Memorandum submitted by Guy Carpenter and Company Limited
Examination of Witnesses (Questions 901-919)
JOHN DRAKEFORD AND GARY HUTCHINGS
WEDNESDAY 1 MAY 2002
901. Gentlemen, thank you for coming in front of us today. The reason we have invited you is that as you know, in the wake of the foot-and-mouth disease outbreak the Government has been talking about perhaps moving to a circumstance where farmers have to insure against disasters and the taxpayer cannot always meet the bills for the disasters. You are in the business of insurance and farm insurance and therefore we thought it would be interesting to see whether there were market solutions to this and whether the marketplace could actually offer insurance to farmers for the sorts of circumstances we have seen in Britain. Could I invite you briefly to give us an outline of where you see the present situation as far as insurance is concerned? Is it realistic to look towards a market solution in this sector and what form might it take?
(Mr Drakeford) If I may, I should like to make an opening statement to give a brief overview of the work we have recently undertaken, a little bit about the organisation that I work for and Mr Hutchings. My name is John Drakeford, I am the Principal of Guy Carpenter and Company Limited, the world's leading global re-insurance broker. Guy Carpenter, part of the MMC group, has a number of specialities including agricultural insurance. Our clients include primary insurers in the private and public sector. We are actively globally but have been recently focusing on Europe where we have been exploring the opportunity to develop insurance based risk management tools for agriculture. As part of the process, we examine the current structure of the market and evaluate how it is likely to change. We look at risk both now and in the future and review the strategies which have been adopted throughout Europe and their effectiveness in the context of new market dynamics. During this process, we consulted widely with a number of key stakeholders in the industry. An abridged version of our recent work has been given to the Committee which we hope you will have had an opportunity to study. My colleague, Gary Hutchings, who is an agricultural specialist of many years standing with specific emphasis on risk management, is largely responsible for this work and I am sure will provide you with more detail should you require it. Responding directly to the question you posed, we certainly believe that there are products out in the market that do meet farmers' need to protect against both yield and commodity price risk. May I start initially with crop insurance and then move on to cover livestock, it is fair to say that there are three principal products available in the market at the moment. The first is either a single or limited risk type coverage which historically has been developed on the back of hail and fire coverage. Hail and fire coverage has been available in the US/Canadian market and interestingly enough in the German market for approximately 100 years now. The hail product is widely utilised also in other European countries and parts of Africa, southern Africa in particular, Australia and interestingly, in a very limited way in the UK market. Almost exclusively it is a product type which has been a private sector initiative with little or no government support almost globally, apart from Italy which does provide premium subsidies of between 20 and 40 per cent to farmers for the hail coverage. As a development of hail coverage in more recent years there has been development of multi-peril policies which are protecting the farmer against production shortfall due to really quite a wide variety of perils. It is almost a comprehensive cover. This is widespread within the USA and the Canadian markets. In both markets it has been developed as a private and public sector initiative, but the difference is that in the US the delivery and risk carrying and to some extent the re-insurance is done on a partnership basis both private and public. In Canada the delivery system and the risk carrying element of that is exclusively government. One European state which has a fairly comprehensive programme is Spain, which is a also public and private sector initiative. Revenue-based products have been developed from multi-peril. Revenue is quite simply a combination of yield or production shortfall and commodity price risk. These types of product are almost exclusively utilised in the US market and again it is a combination of public and private sector. Coverage is currently available in the market for livestock, predominantly for accidental death and sickness. That is widely available almost globally. There is very limited availability, however, for disease cover and there obviously foot-and-mouth disease is an issue, which you are very interested in. Historically there has only been limited coverage and traditionally the cover which is offered is really a business interruption or loss of earnings cover to the farmer who has been affected by foot-and-mouth disease and a small incremental increase in the government indemnity which is provided for the farmer in the event of an outbreak of disease.
