15 April 2014Re/insurance

Mexico: outstanding in its field

Mexico is a complicated country with serious problems to overcome—but committed government support and a strong agricultural market could spell opportunity for international reinsurers.

Agricultural insurance is a difficult line, requiring expertise to write effectively and steadfast government support to make remotely profitable. The massive scale of agribusiness in powerhouse nations such as the US may seem like a natural choice to international insurers and reinsurers, but it’s the US’s southern neighbour that’s exporting a streamlined—and effective—agricultural public-private partnership that reinsurers can really sink their teeth into.

“We believe that Mexico is one of the agricultural markets with the greatest potential for the development of agricultural insurance in Latin America,” said Ramiro Iturrioz, senior underwriter of agriculture reinsurance at Aspen Re. “The country enjoys a good public-private partnership for the development of agricultural insurance. The international experience in agriculture insurance shows that this is almost a pre-condition for the development of this line of business.”

According to Willis Re Mexico’s regional director, Guillermo Oneglia, three insurance companies write agricultural lines in Mexico, along with upwards of 300 mutual insurance funds and one state-owned reinsurer.

Mexico’s staple crops—corn, wheat, sorghum, sugarcane, cotton and dry beans—are at risk most from droughts, floods, wind damage, excess precipitation from hurricanes, freeze and frost. This is according to Dr Oscar Vergara, business development lead, agriculture risk at AIR Worldwide. These crops, according to AIR, account for 70 percent or more of the value insured. The requirements of Mexican farmers are similar to those of US farmers in terms of the crops they grow and the major perils—particularly in the southwestern US—and like their US counterparts, most crops grown in Mexico are not irrigated.

While the crops and risks may be similar to those in the US, the public-private partnership is less complex, according to Hannover Re’s Andreas Bronk, general manager, and Luis Pulido, senior underwriter. The Mexican government provides subsidies to cover a part of the premium; the amount depends on the type of farm seeking coverage.

As Iturrioz said, “The approach of the government to support the development of agricultural insurance has been based on addressing client segmentation.”

The central government contributes between 30 and 50 percent towards the premium costs of commercial farmers, according to Bronk. Commercial farmers can turn to private insurers or Fondos, mutual insurance companies which are a unique feature of the Mexican agricultural insurance marketplace, while poor subsistence farmers have their premiums paid in full by the government. This fully subsidised protection generally comes in the form of the Componente de Atención de Desastres Naturales (CADENA) programme.

The CADENA programme is reinsured by Agroasemex, the state-owned reinsurer, which in turn is reinsured by foreign reinsurers such as Aspen Re and Hannover Re.

According to Iturrioz, the Mexican agricultural insurance market, with upwards of $320 million in premiums, is currently the largest in the region and can claim the highest level of government support. In 2011, the government spent $190 million to support agricultural insurance—that amounts to around 60 percent of total premiums.

“The well-defined public-private partnership for agriculture insurance in Mexico creates a good framework for business development of this line,” he said. “The direct involvement of the government in purchasing CADENA coverage creates demand for tailored reinsurance coverage that meets the government’s risk transfer needs in providing support to small farmers.

“Furthermore, commercial agriculture insurance is linked to rural credit in Mexico, which is positive for a number of reasons, including that it creates incentives for cost-sharing between insurance companies and banks that eventually contributes to a reduction in the cost of insurance.”

The bad seeds

“Agriculture is a difficult line of business,” Pulido said. “It needs two things: expertise on one hand and the support of the government to make the price of insurance affordable for farmers on the other.”

While the well-structured public-private partnership established by the Mexican government and the crop re/insurance industry is ensuring affordability, agricultural lines are still a tricky business.

Iturrioz said, “The overriding concern in Mexico is the volatility of this line of business. The agricultural sector of Mexico is highly vulnerable to a range of external shocks, such as weather events that affect production, threats to animals and plant health. High vulnerability exists in the northern regions of the country, where water availability is strained, and in the southern regions, where tropical storms can cause extensive damage to crop and livestock production.”

The number of perils and complexity of the line make modelling essential. Vergara told Bermuda:Re that using historical yield and loss data AIR can construct a stochastic catalogue of 10,000 yield events that are likely to occur, including past catastrophic events that generated significant losses.

He explained, “Due to the Agricultural Weather Index model, the weather-based yield events in the stochastic catalogue are spatially correlated, which is very important to ensure an unbiased crop portfolio analysis. Also, the yield events are properly ‘de-trended’ to reflect the current technological levels of Mexican agriculture, and the catalogue is not biased by recent historical events.

“The end result is an analysis that produces gross losses and net losses, once the government portion of the losses has been accounted for. The output is in the form of an exceedance probability curve that reinsurers can use to price their quota share or stop loss treaties.”

The biggest barrier to understanding crop loss, according to Iturrioz, is the availability (or lack thereof) of reliable data. He said, “In most of the developing countries in which agriculture is a significant line of business, yield, loss and weather data is spotty or unreliable.”

According to Vergara, AIR Worldwide spends significant amounts of time and resources making sure that the time series of data used in their models are properly cleaned, reconstructed, validated and reliable for use.

In bloom

While challenges exist in the Mexican agricultural reinsurance market, in many ways it is a peach too sweet pass up. Offering diversification, respite from the heavily competitive property-catastrophe market and a chance to combat global poverty as part of a functioning public-private partnership, Bermuda re/reinsurers have more than one reason to investigate the market.

With increased competition in property-catastrophe lines from alternative capital—a threat highlighted in Fitch’s 2014 Bermuda Market Outlook—lines requiring expertise can be an excellent diversification. While Mexico has taken advantage of the World Bank’s MultiCat programme, issuing catastrophe bonds in 2009 and 2012, Bronk and Pulido of Hannover Re see in the absence of any loss cap from the government some scope for cat bonds in frost and drought, and others don’t see the Mexican agricultural reinsurance market as a viable option for the capital markets.

Oneglia said, “So far, due to the availability of capacity offered by traditional reinsurers and the low monetary exposure of the current agricultural insurance values, the use of capital markets has not been needed.”

He continued, “Most agricultural lines are well served, with excess of capacity. There are, however, some insurers in the process of opening agricultural lines. Although they would go first to the existing markets, I do see opportunities for new reinsurers to get involved shortly.”

As it is well supported by the government, Oneglia also believes “the combined ratio, assuming a good global spread and an adequate exposure management make this line quite attractive”.

In fact, according to Iturrioz, the model of public-private partnership used in Mexico could easily be exported to other countries. He said, “The Mexican experience can certainly be replicated in other countries in the region facing similar issues, such as having a high proportion of poor households in their rural population with no access to commercial insurance, and governments looking to provide a safety net for them in the event of natural disasters.”

According to Pulido and Bronk, agricultural insurance and reinsurance, aside from being smart for providers in business terms, can also be valuable tools in the fight against poverty in the developing world.

According to Oneglia, “The support provided by the federal and state governments to farmers through many insurance vehicles is part of the constant interest in providing the sector with economic and financial instruments to, among other benefits, avoid migration from farms to cities.”

Pulido said, “Governments who invest in subsidies for premium are optimising public resources by transferring the losses caused by great natural disasters to the international reinsurance market.”

A win-win, by any stretch of the imagination.