88099 3 Mexico Agriculture Insurance Market Review October 2013 Fondos: Mexico’s Unique Agricultural Mutual Insurance Funds A Rising Need for Affordable The Fondos Model Agricultural Insurance Fondos are mutual insurance funds that are formed The first agricultural insurance program in Mexico began by local growers, and only provide insurance to their in 1942 and was based on arrangements between mutual members. Their advantage lies in their close connection unions and private insurance companies. It was not until to farmers and their knowledge of local agricultural 1961 that the first specialized public company for crop conditions. As Fondos are civil associations, they are insurance was created, the National Crop and Livestock not intended to generate profits either for the Fondos Insurance Company (ANAGSA). Insurance through themselves or the members. Under the law they may ANAGSA was a condition for receiving agricultural credit; only provide agriculture related damage insurance, policies covered multiple-perils and premiums were almost agriculture related property insurance, farmers’ life entirely subsidized. Unfortunately, ANAGSA’s losses were insurance, and accident/illness related insurance. staggeringly high, and during the 1980s the allocation of subsidies for agricultural insurance showed signs of The Government provides support to the Fondos mismanagement, which turned ANAGSA into a loss- system through a program of operational assistance making entity. The Government began reducing subsidies and financing to both Fondos and Integrating Agencies and eliminating flat rate premiums, pushing farmers to seek (OIs), which are associations formed by Fondos more affordable agricultural insurance coverage. members that oversee the activities of Fondos. The operations of Fondos are regulated by the Agriculture Fondos, or farmer mutual insurance funds, developed and Rural Insurance Fund Law (2005), and overseen by in response to rising prices and shrinking availability of OIs and a National Integrating Agency. OIs supervise agricultural insurance. The first Fondo was established in the organization of Fondos’ admission, separation, 1978 in order to reduce insurance costs, offer technical suspension, and expulsion of members; risk retention support for members, develop financial options, as limits; contracts of reinsurance; functions and operations; well as to reinvest any profits back into the community. constitution and investment of technical reserves and Based on the inefficiency of ANAGSA and the rising the social fund; and accounting. Any irregularities are popularity of Fondos, a new public policy framework for reported immediately to the finance ministry (SHCP) . the crop insurance system was initiated in 1989 which concluded the ANAGSA insurance program (1990) Fondos typically retain low levels of risk (normally up to 5 and enacted general rules to govern Fondos (1991). In percent of the sum insured), and are therefore dependent 1992 there were 192 Fondos in existence, and by 2012 on affordable reinsurance to continue operating. there were 388 Fondos operating, with some 1.5 million Agroasemex, the Government entity which replaced hectares covered, representing 63.8 percent of Mexico’s ANAGSA in 1990, was the sole provider of stop-loss commercial insured farmland (the majority of Fondos reinsurance for Fondos until 2005, when a new law eased cover crop insurance)1. After 20 years of existence, the requirements for private reinsurers in the market. Fondos continue being an interesting crop insurance tool/ Subsequently, two private reinsurers have entered option in Mexico; however, perhaps it is time to renew the market to reinsure Fondos, although Agroasemex their targets and goals in order to make their future more remains the largest reinsurer for Fondos by far, covering sustainable. 89 percent of the active stop-loss reinsurance treaties for Fondos in 2012. The dominance of Agroasemex in the market is not necessarily a monopsony risk, given the 1 In terms of total agricultural area insured, Mexico demonstrates a tendency of agriculture insurance markets to be relatively level of agricultural insurance penetration that is one of the highest small with a minor number of players. The main risk in this for Latin America and the Caribbean, but below the OECD average. Table 1. Fondos’ Share of Commercial Crop and Livestock Insurance Market Year Insured Area in Millions of Ha. Market Share Insured Animals in Millions of Head Market Share 2012 1.484 63.8% 16.663 87.9% 2011 1.664 62.3% 134.765 94.4% 2010 1.199 57.6% 5.759 37.8% 2009 0.956 52.3% 135.094 92.4% 2008 1.066 56.3% 55.520 83.4% 2007 1.030 50.8% 3.596 25.5% 2006 1.170 55.8% 2.822 22.1% Source: Agroasemex Quarterly & Annual Reports from its website: www.agroasemex.gob.mx arrangement is the pricing of Fondos, which in the case of may be allocated to a social fund, the use of which is Agroasemex is influenced by equality issues and pressure determined by the General Assembly of each individual from political actors, instead of being based on pure risk. Fondo. Social fund activities include increasing technical reserves, reducing the cost of insurance, strengthening Average premium rates from 2001-2012 were 7.2 percent, the Fondos’ technical, operational or administrative areas ranging from 6.9 percent for very large Fondos to 9.5 or several other purposes that support agro-industrial percent for the smallest Fondos. The difference in premium activities in the community. Details of gross premium and rates is presumably due to the fact that larger Fondos underwriting surplus allocations are outlined in Figure 1. can obtain/negotiate lower rates with Agroasemex (likely due to differences in technological production, lower per Unique Features of Fondos capita administration costs, risk diversification, political leverage, etc.). Underwriting results over this period • Fondos operate under a differentiated and unique challenge the idea that larger Fondos manage risk better: legal framework that has been designed to limit the largest crop Fondos have over this period incurred a their risk taking capabilities and the amount of disproportionately high percentage of 66 percent of the capital that they can accumulate. total claims and are currently operating at a long-term • Fondos are formed by groups of farmers, loss ratio of 97 percent. and reinvest any underwriting surplus into contingency reserves or social services in the Legal regulations determine how Fondos can allocate local community. underwriting surpluses. Once the underwriting year • The diversification required for a viable agricultural is over, Fondos must allocate at least 25 percent of insurance scheme is achieved through any underwriting surplus to a special contingency reinsurance, and the vast majority of Fondos reserve, which is used to retain risk in future years and purchase reinsurance from the public reinsurer, reduce the cost of reinsurance; and up to 70 percent Agroasemex. Figure 1. Fondos Allocation of Gross Premium Allocation of Original Gross Premium 100% Stop Loss Reinsurance Cost (Average of 20% of Gross Premium) Allocation of Underwriting Surplus 100% - 20% = 80% Fondo’s Administrative & Operative Expenses Special Contingency Reserve (Up to 25% of Gross Premium after Reinsurance Cost) 25% (REC) for CAT losses 80%- 25% = 55% Labor Liabilities Reserves for Fondo’s Employees or extra 5% Expenses/Reserves Fondo’s Current Risk Reserves (RRC) (40 to 60% of Gross Premium to pay 1st Layer claims) Social Fund (available to be (Level of RRC depends on Cost of Reinsurance) used/spent as per Fondo’s 70% decision) Source: Authors. Note: SIF = Fondos. • The main benefits of the Fondos approach are during this period to cover Agroasemex’s excess losses the co-insurance among communities (sharing of in a catastrophe year such as 2010-2011. Table 2 shows risk) and their deep knowledge of local conditions. the overall results for Fondos during this period (for only those Fondos reinsured by Agroasemex), and Figure 2 Results shows the historical loss ratios for Agroasemex’s Fondos Reinsurance Portfolio for agricultural Fondos (excluding Fondos are a very important means of commercial crop livestock Fondos). Agroasemex’s reinsurance portfolio insurance in Mexico and over the 11 year period from 2001 losses (Figure 2) are equivalent to Fondos’ insurance to 2012 they have insured a total area of 9.5 million hectares losses (Table 2) less their respective stop-loss priorities. (an average of 865,000 per year) of crops with a total sum insured of MXP 83 billion and a premium income of MXP Challenges, Lessons Learned and 6 billion. In 2012, Fondos’ insurance coverage represented 63.8 percent of total insured hectares and 87.9 percent of Options for Strengthening Fondos insured livestock. The average sum insured has increased Despite some issues to be addressed or improved in the significantly during this period, and the annual premium near future, Fondos are a good example of a successful rates have declined. There is a marked concentration of public-private partnership. The following 5 options are coverage in the northern states of Mexico with the highest presented to strengthen the future operations of Fondos levels of agricultural development and proportionally higher and Agroasemex in Mexico in response to specific GDP per capita, especially in the autumn/winter cropping challenges: season. The average size of Fondos crop is slightly over 3,500 hectares per season, but there is considerable 1. While Fondos have strong local benefits, they may range from very small Fondos insuring several hundred not be successfully scaled up to reach some ad- hectares only, to a few very large Fondos insuring many ditional beneficiaries. A comprehensive agriculture tens of thousands of hectares each season. The trend is insurance public-private partnership strategy is for Fondos to insure an increasingly large area on average. recommended for Mexico and would require high- level changes for Fondos and the incorporation of The Fondos Crop Insurance Program operated with a long complementary insurance instruments to fill current term gross loss ratio of 88.7 percent during 2001-2012. gaps. Option: Develop a transition strategy In 7 of the 11 years the program operated at a loss ratio of that promotes the use of different insurance less than 50 percent and incurred a negative underwriting instruments to fill gaps not covered by Fon- result only in 2011, when the program experienced very dos, and scales