Global Animal Health Initiative: The way forward Washington, 9 October 2007

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

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

Agricultural insurance /2 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

Agricultural insurance /3 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 sector /2 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: • High need for technical assistance (start-up phase). Costs of assistance high in relation to expected transaction size • Often poor underwriting results, particularly in crop insurance (limited attractiveness) • 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

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/1 A 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 thedevelopment 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

The current global financing framework – Progress /2 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.

The current global financing framework – Progress /3 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)/1 Does 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

Possible role for GERFAE/2 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 instrument • For the aim of this analysis this question is not of significance, as focus is on the operational rules

Possible role for GERFAE/3 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

Possible role for GERFAE/4 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

Seven guiding principles GERFAE will ... • Encourage an effective and rapid emergency response for control of epidemic livestock diseases in developing and transition countries, including through compensation of´livestock holders • Function as a financial instrument, not as an implementing body • Promote efficient global animal disease risk management • Focus on diseases that pose a threat to “global public goods” • Provide incentives for prevention and early reporting • Safeguard ownership of emergency response by affected countries • Encourage sharing responsibilities and costs where possible

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 /1 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 /2 Separate windowsto 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

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 ... • Pre-defined and costed country emergency responseplan for relevant diseases and earmarked contingency funds to co-finance measures • Country Compensation Mechanismin place to be eligible for support to compensation payments to livestock holders • 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 • 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)

Mobilisation of funding /2 ‘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

Mobilisation of funding /3 Several factors influence the financial need of GERFAE: • Income eligibility criterion concerning eligible countries • Eligible diseases / measures • Co-financing rate required • Compensation rates applied and types of costs /losses covered Assuming 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

Mobilisation of funding /4 • 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

Country Compensation Mechanism /2 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

Country Compensation Mechanism /3 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

Global Animal Health Initiative: The way forward Washington, 9 October 2007