For various reasons, developing countries should avoid adopting approaches to risk management mirroring those adopted in developed countries. Clearly, developing countries are more limited by fiscal resources than are developed countries. Even more importantly, the opportunity costs of employing those limited fiscal resources are significantly greater, ttus, it is critical for developing country governments to consider carefully how much risk management support is appropriate and how to leverage limited government dollars to spur insurance markets. In developed countries, government risk management programs are as much about income transfers between economic sectors as they are about risk management. Developing countries cannot afford to facilitate similar income transfers, given the high proportion of the population engaging in agriculture. On the other hand, because large segments of developing country populations depend on agriculture or agriculture-related industries for their livelihoods, catastrophic agricultural losses will have much greater relative impact on overall GDP as well on affected populations.
Policymakers should also carefully consider the varying structural characteristics of agriculture in different countries. In general, farms in developing countries are significantly smaller than are farms in countries like the United States and Canada. For traditional crop insurance products, smaller farms typically imply higher administrative costs as a percentage of total premiums. A portion of these costs is related to marketing and servicing (loss adjustment) insurance policies. Another portion is related to the lack of farm-level data and cost-effective mechanisms for controlling moral hazard.
Developing countries also have far less access to global crop reinsurance markets than do developed countries. Reinsurance contracts typically involve high transaction costs related to due diligence. Reinsurers must understand every aspect of the insurance product development and transaction process, including contract design, pricing, underwriting and establishing controls against adverse selection and moral hazard. Some minimum volume of business, or the prospect for strong future business, must be present to rationalize incurring these largely fixed transaction costs. For a global reinsurer to be willing to enter a market, the enabling environment must foster confidence in contract enforcement and institutional regulations. An enabling environment is, in fact, a prerequisite for effective and efficient insurance markets, and these components are largely missing in developing countries. Setting rules and then precedents assuring that premiums will be collected and indemnities paid is not a trivial undertaking, tte alternative risk management products discussed in Sections 22.4 and 22.5 are structured to overcome many of these problems.
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