AIR Multiple Peril Crop Insurance (MPCI) model gains traction in ILS

The insurance-linked security (ILS) and reinsurance-linked investment market increasingly shows an interest in adopting the use of crop insurance risk models, as the sector looks to find new avenues to deploy capital into for premium income return. The ILS and collateralized reinsurance market sees crop as a potential new peril.

Risk modeller AIR Worldwide has recently launched a newly updated version of its Multiple Peril Crop Insurance (MPCI) models for the U.S. and China. These are weather-based crop insurance models that estimate underwriting gains and losses based on crop yield probabilities depending on current weather conditions.

The MPCI Model has had a number of updates. The U.S. version accounts for the latest Standard Reinsurance Agreement (SRA) from the U.S. government to estimate retained losses for crop insurance firms. The model has also been enhanced to include multiple price volatility catalogs allowing for more refined reinsurance analysis given increasing uncertainty in commodity market prices. The new model also allows users to modify industry premiums by adjusting default values as the U.S. government changes premium rates of the key program crops. Finally, the historical event catalog has also been updated to incorporate data from all years from 1974 through 2011, and AIR has added new reporting tools allowing for easy manipulation and visualization of model results and output. The MPCI Model for China has been updated to include the latest policy conditions used in the market and an updated database of industry exposure.

In 2012, AIR siad that the majority of  traditional crop reinsurance transactions were modelled with its U.S. MPCI Model. Crop insurance firms use the models output to assess policy risk and allocate policies to the various risk-sharing funds available in the SRA program as part of their fund designation process.

Interestingly, AIR also notes that the model is increasingly being adopted by investors in the ILS crop risk transfer markets. A number of ILS funds and collateralized reinsurance markets are now deploying capital into crop reinsurance risks. Since the recent droughts, crop risk is seen as a profitable avenue for reinsurers and being weather-linked many ILS investors see it as a peril they can understand, analyse and measure.

We spoke with Oscar Vergara, business development manager at catastrophe modeling firm AIR Worldwide, who explained; “Aside from traditional reinsurance deals in the crop insurance market, there is a growing interest from the investment community for using the AIR Cop Model for alternative risk transfer.”

There is also increasing interest from some traditional reinsurers as well, Vergara expained; “Also, crop insurance is a good risk diversification vehicle for reinsurers that carry significant property risk from hurricanes. A good example of this was Hurricane Isaac in August 2012. It severely damaged property along the Gulf, but the inland precipitation basically ended the worst U.S. drought in the Corn Belt since 1988. By August the corn crop was severely damaged but the soybean crop was saved from the drought. As a result, the net loss ratio for crops in 2012 was 115%, which could have been much worse if not for the precipitation from Isaac.”

That also explains some of the interest from the ILS market, in using crop risk as a diversifying peril within their portfolios for investors. A number of ILS, collateralized and also retrocessional reinsurance players also see crop underwriting as a specialty they can offer to differentiate their reinsurance-linked investment proposition.

In time, it is likely we will see crop reinsurance become a bigger piece of the reinsurance-linked investment market, although perhaps not catastrophe bonds for the moment, although parametric and weather-indices could potentially facilitate this type of capital market risk transfer in future as the ILS market matures.

Not forgetting that the MPCI model is widely used across traditional insurance and reinsurance companies and will continue to be.

“The AIR crop models for the United States and China address significant weaknesses found in traditional crop models,” said Vergara. “To provide the most accurate probabilistic estimate of potential crop portfolio losses, they account for the effects of weather, technology improvements over time, changes in policy types and their market penetration, and changes in government protection agreements.”