Global Animal Health Initiative: The way forward Washington, 9 October 2007 OIE economic studies part III: Supporting insurance of disease losses by Civic

Global Animal Health Initiative: The way forwardWashington, 9 October 2007

OIE economic studies part III: Supporting insurance of disease losses

by

Civic Consulting

2Civic Consulting - OIE Economic studies parts II and IIIGlobal Animal Health Initiative, Washington, 9 October 2007

Question: Is market-based insurance part of the solution for covering epidemic disease losses?


Methodology

• Global survey of insurers / associations

• Interviews with insurers, reinsurers and brokers

• In-depth case studies of regions with existing insurance products for livestock related risks (EU, US, CIS, China, India, some other countries)

• Review of available literature


Study focus

• Overview of epidemic livestock disease insurance products available in some markets, determination of barriers preventing development in others

• Analysis of preconditions for market-based insurance products

• Options for supporting development of market-based insurance products


Insurance sector in developing and in transition countries /1

Insurance sector in emerging markets remains limited in comparison to industrialized countries:

• In 2005, industrialized countries accounted for 88% of global premium, and emerging markets for 12%

• Average per capita non-life premiums were $3,287 in industrialized countries compared to $77 in emerging markets, accounting for 3.82% and 1.42% of GDP respectively


Insurance sector in developing and in transition countries /2

But growth rates of premium income have been stronger in emerging markets:

• Most developing countries have liberalised domestic insurance markets, which were dominated by state owned insurance companies

• International insurance groups have increased their involvement, by joint venture or acquisition of local, state-owned or private companies


Agricultural insurance /1

Rural markets remain unattractive to insurers due to significant difficulties for insurance companies to penetrate into rural areas:• Small farm size• Low insurance awareness • Low economic capacity • Poor rural distribution networks • High rural transaction costs


Strong desire by governments and insurers to improve access to risk management and insurance for farmers:

• Increase of microinsurance, but less rapidly than microfinance

• The focus of agricultural insurance in developing countries has been on crop insurance

• Innovative product development, such as weather index products, has been introduced in a few countries to overcome limitations of traditional crop insurance products




Penetration for livestock insurance products is very low:

• Products marketed in developing countries are individual animal accidental mortality policies

• Sometime they include limited disease coverage, targeted at high value breeding stock.

• Such individual-animal policies have often been linked to credit for livestock, or linked to government programmes for the introduction of improved breeding stock


Summary - insurance sector

Current involvement of insurance sector in agricultural areas, particularly with livestock producers, is very limited

Epidemic cover is even more limited, and restricted to a few developed countries

Limited existing distribution channels to livestock producers

The few insurers specialized in agriculture would generally require significant capacity building to become involved in epidemic insurance programme design and implementation


Reinsurance sector in developing and in transition countries /1

Reinsurance (the insurance of insurance companies) needed to access additional capital, allow efficient transfer of risk, and expansion of risk acceptance capacity:• Reinsurance particularly important for products with

catastrophic exposure (e.g. drought, flood or epidemic disease)

• Financial capacity of national insurance markets is limited in

many developing countries reinsurers play an important role


Reinsurance for agriculture is dominated by a few of the major reinsurance companies operating internationally. Reinsurers have found it difficult to meet the demands of insurers in developing countries:

1. High need for technical assistance (start-up phase). Costs of assistance high in relation to expected transaction size

2. Often poor underwriting results, particularly in crop insurance (limited attractiveness)

3. Underwriting and loss assessment is difficult for individual-farmer policies, and there is often a lack of long term, reliable statistics needed for risk assessment and pricing

Reinsurance sector /2


Pre-conditions for epidemic livestock disease insurance in developing

countries

At least one insurance company in the country must be willing and able to take a commercial interest in establishing and distributing an epidemic disease product

Possibility to set up a pool of insurers

Likely, such an initiative would only follow a government plan to strengthen disease management and direct compensation, linked to external technical assistance, and to the support of interested reinsurers


Other pre-conditions /1

• Insurable client base of farmers in commercial livestock sector

• Effective national epidemic disease strategy and infrastructure including veterinary services

• Government compensation system for direct losses, backed by access to adequate national or international funding

• Linkage to government compensation programme for declaring outbreak, defining slaughter and quarantine zones

• Definition of covered / excluded diseases, diagnostic capacity


Other pre-conditions /2

• Geographically zoned client and livestock database

• Distribution channel(s) to reach farmers

• Technical assistance (design phase, ongoing support)

