.

The law of large numbers stipulates that a serious accident cannot affect, at the same time, all economic agents. This principle is the very basis of risk mutualization and the mechanism of insurance. On an international scale, it applies perfectly to exogenous risks: the probability of a climatic accident affecting the entire world or a whole continent is low. Even if today a drought in Australia affects the world market for agricultural products, it will not trigger an unprecedented crisis. Insurance, therefore, can fully play its role. On the other hand, the law of large numbers can not be applied to endogenous risks: their impact is much greater because they take root in the very structure of the world market. Moreover, their effects are more difficult to quantify. Insurance against this type of risk is therefore pointless.

Over the long term, by promoting the concentration of agricultural production within a few geographical areas, liberalization increases the probability of an accident that could cause a worldwide crisis.

American and European agricultural policies are increasingly letting the market set prices. Nevertheless, to compensate for the resulting increase in risks, they aim at the same time to provide maximum support for agriculture through other channels, especially by developing private insurance schemes which, as we have seen, cannot provide a solution for every problem.

Is this not a paradoxical approach? Unbridled liberalism is promoted in the aim of reducing the number of “disadvantaged”, yet is it not, on the contrary, going to accentuate the downward trend of real agricultural prices and penalize the poorest farmers who cannot afford private insurance? Let us remember that liberalization without safeguards is not synonymous with “social well-being”: markets and fairness rarely go hand in hand, as theories and history have shown us, especially in the case of agriculture where markets are inherently imperfect.

Insurance schemes therefore appear to be a palliative treatment rather than a cure. While they are certainly necessary and effective to a certain degree, they can only relieve a fraction of the world’s farmers from the chronic symptoms that affect them.