Hydrological droughts are a major risk for irrigated agriculture in many regions of the world. The aim of this article is to propose an insurance tool to help irrigators manage the risk of water scarcity in the framework of the Spanish Crop Insurance System (SCIS). Only the United States Insurance System provides this type of coverage, but has very restrictive conditions. To determine the type of insurance scheme that better fits with the SCIS and to the Spanish irrigated agriculture, an expert panel was held with the participation of all stakeholders involved in crop insurance. Following the expert panel conclusions, an hydrological drought index insurance (HDII) addressed to irrigation districts (ID) is proposed. It would compensate water deficits suffered in the whole ID. We detail the conditions that the ID should fulfill to be eligible for HDII. HDII is applied to the Bardenas Irrigation District V (ID-V) in Spain, and the hedging effectiveness of the instrument is analyzed comparing ID-V’s gross margins with and without the insurance contract. Results suggest that the proposed insurance scheme could provide an effective means of reducing farmers’ vulnerability to water shortages and there is no major impediment for it to be included as a new line in the SCIS. This type of insurance can be generalized to any ID fulfilling the conditions mentioned in this paper.
Drought is one of the main environmental risks in Mediterranean Europe. Climate change predictions indicate that droughts will intensify in the 21st century in the region (
To manage water scarcity, deficit irrigation has been studied and implemented, particularly to ligneous crops, showing satisfactory results (
The Spanish Crop Insurance System (SCIS) is one of the most advanced and widespread systems in the EU, serving as a benchmark for international comparisons of insurance systems (
As far as we know, the only experience on drought insurance for irrigated agriculture is implemented in the USA. The Multiple Peril Crop Insurance program in the USA covers the unexpected failure of irrigation water supply. Irrigated yield losses are covered when water shortages are due to a naturally occurring event and cannot be foreseen at the time of the insurance take-up (prevented planting insurance is a possible alternative when a water shortage is expected). The insurance scheme has detailed provisions in order to avoid moral hazard. Besides, decreased water allocations due to a diversion of water for environmental reasons, selling water to municipalities, or other causes are not covered (
Several researchers have proposed other insurance schemes covering water shortage risk. Traditional schemes, using crop production functions or crop simulation models to assess the economic impact of drought have been proposed in some irrigated regions of Spain (
The aim of this article is to propose an insurance tool to protect irrigators against water scarcity in the framework of the SCIS. The tool would mitigate the economic cost of water shortages. The novelty of our approach, with respect to other insurance schemes proposed, is the use of an expert panel formed by 8 individuals representing all stakeholders to select which design is more adapted to the needs of the Spanish irrigators. The Panel included experts and stakeholders related to both water management in the Spain and the SCIS. As a result of the expert panel (the next section offers a detailed description), the best option to ensure irrigated crops in Spain would be a Hydrological Drought Index Insurance (HDII) contracted by the Irrigation District (ID). Index insurance to protect irrigators against water scarcity had already been proposed in the literature by
An expert panel
Two types of insurance schemes were discussed (1) a traditional insurance scheme, with on–field loss adjustment, and (2) an index insurance. In this paper, we refer to index insurance as a type of weather or hydrological based index insurance, in which the indemnity is based on measurements of a specific weather or hydrologic parameter which is the Drought Index (DI). In the proposed index insurance the indemnities are calculated from an hydrological DI which is multiplied by a unitary value of water (calculated from the added value of water of the region). Index insurance gathered more acceptances among the participants to the expert panel. Although on-field loss-assessment provides a better adjustment of the losses suffered by farmers, it is not compatible with water markets and transfer of water rights. An insured irrigator that sells water rights will suffer a yield loss and would receive a double compensation or payment for the loss, from the insurance scheme and from water rights transfer. In consequence, the sale of water rights is not permitted in this type of schemes. Besides, the use of more efficient irrigation methods, water banking and other water sources (via water markets, groundwater, desalinated water, etc.) is not encouraged, since the payoff is adjusted based on the yield finally obtained, so there is no interest in obtaining a higher yield. On the other hand, an index insurance, in which the indemnity is based on an external objective indicator, would be compatible with voluntary exchanges of water rights. In the case of an irrigator selling water rights, the index insurance scheme will only compensate for the potential loss associated to the DI value, while the actual additional decrease in the crop production value due to the transfer of water rights will be compensated exclusively by the water rights price. In consequence both compensations are complementary, and do not overlap as in the previous case. At the same time, the use of more efficient irrigation methods, water banking and the use of other water sources is not discouraged. The farmer would still want to obtain the highest possible yield, since the insurance will anyway pay the indemnity that corresponds to the potential loss of each farm. Irrigators will not hesitate in buying water to other irrigators, investing on more efficient irrigation techniques, in order to obtain a higher yield. Index insurance is also easier to implement because there is no need to monitor moral hazard and to perform on field loss-assessment.
