The Guardian
The globalisation of food trade over the past few decades has made the world food system better equipped to respond to small localised losses in food production and feed a growing global population. It has arguably also increased our exposure to systemic risks.
A major crop failure in top exporting countries like the US, Ukraine, Australia or Brazil will now be felt in every country in the world. This could cause civil unrest in some countries or significantly affect our economic and financial systems.
Between mid-2007 and 2008, crop failures caused by drought, low global stocks and the widespread use of export bans led to the price of major crops (wheat, maize, soybeans and rice) more than doubling.
For many developed countries, the increase in the grain price in 2007 and 2008 was easily absorbed and had marginal impact on food availability. For developing countries, more exposed to international trade, domestic prices increased dramatically. In some this triggered violent protests.
On 16 June, Lloyd’s of London published its Food System Shock report looking at whether a loss of food production in major breadbaskets could indirectly significantly affect the global insurance sector. It combines into one year a set of production shocks similar to those seen in the past for particular grains and considers the current and future possible geo-political landscape to outline some “what if” scenarios. The events are not predictions, but paint a picture of what a global shock to food production might look like.
What if Greece exits the euro and then the EU, and experiences massive domestic inflation as a result? What if this happens shortly before a food production shock, leading to a significant price spike in international markets? Would people in Athens go out and protest not being able to afford food? Would Athens look to Russia for food aid? What could the wider economic and financial impact of this be on already nervous markets? Is this event more likely than the one- in 200-year events the insurance industry is supposed to be able to withstand?
These types of questions are now being asked to explore the possible indirect impact of food production shocks. This is just the start of a discussion, which should reach well beyond the insurance sector.
When a country experiences a food production shock - whether through disease, drought, flooding, hail damage or wind – all can decimate food production. Scientists of the Intergovernmental Panel on Climate Change have found that in more extreme scenarios, heat and water stress could reduce yields by 25% between 2030 and 2049.
In countries such as the US, where government backing makes crop insurance viable, farmers get compensation for food production shocks and business can resume quickly.
Crop insurance is in its infancy, however, and mainly relies on large public-private partnerships to make it viable. One example is the partnership between Swiss Re and the World Bank covering drought in Malawi.
For developing countries, parametric crop insurance, which pays out on weather events, is seen as critical to ensure development gains are not wiped out in one wet or dry season.
Insurance will have a particularly important role in building resilience to food shocks, but the unpredictable nature of these will not make risk managers’ jobs easy. While economic modelling expects a perfect market response based on full information, the reality is messier.
If the insurance industry misunderstands the potential scale and interconnected nature of a food production shock and its indirect impact, insurance companies may fail. If insurance provides perverse incentives so that farmers either take more risks in an attempt to increase yields or take less preventative action to avoid losses because they are insured, it could make food production shocks larger.
Insurance, done well, alongside better policymaking and business planning, can improve the global food system. Done badly, it can make things a lot worse.
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