How to Break the Pig Cycle Dilemma? Price Index Insurance Offers New Ideas
Since the beginning of this year, pork prices have risen rapidly, drawing attention from all sides, and the "pig cycle" has reappeared. How to establish a long-term mechanism to reduce the magnitude of pork market price fluctuations and protect the interests of hog farmers and consumers urgently requires in-depth research to formulate practical and feasible regulatory measures. Hog price index insurance is an important innovation in China's agricultural insurance field in recent years, and is a beneficial exploration of using insurance tools to disperse and transfer market price fluctuation risks and smooth out the "pig cycle." Making good use of price index insurance as a tool is of positive significance for breaking the "pig cycle" dilemma.
Main Practices of Hog Price Index Insurance in China
Hog price index insurance is essentially a type of "put option," meaning that when the actual hog price index during the insurance period falls below the agreed price index, it is deemed an insured event has occurred, and the insurance company compensates for the difference. At present, 16 provinces (autonomous regions and municipalities directly under the central government) across the country have carried out pilot programs for hog price index insurance. From the perspective of operational models, the key elements mainly include the following.
Regarding the basis for claims, localities have basically chosen the hog-to-corn price ratio as the trigger condition for claims, mainly considering that corn accounts for about 70% of hog feed, and corn prices are the main factor affecting hog feeding costs. Using the ratio of hog prices to corn prices (abbreviated as the hog-to-corn ratio) can simultaneously cover changes in both hog prices and feed prices, and can better reflect the actual income situation of hog farmers. At the same time, a hog-to-corn ratio of 6:1 is generally used as the break-even point for hog farming. When the hog-to-corn ratio data published weekly by the National Development and Reform Commission falls below this value, claims are initiated, which is relatively objective and fair, and also easy for farmers to accept. Some insurance companies believe that production levels differ across regions and have not uniformly adopted the 6:1 standard, and some insurance companies have attempted to use absolute prices as the trigger condition for claims.
Regarding the insurance period, during the initial pilot phase, insurance companies basically adopted the method of "one-year insurance, one-year claims." However, because this did not conform to the 4-month slaughter cycle of hog farming, with no compensation during the period, it could not timely compensate farmers for losses in a certain batch of hog farming. Most insurance companies have adjusted the compensation cycle to 6 months, 4 months, or 3 months.
Regarding the compensation procedure, when the average actual hog-to-corn ratio within the compensation period is lower than the agreed hog-to-corn ratio, the insurance company provides compensation. The compensation amount = (agreed hog-to-corn ratio - average actual hog-to-corn ratio within the compensation period) × agreed corn wholesale price × agreed average weight per hog × number of hogs slaughtered. In actual operation, for simplicity and clarity, insurance companies often directly tell farmers that for every 0.01 point drop in the hog-to-corn ratio, 2 yuan is paid. Some insurance companies, in order to lock in risk, have also set absolute deductibles or capped compensation.
Effects Achieved and Problems Existing in China's Hog Price Index Insurance
Strictly speaking, market risk is not insurable, and the best approach is to use the futures market for risk hedging. In the absence of a hog futures market in China, exploring the hog price index insurance approach is of positive significance. For individual hog farmers, when the bulk of premiums is borne by fiscal authorities, purchasing hog price index insurance does play a role in stabilizing expectations and compensating for market risk losses. However, in 2015, China's hog price index insurance underwriting scale was only more than 4 million head, which is almost negligible compared with the national hog market with an annual slaughter volume of more than 700 million head, so its impact on the supply and prices of the entire hog market is also minimal. From the practice in various localities, the operation of hog price index insurance mainly has the following four problems.
First, insurance companies lack channels for dispersing and transferring price risk. Hog price index insurance underwrites the risk of market price declines, and China has already formed a nationwide hog market. Hog price trends in different regions and markets tend to converge, making it difficult to disperse risk spatially. In addition, the international reinsurance market is mostly cautious about high-risk price insurance, making it difficult to find suitable reinsurance arrangements, and the problem of insurance companies facing excess compensation risk is very prominent. From May 2014 to April 2015, the hog-to-corn ratio operated at a low level continuously. Anhua Agricultural Insurance underwrote hog price index insurance in Beijing, collecting premiums of more than 21 million yuan and paying claims of 56 million yuan, with a loss ratio as high as 260%. Therefore, insurance companies often limit pilot programs to a certain scope where risk is predictable and losses are controllable, and do not dare to blindly expand scale.
Second, farmers generally have the problem of selective insurance purchasing. China's hog farming clearly follows the pattern of "one year of profit, one year of breaking even, one year of loss." Experienced farmers can often roughly predict future price trends for a period of time, so adverse selection is very likely to occur, that is, when farmers expect hog prices to fall they actively purchase insurance, and when they expect market prices to rise they choose not to renew. Since the beginning of this year, hog market prices have risen all the way. Many farmers in Beijing had not renewed their insurance after their insurance contracts expired in April 2015. Insured farmers dropped from 606 in the 2014/2015 year to 73 in the 2015/2016 year.