902. I have read your abridged report and as always with an abridged report it is dangerous because the devil is in the detail. I have to say that my first impression was that I was left underwhelmed by the opportunity to move in this direction. I do not know of any other industry that would have such a significant number of people working in it who would not be insuring their end product. We all know about the various cowboys out there doing different things, but why is there no consciousness to see insurance as a precursor to operating in this area, particularly as regards crops. I shall come to animals in a minute because they are more difficult. I would welcome your views on that.
(Mr Hutchings) Yes, it is an interesting problem. Farming is perhaps a unique industry in that it is probably the one industry where you have to invest something like 18 months ahead of your output, you are never sure what revenues you are going to make and all the things that affect that revenue are largely out of your hands: weather, legislation, environment, markets and so on. You would think, with that sort of scenario, that the drivers there to insure yourself against such risks would be very apparent. We probably have to recognise that the system for market support and controls in Europe are very different systems to those that apply in the US. In the US we have seen a great deal of uptake of these types of products. While clearly they do have more climatic risk than we have, a key driver is the significant involvement of the government, both federally and nationally. They encourage the grower to understand his risk through training and also to help him manage his risk through subsidy on the premiums. If you look on the other side of the water in the European context, of course the circumstances are quite different. Our yields, if we look at crops particularlyputting to one side livestockare less variable over here in northern Europe, apart from when you get into the more southern states of Europe, such as Spain and Greece. Also we have mechanisms in place within the Common Agriculture Policy which to a degree have hitherto managed the farmer's risk for him. It is really more to do with the circumstances that we find ourselves farming in. You are absolutely right: it is quite interesting.
903. May I follow up and look at the animal insurance schemes? I should be interested in your views because I did not pick this up. What about intervention by government? We have had this recently with foot and mouth, but I have long understood the way in which bovine TB, which can be insured against, often is not because farmers say that the premiums are too high, but also because of government intervention when the animals get taken out anyway so there is no point paying for insurance. The analogy here is a bit like with schools. I know it has changed again now, but there was a time when local education authorities just gave up insuring property: it was easier to pay out to schools directly because the premiums were seen to be too high. Is this a fair picture?
(Mr Drakeford) Yes, it is.
904. How do you begin to turn this around so that we get a normal insurance model operating?
(Mr Drakeford) I agree with you. You are right that the perception is that the government will step in and bail the farmers out. There have been coverages by the private sector, the insurance sector. The livestock sector is a very small part of the insurance industry, a very specialised part of the insurance industry, and there have been a number of initiatives where insurers have tried to develop new livestock products that have applicability in the UK market. At each step of the way, they have come against the problems associated with exactly the issues that you have raised. My own opinion is that if the risk management of livestock is to be cast more into the private sector, that should be a matter which is discussed between the insurance industry and government to come up with an appropriate model. I will use the US as an example there and we heard mention earlier of the amount of government subsidy that is available to US farmers. The US crop insurance model is a prime example of that and there is an enormous amount of subsidy that goes into not only providing premium support to the farmers and some insurance coverage to the farmers as well specifically by government, but also to assist the insurance industry in developing new products they provide some expense reimbursement and they do provide some re-insurance support where capacity is a major issue. Clearly in the livestock market, with the values that are out there which are currently not insured within the private industry, capacity would prove to be a major problem because of the way the industry is currently structured and the very small sector of the insurance industry which specialises in this class of business.
905. The problem there is that you are asking farmers to go effectively from 100 per cent cover where the government picks up the bill, to something which is potentially going to put the risk on them, but also may not. We know how premiums work: there are always various get-out clauses. Is there a significant difference between the way in which crop farmers insure themselves as against livestock farmers? We have a figure here that between two thirds and four fifths do not. Is there more awareness in the crop sector than livestock or is it across the board?
