AS a looming drought in Western Australia appears increasingly likely to decimate grain production and farm incomes, there is some irony in the lack of enthusiasm shown by governments to firmly establish multi-peril insurance as a preferred option for farmers to reduce drought risk.

Mick Keogh

Just as the first blowfly heralds the arrival of summer, so the first media drought stories inevitably herald demands for drought aid, and it seems governments will once again be caught scrambling for policy responses if current conditions persist.

Australia has one of the riskiest environments in the world for farming, and governments and the farm sector have struggled for over one hundred years to develop a sensible set of policy measures that optimise the ability of farmers to manage adverse seasonal conditions.

Policy responses have ranged from a ‘do nothing’ approach in the early years of the previous century (with predictable Darwinian impacts on farm businesses and regional communities) to a set of policy measures by the end of the twentieth century that effectively meant governments were constantly handing out money and discouraging farmers from drought preparedness.

Australian variability

Unlike international jurisdictions, a viable farm multi-peril insurance market has never developed in Australia, despite or perhaps because Australian climatic conditions are much more variable than is the case in other developed nations.

Some argue that the availability of a constantly changing menu of government drought support policies, especially over the last 50 years, has discouraged both the supply of and demand for multi-peril insurance products, and there is undoubtedly some validity to that argument.

Others argue that the main market failure has always been the likely premium cost, especially in initial years when low uptake is likely to mean high underwriting risk, necessitating high premium costs which discourage uptake.

Drought agreement

The new intergovernmental agreement on drought policy, signed in May 2013 signalled a fresh start on drought policy, with the removal of business support measures and the strengthening of farm family welfare support.

This potentially created the opportunity for the development of multi-peril insurance, both as a means of helping farmers to manage income fluctuations caused by drought, but also as a way for governments to better manage the politics associated with drought, which in the past have invariably led to poor and hastily announced policy measures.

By encouraging the development of a viable multi-peril insurance market, governments would be in a better position to deflect the inevitable calls for taxpayer handouts next time a serious drought occurs.

There has been some recognition of the value of this approach at both the Australian and state government levels, with several different attempts made to provide stronger incentives to encourage self-insurance by farmers.

At the Australian Government level, the “Managing Farm Risk Program” was introduced which provided rebates of up to $2500 for farmer’s expenditure on advice and/or assessments related to multi-peril insurance policies. It is understood that only around 50 farmers have taken up this program.

The NSW Government commissioned its independent pricing regulator, IPART, to consider whether some form of subsidy for multi-peril insurance would be consistent with NSW commitments under national drought policy.

Perhaps to the surprise of the NSW Government, the interim report by IPART found that subsidising farm multi-peril insurance would be consistent with national drought policy, and may deliver benefits.

The final IPART report backed away from this initial finding, and the NSW Government firmly squashed any potential for such a subsidy in its response to the IPART report, although did agree to remove a 2.5 per cent stamp duty on multi-peril insurance products from 2018.

Market failure

There is obviously considerable debate about whether a ‘market failure’ exists in relation to multi-peril insurance that warrants government intervention – even during initial stages of the development of a market.

IPART seems to have waxed and waned on this issue to some degree, although the history of failed and discontinued efforts to create such a market over the past twenty years seems to provide pretty reasonable evidence that such a failure does exist.

The recent announcement by one company that it will ‘discontinue’ its insurance offering during 2017 is another depressingly familiar chapter in a history book full of promising commercial efforts that fail to persist in this market.

Given evidence of market failure that appears pretty compelling, the question is whether and what form of government intervention might be justified.

There is plenty of evidence that subsidising premium costs (farmers involved in the US multi-peril crop insurance scheme have about 60pc of their premium costs subsidised by the government) encourages adoption, but becomes almost politically impossible to discontinue.

Government run schemes are unlikely to be administratively efficient, and would create political difficulties in the event of an underwriting loss.

Subsidies for advice or assessments will always have limited impact if premiums remain relatively high, as has been the case recently.

Tax deduction

One suggested approach that appears to have some promise is for the Australian Government to offer a 150pc tax deduction on the cost of premiums paid for accredited farm multi-peril insurance policies, supported by an agreement by all state and territory governments to waive stamp duty on such insurance policies.

The 150pc tax deduction could potentially have a relatively low cost for the national government, as any revenue loss would be offset in drought years through farmers having income (from insurance policy payouts) on which tax would be payable.

At the same time, this income would flow through to regional communities, which typically suffer economic downturns as a consequence of serious drought, and hence impose additional social welfare costs on the government.

Similarly, state governments are likely to gain some potential benefits (in the form of more stable economic activity in regional communities) which will offset the loss of stamp duty revenue.

In combination, the adoption of these measures by national and state governments have the potential to do two important things to boost the adoption of multi-peril insurance.

The first is to reduce the effective premium cost, which will encourage greater farmer adoption, reducing underwriting risk, and ultimately lowering premium costs.

The second is to send a strong and enduring message to farmers that governments are committed to the development of a commercial multi-peril insurance market as the future mainstay of risk management by farmers, and that calls for drought handouts will fall on increasingly deaf ears in the future.

Governments have repeatedly told farmers that they need to be better prepared for droughts. Perhaps it time governments also took heed of this same advice!

Source: Australian Farm Institute. This article was originally published on the AFI website