• Access to data and modelling of each covered disease, to permit estimation of maximum probable losses, establishment of appropriate financial limits, and setting of premiums

• Access to reinsurance

• Adequate legal and regulatory framework


Challenges faced in supporting the development of market-based

insurance products /1A main challenge for developing epidemic livestock disease insurance is the need for a well-planned government disease prevention and control programme.• Effectiveness of veterinary services influences risk of infection

and size of losses. Capacity of veterinary service is crucial: OIE PVS instrument could be valuable in assessing it

• In terms of loss assessment, it may be possible to follow government slaughter decisions, which for the insurer means a need for confidence in the independence and integrity of the services responsible for government slaughter decisions.


Challenges /2

Each country has different circumstances concerning:• Capacity of veterinary services

• Structure and degree of commercialisation, as well as organization and disease status of the livestock sectors

• Rural insurance, capacity of insurers

Each country would require tailored adaptation of epidemic

disease insurance solutions, although this could be eased within

a framework for international standardization in product

design, backed by technical assistance, and reinsurance


Challenges /3

Financial management of the consequences of disease outbreak, with infrequent but potentially severe claims, require major risk transfer by domestic insurance sectors

• International reinsurers would need to play important role, would be more interested in a programme aimed at developing such cover in many countries (economies of scale, risk spread)

• Layers of commercial reinsurance, and possibly high-level government-backed catastrophe cover could be foreseen


Conclusions: A global scheme to support the

development of market-based insurance products? /1

No “universal” scheme can be foreseen which would be suitable for application in all countries

There is a wide diversity between countries in the pre-conditions existing for an epidemic product

There is limited experience, in comparison to other classes of insurance, of epidemic scheme design and of best practices to act as examples for international transfer of know-how


Conclusions /2

In spite of the negative outlook for “a scheme” for market-based epidemic insurance, high degrees of synergy between the needs of the insurance market in the strengthening of VS, and other measures, e.g. a database for identification of livestock herds/owners

Market-based insurance needs to be integrally linked to a government compensation system for livestock diseases. It cannot replace such a system (need of linkage for loss assessment, problem of moral hazard)


Strategies to encourage epidemic insurance /1

Strategies which could directly encourage market-based epidemic insurance include:

Premium subsidy

Public sector reinsurance

Promotion of public – private partnerships

Technical assistance


Strategies to encourage epidemic insurance /2

Strategies which could indirectly encourage market-based epidemic insurance include:

Development of government and international veterinary services capability; use of benchmarking and independent evaluation of VS

Establishment of improved information systems

Client and livestock database

Classification of livestock sectors and disease risks


Answer: Market-based insurance can be part of the solution for covering epidemic disease

losses, if - the veterinary system is working,

- a government compensation system is in place, and

- the livestock and insurance sectors are ready.

Global Animal Health Initiative: The way forwardWashington, 9 October 2007

OIE economic studies part II: A global fund for emergency response in

developing countries

by

Civic Consulting*

*with support of Agra CEAS Consulting and from the Institute of Risk and Insurance of Hamburg University


Question: Is there a need for a global fund for emergency response in developing countries? If

so, how should it operate?


Methodology

• Desk research, literature review and construction of a detailed literature database

• Interviews with key institutions and experts

• Case studies of selected national compensation schemes for epidemic livestock diseases in four countries (The Netherlands, Australia, Vietnam, Nigeria)

• Case studies on operational principles of five global funds (GFFATM, UN CERF, WFP WCF, FAO SFERA; OIE WAHWF)

• Economic analysis based on incentive theory


Study focus

• The study explores the need for and possible operational rules of a Global Emergency Response Fund for Animal Epizootics and Zoonoses (GERFAE) that would provide developing and transition countries with immediate funding to cover the cost of control measures and livestock owners’ compensation costs


The current global financing framework – Progress /1

The global framework for the financing of costs and losses of epidemic livestock diseases has significantly improved during the last decade, partly as a consequence of the Avian Influenza crises and other large scale outbreaks of animal diseases



Significant progress during the last decade:• more global coordination of donors and recipient

countries,

• increasing number of multi-lateral financial initiatives and mechanisms, created mainly during the last few years

partly a response to the threat of AI and other zoonoses, but also the consequence of increased awareness for the need to have effective and efficient global mechanisms to address specific global problems or emergencies.