(Mr Drakeford) There is no lack of awareness. Using the US as an example, one of the key drivers there is government support, both by way of physical subsidy and also promoting the adoption of these types of insurance coverage, which has been prevalent in the crop market for the US, but no such initiative is currently in place for livestock. That is a very, very high profile issue at the moment. No private/public partnerships have currently been established for livestock producers. Interestingly livestock producers in the States are not at all interested in quantity price risk, but they are very interested in a product that can deal with the outbreak of disease because of the current very high profile situation we are experiencing at the moment. We are aware of an initiative that is being considered at the moment by the US Federal Government for a public/private sector partnership to deal with some of these issues for livestock farmers.
906. May I introduce the implications of the CAP reform? Presumably CAP reform will make insurance-based models more attractive and more likely. What is your understanding of where the CAP is in relation to this? I know you said Spain has more but is there a Commission view on this that is being driven forward or is it up to individual national governments to find some money somehow?
(Mr Drakeford) At the end of the day it is a mix of both. Without doubt each Member State will have to drive its own initiative, but there may be the establishment of some form of federal model which can be adopted within each of the Member States.
(Mr Hutchings) It is slightly related to your previous comment regarding why. They have governments who will bail farmers out wholeheartedly so why should they buy risk insurance. It really is about perception of risk: whether it be insurance based or even market based risk, price risk is a key risk for the European farmer at least. If your perception is that your risk is low then you will not insure yourself against it. If your perception is that somebody else will resolve the problem for you, then perhaps you will not take a great deal of action to manage it. It is a bit unfair to think what we are only now seeing CAP reforms. Really it got started with the reforms back in 1992. That was the first fundamental reform of the Common Agriculture Policy. That started reducing some of the support measures, some of the intervention measures which were in place and by doing so, began to increase the risk profile the European farmer was faced with. That clearly is more around price risk. That has moved further forward with Agenda 2000, which has now moved considerably forwards, refocusing some of the support away from market and production into other areas. That in itself has left us more exposed to the world markets, be they livestock or indeed be they arable. We are seeing that now with export subsidies: there are none. Import duties are significantly below what they used to be. That in itself is changing the environment and will therefore change the risk perception of the European and UK farmer.
907. Can you just give me a feel for who the insurers are going to be? This is about demand and supply and there does not seem to be much demand from farmers. Is that because, as is my understanding with bovine TB, the premiums are just deemed to be too high for a lot of farmers? Who are these? Presumably there is the NFU Mutual. I should be interested to know other names of organisations. Just give me a feel for the market structure of how this operates today and how, if it becomes much more big business, it is likely to operate tomorrow.
(Mr Drakeford) You are right, the NFU Mutual would certainly be a carrier for this type of product in the UK, indeed I believe they do already have livestock coverages and a limited number of crop insurance coverages which are available to UK farmers. Looking further afield into Europe, there is a number of specialist insurance companies: in France SCORE is a well-known provider of farmer-based risk management tools; in Spain they have AgriSeguros which is the Spanish consortium. Each country has one or more specialist agricultural insurance carrier. To a large extent the amount of capacity and their ability to underwrite risk is driven by the availability of re-insurance. This is quite true with the development of new agricultural insurance products, where the development of products is to some extent largely driven by re-insurance capacity. That would be very true from the point of view of livestock disease risk product development. One of the problematical areas as perceived by insurers, the disease risk, foot and mouth for example, albeit a very low frequency has a potentially very high volatility level and is regarded as a major catastrophe. If you have a major outbreak it is going to blow however many years premiums you have had going back for a long, long way. They do have to lay off their catastrophe exposure into the re-insurance market.
908. You put your finger on it when you could only think of NFU Mutual. If, for example, you have fallen foul of them because they see you as a bad risk, that does not give you much hope of being someone who could pursue insurance cover. There is surely a problem in the lack of a real marketplace here.
(Mr Drakeford) In that regard, if there were the seed market for us to grow our business in in the UK, if the right products were developed, the appropriate support. . . One of the big issues here which I have not touched on is availability of data. You do need good quality credible data to be able to develop an insurance product and to rate an insurance product.
