SECOND CHANCE FOR AGRICULTURAL INSURANCE

The objective of reforms in agriculture implemented by the government in recent years is to ensure technological upgrades, development of export-oriented agriculture parks and logistics to achieve increased profitability and lower production costs by creating effective agricultural clusters. However, the first and utmost task is to make the sector less risky for investors and creditors through the development of effective system of agricultural insurance.

There is money but no interest

Despite the growth of the agricultural sector in 2018 (4.6%), which is more than three times higher than the annual GDP indicator, the industry still does not show the expected production indicators.

"We did a lot in recent years, including ​​land reclamation, state support for farmers and processing companies, which ensured production and export growth. However, I believe that the growth rate in agriculture could be even higher. I believe that the 3.6% growth since the beginning of this year does not reflect the potential of our agriculture," Azerbaijani President Ilham Aliyev said at the meeting of the Cabinet of Ministers on the socio-economic development of Azerbaijan in the first quarter of 2019.

President noted that agriculture should become a high-tech industry. Thus, it is necessary to apply new mechanisms, including the mechanism of agricultural insurance. As part of the first stage of agrarian reforms implemented since 1997, it was impossible to recreate the system of agricultural insurance largely due to the lack of necessary state funding at that time, as well as the underdevelopment of the banking and insurance sectors.

The first step in this direction was the law on the promotion of insurance in agriculture adopted in 2002. The new rules assumed that the state pay off 50% of the insurance premium to insurance companies. So, the state showed that it was ready to assume half the cost of insurance against natural disasters such as fire, hail, floods, frost, drought, etc. The same preferential insurance is provided in the case of the spread of particularly dangerous pests and infectious diseases among plants and animals. Payments on crop insurance amounted to at least 70% of the value of production, in animal husbandry up to 80%, and for real estate, equipment and agricultural equipment the size of insurance payments is equal to their full market value. Furthermore, insurance facilities cover wheat, barley, corn, sunflower, potatoes, sugar beets, etc. as sensible crops insured from the state budget.

Average tariff for agricultural insurance in Azerbaijan at that time was about ₼1,500 per year (5%/ha), although the average profit per hectare of land was approximately ₼25,000 per year.

However, the benefits provided by the above law failed to create an effective system of agricultural insurance. Thus, the recently submitted report of the Accounts Chamber of Azerbaijan states that the state funds to cover 50% of the insurance premium on agricultural property insurance remain largely unused. In 2012, the budget allocated ₼750 thousand, of which only ₼35.1 thousand (4.7%) were used. "In 2013-2015, of ₼3 million state funds assumed for agricultural insurance a little less than 2% was used on average. In 2016-2017, the funds were not used at all," the report indicates.

The situation was a little better last year: insurance companies provided agricultural insurance services at a minimum level, and farmers themselves often were not interested in them. In particular, in 2018, the premiums of Azerbaijani insurance companies reached to ₼2.7 million, while payments were at ₼755 thousand. The largest portion of payments and fees in this area was used for the insurance of farm animals. Crop production, due to its high riskiness and unprofitability, as in all previous years, remained largely outside of the insurance market.

Unprofitable sphere

There are several reasons why insurance companies are so weakly represented in the agricultural sector. One of the main reasons is that Azerbaijani banks lack interest in this area of economy. As world practice shows, the demand for insurance products in agriculture is closely related to bank lending, as banks, as a rule, do not issue loans to farmers, unless they insure their crops or livestock.

Unfortunately, in Azerbaijan cooperation of banks and insurance companies is very insignificant. This is largely due to the objective factor, when high interest rates (25-30%) are unaffordable for the majority of Azerbaijani farmers, while banking programs for long-term lending to agricultural enterprises are insignificant.

Therefore, it is not surprising that with the growth of the loan portfolio of commercial banks and non-bank credit organizations of Azerbaijan in 2018 by 10.7% (up to ₼13 billion) only 3.6% of loans were used in agriculture and processing. In fact, in recent years the Entrepreneurship Development Fund (in the past, the National Fund for the Support of Entrepreneurship) has remained the main donor of farms, whose resources are limited for obvious reasons.

According to the expert of the Economic Initiatives Support Centre Samir Aliyev, Azerbaijan's banking sector has demonstrated little activity in financing agriculture due to the high level of risks, which is also associated with a number of unresolved issues in agricultural insurance. Imperfection of laws and inflexible administrative mechanisms, in particular between farmers, insurers and the Ministry of Finance, did not allow covering all risks and created restrictions in reinsurance.