Other important developments:• Growing attention for a need to provide financial

resources for prevention of epidemic livestock diseases and improving VS

• Emergency response plans are increasingly prepared and implemented in many potentially affected countries

• Vaccine banks are being established that allow in case of outbreaks to respond rapidly with vaccination

• There is growing awareness for the need to compensate livestock holders in case of disease related culling


The current global financing framework – Shortcomings

However, there are still significant shortcomings:• Limited support: hardly any global structure for the financing

of animal disease risk management of TADs other than AI

• Fragmentation of donor response: Multilateral facilities do not address challenges of the animal disease risk adequately, namely its cumulative nature (highly volatile funding needs)

• Inefficiencies caused by lack of incentives for prevention

• No consistent policy on cost-sharing with farmers


The current global financing framework – Challenges

It is a significant challenge to develop an efficient global institutional framework to finance epidemic livestock disease risk, which:Mobilises and allocates financial resources for

epidemic livestock disease prevention and control for diseases other than AI

Creates incentives for prevention at all levels Provides a mechanism to cope with the highly

volatile nature of animal disease risk


Possible role for a Global Emergency Response Fund for Animal Epizootics

(GERFAE) /1Does not seem likely that it would be possible to improve global financing of animal disease risk management purely through better coordination of bilateral donor community:

• Needs to be a party that is ultimately taking and managing the animal disease risks agreed upon with eligible countries

• Unlikely that any individual donor would be willing to take this responsibility

Need for a new global mechanism for the financing of animal disease risk management


This new global mechanism for the financing of animal disease risk management could either be developed

• by extending the mandate of an existing fund/facility, for example developed in the framework of the AI crisis

• or by creating a new instrumentFor the aim of this analysis this question is

not of significance, as focus is on the operational rules

Possible role for GERFAE /2


Developing emergency response standards and technical assistance to implement them should as a general principle not be performed by GERFAE, but by other appropriate institutions of the global animal health framework

GERFAE would mainly be a financial instrument



The new instrument (or the existing facility with an extended mandate) would make a difference:

• It would focus on all eligible animal diseases• It would focus on providing a financial mechanism for

eligible developing countries. The financial support provided would be conditioned as to create incentives for prevention at all levels

• Its operational rules would take into account best practices to enhance control of eligible animal diseases, including through compensation of livestock holders, while preventing the creation of adverse incentives through overcompensation



GERFAE will ...1. Encourage an effective and rapid emergency response for control

of epidemic livestock diseases in developing and transition countries, including through compensation of´livestock holders

2. Function as a financial instrument, not as an implementing body3. Promote efficient global animal disease risk management4. Focus on diseases that pose a threat to “global public goods”5. Provide incentives for prevention and early reporting6. Safeguard ownership of emergency response by affected countries7. Encourage sharing responsibilities and costs where possible

Seven guiding principles


Planning and emergency response

Two different approaches are possible:

•Approach A: GERFAE would provide support to eligible countries in case of disease outbreak and provide support for emergency response planning in times without outbreaks

•Approach B: GERFAE would provide financial support to eligible countries in case of disease outbreak of a relevant disease only. Global support for emergency response planning through other sources/mechanisms

Analysis indicates advantage of Approach A


Eligible diseases, that may trigger support of GERFAE in case of an outbreak, should be determined on basis of the following criteria: The public relevance of a livestock disease

(depending e.g. on contagiousness and potential public health impact)

The need for global coordinated action

The character of a livestock disease as relevant emerging risk

Eligible diseases /1


Separate windows to support the emergency response regarding

outbreaks of the following diseases (in order of priority):

Category 1: Emerging livestock diseases of high public

relevance with a need for global coordinated action

Category 2: Other priority epidemic livestock disease(s) of high

public relevance with a need for global coordinated action;

Category 3: Under-funded diseases of high public relevance

with need for regional action, where countries in the region lack

resources and capacity and there is clear risk of global impact

Eligible diseases /2


Eligibility criteria /1

In principle, all emergency response measures that are supported from GERFAE should be co-financed in kind or in cash by the recipient country Co-financing requirements may differ for specific categories of emergency response measures and have to be pre-defined within each country emergency response plan to increase transparency and reduce the administrative burden related to documentation and audit


