Agriculture–industry sector

Feeding the world When it comes to food security, Africa has the potential to feed the world. Africa will attract a significant portion of global agricultural investment during the next decade as food producers open ‘new soils’ across the continent. The ABSA Agriculture Outlook 2015 reveals that the agricultural production potential in Sub Saharan Africa far outstrips that of developed economies. The report references research by the International Monetary Fund, World Bank and United Nation’s Food and Agriculture Organisation, which suggests the amount of dry land available for crop production in Africa will increase exponentially from just 279 million hectares in 2010 to 1,357 million hectares in 2050. Estimates are that the continent will boast more crop land than Asia and South America combined by that time.hideIf this estimate is combined with the higher yields that accompany improved farming techniques, Africa could well emerge as the ‘bread basket’ of the world three decades hence. Maize production in South Africa, for example, increased from around one ton per hectare (t/ha) in the 1960s to five t/ha in 2014. Gerhard Diedericks, Head of Santam Agri, says that Africa has huge untapped potential: “Zambia has more than three million hectares of land with high potential for crop production that receive in excess of 1,000 mm of rain annually while some maize farmers in South Africa are growing the crop with less than 600mm of rain a year.” Risk assessment Although attractive, investors are warned not to rush into Africa before considering the risks. Barclays Africa ranks the potential attractiveness of African agricultural opportunities using a matrix that includes economic, political, social and technological risks. The group rates South Africa as the most attractive destination for agricultural investors on the continent, followed by countries such as Morocco, Ethiopia and Tunisia. The investment risks inherent in African agriculture opportunities are similar to the operational risks faced by food producers. Sugar producer Illovo Sugar singles out market risk, policy risk, social risk and macroeconomic environment risks in its 2014 integrated report. But risk managers at Africa-based food producers spend most of their time assessing and negotiating covers for risks that are climatic or natural—most notably drought, floods, hail, fire and frost. “The key risks that we face remain weather and water-related risks, in particular the impact of climate change,” says Chris Fitzgerald, a spokesman for Illovo. “While we also focus on price and volatility risks, it can be difficult to mitigate them due to their interdependency on weather risk.” South Africa has an advanced agriculture insurance industry with insurers, reinsurers, insurance brokers and risk managers all playing a vital role in assisting commercial farmers with risk mitigation. “Weather-related uncertainties and the ongoing pressures on primary producers combine to make the agriculture insurance sector an exciting place to conduct business,” says Andries Wiese, Manager, market intelligence at Mutual & Federal Agri. Mutual & Federal, Santam and Absa handle upwards of 80% of domestic crop insurance business while a number of insurers compete for a share of agriculture asset insurance, such as cover for farm buildings, machinery and other implements. The most commonly sold agriculture insurance products are standalone hail policies taken out as cover against crop damage due to hail and multi-peril policies, which cover losses due to fire, frost, excessive rain and drought. “Multi-peril insurance tends to be more difficult to underwrite because of severity of claims in this space—although infrequent it can be extremely high in value,” says Mr Diedericks. “An insurer can enjoy many profitable years before a single drought event decimates all the premiums collected in the preceding years.” Investors and insurers in the agriculture industry cannot afford to ignore the rest of Africa for long, because its agriculture-insurance market is estimated at 20 times that of South Africa’s market. Santam says the total market size is about R3.6bn and that the insurance take-up so far is between R1.6 and R1.8bn. Aside from the risks already mentioned, the biggest drawbacks to investment into the continent are the poor management of resources and limited availability of agriculture infrastructure, including finance houses and suppliers of fertilisers, implements and seeds. “The management of resources remains a challenge across other African countries specifically in relation to bulk water supply,” says Mr Fitzgerald. “Before entering a new venture investors must ensure that legal requirements with regards to the allocation of water resources and maintenance of infrastructure are met and that sound farming practices are adhered to.” Local challenges Insurers that are keen to utulise the opportunity to underwrite farmers in Africa face many challenges. Mr Diedericks explains that domestic farming activities are substantively different to those observed in sub Saharan Africa. “In South Africa the average maize farmer farms on 400-500 hectares with some planting as much as 10,000 hectares whereas the typical farm in the rest of Africa is between two and four hectares.” “Although the traditional covers could be appropriate for smaller farmers there will be a demand to provide niche covers to emerging farming communities,” says Ross Simmonds, Financial Director at Unigro Financial Services. “Insurers that enter the market with the right distribution and claims administration models will benefit from this potentially