“CATASTROPHIC” NECESSITY

Domestic insurance market has overcame the consequences of recession caused by the collapse of oil prices and depreciation of the national currency, which resulted in a serious banking crisis about three years ago. In 2017, positive trends in the non-oil sector of the national economy helped insurance companies maintain the growth trend and ensure a rapid rise in five months of 2018. Nevertheless, the insurance industry, where the top ten companies account for 90% of insurance premiums, still have to overcome tangible problems. Thus, it is necessary to strengthen the specialisation of insurance companies and ensure the development of the most unreached areas, in particular agricultural insurance.

Strategic Objective

Insurance market, like the entire financial sector of Azerbaijan, failed to escape negative consequences of the energy crisis, devaluation and recession of the non-oil economy in 2015-2016. This and a number of other reasons resulted in the withdrawal of the weakest segments of the insurance market such that the number of Azerbaijani insurance companies has decreased from 27 to 22 since the beginning of the crisis. According to the Associate Director of Standard & Poor's Yekaterina Tolstova, banks are the owners of most of Azerbaijan's insurance companies. Therefore, their financial problems because of the devaluation also affected the insurance sector. “In 2013-2017, insurance income in Azerbaijan decreased by 38% in dollars and increased by 37% in manats. This is due to the position of the national currency”, Tolstova said.

Stable positive trends in insurance sector appeared only by the end of 2016. By the end of 2017, total premiums of insurers in Azerbaijan reached ₼556.9m (an increase of more than 12%).

Economic reforms of the last three years have contributed to the growth of the non-oil sector, exports and a significant improvement of the trade balance. These measures, as well as state-supported projects in housing construction increased financing of industry and agriculture, helped insurance companies to quickly catch up on missed opportunities. According to statistical data of the Financial Markets Supervision Chamber (FMSC), in January-May 2018, aggregate fees of insurance companies in Azerbaijan reached ₼350.8m, which is 46.11% more than in the same period last year.

However, despite record growth rates of insurance premiums, their share in the total volume of the country's GDP is still extremely low (0.8%). “Azerbaijan needs to increase the share of insurance premiums in the non-oil GDP. Our strategic goal is to increase this indicator to 8%. In particular, before the end of 2018 we intend to increase the share of insurance premiums to 1.4%,” FMSC Executive Director Ibrahim Alyshov said during the recent conference “Insurance in Azerbaijan: New Perspectives”. According to Mr. Alyshov, it is also necessary to increase the share of insurance assets in the total volume of financial assets of Azerbaijan. Today, this indicator does not exceed 2%, and over the past two years, it has not been possible to ensure its growth.

According to experts, the increase in the turnover of the insurance market is possible provided a more complete coverage of a number of areas, the development of which currently does not correspond to the available potential. This, for example, is the insurance of residential real estate, compulsory medical insurance, as well as a multiple increase in the coverage of insurance services in agricultural sector.

Existing risks not covered by insurance

In particular, these measures are included in the Strategic Roadmap for the Development of Financial Services in Azerbaijan. One of the promising directions in the “road map” is the development of agricultural risks insurance, a segment, which remains marginal in the insurance market.

There are several reasons for the low activity of insurance companies in agricultural sector, and weak interest of Azerbaijani banks in this sector plays an instrumental role here. As the world practice shows, demand for insurance products in agricultural sector is closely associated with bank lending, as banks, as a rule, do not give loans to farmers if they do not insure their harvest or livestock. In Azerbaijan, the activity between banks and insurers is almost invisible. This is not surprising, considering that in four months of 2018, ₼455.9m was allocated for the development of agriculture and processing industry from the aggregate loan portfolio of Azerbaijani banks and non-bank credit organizations (NBCO), which exceeded ₼11.8b. In other words, only 3.9% of the total volume of loans allocated by banks and NBCO was directed to agriculture. This amount is extremely small given that about 40% of Azerbaijan's working population is involved in agriculture, and agricultural processing is one of the leading industries of non-oil industry and non-oil exports of the country.

But do agricultural entities really need insurance products regardless of the interests of the banking sector? Obviously, they do considering that Azerbaijan is in the zone of risky farming: drought and lack of water for irrigation, salinisation and erosion of soil, periodic floods and mudflows - this is an incomplete list of risks that local farmers face almost every year.

Attempts to attract insurance companies to the agricultural sector were made back in 2002, when the law “On the stimulation of insurance in agriculture” was adopted in the country. According to these rules, the state covers 50% of the insurance premium (insurance tariff) by transferring funds to the account of insurers from state budget. So, the state is ready to take half of the costs of insurance against natural disasters - fire, hail, floods, frosts, drought, etc. The same preferential insurance is also provided for the spread of especially dangerous pests and infectious diseases among plants and animals. Reimbursements for crop insurance account for at least 70% of production costs. In animal husbandry, it reaches 80%, but for real estate, equipment and agricultural machinery, the size of insurance payments is equal to their total market value. In addition to wheat, barley, corn, sunflower, potatoes, sugar beet and other crops are included in the list of crops insured by the state. Average tariff for agricultural insurance in Azerbaijan is about ₼1,500 per year (5% / ha), and this despite the fact that the average profit per hectare is about ₼25,000 a year.