Eligibility criteria /2

Recipient countries need to have ...1. Pre-defined and costed country emergency response plan

for relevant diseases and earmarked contingency funds to co-finance measures

2. Country Compensation Mechanism in place to be eligible for support to compensation payments to livestock holders

3. Conducted a PVS evaluation of the Veterinary Services and to develop and implement a country strategy to upgrade Veterinary Service to address relevant deficits identified

4. A country emergency management facility in place that can coordinate measures in case of an outbreak

Need for a threshold related to income level of recipient countries


Mobilisation of funding /1

• Amongst national donor agencies the desire to contribute to such a fund has to be viewed in the context of a permanent tension between the ‘benefits’ of bilateral support compared to support channelled through multilateral agencies

• Deemed essential that disease control be driven by the powerful incentive of the prospect of increased sales and revenue for farmers and countries (access to markets)

• Issue of accountability - while donors seem to be willing to accept a ‘trust fund’ managed by an intermediary such as the World Bank which ‘signs off’ on the accounts, accountability may be difficult to achieve (compensation payments)



‘Most likely’ scenario (part I) of total direct disease losses and control costs of an HPAI outbreak, calculated on an annual basis:• US$ 5.3 billion in scenario A (H5N1 infected countries), • US$ 6.1 billion in scenario B (infected and non-infected

at immediate risk countries)• US$ 9.7 billion in scenario C (all OIE developing country

members)• If income eligibility criteria would apply (only LCD

eligible): Under the most likely scenario, estimated direct impact (excluding consequential losses) for the LDCs ranges from US$ 73 million (scenario A) to US$ 258 million (scenario B) and nearly US$ 600 million if all 40 LDCs were to be affected



Several factors influence the financial need of GERFAE: Income eligibility criterion concerning eligible countriesEligible diseases / measuresCo-financing rate requiredCompensation rates applied and types of costs /losses

coveredAssuming scenario B prevails and on basis of average compensation rates at 75% and a cofinancing rate for eligible countries of 50%, the total required annual budget for GERFAE regarding HPAI would amount to US$ 103 million for the LDCs affected under scenario B, or US$ 2.45 billion on a global level



Decisions on the eligible countries, diseases and measures, the co-financing rate required; compensation rates applied and types of costs compensated have to be taken early on in the planning process of GERFAE, as this significantly impacts on the budget required

Due to the variability of capital requirements for emergency response measures during a given budgeting period, an elaborated system for managing the risk of the fund has to be developed


Country Compensation Mechanism /1

Need for a close linkage between CCM and VS:• Emergency response planning of the Country

Compensation Mechanism (CCM) is directly related to planning of the Veterinary Service (VS) regarding culling

• Availability of data on livestock herds/holders crucial• Control measures carried out under the authority of the

VS, timely compensation requires close cooperation• Availability of contingency funds/a relevant government

budget line to (co-)finance measures is equally relevant for both CCM and VS



CCM has to be adapted to a country’s VS infrastructure and livestock production structure:

• No institutional „blueprint“ for CCM

• CCM should draw on existing social, political and industrial institutions in order to increase acceptance and reduce set-up costs

• To avoid collusion, the use of independent financial auditors is recommended



Common operational rules for CCM• Compensation requires registration: Registration of livestock

holders is an important precondition for animal disease risk management and compensation. However, in most countries a complete registration of livestock holders cannot be reached:

Need to differentiate between livestock production sectors. A CCM should define a maximum number of animals for each specie that are compensated in case of culling, if the livestock holder is not individually registered. This splits livestock industry in two sectors: registered commercial producers and unregistered small-scale and backyard producers


Compensation of commercial livestock producers /1

• Evidence from countries with HPAI outbreaks has shown that a compensation rate of 50% of the type specific animal value (based on market value) can be enough, if veterinary restrictions are accompanied by strong control efforts

• A compensation rate of over 100% of market value is not recommended because of the creation of adverse incentives

• Based on these international experiences it is suggested to provide higher compensation rates to commercial livestock producers meeting higher predefined bio-security standards


Compensation of commercial livestock producers /2

• Low, moderate and high bio-security farms should be compensated at rates of 60%, 75% and 90% of the animal value for healthy animals and half of these rates for visibly diseased animals. Dead animals not compensated (exceptions possible)

• Compliance of commercial livestock holders with veterinary restrictions either through an incentive-based approach by also compensating business interruption and other losses directly caused by veterinary restrictions, or through policing

