When a traditional risk fix isn’t the fix, and sometimes a fix needs to be found for a risk

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It’s an increasingly connected world- digitally and physically- and that means occurrences there increasingly have effects on business existence here.  ‘Effects’ means risk, risk means exposure, and exposure means need for insurance.  Climate/environmental occurrences, urban congestion, or virus outbreaks have far reaching consequences.  It used to be that businesses simply dealt with consequences over which they had no control in mitigating, and who was dealing with the issues were local to the effect or involved in the business or its collaterals. Is that true in today’s insurance world?

Patrick Kelahan is a CX, engineering & insurance consultant, working with Insurers, Attorneys & Owners in his day job. He also serves the insurance and Fintech world as the ‘Insurance Elephant’.

Daily Fintech– a top financial blog per Feedspot for Financial Technology Pros for 2020.

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Few risks are more terror-inducing than an unmanageable viral outbreak with unconfirmed causation such as is the coronavirus outbreak focused on the Wuhan region of China.  What to do other than quarantine the outbreak area, and limit individuals’ movement into other areas.  Prudent.  So, what do businesses do that are reliant on the movement of and visitation by persons?  Airlines, hotels, transport, tourism, and commercial businesses will have significant direct and indirect effects of the virus due to reduced attendance from travel, tourism and just regular business.  Compounding the effects for business is as reported by Insurance Journal, “companies are set to face billions of dollars (US) in losses linked to events and travel cancellations and closures of businesses.”  Most standard commercial insurance policies have had exclusions placed for communicable diseases in the wake of the SARS, Ebola and Zika viruses, leaving the insureds to self-insure for these occurrences.

But what of parametric options?  If you are a cruise ship operator whose business is reduced by 1/3 due to customer fear of an outbreak that happened across the globe, is there not a trigger/index that can be factored for in a parametric policy?  Even more common for that business is passenger count reduction for a single cruise due to norovirus outbreak- or fear thereof.   Same principle can apply to larger firms that may be affected in other industries- beaches, theme parks, tour providers, hoteliers, airlines, etc.  The Sydney (Australia) Morning Herald reports that the country’s economy may be affected to the tune of $2.3 Bn (Aus) due to the coronavirus’ effects as students and tourists remain home.

The Wall Street Journal reminds the business world of the far-reaching effects of outbreaks in densely populated areas- the need to repatriate employees from outbreak areas, and mass closures of businesses, e.g., Starbucks, McDonald’s, IMAX, and other widely distributed businesses.  China does mandate that employers reimburse employees for lost wages, but on a practical basis the effectiveness of those regulations is low.  Risk exposure with little sharing of the cost of risk.  But is there an opportunity for a micro-insurance product to protect individuals?

Are there other risks to which property owners or business operators are exposed without easy access to risk sharing?  Sure.  Regional perils, environmental perils, and/or climactic risks such as earthquake, flood, temperature extremes are a few of these.  Flood insurance has been available for some decades but is not an easy match to insurance limits needed, and most often that cover is government subsidized and regulated, and is expensive if a subject property is in a flood frequency area.  But what of those persons who own property in less sophisticated emerging markets?  Well, more and more governments are looking to collaboration with other countries in establishing risk response pools, catastrophe bonds, or leveraging insurance linked securities (ILS) in smoothing the cost of disaster response.  These are products that may not have existed as little as ten years ago, and even when present in a country’s emergency portfolio may not provide the expected benefits.

Take for example the risk vehicle Mexico placed prior to Hurricane Odile (2014), providing reinsurance for the country’s Fund for Natural Disasters (FONDEN).  The bond was established as a hedge for when a hurricane met a certain central pressure trigger within a ‘box’ regional area.  Good idea, unless the index values are not clearly defined in how the values are confirmed.  The index was not met at that time but might have, except there was only one index measure point managed by one observer.  Even if triggered the basis risk the country was exposed to would not have been met by the full release of the bond’s principal, supporting natural disasters as being global basis risk issues.