Third, the scientific nature of the basis for insurance claims needs to be improved. Calculating the hog-to-corn ratio based on corn prices ignores the impact of price fluctuations in protein raw materials such as soybean meal and wheat bran (about 30%) in hog feed. Moreover, for hog farmers, especially large-scale farms, land rent costs, labor costs, and disease prevention and control all affect hog feeding. In addition, the break-even point of a hog-to-corn ratio of 6:1 is calculated based on historical data on the composition of hog production costs, and fixing this value as a reference cannot truly reflect expected costs. From January 2016 to the present, the hog-to-corn ratio has operated above 9:1, breaking through 11:1 at the end of April, a serious deviation.
Fourth, relying solely on local fiscal subsidies creates relatively heavy pressure. Hog price index insurance has not yet been included in the scope of central fiscal subsidies. Pilot areas all rely on local fiscal authorities to provide a certain proportion of premium subsidies, with differing sources of funds and differing levels of support. At present, the underwriting scale of hog price index insurance pilots is limited, and the pressure on local fiscal authorities is not yet very prominent. If promoted over a larger scope, the source of huge subsidy funds is an important issue that needs to be resolved.
Focus on Giving Play to the Positive Role of Hog Price Index Insurance
Hog prices are mainly determined by market supply and demand. Price changes in response to changes in supply and demand will in turn guide the reallocation of market resources. Hog price changes and the market risks derived from them are the inevitable result of the operation of market economy laws and cannot be completely eliminated. In the context of comprehensively deepening reform and advancing the reform of the price formation mechanism for agricultural products, stabilizing hog market prices should adhere to market regulation as the main approach. As a risk management tool, hog price index insurance cannot completely smooth price fluctuations, but as the underwriting scale continues to expand, its impact on hog market price fluctuations will gradually emerge. It is expected that after reaching a certain scale, it can reduce the magnitude of price fluctuations to a level acceptable to the government and society. Next, the following tasks should be focused on.
(1) Improve hog price index insurance products and operational models. The selection of insured entities should differ from the traditional practice of "insure all who are willing" for breeding sow and fattening hog insurance, and should be limited to relatively large-scale farmers, cooperatives, or enterprises. This can not only effectively reduce insurance company expense costs, but also achieve the policy effect of guiding and promoting large-scale farming. A multi-year continuous insurance mechanism should be established, for example, implementing "one insurance policy for three years" with reference to the pig cycle, dispersing operational risk over time and avoiding speculative behavior by farming entities. Full consideration should be given to regional differences among hog farmers and differences in their willingness regarding the level of protection. Insurance companies should be encouraged to develop hog price index insurance products with different levels of protection. Through the accumulation and analysis of pilot data, insurance products and operational models should be further improved, laying the foundation for large-scale promotion.
(2) Promote the introduction of policies and measures for developing hog price insurance. First, as a supplement to traditional fattening hog insurance, hog price index insurance should be included in the scope of central fiscal premium subsidies, achieving a policy breakthrough in central fiscal premium-subsidized insurance types from natural risk to market risk protection, or in agricultural subsidies such as rewards for major hog-producing counties, it should be clearly stipulated that they can be used for hog price index insurance subsidy expenditures. Second, accelerate the promotion of hog futures listing and trading, determine the protection price of hog price index insurance based on futures market prices, and at the same time adopt an "insurance + futures" approach to disperse the risk of huge compensation. Third, explore the establishment of a policy linkage mechanism, coordinating hog price index insurance with other agricultural benefit policies such as subsidies for large-scale farms, subsidies for improved livestock and poultry breeds, hog slaughtering, and preferential loans, and achieve the policy goal of stable and healthy development of the hog industry through a "combined punch."
(3) Improve the hog market price monitoring system. Accelerate the establishment and improvement of a monitoring system and information release system for the hog farming industry, strengthen data monitoring of indicators such as prices at the hog purchase, wholesale, and retail stages, hog farming scale, and prices of various types of feed, improve comprehensive information collection platforms, and strengthen comprehensive and dynamic analysis of indicators such as the hog-to-corn price ratio and break-even point, providing a reliable basis for product innovation and business development of hog price index insurance.
(4) Study and promote the innovation and upgrading of price index insurance products. The focus should be on conducting in-depth research on issues such as the functional positioning, development strategy, underwriting scale, support policies, and product model innovation of hog price index insurance, and promoting the gradual expansion of hog price index insurance toward revenue insurance and income insurance. This will not only help popularize and promote hog price insurance over a larger scope, but also play a positive role in deepening the reform of the price formation mechanism for other important agricultural products and promoting the healthy and sustainable development of the agricultural industry.