EVERY year, floods hit the northern part of the UK and cause damage and destruction to the tune of severalbillions. Despite this, their insurance sector still steps up to the plate to pay out claims tofund rebuilding and restoration efforts. Africa is in the headlines for a different type of story – that of droughts and crop failure. Yet we wait for food aid and assistance. Why is it that we can’t seem to help ourselves out of our troubles? I have raised this issue of how our insurance and financial industries can play a pivotal role in the fight against poverty and many people have responded to my ideas by saying that such initiatives are bound to fail since most of the risks such as drought are either uninsurable or if they are, the premiums will be out of reach of the intended policyholders.
If you put yourself in the shoes of a small scale farmer, two risks are bound to keep you up at night or on your knees praying to God. The first is the risk of crop failure due to drought or pest/diseases. The second is the risk that even after a good harvest, the price of your crop will be so depressed that when you sell your harvest, you will obtain a small income that can barely sustain you till the next season.It is interesting to note that miners are also faced with this risk of falling commodity prices. Africans have mainly resorted to counter the effects of these risks by looking towards their governments and aid organisations to bail them out of their misery.
Farmers in developed countries have already found innovative ways of dealing with the risk of falling commodity prices. Has is ever occurred to you that while a farmer is worried that the price of wheat will go down, a bakery is worried that the price of wheat will actually go up? Two economic agents with opposite risk exposures make for a perfect recipe for risk arbitrage. The result is a multi-billion dollar market in financial instruments called commodity derivatives which allow commodity producers and consumers to hedge their exposure to price movements. It is now possible for a farmer to know the minimum price at which he or she will be able to sell their produce before they even start planting! The challenge for Africa is to make these commodity derivatives accessible to even small scale farmers/miners.It is a shame that African farmers and miners not only produce and sell/export raw minerals/produce, but they remain at the mercy of the uncertain commodity prices.
Combating drought risk is not as easy however, but it is still possible and within our means as a continent. While risk mitigation in the form of irrigation and cloud seeding is undoubtedly very efficient, it is financially impossible to irrigate every single piece of agricultural land. At the same time, traditional insurance alone cannot be a viable option because, the systemic risk to an insurer of providing drought cover to a restricted geographical area such as a single country can result in insolvency in the event of a prolonged drought. For insurance to be sustainable as a cushion against the effects of drought there has to be a way to spread/diversify the risk. Through a government linked reinsurance company called Flood Re, the British have managed to ensure that the cost of insurance against floods remains affordable to those living in flood prone areas. Another similar scheme called Pool Re was set up in 1993 to enable terrorism risks to be insured.
In my opinion, in the absence of Flood Re, trying to insure some of the homes in the northern part of England would be like trying to insure a house situated on the edge of a crumbling cliff. But most of us in Africa do not have the privilege of having governments that are financially stable with deep pockets, how can we pull off a risk pooling arrangement similar to Flood Re? The answer is that we must rethink the way we provide aid.Some of the money that is channelled towards aid needs to be channelled towards risk pooling mechanisms to which the potential beneficiaries also contribute to. This seed capital is necessary to ensure that such risk pooling arrangements quickly attain economies of scale and gain the capacity to absorb catastrophic droughts.
A Drought Re Fund run across the continent will enable risk of drought to be spread over the entire continent. From Cape to Cairo, small scale farmers can contribute micro-insurance premiums that will be channelled towards the Drought Re Fund. Schemes such as these are already taking shape in India with peasant farmers paying micro insurance premiums as low as 80 cents a year! My dream is that one day in the future when I tune onto CNN and learn of a drought in say Somalia or even here in Zimbabwe, I see that the people are benefiting from a continental Drought Re Fund that is funded by premiums from all African countries. Current donor focused forms of relief are expensive and may not be sustainable in the long run. We need to put in place mechanisms to pool drought risks across vast geographical areas.
Thomas Sithole is an Actuarial Analyst and the current Head of Enterprise Risk Management (ERM) Solutions at Bluecroft Actuarial Solutions. If you have any comments or questions concerning any of the matters discussed on this platform, please do contact him on firstname.lastname@example.org or his twitter handle @ZimboActuary.
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