up Fondos where necessary. high frost losses. The underwriting results for that highest 2. Although Fondos (and in particular small Fondos) loss year demonstrate the advantageous reinsurance have had an acceptable performance within the protection provided to the Fondos by Agroasemex’s existing legal and regulatory framework, the overall stop-loss treaties; however, the original premium rates system is not sustainable based on the combined charged on the Fondos program have been inadequate loss ratios of the system. Option: Introduce Table 2. Fondos Overall Crop Insurance Results 2001/02 to 2011/12* Total Sum Total Total Under- writing N° of Insured Area Loss Cut Loss Ratio Insured Premium Claims Year Fondos (Hectares) (%) (%) (MXP 000) (MXP 000) (MXP 000) 2001/02 175 394,410 1,887,798 143,720 148,510 7.9% 103.3% 2002/03 219 771,635 3,964,901 346,386 155,645 3.9% 44.9% 2003/04 217 716,464 3,840,452 306,764 243,496 6.3% 79.4% 2004/05 244 805,706 5,561,851 442,116 154,486 2.8% 34.9% 2005/06 242 817,735 6,182,388 478,249 153,070 2.5% 32.0% 2006/07 246 839,269 6,508,303 434,868 135,864 2.1% 31.2% 2007/08 246 888,389 7,474,420 483,079 203,746 2.7% 42.2% 2008/09 241 910,496 9,731,892 621,286 185,516 1.9% 29.9% 2009/10 250 951,430 10,205,740 667,460 399,755 3.9% 59.9% 2010/11 269 1,083,850 11,855,872 716,319 3,014,370 25.4% 420.8% 2011/12 295 1,331,533 16,042,824 1,387,718 553,853 3.5% 39.9% Total 2,644 9,510,917 83,256,440 6,027,964 5,348,311 6.4% 88.7% Source: Agroasemex. Note: *These results apply only to those Fondos which are reinsured with Agroasemex in 2012 and do not include subsequent Agroasemex Stop-Loss Insurance coverage. Figure 2. Evolution of Loss Ratio of Agricultural Fondos (Agroasemex Fondos Reinsurance Portfolio) 1,203.3% 500% 400% 300% 200% 133.2% 132.7% 100% 67.1% 45.1% 27.9% 15.4% 27.8% 36.9% 12.9% 3.0% 14.0% 0% 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 Source: Agroasemex website and 2011 Financial Statements. Note: The loss ratio is calculated excluding Agroasemex’s reinsurance coverage. steps and incentives for the decoupling of the place of a proportional retrocession in order risk taking framework from other functions to reduce retrocession costs and stabilize (social) provided by Fondos. results. 3. Under the current supervisory structure, 5. Fondos are only required to reserve 25 percent the Boards of the OIs are comprised of of their underwriting surplus and can use up representatives from the Fondos they oversee. to 70 percent for activities under a social fund. This situation presents the potential for conflict of After catastrophic events like the severe frost in interest and a lack of objectivity in the supervisory 2011, capital accumulation may not progress function. Option: Establish an independent quickly enough under these requirements. supervisory authority. Option: Increase the statutory allocation 4. While the worst underwriting year (2010-2011) of underwriting surpluses to the Special demonstrates the advantageous reinsurance Contingency Reserve Fund to a minimum of protection provided by Agroasemex stop-loss 50 percent. reinsurance treaties, Agroasemex’s dramatic losses –a 1,203 percent loss ratio– demonstrate About the Authors a need to purchase a higher level of stop-loss retrocession reinsurance protection on its Fondos’ This paper contains a partial summary of the report “Mexico: Agriculture Insurance Market Review” (June, 2013) which was crop account. Additionally, the geographic and authored by a World Bank team led by Diego Arias (Senior seasonal concentration of liability indicates Agriculture Economist, LCSAR) and composed of Charles a need for accumulation control. Option: Stutley (Senior Agriculture Risk Management Specialist, Develop a more sustainable stop-loss LCSAR), William Dick (Senior Agriculture Risk Management Specialist, LCSAR), Sandra Broka (Senior Rural Finance reinsurance program under Agroasemex Specialist, ECSAR), Michael Grist (Senior Financial Sector which accumulates adequate catastrophe Specialist, FCMNB), Hector Peña (Economist, LCSAR), Sophie reserves backed by sufficient levels of Storm Theis (Environmental Specialist, LCSSD), Mildred Brown retrocession reinsurance protection. En- (Economist, LCSOS), Miguel Camarillo (Agriculture Insurance Specialist, LCSAR), Marcelo Angione (Agriculture Insurance courage participation of additional private Specialist, LCSAR), Héctor Ibarra (Senior Financial Officer, insurers in reinsuring Fondos. Consider a FABBK), Erika Salamanca (Project Assistant, LCSAR) and Ariel stop-loss Fondos portfolio retrocession in Donnini (Senior Agriculture Reinsurance Specialist, LCSAR). This paper is a product of the staff of the International Bank for Reconstruction and Development / The World Bank. The findings, interpretations, and conclusions expressed in this paper do not necessarily reflect the views of the Executive Directors of The World Bank or the governments they represent. The World Bank does not guarantee the accuracy of the data included in this work. The boundaries, colors, denominations, and other information shown on any map in this paper do not imply any judgment on the part of The World Bank concerning the legal status of any territory or the endorsement or acceptance of such boundaries.