On the other hand, insurance of crop products is highly unprofitable and, as a result, draws small interest of insurance companies in this area, as well as the forced need to keep high rates for insurance policies. The situation is complicated by the fact that Azerbaijan is in the zone of risky farming. Drought and lack of water for irrigation, salinisation and soil erosion, periodic floods and mudflows are only a few problems that local farmers face almost every year and create excessive risks for both insurance companies and banks.

Therefore, it is not surprising that in 2016 only five companies worked in the field of agricultural insurance, and the loss-making ratio was 136%. In 2017, the number of companies decreased to four, and the loss-making ratio was 96%.

According to experts of the International Finance Corporation (IFC), who have researched on the issue for several years, about 3/4 of agricultural lands are used by small farmers, each share accounting for an average of 2 hectares of land. Due to their lack of acceptable land and other property for pledge, they are not of interest to the banking sector. In turn, the insignificant market turnover and small profits of small-scale farmers make relatively expensive insurance products inaccessible.

In fact, there is a vicious circle: banks are not able to offer low-interest loans acceptable to farmers, which consequently makes agricultural sector less demanding for insurance companies.

New law

A way out of this situation should be the adoption of a new law on agriculture insurance. The draft of the document was developed by the Ministry of Agriculture and the Financial Markets Supervision Chamber with the support of IFC specialists. The experts have so far studied the international experience on agricultural insurance in the United States, Spain, Israel, Canada, as well as the Turkish model called TARSIM, when the state provides support to all farmers and farms in the form of a certain amount of insurance payments, and farmers pay for additional coverage on their own.

According to the draft document, the state determines the objects and risks of agrarian insurance, controls the system of agrarian insurance, and also takes measures to develop this system.

Agricultural insurance and crop products, agricultural animals (large and small horned livestock), poultry, bee families, as well as rabbits, inhabitants of water bodies and other animals bred for this purpose are agricultural insurance items. During the recent discussions of the draft document, the Accounts Chamber of Azerbaijan made a proposal to include such products as cotton, tobacco, tea, rice and mulberry trees in the list of plants that receive state support for their insurance.

Agricultural producers are insured against natural disasters, including fire, accidents, infectious diseases and poisoning, attacks of wild animals and the spread of especially dangerous pests, third-party actions.

It is expected that the premium for agricultural insurance will be paid in two ways: partly by the insured and the state budget funds. Thus, during a recent meeting of the parliamentarian Committee on Agriculture Policy, expert Zahid Abbasov noted that the main advantage of the new law is that the state takes a significant part of existing risks in agriculture. Furthermore, the state agency for agricultural insurance will not enter into contracts with the insured, and create an intermediary management structure. Through it, the insurance process will be carried out, the direct management of the agricultural insurance system and the database of farmers within the framework of the Unified Electronic Information System, including also databases on the hydro-meteorological state of the region and land reclamation state.

It is expected that the management structure will be created by legal entities licensed for insurance activities other than life insurance.

It is very likely that the institution will be founded on the basis of insurance pool and act as a fund, which will include insurance companies operating in the country. Also, work should soon begin on specific insurance rules that will cover items such as tariffs, methods for calculating them, insurance premiums, methods for analyzing risks, commissions paid to insurance companies, and other mechanisms.

According to the new model, in the insurance event the farmer applies to the intermediary insurance structure, which in turn informs the fund. After that, an independent expert is appointed, who investigates the incident and reports to the Agricultural Insurance Fund, which, after making a positive decision, will transfer insurance payment directly to the farmer’s bank account. In other words, insurance companies are mainly assigned the role of agents: they receive interest from the concluded contracts, while their risks are minimal.

During the preliminary discussion of the draft law, other options for agricultural insurance mechanisms were considered. Initially the government will remain as the main donor of insurance subsidies. "At the initial stage, Azerbaijan will require funds, some ₼8.5 million to subsidise agricultural insurance. In the second year the amount will increase to ₼10 million, in subsequent years to ₼12.5-13 million," the chairman of the Agency for Agrarian Lending and Development under the Ministry of Agriculture, Mirza Aliyev, said recently. This amount will decrease in about ten years, when the mechanism of agricultural insurance will work in full force and switch to self-financing.