Several difficulties hindering the implementation of such scheme were identified. Basis risk is one of them, which implies that the payment may not necessarily correspond to the actual losses incurred by the insurance policy holder (
Concerning who should be the policyholder, either (a) individual farmer or (b) collectivity, a collective insurance policy, contracted by the ID as a whole, is preferred. This preference is explained by the fact that usually, within the same ID, irrigators do not receive the same water allotment per hectare. Water allotments for each irrigator are not only dependent on water availability, but they might be dependent as well on (i) the type of crops cultivated, (ii) water rights hold and /or purchased (in case there is a running water market) by the irrigator, and also on (iii) the quantity of water that each irrigator asks for at the beginning of the irrigation season. These water distribution mechanisms promote a more efficient use of water, since the most productive lands would probably receive more water than the least productive lands. But at the same time, all these variables (from (i) to (iii)) taking part in water distribution mechanisms within an ID make difficult defining clear rules in water distribution that would remain constant over the years. In consequence, a collective insurance policy is the insurance scheme most appropriate to cover water supply risk. Nevertheless, it was highlighted that the implementation of a collective policy, especially with regard to the premium share and the indemnities distribution, is a delicate issue, since individual risk aversion and cropping patterns might be highly diversified within the same ID. Additionally, the fact that the insurance is bought by the ID, makes it compulsory for all irrigators, even for those who are not interested in buying it.
According to the ideas drawn from the expert panel we conclude that the best option to ensure irrigated crops in Spain is a HDII contracted by the ID. HDII uses a DI to estimate farmer losses due to water shortages. The unitary indemnity is given per square meter of water deficit per hectare.
The HDII defines a guaranteed level of water allotment measured in m3/ha. This guaranteed water allotment (
The water allotment in an ID (
The model reflects the decisions related to water management and infrastructure operations. The design of index insurance requires that hydrological data should be stationary (DI and water allotments), otherwise detrending procedures should be implemented. In addition, operating rules should remain constant over the guarantee period of the contract. The selection of the index
The indemnity (€/ha) received in a year
We estimate this unitary indemnity or
where
We estimate a water value that varies depending on the water allocated to the ID. The average water value corresponding to water allotment received is calculated comparing a scenario
Consequently, there is an average water value for each water allotment
The liability or guaranteed value of the insurance scheme is determined following
The threshold of the DI that triggers a payoff (
The premium rate of the insurance scheme is calculated based on the expected indemnity (
All premium rates calculated in this paper are pure premiums, without subsidies or any additional costs. A charge to cover administrative, underwriting, reserves, reinsurance and operating costs should be added to the premium. However, the charge should be smaller than in traditional insurance because there is no need of on-field loss adjustment.
In case ligneous crops are present in the ID, several characteristics are to be considered when establishing the premium rate and the unitary indemnity: (i) crop distribution in the farm that presents exclusively ligneous crop does not change, consequently, the unitary indemnity to be received by the farmer is specific to the crop; (ii) unitary indemnity should reflect that ligneous-crop economic losses might be higher (investment is higher) and might be prolonged several years after the cause of loss, since the plant health might be threatened and next season’s yield may be lower; (iii) Drought Management Plans in Spain prioritizes water allocation to ligneous crops over annual crops, in consequence risk of water shortage is smaller.
