Original publication: March 2016
Authors: Research Centre for the Management of Agricultural and Environmental Risks (CEIGRAM): Isabel Bardají, Alberto Garrido  (Coordinators)
CEIGRAM: Irene Blanco, Ana Felis, José María Sumpsi
Institute of Economics, Geography and Demography (CSIC): Tomás García-Azcárate
With the collaboration of:
University Grenoble Alpes: Geoffroy Enjolras
University of Naples Federico II: Fabian Capitanio
Short link to this post: http://bit.ly/2JoZlU3

Introduction and Objectives of the Study

There is wide consensus in the academic and political environments that EU agriculture faces important levels of uncertainties and insecurities in all relevant fronts. The risks farmers must cope with are often perceived differently from Member States (MS) to MS, which has led MS to develop their own risk management approaches. The 2013 CAP reform inaugurated a new era for the EU with respect to the development and implementation of alternative risk management tools. It had to strike a balance between pursuing common policy goals and allowing each MS to keep what it worked with respect to their own risk management approaches.

 

The purpose of the study is to review the implementing arrangements adopted by the MS with regard to the risk management provisions of Regulation (EU) No 1305/2013, which were submitted to the Commission in 2014. Specifically the goals are:

1) To develop a general overview of the state of play of risk management in 2014/2020 Rural Development Programmes submitted by Member States (or Regions);
2) To examine similarities and differences in risk management tools implemented in order to gain a better understanding of their scope, their design, their limits and their potential efficiency.
3) To suggest future CAP developments related to risk management in order to deal more effectively with income uncertainties and market volatility.

The document is structured into six chapters, including the introductory one. Chapter 2 proposes a mapping of main risk management instruments according to 15 different factors and includes a final section where reinsurance needs are discussed. Chapter 3 analyses the rules of the World Trade Organisation (WTO) and the institutional framework (CAP and State aids) to support agricultural risk management before and after 2014. Chapter 4 compiles detailed information about the implementation of risk management tools by Member States, both for the period 2007-2013 and 2014-2020. Chapter 5 develops some perspectives for supporting risk management in agriculture. Finally, chapter 6 includes some conclusions and recommendations. The document has also an Annex with an accompanying collection of fiches for those MS from which information could be collected and analysed.

Risk Management Instruments

As any other business, farming is a risky activity. There are risks that are idiosyncratic to the farm, while others are specifically related to the grown crops, raised animals, specific geographical location and specific markets where relevant prices are formed. Permitting farmers manage efficiently their risks enables them to make right investment choices and produce the commodities for which they have some comparative advantage. Currently,  farmers have different types of risk management instruments at their disposal: insurances, mutual funds, saving accounts, ad-hoc payments, and fiscal measures.

An insurance policy is based on a contract in which an insurer (farmer) pays a premium and receives compensation against losses caused by specific risks from an insurance company. In order to make premiums affordable, the insurance company has to be able to compensate risk through pooling farmers with different risk profiles. The most extended type of insurance is the single peril crop insurance that covers specific risk, mainly hail or frost. Income and revenue insurances are less developed, except in the US and Canada, but they have attracted increasing attention in the last years.

Mutual funds are based on the establishment of financial reserves, built up through participants’ contributions, which can be withdrawn by members in the event of severe income losses, according to predefined rules. The basic idea, common to the principle of insurance, is to spread the risk within a pool of members, with the additional effect that, by long-term commitments, mutual funds may also provide effective risk pooling also over time. The establishment of mutual funds can be encouraged by different kinds of public support, among them: i) contribution to start-up capital; ii) governmental allowances to annual contributions to the fund; iii) compensation of payments made to farmers; iv) fiscal incentives to the deposits of funds. One fundamental difference between mutual funds and insurance is that, while mutual funds group farmers according their production and region, revenue and income insurance are managed by governments or insurers and addressed to all kinds of farmers.

A main difficulty for Income Stabilization Tool (IST), either mutual fund or revenue/income insurance, is measuring the expected/guaranteed and actual revenue/income. It can be done either directly through tax and accounting records or through indices. At the moment, index insurance is not developed in the EU, mainly because of the heterogeneity of productions and climates. In these conditions, creating a crop index common to farmers of a same region appears difficult. Also, no overcompensation is admitted by the current EU regulation and this possibility may not be completely ruled out using indexes.

Saving accounts are a risk management tool based in the risk compensation (offset) along time, not among farms or farmers. Each year, farmers can make a deposit (part of their annual income) on a special account, which provides interest payments. In case of need, deposits, part or totally, can be withdrawn. In order to encourage the establishment of saving accounts, some public support can be envisaged: i) tax exemptions upon withdrawal; ii) subsidize savings by increasing interest rates; iii) governmental contributions to the deposits; iv) compensation of payments or withdrawals caused by production or income losses. One of the main advantages of savings accounts is that funds are kept by farmers and not transferred to an insurance company, which may incite farmers to use such instrument.

