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The PIISA project aims to evaluate the feasibility of insurance in managing climate risks in Europe. PIISA pilot 3, which investigates insurance services for agriculture, conducted a study to assess Finnish farmers’ interest in parametric weather insurances. Though Finland has a long tradition of providing indemnity insurances, parametric weather insurances are currently not sold in Finland. Sami Myyrä, leading expert for LocalTapiola, talks about the results of a questionnaire sent to LocalTapiola’s farm customers, which yielded over 600 responses.

Parametric insurances are still largely unknown among Finnish farmers

Finnish farmers have long managed weather risks either by different on-farm methods or by insurance cover. The Finnish government ran a crop damage compensation scheme until 2015. It was designed to cover weather induced crop losses. After the scheme was abolished due to moral hazard^{1 Moral hazard refers to insureds not having enough incentive to mitigate risks because they believe that insurance will cover the costs of possible damages.} , some insurance companies attempted to develop their own market-based risk sharing instruments to fill the void. However, the market for such instruments did not grow as expected.

Traditional indemnity insurance schemes have barriers such as moral hazard and asymmetric information^{2 Asymmetric information functions as a barrier when one party of an economic transaction can access more or better information, which they could then use to their advantage.} . In addition, with traditional indemnity insurances it is difficult to show whether damages occurred due to weather conditions or the farmers’ own actions. Parametric insurance could solve such issues by connecting insurance payout to a specific parameter triggering, such as certain levels of precipitation or temperature. Parameters cannot be manipulated by an individual farmer’s actions on the farm, and therefore they cannot be affected by barriers such as moral hazard. However, as Myyrä explains: “Here in Europe, we are still in the very early stages of insurance market development.”

Parametric insurances are not sold in Finland, and there is not even an established term in Finnish. Therefore, one of the most important steps of the study was to explain the idea behind parametric insurance in Finnish and still avoid the so-called anchoring effect, which could have affected the respondents’ answers and the reliability of the results. This also means that the study focused on a hypothetical product.

Farmers need risk management methods to manage weather risks in agriculture

According to Sami Myyrä, the main takeaway from the study is that most Finnish farmers recognise that climate change is happening, extreme weather events are more frequent than before, and it impacts their livelihoods. Most farmers agree that they cannot manage these risks with the methods currently available. “That is novel information”, says Myyrä. “I guess it did come as a surprise that farmers feel so strongly about the need for tools to manage risks”, he continues. It makes a strong case for the demand of new market-based risk sharing instruments. According to Myyrä, it is also surprising that in this situation the financial market lacks insurance products.

The study aimed at gauging the interest in parametric weather insurance among Finnish farmers. Based on the results, ⅔ of Finnish farmers are interested in managing weather risks through insurance. From this group, just over half accept parametric insurance, meaning that they also accept the basis risk^{3 Basis risk means that the parameters which describe weather variability do not always correlate with the yield and income variability experienced by farmers. Basis risk is unavoidable in parametric insurance.} included in this type of insurance product. Thus, around 38% of the arable land in Finland is owned by potential parametric weather insurance users. However, attitudes towards basis risk divide the farmers. On average, farmers reject basis risk and less than 20% think it would be fair to accept an indemnity payment without experiencing any real damages. This poses a real challenge to the development of parametric insurance schemes in Finland.

Farmer clusters based on their opinions on risk insurance
(% of all farmers)

Approximately ⅓ of farmers believe that they can manage crop variation on their own through agricultural methods, and that extreme weather events are not increasing due to climate change. This shows how Finnish farmers are a heterogeneous group and have varying needs in terms of risk management. But it is important to note that willingness to pay was not included in the scope of the questionnaire, thus leaving price elasticity as a topic for future research.

Parametric weather insurance has potential in the Finnish agricultural sector, but policy action is needed as well

“We need to respect our customers' opinions, [as] the customers own LocalTapiola”, Myyrä reminds, in response to how these results can be utilised by LocalTapiola or other insurance companies. “We might have to develop some kind of a hybrid [insurance option]”, he continues. Such an option could be based on a two-step model, where insurance compensation would require certain parameters to trigger as well as an on-site inspection. This is not ideal for insurers, as inspections are costly. This model is not a completely new idea, as LocalTapiola’s current product includes some weather-related parameters. In Finland, the farm customer group is small, so it’s best to develop a generic insurance product which suits most, rather than a pure parametric insurance product that only 1⁄3 of farmers are potential users of.

Myyrä calls for policy action as well, such as more active consideration of risk management elements, like premium subsidies. Such policies are already extensively in use in the United States, and echoes of this development have reached Europe. In Finland however, similar policies do not exist. According to Myyrä, premium subsidies should be considered in the Finnish context, because they could encourage farmers to bridge the insurance protection gap, resulting in better management of weather-based risks in Finnish agriculture.

After the study, PIISA pilot 3 continues with the other innovation rounds. Myyrä is especially keen on following up with the results from other countries, and LocalTapiola continues as an active partner in the PIISA project. Listening to the customers and showcasing their point of view was the study’s main contribution to the pilot.

Authors

• Marika Huttunen, Tyrsky Consulting"