Basis risk of the index insurance is analyzed comparing insurance indemnities and actual losses. Insurance indemnities are calculated according to the index insurance scheme, so that water allotments are estimated from past records of drought indices. Actual losses are calculated directly from historical water allotments. The probable farmer losses and gains due to index insurance basis risk are denoted as basis loss and basis gain respectively (
The hedging effectiveness of index insurance is analyzed by comparing ID gross margin with and without the insurance contract, measuring the standard deviation (
The gross margin in the ID in a year
The average gross margin by crop is calculated following
where
For calculating the gross margin, indirect costs, amortizations, and subsidies were not considered. Gross margin of fallow land was then equal to 0. For the evaluation of the hedging performance of the index insurance, we considered a constant gross margin per crop, because the instrument is meant to stabilize the losses due to water scarcity, and not to changes in prices, production costs, or crop yields due to other causes (
In order to generalize the methodology, we detailed the conditions (C) that an ID should meet to be insured under the insurance scheme proposed:
(C1) The ID (actual policy holder) assembles all irrigators that irrigate their farm from the same water source. The ID is responsible of the water distribution among irrigators and is in charge of collecting water fees.
(C2) Ideally, water supply in the ID comes from a reservoir or a reservoir system situated in the headwaters, where inflows do not depend on human actions, but only on weather conditions. Otherwise, the DI should be selected carefully in order to be objective.
(C3) Water shortages cannot be predicted at the beginning of the crop season (the take up period). In other words, the correlation between historical volumes stored at the beginning of the crop season and the historical volume stored at the beginning of the irrigation season should be not significant.
(C4) When implementing the insurance scheme, the payment of the premium and management of economic compensations in case of drought is carried out by the ID’s managers. The ID distributes water, the premium share and the economic compensation between the farmers in order to optimize water productivity in the whole ID. The sharing rule shall be signed by every member of the ID.
The region of study was selected in order to fulfill all conditions described in the previous section and is vulnerable to hydrological droughts. The most restrictive condition is C3, since it is common that reservoirs servicing the main irrigated areas store more than one-year of water demands to face drought episodes. Collaboration and data provided by the ID was also decisive to select the study area.
Case study selected is located in the Bardenas General Irrigation District, in the Ebro River Basin. It distributes irrigation water to 82,000 ha of irrigable land divided into 20 irrigation sub-districts (ID) located mainly in the province of Saragossa. Crop water demand is established at 7512 m3/ha (
ID-V is serviced by the Bardenas Canal, which is serviced with water from the Yesa Reservoir (with a maximum capacity of 447 hm3
The Bardenas General Irrigation District is irrigated mainly by surface irrigation (78%) and to a lesser extent by sprinkler irrigation (22%). The main irrigated crops are winter cereals (38%), maize (21%) and alfalfa (20%) (
For the unitary indemnity calculation and for calculating the hedging effectiveness, data concerning provincial crop yields and national crop prices are sourced from the Statistical Yearbook data set published by the Ministry of Agriculture, Food and Environment (
For the empirical estimation of the regression that estimates water allotments depending on the Indicator, Drought Status Indicators (DSI) were facilitated by the Confederación Hidrográfica del Ebro. Last, crop water allotments, were sourced from the Bardenas annual reports (
In order to estimate the unitary indemnity, depending on the water allotment finally received, we have defined different crop distribution scenarios (see
We tested several DIs, and selected the one that best correlates with water allotments in the ID. The DIs tested are those defined in the 2007 Drought Management Plan (DMP), called DSIs measured in February, March, April, May and June, for regulated sections (DSI based on reservoir stocks) and non-regulated sections (DSI calculated from river flows) in the Aragon River Operating system (
Asterisks denote significance level *=10%, **=5%, and ***=1%.
Linear and log linear models linking the DI selected and water allotments are compared by means of the Box-Cox transformation. Data series from 2000 to 2014 and OLS estimation were used for the model estimation. Despite the fact that water management regulations have changed (Drought Management Plan is being applied since 2007), water management rules are consistent over the whole period 2000-2014, since no statistically significant changes are detected before and after 2007.