Fiscal and tax measures can also provide some revenue stabilization effect. If farmers are allowed to average out income during various years, they can reduce the tax receipts and compensating bad with good years. Taxes can also be reduced for farms that are hit by climatic hazards, and market and sanitary taxes.

Ad-hoc payments provide farmers some economic relief after suffering severe losses. In general, most Member States have some provisions to provide payments under catastrophes. Most of the times, ad-hoc payments serve the purpose of helping farmers rebuild their lost capital (buildings, roads, machinery, tree plantations…) or the herds, when available insurance cannot provide coverage for the  uffered losses.

Reinsurance is a particular form of insurance. Reinsurance covers are provided to insurers which pay premiums and receive indemnities if their portfolio is at-risk. There are two main methods of reinsurance: facultative reinsurance and treaty reinsurance. Also, two types of reinsurance arrangements: proportional contracts and non-proportional contracts. Reinsurers are part of the solution for large risks. Compared to insurers, their larger size makes them able to perform a geographical diversification. They have also a facilitated access to financial markets and investors. Some instruments may require public reinsurance support, but with time and counting on sufficiently large stabilisation reserves, instruments may not need public reinsurance.

The Support to Agricultural Risk Management in Agriculture

As direct public support to agriculture has been declining, other instruments with lesser distorting effects on trade have been developed. Insurance subsidies are qualified in the Uruguay Agreement on Agriculture (AoA) as distorting measures and included in Amber Box, unless they comply with the criterions set out in the Annex 2 of the Agreement. The conditions imposed in Annex 2 for qualifying insurance support as a green box policy are very severe. In fact, almost all notifications to WTO on insurance support are classified as amber box and most countries notify it as non-product-specific subsidies, at least until 2012.

The EU disposes of a flexible regulatory framework to support risk management instruments, which allows for coping with very diverse and heterogeneous agricultural risks faced across MS. This framework is delineated by the CAP and by the rules applicable to State aids in the agricultural sector.

Within the CAP, prior to the last reform for the period 2014/2020, the possibility to support risk management instruments was envisioned in Pillar 1. The first possibility was established in 2007 with the reform of sectoral regulations, starting with the fruit and vegetables (F&V) sector, followed by the wine sector, which allowed for introducing mechanisms of prevention and crisis management, including support to crop insurance or setting up mutual funds. More ambitiously, in 2008, the Health Check reform extended the possibility to support risk management instruments for all sectors through the use up to 10% of their national ceilings devoted to the single payment scheme (Article 68 of the Regulation (EC) No 73/2009).

During the period 2007-2013, State aids occupied a fundamental role in risk and crisis management. State aids are national government support granted to farms or companies. As they can hinder the competence their use has to comply with the EU regulation according Articles 107, 108 and 109 of the Treaty on the Functioning of the European Union. The general rule is that granting State aids is prohibited unless a) the Commission authorizes them on the basis of concluding that they are compatible with the internal market, b) the aid be exempted of the notification process or c) not constitute a State aid. In the first case, the authorization of State aids had to fulfil the Community Guidelines for State aids in the agricultural sector. Besides the guidelines, the Agricultural Block Exemption Regulation (ABER) determines the aids that are exempted from the notification procedure simplifying it and enabling the Commission to declare compatible some categories of aids. The main difference between the use of the Guidelines and the use of the Agricultural Block Exemption Regulation is that in the first case aid is required to be notified to the Commission that declares its compatibility or rejects it, while with ABER the MS is only required to communicate it 10 days before its entry into force, remaining afterwards responsible for demonstrating its compatibility. Finally, the last possibility is that the aid not be considered a State aid. In this case, the aid does not require that it be notified and only the Member State can ask the Commission for clearance. These aids are regulated by the “de minimis” Regulation , concerning aids granted to undertakings active in the primary production.

The reform of the CAP of 2014 represented an important change regarding the framework to support risk management instruments. The provisions on crisis prevention and management (CPM) for fruit and vegetables and wine sectors were kept in the new Common Market Organization (CMO). However, the main risk management tools, existing so far in the direct payments scheme, were shifted to Pillar 2 within the Regulation on support for Rural Development, with the possible inclusion of various measures in Rural Development Programmes (RDP) drawn up by MS. The support for risk management under Pillar II is considered through financial contributions to insurance premiums, mutual funds, and an income stabilisation tool (IST). The EU, recognizing the increased exposure to market risks and considering the importance of risk management instruments for the new circumstances, introduced this new IST instrument, albeit not in the form of insurance, rather as a mutual fund.