(Mr Hutchings) You asked about the consultations we have had. We have spoken to quite a few organisations throughout Europe. We spoke to Directorate-General Agriculture and it is a contentious issue. One of the things is that unless we can develop a product which is bespoke and manages that individual farmer's risk, whether he be a livestock farmer or an arable farmer, then he is not going to buy the cover because it does not do the job he is trying to do. It is chicken and egg. Whilst you are saying the NFU Mutual is the only one involved, it is a commercial market and being a commercial market there are many commercial insurers out there who will very readily build products if there were appropriate structures in place and appropriate data available to allow those products to be managed properly from a risk management point of view for their own risk. Of course re-insurance capacity is another big issue. We have to get these things in place before we can come in with a structure which then does the job we think the industry are looking for us to do. Certainly the will is there, but we are now looking for some of the tools.
(Mr Drakeford) We would say that we are well positioned, or ideally positioned to be able to assist an insurance company to develop the infrastructure it would require and the knowledge base it would require to develop both the insurance products, the delivery system and the risk management capability, to be able to provide insurance-based risk management products to farmers in the UK.
909. I just find it incredible in the 21st century that an industry which in essence is so dependent on data collection is so backward in this area. I am sure that your report will take this forward. You may want to bring that into other questions you get but actuarial knowledge of what is going on is at the root of insurance, yet here you are saying you do not have the information.
(Mr Drakeford) Absolutely agreed.
(Mr Hutchings) May I defend the insurance industry from an agricultural perspective? Unfortunately that data until relatively recentlyand we are talking about the last few decadeshas not been readily available, whereas in the US data has been available for nearly 100 years. The insurance sector there has been able to get hold of that and manage the process. That is the problem. Yes, individual farms have data, but it is the credibility of that data. You are insuring against a risk and if a farmer says he normally yields eight tonnes per hectare and that is what he wants us to insure against, he has to provide the evidence for that normal historical yield. That is the issue with agriculture.
(Mr Drakeford) Absolutely. May I just expand slightly? Yes, there is area yield data available to us to be able to look at and analyse, but if you based an insurance risk or an insurance model on area yield data which responded to individual farmer's risk, there would be virtually zero correlation between coefficient of variation on area yield data and the individual farmer's own risk. An individual farmer's risk is far more volatile. It is getting down to that depth of data that we really do somehow have to access.
910. I am fairly clear how you could insure against livestock or crop damage but in the very helpful material you have provided you talk a lot about policy changes and that the agricultural sector is undergoing major change. Is it possible to insure against that? One would have to benchmark it in some way. For example, if your crop reduced in price, there may be something you could insure against there, but what is the insurance perspective on the generality of policy change?
(Mr Hutchings) One of the problems with legislative risk is that it is by its very nature unpredictable. The consequences of it are unknown until it occurs. Let us take pesticides tax or something like that. If something of that nature occurs and imposes upon the farmer certain regimes that he had not hitherto been using, then clearly if he was told today he could not use fertilisers, for example, then his yield would drop, then the insurer has a problem. He is insured at eight tonnes but actually it is only producing five tonnes because he is not using fertiliser. A series of benchmarks has to be put in place and those are really around good farming practices. This again comes back to the data. What do we define as good farming practice? It is different from different farms, you have different demands. You have a commodity farmer who is belting it out as quickly as he can and you have an organic farmer who is trying the best he can without any chemical inputs. These things have to be defined very clearly before the risk can be evaluated and the product can be made for it. That in a sense is the nub of the problem, which is why it is going to take a bit of lead time to try to get to the point. We have to have an understanding that is the way we want to go and the right way to go before we go to that time and effort and, let us not be coy, the expense for the industry to try to put that sort of thing together can be significant. That is why we have to make sure it is appropriate.
911. Conceptually it would be possible to do.
(Mr Drakeford) Yes.