Water allotments delivered in 2000 and 2001 are considered outliers, since they are far larger than the crop water demand that is planned in the River Basin Plan (
Asterisks denote significance level *=10%, **=5%, and ***=1%.
The crop surface distribution, the water allotment and the NVAP associated with each scenario described in previous section are presented in
The index insurance guarantees the average water allotment received in the ID in the period 2000-2014, for
In this research we have identified several sources of basis risk: basis risk associated to the selected DI, and basis risk associated to the use of an Aux I to estimate water stocks in order to reduce the risk of index manipulation. Both measures of basis risk are disaggregated in basis loss and basis gain comparing indemnities from the insurance scheme (based on drought indices either actual or estimated) to potential indemnities calculated from past records of whole-farm
In order to test the performance of the index insurance in reducing economic consequences of water supply risk, we compared the ID gross margin or GM
In addition to the pure premium rate, we consider premium loadings of 20%, 30%, and 40%, representing possible administrative and capital costs of the insurance company. Results of the hedging effectiveness analysis of the index insurance scheme can be observed in
The proposed insurance scheme has some issues related to its implementation that merit a few comments. Firstly, the implementation of the collective policy may confront some difficulties since all irrigators in the ID should agree on the decision to insure and on contract conditions. In case farmers from the ID do not find a consensus that satisfies all of them, one alternative would be to establish individual contracts (so contract conditions C1 & C4 would no longer be applicable). Individual contracts following the scheme proposed can only be established in the case water allocation between the farmers is fixed and not subject to the irrigators water allocation’s requests. However, this is unlikely, since usually irrigators make a formal request to the ID concerning the water allocation they need. Then, ID tries to meet all irrigators’ requests taking into account water availability and water rights. As a consequence, insurance is to be based on the average water allotment granted to the ID by the Basin Agency. The insurance design would then offer excessive coverage to irrigators cultivating low water demanding crops and would fall short offering coverage those cultivating high-water demanding crops. Another alternative would be to let the irrigators set freely the liability, as proposed by
Secondly, the insurance scheme requires that water management rules should be implemented in full over the validity period of the insurance policy and no significant changes in water infrastructure should be observed. In case it does not hold, the model and all the calculations will need to be updated. Since there would not be historic data on DI and water allotments for the new situation, we could only rely on water simulation models to generate water allotments and DI values under the new situation. In case of technical change in crop production, it would not affect the index insurance model that estimates water allotments from a DI. However, it might affect the water allotment guaranteed and also the unitary indemnity estimation, since technical changes would result in larger farmer’s income, yielding higher GM for the same water allotment.
Thirdly, the probability and severity of droughts can also be influenced by climate change. Climate change introduces an additional factor of uncertainty in drought risks (
Finally, unitary indemnity estimation does not completely offset economic losses that might affect ligneous crops in case of drought, especially when drought affects production in subsequent years.
Some limitations specifically related to our findings for the Bardenas case study are associated to data availability. The unitary indemnity estimation and hedging effectiveness analysis rely on provincial and regional data, and not on local data. Besides, some of the crop patterns linked to water allotment scenarios, used for the unitary indemnity calculation, are designed based on the discussion with irrigators, due to the lack of longer data series. This could be a source of inaccuracies in the results that could be addressed with appropriate and longer data series. Collaboration among insurance companies, producers associations, and/or public entities would be required to have access to a more appropriate data. Besides, we have detected the presence of outliers in water allotments in the period analyzed, which had to be addressed including a Binary variable to the model.