lucrative market going forward.” Mr Wiese observes that it remains difficult to market foreign concepts such as insurance to the largely untapped rural communities throughout Africa. “Insurers that offer an agricultural product in these markets focus on basic ‘single peril’ covers for fire and hail,” he says. International reinsurers that participate in the African market often subsidise their agricultural business through their more lucrative offerings in the construction and engineering fields. To get around this issue, many insurers are experimenting with weather-based index products whereby all farmers on cover are protected from extreme weather events based on average production for a given crop and region. One of the challenges with index product is that good farmers—those that produce above average yields—are penalised in favour of poor farmers; but insurers are working on improving outcomes. Another stumbling block to underwriting crops in Africa is the lack of suitable information to make informed underwriting decisions. In South Africa, insurers can rely on farm-specific historic information on crop production and weather events spanning multiple decades and therefore easily calculate client-centric premiums. It is almost impossible to do the same in the rest of Africa, where subsistence farming dominates. Even so, insurers are looking at expanding their activities into Africa. Mr Wiese says that insurers are serious about expansion opportunities on the continent. “We expect momentum to pick up towards the latter half of 2015 as insurers consider specific territories and specific product offerings with the aim to grow market share while limiting their overall exposure,” he says. Santam is among those insurers that already has an increasing footprint on the continent. Sanlam Emerging Markets—a vehicle for investing in diversified financial services firms in developing economies—has shareholdings in insurance companies in more than 10 countries throughout Africa. “The preference is to invest in known brands in these countries and then to work closely with their broker networks to supply products, advice, underwriting and information,” says Mr Diedericks. Agriculture insurance is a complex discipline where distribution is best accomplished by insurance brokers, who often work closely with corporate risk managers. “Various options with regards to insurance cover for crops are considered on a bi-annual basis but the perils covered by insurers are often charged at a high premium which, relative to the cover limits offered, can become unaffordable,” says Mr Fitzgerald. He adds that, in some instances, weather risk can be transferred but only to the extent that the insurers are prepared to cover certain perils. As a result some companies insure their own crops in a tailored cell captive structure while their agriculture infrastructure is typically insured under the firms’ main assets policy. “The decision by a commercial farmer to ring-fence his premium in a cell captive or investment vehicle can be risky,” says Mr Diedericks. “But in the event of a major weather catastrophe, as we had with severe hail in the Ceres district in 2012/13 losses quickly mount up.” The same is true where drought is concerned, with a single claim event capable of undoing many years of premium savings. One of the ways that insurers address this issue is to propose higher excesses, thus enabling farmers to insure against catastrophic events with a more affordable premium. Specialist agriculture insurance brokers are vital in communicating with farmers regarding premium and the provision of sustainable insurance solutions. Whether insuring or self-insuring, firms must take steps to mitigate their exposure due to weather and other agriculture risks. “Mitigating controls include drainage systems, dykes and canals to protect crops, as well as early warning systems and weather forecasting,” says Mr Fitzgerald. Larger commercial farmers have additional weapons at their disposal in that they can diversify geographically and by crop type to reduce overall risks. “Commercial farmers often have a wider geographic spread, which favours self-insurance,” says Uingro’s Mr Simmonds. “Their crops and assets are not concentrated in one area and generally they are not affected by a localised weather event—which means they can insure for catastrophic losses only.” Looking ahead What does the future hold for agriculture and agri-culture insurance through 2015? “Agriculture has its challenges but the outlook for South Africa is reasonably bullish, with growth in the sector ex-ceeding that of most other industries in 2014,” says Mr Wiese. “It follows that the insurance sector has a positive outlook for the immediate future too.” Will insurers be able to write more business in South Africa and the rest of Africa this year? “The demand to write business is there, but reduced underwriting capacity at reasonable rates—in part due to historical loss ratios—has made it more difficult to place business in certain geographical areas,” says Mr Simmonds. From an insurance perspective, the outlook for South African agriculture insurance premiums growth is anything but straightforward because premium values in the agriculture sector are not only driven by the number of hectares planted, but by the commodities farmed. “We can reflect on the impact of commodities on crop and multi-peril insurance premiums by considering the cost of cover per hectare of various commodities that can vary from R250 to R1,000 per hectare, says Mr Diedericks. “A decision by the farming community to switch from one commodity to another can have a major