Can this be made mandatory?

Aug 19 - 25, 2002

The GoP wishes to promote crop insurance with an objective to hedge the risk associated with lending to agriculture sector by the commercial banks. There is general lack of awareness about insurance and insurance companies, after burning their fingers in the past, are reluctant. Under the new arrangement Securities and Exchange Commission of Pakistan (SECP) is required to oversee the insurance companies, which has not been able to quantify the business. It is yet not clear that what sort of covers will be available. It may be true that hedging the risk of farmers is necessary to minimize the government liability particularly in case of natural calamity, but hedging of lending seems to be the GoP's priority.

One may ask why hedging of credit risk is more important than protecting the interest of farmers? The reason is that specialized financial institutions as well as nationalized commercial banks (NCBs) have been extending large credit to the agriculture sector. It comprises of two key areas< 1) loans for the purchase of agricultural implements and 2) credit for the procurement of various inputs, i.e. seed, fertilizer and pesticides. In case of any natural calamity the GoP has to bear double the amount. The GoP is obliged to write off agricultural loans, either partly or completely and provide financial support to the farmers. Therefore, the analysts believe that the GoP has realized the need for crop insurance though very late. Under the proposed arrangements, when fully implemented, insurance companies will pay the claim to farmers, who in turn will settle their liabilities towards the financial institutions. The added advantage to the GoP will be the saving of millions of rupees paid almost every year.

Insurance sector experts believe that since the GoP wishes to minimize its risk it must also take the initiative. National Insurance Corporation (NIC) enjoys the exclusive right to underwrite insurance business originating from the public sector. Therefore, NIC should provide risk cover for credit, related to agriculture sector, mainly lent by the financial institutions operating in the public sector. As the system and mechanism develop private sector insurance companies will be more than willing to underwrite crop insurance business.

An important factor to be kept in mind is that the quantum of crop insurance business has not been estimated as yet. To start with one may use two basic indicators to estimate the size of crop insurance business. These are: 1) worth of four major crops, namely wheat, rice, cotton and sugarcane and 2) grand total of funds extended under agriculture loans by all the financial institutions for seed, fertilizer and pesticides.

If crop insurance remains voluntary, no farmer will be keen. Therefore, the only way to implement this scheme is to make crop insurance mandatory. Bulk of the general insurance business is realized due to mandatory requirement of financial institutions which demand insurance of goods in transit, plant and machinery, stocks and vehicles. A similar approach should also be followed at the time of credit disbursement to agriculture sector.

The critics may say that most of the farmers are poor and cannot afford payment of insurance premium. This is an over exaggeration of the fact. It is on record that 98 per cent of cultivable land is controlled by less than two per cent of the total farmers. Therefore, it will be the land owners who will be required to pay the premium. However, agri sector experts also say that most of the land owners fall in the category of 'absentee' land owners and farmers/workers are forced to pay all types of taxes.

According to sector experts some common denominator has to be used. In Pakistan this common denominator is PIU (produce index unit). Since land revenue and loans are approved on the basis of PIUs, the same may also be used for payment of crop insurance premium. As the basic purpose of crop insurance is to hedge the risk of medium to small farmers, the size of applicable PIU can be worked out with the help of Agriculture Development Bank of Pakistan (ADBP), which has the longest history of credit extension to farmers.

Analysts say that various models are also available round the globe, including our neighbouring country India. Based on their experience and expertise detailed strategy can be developed. It may also be mentioned that initially part of the premium may be realized from other stakeholders. In agriculture there are three main stakeholders: 1) the government, 2) financial institutions and 3) farmers.

One may raise the question, why should the government and financial institutions share the premium? In case of any natural calamity the government and financial institutions get the biggest hit. With the shortfall in the produce, the government has to spent millions of dollars for the import of these commodities. The shortage also affects exports.

The SECP has recently appointed Etrat Rizvi as Commissioner Securities (Insurance). He has very aptly managed various financial institutions. Implementation of crop insurance is a test case for him. The insurance companies must help him in making this dream come true.