Additional insight into the quality of our results is gathered by comparing our findings to previous literature results. Firstly, the liability of our insurance scheme (equal to 752 €/ha) is smaller than the liability reported by
There are some issues about the use of the Aux I, which is required in case the selected DI might be subject to manipulation. One disadvantage of its use is the increase in basis risk. In our case study, the use of an Aux I increases basis loss (0.11% for NFD and 0.03% for FD) and basis gain (0.08% for NFD and 0.8% for FD). Another important fact to take into account is that the Aux I would not reflect some impediments that might prevent water from being delivered to irrigators, such as a breakdown in the canals or conveyance system, or a pollution problem. Under these circumstances, irrigators would not receive an indemnity, but would suffer economic losses. This would need to be clearly stated in the policy wording. If water management is performed according to predefined rules, there would be no need of such an Aux I, which may be warranted when the selected DI (
It is interesting to observe how basis risk is distributed among basis loss and basis gain. Ideally basis loss and basis gain should be similar, so the insurance scheme is favoring neither the farmer nor the insurance company. In Bardenas, basis loss in the analysis period is larger than basis gain in all cases, meaning that the insurance scheme is overestimating water allotments. This is due to the fact that in several years the DI was above the trigger, and irrigators received a water allotment below the guaranteed water allotment. These cases would require further investigation. Despite this, the hedging effectiveness analysis shows that NFD and FD insurance schemes are effectively reducing risk exposure, even considering a 40% premium load to cover administrative and capital costs of the insurance company. Note that premium loading for the FD scheme might be smaller than for the NFD scheme, because the more frequent the payoffs take place, the higher the administrative costs that the insurance company is going to charge.
Results suggest that the insurance scheme would be useful to provide economic stability to IDs. It would constitute a means for irrigators to adapt to climate variability and it could encourage investment in irrigation technologies as a means of adaptation for dryland farmers. It would also promote a more efficient use of the irrigation water. This insurance can be generalized to any ID fulfilling the conditions mentioned in Section “Index insurance design, hedging effectiveness, and contract conditions”. IDs not fulfilling condition C3 might be subject to intertemporal adverse selection. Intertemporal adverse selection comes from the fact that preseason weather information can influence crop insurance decisions (
The use of an expert panel to determine the type of insurance scheme that better fits with the Spanish framework is expected to bridge the gap between theory and practice, contributing to a more attractive and adapted insurance scheme to local conditions. Further discussions with the expert panel exploring the implementation difficulties of the insurance scheme selected and developed would be of interest for the research.
Public support to index insurance is currently accepted in EU legislation, under certain conditions. Specifically,
The main strength of this insurance scheme is the compatibility with water markets, water banking, transfer of water rights, and groundwater use. Another important strength is that farmers might receive the economic compensation as soon as the DI is measured, far before the end of the crop season, allowing them to have ready cash for any eventuality arising in the crop season, such as the possibility of participating in water market mechanisms.
We acknowledge the collaboration and data provided by the Bardenas Irrigation District and the Office of the Undersecretary General for Analysis, Prospective and Coordination at the Spanish Ministry of Agriculture, Food and Environment. We would like as well to thank the collaboration of Jorge Ruiz, Ana Iglesias, Dionisio Pérez, and all experts and stakeholders that participated in the expert panel, as well as two anonymous reviewers for many constructive comments.
The expert panel is part of the project “Hydrological drought insurance for irrigation: an adaptation tool for climate change” (AGL2010-17634).
The Olympic average is defined as an arithmetic mean calculated after first dropping the highest and lowest values within the last five years, measure that is established in the World Trade Organization’s risk management agreements.
Yesa reservoir enlargement Project is being executed since October 2014. It is expected that works will conclude by April 2018. Enlargement will allow to supply urban water to Saragossa, to Bardenas General Irrigation District, and to environmental purposes, and will reduce the risk of floods downstream Yesa reservoir (
Technical Reports are not publicly accessible. They have been provided by the Office of the Undersecretary General for Analysis, Prospective and Coordination at the Spanish Ministry of Agriculture, Food and Environment. Therefore, they are subject to a privacy commitment. They can be made available upon permission from Spanish Ministry of Agriculture, Food and Environment.
Spain is divided in 17 regions, also called ‘Autonomous Communities’.
The gross aid intensity must not exceed 65 % of the cost of the insurance premium (
It could be subsidized from national funds under