• As soon as this is feasible, the GERFAE Governing Board should require CCMs from eligible countries to share costs and responsibilities with commercial livestock producers


Compensation of small-scale and backyard holders of livestock /1

Need for a community based compensation approach to increase collective responsibility and communal accountability for animal health:

• The CCM formally should treat groupings of small-scale/ back-yard livestock holders as one entity (production community)

• Compensation rules community-based, i.e. High numbers of visibly diseased and dead animals would

reduce compensation payments to the community as a whole. The individual livestock holder however receives a fixed share of total community compensation, which represents his share in the number of animals culled (independent from disease status)


Compensation of small-scale and backyard holders of livestock /2

• Animal losses due to culling incurred by small-scale and backyard holders of animals that are member of a production community compensated according to the bio-security level of the production community

• Animals from production communities that do not take specific precautions should be compensated at rates of 75% of the type-specific animal value for healthy animals and half of these rates for visibly diseased animals. For production communities adhering to certain verifiable bio-security measures (e.g. fencing of animals) this rate should be increased to 90%


Compensation of small-scale and backyard holders of livestock outside of

production communities /1

Atomised backyard holders of livestock are most problematic from a risk-management point of view: very difficult to reach – both to increase awareness for prevention/bio-security, and for control measures in case of an outbreak

The compensation guidelines should therefore provide clear incentives to form production communities, if the system is assumed to be feasible in the particular country/region




• Losses due to culling of animals backyard holders outside of production communities should be compensated at rates of 60% of the animal value for healthy animals and half of this rate for visibly diseased animals (i.e. lower than in production communities)

• An additional incentive for early disclosure could be provided by a first-notification compensation rate of 90% of the animal value for backyard holders (only for first notification in region)




• Caveat: Community based compensation approach needs to be tested thoroughly. Experiences (e.g. in Vietnam) seem to indicate that it is possible to channel compensation payments through existing communities. However, this may not be feasible in some regions or countries


GERFAE governance arrangements

To facilitate coordination of emergency planning and response, both activities should be funded by one mechanism under one management structure

• GERFAE should be created through a collaboration of relevant institutions. One institution should manage the day-to-day running and management of GERFAE, possibly in a Trustee function, in close cooperation with expert Technical Agencies

• GERFAE should have a governance structure which includes a Governing Board, an Advisory Panel and a Secretariat


Payment procedures & monitoring /1

Two levels are relevant:• At the level of the fund itself i.e. the relation

between the fund and recipient governments• At the level of disbursement of compensation

payments to livestock holders through a Country Compensation Mechanism

In both cases, it is essential that a clear audit trail is established


Payment procedures & monitoring /2

• Governing Board, with guidance from the Advisory Panel and Technical Agencies, must establish audit and monitoring processes, taking into account experiences of the ongoing projects funded through the Global Program for Avian Influenza

• Experience with other supranational compensation mechanisms shows that creating an audit trail for compensation costs is feasible, but can lead to a very high administrative burden

GERFAE needs to delegate as much auditing functions as possible through the use of independent financial auditors, to be contracted when a Country Compensation Mechanism is set up


Managing the risk of GERFAE /1

GERFAE has to provide funds rapidly to support emergency measures in eligible countries, even before related donor contributions are received:

• Challenge is to find financing strategy that addresses temporary shortcomings and prevent structural deficits in case of a catastrophic animal disease crisis

• Ex-ante contingent agreements should be arranged as opposed to negotiating ad hoc capital provision when capital is needed


Managing the risk of GERFAE /2

A layered approach to manage the risk of GERFAE:

1. Initial working capital: donor contributions that are sufficient to finance emergency response planning expenses („peace time“) and emergency response measures („outbreak“) under relatively certain scenarios within the given period

2. Contingent grants from donors: when needs are higher 3. Pre-arranged contingent loan agreements: could be

triggered in periods with several or large-scale outbreaks. To be paid back in following periods

4. GERFAE should also target to developing access to the international risk markets to relieve the burden of animal disease risk financing from donor budgets


Answer: Yes, there a need for a global risk-management instrument to finance emergency response in developing countries and provide

incentives for prevention at all levels. To make it work, an interagency collaboration is needed,

best practices in compensation have to be applied and hard choices will be required.

Documents

Global Animal Health Initiative: The way forward Washington, 9 October 2007 OIE economic studies part III: Supporting insurance of disease losses by Civic