An Analysis of the Catastrophic Risk Diversification Mechanism for Agricultural Insurance

The "Decision" of the Third Plenary Session of the 18th CPC Central Committee proposed to “improve the insurance economic compensation mechanism and establish a catastrophe insurance system” and to “improve the agricultural insurance system”. The catastrophic risk diversification mechanism in agricultural insurance operations is an indispensable institutional element and important component of the agricultural insurance system. Combining study and implementation of the spirit of the "Decision", this article analyzes the current situation, problems and necessity of China's catastrophic risk diversification mechanism for agricultural insurance, and, on the basis of drawing on advanced foreign practices and domestic practical experience, puts forward countermeasures and suggestions for accelerating the establishment of a catastrophic risk diversification mechanism for agricultural insurance.

Current situation and problems

Overall current situation. At present, a nationwide catastrophic risk diversification mechanism for agricultural insurance has not yet been fully established. The "Agricultural Insurance Regulations", implemented from March 1, 2013, made provisions for the first time from a regulatory perspective for China to establish an agricultural insurance catastrophic risk management system. Subsequently, on July 1, 2013, the "Guiding Opinions on Financial Support for Economic Structural Adjustment and Transformation and Upgrading" issued by the General Office of the State Council put forward the requirement to “establish and improve a fiscally supported catastrophic risk diversification mechanism for agricultural insurance”. At the end of 2013, the Ministry of Finance issued the "Measures for the Administration of Catastrophic Risk Reserves for Agricultural Insurance", which began to be implemented in 2014, marking a key step forward in the establishment of China's catastrophic risk diversification mechanism for agricultural insurance. On August 10, 2014, the "Several Opinions on Accelerating the Development of the Modern Insurance Service Industry" issued by the State Council, namely the “Ten National Insurance Guidelines”, once again put forward the explicit requirement to “improve the fiscal subsidy policy for agricultural insurance and establish a fiscally supported catastrophic risk diversification mechanism for agricultural insurance”.

Existing problems. First, the mechanism has not yet been fully established. China's provinces, municipalities and regions differ considerably in their practices for agricultural insurance risk diversification management, policy volatility is strong, and the insurance industry's ability to withstand major agricultural catastrophic risks is very limited. The fragility of the catastrophic risk diversification mechanism for agricultural insurance has become an important issue restricting the sustainable development of China's agriculture. With the rapid development of the scale of China's agricultural insurance, the problem of the absence of a catastrophic risk diversification mechanism for agricultural insurance has become increasingly prominent.

Second, supporting laws and regulations are incomplete. At present, the laws and regulations applicable to catastrophic risks in agricultural insurance are still imperfect and unsound, and there is a relative lack of institutional provisions and policy basis for the establishing entities, operating models, modes of operation and reserve accumulation of the catastrophic risk diversification mechanism for agricultural insurance. Although the "Measures for the Administration of Catastrophic Risk Reserves for Agricultural Insurance" issued by the Ministry of Finance in 2013 stipulated that agricultural insurance operating enterprises should set aside agricultural insurance catastrophic risk reserves according to a certain proportion of agricultural insurance premium income and excess profits from agricultural insurance business, these reserves are only accrued at the level of insurance enterprises and are limited to internal use within the enterprises, and their ability to withstand catastrophic risks is clearly insufficient.

Finally, the accumulation of catastrophic risk reserves is insufficient. In a broad sense, the accumulation channels and scope of application of catastrophic risk reserves should be more diversified and extensive, but at present only some regions in China have arranged regional agricultural catastrophic risk funds, and both the scale and operating model of the funds have major shortcomings. In addition, the agricultural insurance catastrophic risk reserves of various agricultural insurance operating enterprises have also accumulated insufficiently. Before the "Measures for the Administration of Catastrophic Risk Reserves for Agricultural Insurance" began to be implemented in 2014, the insurance enterprises undertaking agricultural insurance had not set aside catastrophic risk reserves in full according to the old measures, resulting in a relatively large reserve gap; once a catastrophe occurs, insurance companies will be unable to pay compensation.

Analysis of necessity

An inevitable requirement for implementing the spirit of the Third Plenary Session of the 18th CPC Central Committee and the No. 1 Central Document. The "Decision" of the Third Plenary Session of the 18th CPC Central Committee proposed to “improve the insurance economic compensation mechanism and establish a catastrophe insurance system” and to “improve the agricultural insurance system”. Among the 7 No. 1 Central Documents issued by the central government from 2007 to 2014, 6 mentioned the issue of establishing a catastrophic risk diversification mechanism for agricultural insurance. A series of document spirits show that establishing a catastrophic risk diversification mechanism for agricultural insurance is an indispensable and important component of agricultural insurance system construction, and is of great significance for improving agricultural insurance policy, preventing major catastrophic risks in agricultural production, ensuring national food security, safeguarding farmers' interests, and maintaining the sustainable development of agriculture.