Considering the disaster ‘protection gap’ being most notable in emerging markets (on average only 5% of disaster losses having cover in poorer countries), there are organizations such as Global Parametrics(GP) that are working to improve access to cover by means of parametrics products.  GP’s CEO, Hector Ibarra reports that a recent placement of parametric product produced advance payment to Oxfam and Plan International in anticipation of Typhoon Ursula in December 2019.  The use of forecast-based indices (payments triggered on forecast of certain conditions) provided communities in the Philippines payment before the actual typhoon landfall, allowing evacuation funding for residents.  Proactive risk sharing, with immediate payment upon reaching an index value.  Not a perfect answer to all similar events, but certainly a start from which to build.

Are the principles behind parametric products adaptable to local risk factors that regions or businesses encounter but cannot find effective indemnity products for?   Weather risk parametrics have gained a foothold within emerging ag markets in the form of micro-parametric products, with index factors of ‘on the ground’ conditions being verified by new techniques (sensors, satellite, drones).  Larger scale weather-related ag parametric products are slowly getting traction and are beginning to supplant traditional crop insurance.  In discussion with Norm Trethewey of Weather Index Solutions of Australia there are now more companies willing to underwrite smaller ag weather parametric or derivative products, say a $200K cover that used to be passed on by firms like Swiss Re and Munich Re.  The presence of wider and deeper data sets there can be indexes established that in the underwriters’ estimation will be profitable and responsive.

The exhibit noted below shows some of the relative complexity of cover that is supported by available data and the sophistication of index monitoring:

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There is not the same concerns of basis risk for ag parametrics because the value of the crop is known (within a range) so what remains is the farming business to calculate premium cost versus potential loss of yield.  This sounds straight forward enough but changing the ag industry’s thoughts on what to do about Mother Nature becomes the nuance of the product.  One thing is certain- as available data improves even more the underwriting of these parametric options will become more commonplace, for developed and emerging markets.

And for more extreme climate like there typically is in Australia, and where ag production includes upwards of 20 million exportable bushels of broad acre crops, having a spectrum of risk management options to include parametric and derivative covers is a potential stabilizing factor during spikes in conditions.

To wrap up this column is a short discussion of risks that simply may not have indemnity or parametric solutions, e.g., the number of, confusion caused, and accidents experienced through use of okadas (motorbikes) and kekes (three-wheeled vehicles) within the city of Lagos, Nigeria.  One of the most populous urban areas on the African continent Lagos has waged a continuous battle against sprawl and traffic congestion.  Add to that the easier acquisition of motorbikes and trikes compared to autos, and the growth of informal ride sharing using the more informal vehicles and you have traffic mayhem.  The state government has banned the vehicles’ use, presenting survival mode for commercial ride sharing companies like Max.ng, Oride, and gokada.ng.  Traffic risk, government risk, and no easy solution other than tossing the figurative baby out with the bathwater, and exacerbating the very commuting challenge for the city’s residents that prompted the popularity of the bikes and trikes.  Thanks to the East African for the reporting on the ban.

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Could Blockchain help the dysfunctional crop insurance sector in India?

At the Singapore Fintech Festival last week, the Indian Prime Minister Narendra Modi, delivered an amazing key note speech with Financial Inclusion at its core. During the speech he touched upon several of his achievements, including Aadhaar. In the last 4 years, he claimed the banked population in India has gone up from 50% to almost most of the country.

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I am a big fan of Modi. He has managed to achieve some major milestones with Aadhaar and meaningful steps for a country where 70% of its population still earns from agriculture. However, in times of natural disasters, in a country dealing with 1.3 Billion people, one ambitious and dedicated leader can only do so much.

Earlier this month, my home state in India, and some of the neighbouring states were hit badly by a storm named Gaja. Gaja in the regional tongue refers to Elephant. In my state, the most hit districts were the most fertile parts, that are called the delta region (of the river Cauvery). On top of human casualties (33) and about 75,000 being relocated, the storm hurt farmers massively.

