ANALISIS DE LOS PROCESOS DEL DEPARTAMENTO DE CAPITAL

Public Law 381 sets the stage for heavy government involvement in providing crop insurance. The law was a response to serious problems suffered in crop production in 2000 and 2002. However, the law also extended into other sectors in agriculture for calamities (livestock, poultry, hives and fish). These additional sectors merit some investigation. Nonetheless, this report is limited to only major crops in Romania (maize, wheat, barley, sunflowers, and soybeans). Despite this limitation, these crops comprise between 60% and 70% of the value of all crops in Romania, providing a good foundation for making some estimates of the possible cost of the new insurance law.

While the technical aspects of the newly passed law are still being finalized, it is difficult to know important details. Without knowledge of the details on implementation, it is possible to make mistakes in estimating likely cost. Still current interpretations of the law motivate an attempt to assess cost of the government proposal. First, it is reported that the government will provide free assistance for losses due to drought. Second, nearly all other losses will be paid with insurance that has a subsidy at some level to be

determined. The losses will be paid based on 70% of cost of production up to the point of the calamity. Further, losses will only be paid when crop yields are at 70% of normal or below (a 30% deductible).

In effect the government of Romania is embarking upon a multiple peril crop insurance plan. Such an undertaking represents a potential for a highly wasteful use of precious government resources. The beginning of this report documents the cost of various multiple peril crop insurance programs in others countries. This is done so that policy makers in Romania will begin to understand the cost and limitations of these programs. While these programs have many attractive features, they are expensive and require a significant infrastructure to implement. Such individual crop insurance is particularly problematic in a country like Romania. Given the small farm structure, the monitoring and implementation problems associated with a farm- level crop insurance program will very likely result in excessively high cost. Such cost can easily swamp any social benefits that may accrue from a crop insurance program in Romania. If significant investments are not made in monitoring, loss adjustment, and implementation, the crop insurance program planned for Romania will undergo tremendous moral hazard and adverse selection problems as has been developed elsewhere.

Given the analytical work presented in section 6, it is possible to make estimates of the probable cost of the current crop insurance law. Estimates of the pure premium rates for a 70% multiple peril crop insurance program are roughly 6.5%. As estimated in section 8, the true market cost for this policy would be about 14.2%. The value of crops examined in this work is roughly US $1.5 billion. This value would increase to about $2.5 billion if all crops are considered. Since the government plans to only cover cost of production, the total crop value can be reduced by a factor of roughly 60%. Thus, if all crops in Romania were insured, the total insured value would approach $1.5 billion. Drought losses in the US crop insurance program exceed 50% of the cause of loss.

7: Forecasting Costs for Romanian Crop Insurance Law GlobalAgRisk Report November, 2002 Drought is also the dominant cause of loss in Romania. To be conservative on the cost estimates, we assume that drought is only 50%. Given this and other assumptions, if the government provides free drought insurance, the expected losses can be calculated using some straightforward assumptions.

ü Drought accounts for 50% of the expected crop losses a 70% MPCI ü A conservative premium rate of 10% will be used

ü A value of $1.5 billion will be assumed eligible for assistance 10% x 50% x $1.5 billion = $75 million.

Thus, it is not unreasonable to expect that the average cost of the free drought assistance in Romania could be $75 million per year. Given the shape of the loss functions that are presented in section 5, one can also expect years with excess loss that are five times the average loss values. Therefore, in the biggest drought years, such a program could have cost that exceed $357 million. Keep in mind that these estimates are developed using a conservative premium rate of 10% and not the 14.2% value that is estimated in section 8 below.

Beyond the direct cost associated with providing free drought insurance, there is mention of additional subsidies that would be provided for the multiple crop insurance program and for the livestock, poultry, hives and fish. While it is difficult to kno w what these added cost may be; one can take a relatively straightforward approach at estimating them. For example, if we assume that the premium subsidy is a modest 20% of premium and that participation rates in the insurance are at 50%, it is easy to envision added another $25 million to the $75 million annual estimate above.

ü 50% participation on a value of $1.5 billion

ü 20% premium rate subsidy on a premium rate of 14%

These cost estimates are provided as a baseline only. There are many assumptions that will change the estimates. However, the methods and information presented in this report can be used for a variety of assumptions. It is hoped that policy officials in Romania will attempt to make similar cost estimates using their own

assumptions. The assumptions developed here may well underestimate what these programs could cost the Romania government. Thus, any information that elevates the debate and discussion regarding the likely cost of these programs could be critical at this moment in Ro manian history.

8: Recommended Strategies for Crop Insurance in Romania GlobalAgRisk Report November, 2002