Despite legislative and material efforts of the state, the interest of farmers and insurance companies to rural insurance is still insignificant. Statistical data of the Ministry of Agriculture also confirmed this. For example, in 2007-2015, about ₼7.5m were reserved for agro-insurance purposes, but only about ₼60,000 (0.8%) of budgetary funds were allocated from this amount.

Over the past two years, the situation has remained without any tangible changes: insurance companies provide agricultural insurance services at a minimum, and farmers are often not interested in them. So, according to FMSC, in January-May 2018, insurance fees in agriculture amounted to ₼1.56m with payments of ₼282,900. Most of payments and charges in this sphere are associated with insurance of farm animals (₼947,700).

According to experts of the International Finance Corporation (IFC), 75% of lands suitable for agriculture is used by small farmers in Azerbaijan, each of which accounts for an average of 2 hectares of land. Insignificant market turnover and low profit of small-sized farming households make insurance products inaccessible for them. Also, underdevelopment of insurance among small and medium-sized farms deprives them of access to bank financing and, in general, has a very detrimental effect on the diversification of the sources of financing for agriculture.

Bad weather conditions further complicate the situation as they affect the crops and producers cannot repay loans. As a result, the share of problem loans of banks increases. That is why the country's banking sector is so cautious and conservative in matters of financing of local farmers.

Another reason for the underdevelopment of agricultural insurance was due to the imperfection of the statutory framework and administrative mechanisms in this area. Currently, a mechanism when farmers apply to insurance companies while they in turn apply to the Ministry of Finance is inflexible and cannot cover all risks, and is also limited in reinsurance. It is also worth noting the high loss ratio and, as a consequence, the disinterest of insurance companies in this area. In 2016, only five companies operated in agricultural insurance, and the loss ratio was 136%. In 2017, the number of companies decreased to four, and the loss ratio was 96%.

New bill

Over the past few years, IFC specialists together with the Ministry of Agriculture and FMSC have been working on a project to introduce a new agricultural insurance system in Azerbaijan to improve legislation in this area, as well as risk assessment and new product development. In particular, some work has been carried out to select a model of institution that will monitor agricultural insurance activities. Most likely this institution will be created on the basis of insurance pool and will act as a fund, which will include the insurance companies operating in the country. For this purpose, agricultural insurance experience of the USA, Spain, Israel, Canada, and Turkey (TARSIM)  was studied as a model of agricultural insurance. As a result, a new law on agro-insurance should be adopted. The next step is the creation of agricultural insurance fund, which will increase the number of insured agricultural producers by at least three times.

“The new bill on stimulating agricultural insurance has already been prepared and sent to the government for consideration, and we hope that the document can be adopted by the parliament by the end of this year,” said Ibrahim Alyshov at the conference “Insurance in Azerbaijan: New Perspectives”.

After the adoption of the law, works will begin on specific insurance rules covering issues such as tariffs, methods for calculating them, insurance premiums, risk analysis methods, commissions that will be paid to insurance companies, and other mechanisms. By the way, mechanisms envisaged in the new bill on stimulating agricultural insurance are quite simple and will significantly increase the attractiveness of the market for reinsurers.

“According to new model, farmers will apply to insurance companies, which will act as an insurance intermediary. The company then will conclude a contract on behalf of the Agricultural Insurance Fund, part of the insurance premium will be paid to the fund by the farmer, and the remainder - from the state budget,” specialist of the FMSC Department for Supervision of Insurance Markets Firdovsi Aghashirinov said. In the event of an insurance event, the farmer will also apply to the insurance company, which will inform the fund. After that, an independent expert will be appointed. He investigates the incident and reports to the Agricultural Insurance Fund, where, after making a positive decision, insurance payments will be transferred directly to the bank account of the farmer. That is, the insurance companies in this model are assigned the role of agents; they do not bear any risks, receiving interest from the concluded contracts. In addition, insurers can reinsure contracts in the fund, but they, of course, will bear certain risks for reinsurance.

Apparently, the proposed mechanism based on a centralised insurance mechanism also has certain drawbacks. According to the president of the National Union of Agricultural Insurance (Russia) Korney Bizhdov, such a mechanism gives a very passive role to insurance companies: the duties of insurers are reduced to agency functions, they practically do not assess the risks, do not participate in tariffing and settlement of losses. On the other hand, in case of catastrophic losses, the state will replenish the funds of the Agricultural Insurance Fund, since the possibility of forming reserves and participation of insurance capital is practically excluded.

Today it is difficult to predict the consequences of the new law and the activities of the Agricultural Insurance Fund on agriculture. We just hope that new mechanisms of agricultural insurance will allow reducing costs, balancing the tariff policy of insurers, creating a single line of insurance products, making them affordable for a large number of producers in agricultural sector, and developing uniform standards for organizing and conducting agricultural insurance, including independent damage assessment system.