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INDEX BASED INSURANCE (IBI)EZEKIEL MACHARIA FIACONSULTING ACTUARY
THE ROLE OF INDEX BASED INSURANCE IN SUPPORTING GDP GROWTH IN KENYA
APRIL 2016
PRESENTED TO MONTHY ACTUARIAL SOCIETY OF KENYA TALKNAIROBI, KENYA
AGENDAWhat is Index Based InsuranceRegulation and IRA Progressive Support
Pricing a Index Based ContractSupport for WIBIConclusion 2
INDEX BASED INSURANCE (IBI)
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An IBI contract is a contract whose payment to the policyholder is triggered based on one or more indices rather than the individual’s actual loss.
Payment is designed for compensation and not indemnity (mitigation costs or losses)
INDEX BASED INSURANCE (IBI)
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Payment may be triggered before the actual loss is incurred – can be used to meet cost of preparation or to mitigating effects of risk.
It is expected that the insured person has insurance risk – adverse & material impact (damage, loss -economic & consequential - and cost of mitigating risk)
INDEX BASED INSURANCE (IBI)
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Agree on an Index
Set points in the
index that will trigger
a claim
Index is Triggere
d
Repeat
INDEX BASED INSURANCE CONTRACT
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A simple trigger can be to pay a farmer KES 1,000 per day if the temperature in any given month exceeds 27oC.
The index is the observed daily temperature
The farmer has an insurable risk.*Source: World Bank – Climate Dataset
INDEX BASED INSURANCE CONTRACT
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It doesn’t have to be for farmers only
Index Insurance can pay when it rains on a policyholder’s wedding day.
*Source: 500.px
INDEX BASED INSURANCE CONTRACT
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The trigger point can be a commodity price
Derivatives Anyone?
*Source: 500.px
BASIS RISK
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Basis risk occurs when the client expects you to pay and you don’t or you pay when client is not expecting it.
For example, using the Rainfall in Nairobi as a measure when two clients – one in Langata and another in Donholm have different rainfall measures.
NO RAIN RAIN
SAME AREA
AGENDAWhat is Index Based InsuranceRegulation and IRA Draft Guidelines
Pricing a Index Based ContractSupport for WIBIConclusion 10
IRA DRAFT GUIDELINES
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1. Minimise Basis Risk2. Minimise adverse selection against insurer3. Contract is fair and adds value4. Reasonable maximum sum assured that is in line with the
losses/costs after risk5. Appropriate exclusions6. Purpose to cover high-impact low-likelihood events instead of
low-impact high-likelihood events.
Criteria for an IBI contract
IRA DRAFT GUIDELINES
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1. Transparent & Objective2. Data is produced/verifiable by an independent third
party3. Easily accessible data4. Data is sufficient & adequate to assess risk5. The trigger and amount payable can be determined in
a timely manner
Key Features
IRA DRAFT GUIDELINES
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1.Payment of a fixed sum based on a stated index/indices
2.Protect insurer with a maximum sum assured
3.Contract can be purchased by those who have insurable interest
4.Cash & Carry
Requirements
IRA DRAFT GUIDELINES
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1. No Cancellations2. Fall back Index in case the main index is unavailable3. Dispute resolution mechanism4. No assessment of risk or premium payment grace
period5. Policyholder to provide that that they had insurable
interest on cover start date
Requirements (2)
AGENDAWhat is Index Based InsuranceRegulation and IRA Draft Guidelines
Pricing a Index Based ContractSupport for WIBIConclusion 15
DATA
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1. Source of data used in each indexa) Index used to trigger paymentb) Index used to determine payment
2. Fall back index and its data source3. Data is appropriate, sufficient & adequate to assess risk4. If time series – appropriate historical data5. Data is independently verifiable6. Data is easily accessible
As actuaries – data is key
DERIVATIVES ANYONE?
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From the perspective of the person issuing a derivative (underwriter)
You give the client the option to buy an asset at a fixed price in the future.
Asset is in the money Client has to take the option but the
clearance house will ask you to put up some money immediately the contract is in the money– margin call.
Call Option From the perspective of
the insurer (underwriter) Based on a price of a
commodity (the index) On trigger, pay a certain
amount Automatic Payments
based on contract
Commodity IBI
HOW TO PRICE AN IBI CONTRACT
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1. Future level of index is unknown2. Pricing model will depend on the index and models used include:-
Binomial model Stochastic models (Brownian Motion – a stochastic process) Replicate the pay-off (Black Scholes Model - replicates the volatile Stocks
price)
3.Reinsurer and pass the headache
How do you price for a derivative?
What is Index Based InsuranceRegulation and IRA Draft Guidelines
Pricing a Index Based ContractSupport for WIBIConclusion
AGENDA
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KENYA
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Why Agriculture?Accounts for 25% direct contribution to GDP of Kenya27% indirect contribution - resulting in over 50% of contribution
to GDPSmall scale (75% below 3 hectares) and rain fed
Catastrophes in Agriculture2011 Drought worst in history – killed 30% of livestock in KenyaAnnual burden on extreme climate events in Kenya is KES 50b
(2% of GDP)
KENYA
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Private SectorAPA: Global Index Insurance Facility
Swiss Re, APA, ILRI – Livestock drought at 3% - 5% of cattle cost.AIG Index Based Weather Insurance CIC Index Based Weather Insurance UAP: Kilimo Salama Jubilee – Crop Insurance (Sorghum)Freshco Seeds: Discount on Seeds bought after extreme
weather Ngao ya Mkulima - APA & Micro-ensure
UGANDA : SUBSIDIES FOR MARKET
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Expectations of subsidy as per IRAU: Increase investments in agriculture sector and boost agriculture productivity due increased access to credit.
Risks covered: Excessive rain, fire, flood, drought, epidemics, crop pests and diseases.
After a BUNDALANGI government pays regular annual premium instead of 100%.
Subsidy based on acreage owned, annual income, kukus owned, pigs, fish farm and cattle
Everybody gets at least 30% subsidy
Kungula Agrinsurance Start Date: 1 July 2016 Farmers in Uganda get UGX 5b
(KES 160m) subsidy – to be allocated in the next financial year (2016/17).
Participating insurers: NIC, FICO Lion Assurance, APA, UAP, NIKO
What is Index Based InsuranceRegulation and IRA Draft Guidelines
Pricing a Index Based ContractSupport for WIBIConclusion
AGENDA
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CONCLUSION
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Next StepsIndex based insurance contract has an automatic
payment after an agreed trigger based on an index.IRA is already ahead of the market and developed
Draft GuidelinesPricing a IBI and pricing a derivative is similarThere is a lot of capital from private and public sector
to support IBI and in particular Weather IBI – Climate Risk