impact on the total written premium in a specific season.” More maize and less soya beans would result in a drop in premium, albeit for the same amount of insured hectares and vice versa. Local agriculture insurers had a bumper 2014 thanks to larger soya crops and the fact the total hectares planted grew above inflation too. The outlook for insurers in Africa is less certain. “One has to distinguish between the size of African agriculture insurance business and its potential,” says Mr Wiese. “A large part of African agriculture consists of subsistence farming on small plots of land, with the result that the insurance sector faces some real challenges if it wishes to penetrate this market—the biggest being distribution and the collection of premiums.” Commercial farmers and other primary food producers will also have to up their game to survive the real dangers that climate change poses to their businesses. Individual farmers can mitigate weather risks by partnering with a responsible and successful insurer, using insurance as a tool in their overall financial and operational plan. Having the correct insurance policy in place can be the difference between surviving a loss event and losing everything. “Taking everything into consideration—including that agriculture faces challenges in South Africa and elsewhere on the continent—we believe the outlook for the sector is positive and that insurers who act prudently and with the necessary commitment will have a very successful period ahead,” concludes Mr Wiese. Mr Diedericks agrees that the environment is challenging, but reminds all stakeholders that the agriculture economy follows longer-term cycles. “Firms in this sector cannot focus narrowly on the next 12 months because the real challenge is how to deliver a sustained return on capital to our shareholders over a a longer period,” he says. “Santam advocates long- term stability through sensibly underwritten premiums that allow insurer to perform when the client really needs them.” Technology paving the way for greater commercialisation of agriculture across Africa Millions of Africans depend on agriculture for their livelihood, with many working on a subsistence level. However, new initiatives are bringing more of them into the mainstream and giving larger concerns access to their surplus yields. Commercial Risk Africa talks to Lovemore Forichi, Vice President at Swiss Re, about how the agricultural picture across Africa is changing and how that is affecting the insurance markets. Q: How is the agricultural insurance market across Sub Saharan Africa developing? A: The African agricultural insurance market is picking up pace. In the past two years we have seen demand for agricultural insurance picking up in some markets that never offered the product before, like Uganda and Tanzania. At a micro level, the adaptation to innovative ways of offering the agricultural insurance product, such as ground-based weather index insurance as well as satellite-based solutions, has stimulated demand. At meso level, we have seen a lot of interest from banks offering loans to commercial farmers and needing insurance as collateral. Input providers, such as seed and fertilizer companies, have bundled insurance with their loans in some loyalty programmes of one form or the other. At macro level, we have seen the formation of the Africa Risk Capacity (ARC) body, which brought together several African countries as they try to share the risk pool. The first payout under the ARC programme has seen the disbursement of $25m to three affected countries early in 2015. The challenges that remain are the suitability of the product, the affordability of the product and the distribution mechanisms and infrastructure. Given the importance of agriculture in Africa (contributing on average 20% of GDP), an insurance penetration of roughly 1% is a far cry from the potential that agricultural insurance can provide in these markets. Q: Are there any particular hotspots? A: In Kenya, the government is in the process of developing crop and livestock insurance solutions in the form of a public-private partnership (PPP), which will see previously marginalised pastoralists accessing agricultural insurance and the private sector responding with risk-taking and using insurance policies as collateral for input loan disbursement. We hear that countries like Ethiopia and Tanzania are also mulling the idea of a PPP in their own territories. Q: Are there any markets that are underserved at present, which you are looking at? A: At Swiss Re we have developed a Sub Saharan Africa strategy, which aims to develop markets in the target region. We are working with our local partners in countries such as Uganda, Tanzania, Kenya, Ethiopia, Nigeria, Zambia, Zimbabwe, Cote d’Ìvoire, Cameroon and Ghana, just to name a few. Together with our local partners we are working at solutions that are demand-driven and that can sustain themselves in the long term and make business sense. Q: Can you describe some of the recent innovations and the use of technology? A: We have seen an increasing demand for use of innovative products such as weather index insurance and satellite-based solutions, especially at micro level where the traditional multi-peril crop insurance (MPCI) covers are uneconomical to administer. Countries that have advanced in this offering include Ghana, Kenya, Ethiopia, Malawi, Zambia and Zimbabwe. In Kenya, the Kilimo Salama product can be seen as a successful utilisation of innovation in product offering, as well as innovation in the distribution of the product (using mobile phones). In Zimbabwe, farmers can also receive payouts using