Farmers, as a disadvantaged group, are unable to bear major agricultural catastrophic risks. In China, due to historical reasons, economic structure and the distribution of social resources and other factors, farmers have historically belonged to a disadvantaged group. Farmers' ability to obtain market information, participate in social competition, create and accumulate wealth, protect their rights and interests, and achieve self-realization is relatively weak. China is also a major agricultural country, with a huge rural population, a weak foundation for agricultural modernization, and a relatively low level of insurance protection for agriculture and farmers. Affected by factors such as complex natural conditions for agriculture, a weak agricultural disaster prevention system, and low ability of agriculture to withstand risks, the frequency of agricultural natural disasters is relatively high and the degree of damage is relatively severe. Taking Henan Province as an example, in 2013 alone the autumn crop affected area in the province reached more than 58 million mu, the total crop failure area exceeded 20 million mu, the affected agricultural population was nearly 45 million, and direct agricultural economic losses reached 18 billion yuan. At present, when agricultural insurance can only provide the most basic protection for materialized costs, and the growth rate of insurance coverage is clearly lagging behind the rate of increase in agricultural production material prices, once a major natural disaster occurs, the current agricultural insurance policy simply cannot provide adequate protection for affected farmers.

The risk characteristics of agricultural production determine that catastrophic risk protection must be established. Agriculture is a disadvantaged industry with high risk and low returns. Agricultural catastrophe risk management is an important prerequisite and necessary guarantee for the healthy development of the agricultural insurance system. From the perspective of risk management, agricultural risks have characteristics such as high frequency of occurrence, large risk units, strong systemic nature and strong correlation. The author believes that the development of China's agricultural insurance should take the province as the unit, and that provincial-level governments are the main body of the catastrophic risk diversification mechanism. When formulating catastrophic risk diversification policy, it is necessary to consider the question of what proportion of risk to bear. If the government shares too much risk, it will bring a heavy burden to public finances and at the same time “crowd out” insurance companies' risk transfer function; if the government shares too little risk, it cannot achieve the purpose of transferring and diversifying catastrophic risk. Taking wheat insurance in Henan Province as an example, from the government's perspective, using historical data on county-level wheat production, it quantifies and analyzes wheat production risk within the province, designs an optimal sharing measurement model for agricultural catastrophe risk, and calculates the optimal catastrophe risk sharing ratio between the provincial government and insurance companies.

The systemic characteristics of agricultural risk weaken insurance enterprises' ability to diversify risk among farmers, among crops and among regions. If a drought disaster in the planting industry or an epidemic in the livestock industry occurs, it often affects multiple counties, cities or even multiple provinces, that is, the individual risk unit of agricultural risk is relatively large. For example, the floods that occurred in several river basins in China in 1998 caused more than 500 billion yuan in direct agricultural economic losses; the continuous drought in several central and western provinces of China in the spring of 2009 caused hundreds of billions of yuan in economic losses to crops such as winter wheat; the severe drought in southwestern provinces such as Yunnan and Guizhou in the spring of 2010 and the floods in many southern provinces and regions since May of the same year also caused more than 100 billion yuan in economic losses to agricultural production.

Single entities such as local governments or insurance companies are unable to bear major agricultural catastrophic risks alone. Since the central government launched the agricultural insurance premium subsidy policy in 2007, China's agricultural insurance has achieved rapid development and is currently second only to the United States, ranking second in the world and first in Asia, becoming one of the most important and active agricultural insurance markets in the world. However, as the insured area of agricultural insurance continues to expand, the number of insurance types continues to increase, and underwriting liabilities continue to grow, the risks accumulated by agricultural insurance, especially major agricultural catastrophic risks, are also constantly increasing. Once a large-scale agricultural disaster occurs, entities such as local governments or insurance companies are unable to bear major agricultural catastrophic risks alone. Local governments whose main industry is agriculture are mostly economically backward with limited financial resources and no sufficient budgetary funds to arrange for bearing agricultural risks; insurance enterprises may also incur huge losses beyond solvency or even go bankrupt. Once local governments and agricultural insurance operating enterprises find it difficult to honor their compensation commitments to insured farmers, it will lead to social disharmony and instability.