The measures included in the Rural Development Regulation have three major weaknesses: (1) they must strictly adhere to the criterions imposed by the WTO green box; (2) the ample margin of flexibility and optionality permitted in Pillar II might lead to an uneven implementation, not only among MS but also within MS; and (3) the inception of new risk management measures in the limited  budget of Pillar 2 would imply a reduction on the budget allocated to other important measures traditionally included in the RDP. Otherwise, the inclusion of support to risk management tools in the new CAP, even in Pillar 2, presents also some advantages. It is a first timid but important step, while it opens the door to a possible design of a new European risk management policy with flexible cofinancing; respectful with the budget distribution, and adapted to the characteristics and needs of different MS.

The rules applicable to State aid have also been updated in 2013 as part of Commission’s State aid Modernization initiative, going hand in hand with the new Rural Development policy. The rules regarding the conditions under which a State aids can be considered compatible with the internal market are in the Guidelines for State aid in the agricultural and forestry sectors and in rural areas for 2014 – 2020. These Guidelines do not consider specifically aids to support market risks. However, taking into account that all aids included in the CAP are compatible with the internal market by definition, the IST could be supported under State aids framework in the same conditions specified in the Regulation (EU) No 1305/2013. As in the previous 2007-2013 period, the aids exempted of the notification process are included in the Agricultural Block Exemption Regulation (“ABER”). The regulatory framework for State aids is characterized by its flexibility under a common and increasingly detailed outline. It should also be noted that the loosening of the need to meet the criteria for the green box, including all the support granted under the new Guidelines inside the amber box, make its implementation easier.

Implementation of Risk Management Tools by Member States

The EU does not count with a harmonised EU-wide agricultural risk management scheme. The types and extent to which risk management tools have been adopted differ widely within MS. Also, the level of coverage and subsidization vary widely from MS to MS with programs down to regional level in some EU MS. All this complexity, together with the fact that few or no figures at all can be found in standard statistical sources, make it extremely difficult to collect information on the situation of risk management tools in the EU. In the present study, data has been collected from various data sources: online databases, literature review, and expert consultations when possible. Special emphasis has been put on collecting information about government spending on the implementation of risk management tools in the agricultural sector in the 28 EU MS.

The findings of the study reveal that the risk management instruments supported by the CAP during 2007-2013 have not been very successful. First, the use of crisis prevention and management measures under Pilar I in the F&V and wine sectors has been very low (only EUR 173.47 million). General reasons behind this are the small size of many POs, the limited amount of financial resources, and the considerable amount of red tape involved. Although it seems to be a consensus for keeping CPM measures alive, available data for 2014-2020 suggest that harvest insurance and mutual funds will probably continue to have little role in the new single CMO. Second, provisions under Article 68 did get more attention, the EU spent EUR 761 million from 2010-2013. However, only a few MS used these provisions (France, Italy, Hungary and the Netherlands) and mainly in connection with crop/animal/plant insurance. In general, the implementation of mutual funds has been very limited, which may be explained by the inner complexity of this type of measure and the  narrow scope of the EU financial support, oriented only toward covering the administrative costs of setting up mutual funds, that limits their practical use.

For the period 2014-2020, the CAP offers the opportunity to fund risk management measures under Rural Development in Pillar II. Forecast amounts reveal that Pillar II expenditure on CPM measures will be higher than previous Pillar I expenditure under Article 68. Total public spending committed for the three risk management instruments available (insurance, mutual funds, and IST) is EUR 2699.6 million, with over EUR 1,700.7 million (63%) coming over CAP Pillar II budget. However, although the CAP support to agricultural  risk management has increased, the share of CAP funds being spent on CPM measures continue to be very low, over less than 2% of the Pillar II funds and 0.4% of the total 2014-2020 CAP budget. Looking at the take-up of measures by MS, it is noticed that all MS that used Pillar I Article 68 funding during 2007-2013 will be using new Pillar II rural development measures on risk prevention and management. Additionally, eight MS (five at the national level and three regionally) that were not previously using Article 68 will also be adopting risk management measures under Pillar II. The estimated number of EU holdings participating in risk management measures is 635,000, most of which are concentrated in France (some 495,000). As expected, ‘insurance’ is fairly the most extended measure. On the contrary, the implementation of mutual funds and, in particular, IST has been very low. At the moment, only two MS and one region have decided to apply the new IST.

All EU MS use State aids to respond to crisis situations. In fact, the bulk of MS is basing their public aids exclusively on State aids (ex-post measures devoted to crisis management), which reveal a clear under-use of ex-ante (risk) management measures. As expected, those MS which agriculture is highly exposed to risk, occupy the top of the ranking in terms of absolute public expenditure. Spain’s public aid is the biggest in absolute terms, followed by Italy, France, United Kingdom, Greece, Poland and Germany. When considering the amount of public support to risk management in relative terms, that is, in relation to the value of the agricultural output, Cyprus appears as the most publiclysupported risk management system, followed by Slovenia and Greece. In Greece and Cyprus insurance is public and compulsory. Thus, these results evidence that the level of development of agricultural insurance in a MS is linked also to the economic support given by each MS to the insurance systems.

Link to the full study: http://bit.ly/573-415

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