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Many farmers in the delta region had moved from cultivating paddy to coconuts as paddy is considered water intensive. This farming tactic has heavily hurt them, as coconut trees took 10-15 years to grow, and the damage caused by the storm was to their decade of hard work – which were not insured.

I come from that part of the world, and had the privilege of going to school and University with many, whose parents were farmers. One of them sent me texts post the storm, this is the summary.

Tall coconut trees were just twisted and broken right in the middle. Wind speed seem to have been around 100 kmph. Interior delta regions don’t get exposed to this level of winds. Usually Only the coastline takes the brunt.

People weren’t prepared and seem to have been caught by surprise. The last time something similar happened in the interior areas was in early 50s. But back then this area primarily had paddy cultivation.

Years of effort in tending to them (coconut trees), watering them.. at least for us it was just additional income. For many farmers we know, the 10k or 15k INR, they get out of these coconut farms every month is their only income.

I understand, this is not a weather news channel – so back to crop insurance and Blockchain.

So what has been done by the Modi government for Crop insurance?

In January 2016, Prime Minister Narendra Modi launched a revamped crop insurance scheme, his government’s flagship scheme for farmers, the Pradhan Mantri Fasal Bima Yojana (PMFBY).

How does the insurance work?

The premium is subsidized for farmers who own less than two hectares of land. Insurance coverage is for two aspects,

  • Yield protection, which protects the farmer from a lower yield
  • Weather linked insurance that covers for disasters and other weather irregularities

The claim is calculated on the basis of crop cutting experiments carried out by agricultural departments of respective states. Any shortfall in yield compared to past 5 years average yield is compensated. In essence – a very manual process.

The insurance is mandatory for farmers who take loan for their needs. For the rest of the farmers it is not.

crop insurance

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What has happened to the Crop insurance industry since then?

These were the key findings,

  • Number of farmers covered has increased by 0.42%.
  • Premiums collected from farmers has gone up by 350%
  • Claims paid out have increased marginally. But time taken to pay claims is already hurting farmers.

Points one and two clearly highlight where the monies are going – insurance providers are having the last laugh – at the cost of the farmers.

Also, If one season fails, and farmers  didn’t get their claim money in time for the next season, they don’t have funds to buy seeds for the next season. So timing of the release of claim money is critical.

There are several other issues with the current process that include lack of transparency, errors in setting yield thresholds, poor awareness amongst farmers, complex criteria and documentation.

What could we do in future?

Well, we seem to have got a silver bullet in Blockchain. I have written about how Blockchain can help crop insurance before, but will revisit some of those points again. In an Indian context, this is how I see it working.

  • Every farmer has an Aadhaar, so use the biometric identification.
  • When a farmer opens a bank account, make it compulsory to get them on an insurance
  • Explain the criteria, payment schedule and agree on thresholds and how they could change.
  • Create a simple data driven smart contract to list the criteria that would trigger a claim – without the farmer having to claim.
  • Source the required information on weather and soil dampness from satellite data
  • When there is a natural calamity, automatically trigger the claim, in near real time, using self executing contracts.
  • Last but not the least – have strict guidelines for crop insurance firms profit margins.

This would still need state/crop level data on yield thresholds, which is apparently decided by the local authorities post every season. But apart from that data point, most other information can be automated. The customer (the farmer) should have a frictionless experience.

They don’t have to understand insurance, they just need to know they are protected and taken care of when disaster strikes. Blockchain can create that trust in the process.

Once the confidence in the system comes back, number of farmers enrolling for the scheme will easily go up.

During the Singapore Fintech festival, Mr.Modi mentioned how Blockchain was a hot trend amidst VCs. If he had advisors for his financial policies, who were half as good as his PR team that wrote his speeches, the nation should soon see some relief from its dysfunctional financial services.


Arunkumar Krishnakumar is a Venture Capital investor at Green Shores Capital focusing on Inclusion and a podcast host.

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