mobile technology for their weather index insurance covers. Q: Is it possible to coordinate these various schemes and upscale them? A: The famous quote of not ‘reinventing the wheel’ can apply to modern and innovative ways of offering solutions. The big word here is ‘adaptation’ to suit the demands of the local situation. This means innovative solutions can be scaled up across geographies, but in modified forms that suit the local conditions. Failures normally result from (re)insurance companies taking a prescriptive approach, thus dumping a ‘solution’ on the farmers without their involvement in product design. Swiss Re and its local partners tend to take a diagnostic approach. This involves deploying resources on the ground and understanding the needs of the farmer and then designing or suggesting appropriate solutions. This way, the product offering is more sustainable. Q: What are the risks in such reliance on technology? A: Adoption of technology such as satellite-based solutions is the way for the future. This is because such solutions should be cheaper and easier to administer while also removing the moral hazard related to the human factor. Disparity between the reality on the ground and the technologically-derived index (basis risk) will remain a challenge, but there is no product that is watertight. For the micro level, use of technology remains the most viable solution. Another challenge of innovative offerings such as weather index is the ‘limited’ offering. Farmers have a demand for protection against more perils than the products can offer. For large commercial set ups, traditional MPCI covers are still economical and address most of the farmer’s needs, such as drought, excessive rain, windstorm, hail, uncontrollable pests and diseases and fire. A shortcoming of the MPCI product has been that the product is active only after germination; this can be circumvented by offering an index-MPCI hybrid cover, with product designs tailor-made for specific situations. Swiss Re offers a toolbox of solutions to the farmers, which addresses their specific needs. Hopefully, this will stimulate demand and result in product upscaling. ARC makes first payout to drought-affected countries Less than a year after it was formed, the ARC Insurance Company is paying $25m in drought insurance claims to three countries in the Sahel. Mauritania, Niger and Senegal, which paid a combined premium of $8m, will use the payout to mobilise early interventions in response to drought based on pre-approved contingency plans. The catastrophe insurance model is tailored to African climate issues, developed by the African Risk Capacity (ARC), a specialised agency of the African Union, and its affiliated mutual insurance company, the ARC Insurance Company. The inaugural pool was set up in 2014 to help member states build resilience to extreme weather events and protect food-insecure populations. Coverage for tropical cyclones and floods will be available in 2016. “This African-owned approach is addressing specific country-level climate change concerns, decreasing reliance on external aid, and promoting a sustainable solution to one of our continent’s biggest challenges,” says Dr Ngozi Okonjo-Iweala, Nigeria’s Minister of Finance and Chair of ARC’s governing board. By purchasing parametric drought insurance policies last year, Kenya, Mauritania, Niger and Senegal became the first African countries to embrace this new model of innovative funding, taking a major step towards transforming the disaster response paradigm on the continent Robert Piper, UN Regional Humanitarian Coordinator for the Sahel, acknowledges: “These first payouts by ARC represent a milestone in government leadership and financial innovation for emergency response across the Sahel.” ARC’s information and action is spearheading what will be a substantial global emergency response in the coming months to mitigate what could otherwise become a major food security crisis. Amadou Ba, Minister of Economy and Finance for Senegal, says: “For African governments, extreme weather events require significant response capacities and are often associated with large fiscal costs. With the payment of $16.5m coming into the Treasury, we are fully convinced that it is possible to move from managing crises to managing risks.” Payouts are made based on calculations using ARC’s in-house drought monitoring and loss calculation software, Africa RiskView. ARC and its member states work in partnership to develop country-level contingency plans based on existing and scalable government programmes. Prior to payouts being made, governments must submit a final implementation plan, which is certified by the ARC governing board’s peer review mechanism. Dr Richard Wilcox, founding Director General of ARC Agency, says: “This is a transformative moment in African food security, demonstrating the potential for cost-effective disaster financing. ARC has the potential to transform disaster risk management on the continent. With the ability to scale to a multi-billion dollar port-folio, ARC could offer coverage to 20-plus countries by 2020.” ARC Insurance Company was capitalised with financing of $200m from the UK’s Department for International Development and Germany’s KfW development bank on behalf of BMZ, the German Ministry for Economic Co-operation and Development. Additional partners include the International Fund for Agricultural Development, Rockefeller Foundation, Swiss Agency for Development and Co-operation, Swedish International Development Cooperation and the World Food Programme.

Agriculture–industry sector

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