912. But until data emerges and because of the unpredictable behaviour of politicians this is a high risk factor.
(Mr Drakeford) Benchmarks are built into the insurance policy which would ensure that the farmer carried out certain farming practices. If you were using his historical yield data, the subjectivity of the policy is that he would be carrying out the same growing regimes that he has done for X number of years prior to that to develop that yield experience that he has had.
913. One of the things which I took away from the report was the notion of people leaving the industry. You describe farmers as being risk averse and those who cannot take the risk are getting out. Is there any evidence that farmers are becoming more business oriented, more professional and therefore more interested in minimising the risk and being backed by insurance?
(Mr Hutchings) The answer to that is emphatically yes. It is a bit unkind to say that farmers have not actually been business-minded until just now, because they have been for many, many decades. They have always managed their risk in different ways, through portfolio management, by growing different crops, through growing for different markets. We see a lot of that activity going on. These are things which are within their control and things without it are more an issue for them. They will continue to do this risk management strategy at home. It is not fair to say that they have not been doing it up to now. The problem is they really do not have enough tools to do it in the future. You are right. What you will see is that the farming industry will to an extent diversify into different areas. You will get the farmers who will generally be supported heavily perhaps and look after the land and the land manager type of farmer who is really looking after the environment directly and perhaps is being funded to do that. You will have the major sector which will be the commodity producers. The New Zealand farmer is a good example of that. Most farmers would rather produce as much as they can with all the tools available rather than be restricted. They do not want their hands tied behind their back and those guys are very, very efficient and very capable. Then you are going to have the niche farmer who will continue, there will be more of it, he will start growing more organics, maybe even non-GM products if that is an issue for the market and even special flavoured products. That is a market and these guys are very, very conscious that they are in a market. If we can then look forward and look at their risk requirements and produce something which managed that risk in an effective manner, then yes, they will adopt it.
914. When will these products be available? What timescales are we talking about?
(Mr Hutchings) Realistically we are probably looking at harvest 2004. This has quite a long lead time because of the data issue, because of product development, because indeed a lot of the industry insurers have to recognise that this is something for them to invest in and we do need to invest. That is maybe where we can look at it from a government intervention point of view. The Government have a role to play in making it known that this is a way that risk should be managed and perhaps facilitate the process of the development, the front-end loading. Before we even talk about subsidies of the actual products themselves there is a bit up at the front which we need to look at. The UK is well placed for that.
915. If government were to come forward with support for insurance products for the sector, and we have already discussed the fact that you need rather more data to work out what the risks really are, one would probably expect that the insurance sector would want some input into the policy which would contain those risks as well. Have you given some thought to that?
(Mr Drakeford) I am sorry. When you say they would want to contain the risk . . .?
916. To give a very concrete and simple example, there has been quite a lot of discussion about the risks of imported meat bringing foot and mouth into this country and other foreign disease of plants or animals. One would expect a sector like yours to say "If we are going to develop some products, then we want to control the risks as far as possible through policy instruments of some kind". Am I assuming right?
(Mr Drakeford) Yes, you will be.
917. Have you given some thought to the kind of inputs you would make to that process?
(Mr Drakeford) Traditionally the way that has been handled with crop insurance is that the farmer has always been expected to carry part of the risk. From the point of view of an insurer, he is not going to give the farmer cover for his entire production. He is going to want to ensure it is in the interests of the farmer to carry out good farming practices and in his interests to produce a crop rather than have the crop dwindle in the field and the insurer pay for it. There has to be an element of risk carrying for both sides.
918. Exactly the same as in household insurance where you expect certain standards of locks, things of that kind, otherwise you are not covered.
(Mr Drakeford) Absolutely.
919. I am assuming that if we were developing products in this area obligations would be placed both on farmers but also on the control systems which are governed by the Government if these insurance products are to operate.
(Mr Hutchings) What you are talking about is risk mitigation. The individual must take appropriate measures for risk mitigation, be they farmers or governments. If you are talking about controls on certain products which might increase the riskI do not know what they might bethey would be defined and hence the reason for the government/private sector partnership and discussions would be required to flag these things up.