Building a scalable insurance solution
The problem of poor yields
Currently, food and beverage manufacturers face multifaceted challenges in managing their supply chain in respect of ingredient sourcing. Having multiple back-up suppliers may not be sufficient if the impact of climate risk heavily impacts a crop harvest on a global scale. In such a scenario, it may be impossible for manufacturers to source alternative raw materials at short notice.
For manufacturers, there is no recourse in relation to poor yield against the end farmer. While suppliers may have some contractual liability if they fail to meet minimum delivery volumes, this is heavily dependent on how the contracts are written between manufacturer and distributor.
Case study: California’s almonds
California is the source for 80% of the worlds almonds. However, it is also a region heavily impacted by drought and wildfires. The La Niña phenomenon in 2020 drove both the warmest and driest period in California since 1895, temperatures were 3.5 degrees Celsius above the twentieth-century average according to the University of Michigan.
These challenges are compounded by the nature of the almond tree itself, a hugely water intensive crop. For manufacturers, this creates a risk paradigm that is outside of their control. The impact on California’s almond production is stark: despite the state’s almond-bearing acreage increasing by 120,000 acres between 2020–2023, production of almonds over the same period fell by around 450,000kg. As supply shortens, demand doesn’t necessarily reduce, and prices are driven up.
Traditional insurance – and it’s limitations
Considering the significant and increasing impact of weather events on crop production, supply chains, and commodity prices, there is arguably insufficient protection available in the conventional insurance market.
The cover available to manufacturers through conventional insurance products – such as Property Damage (PD) and Business Interruption – is currently limited to owned assets, stock and finished goods, and supplier locations. The latter can be heavily sub-limited, and may respond only to certain perils under the policy such as fire, explosion, or theft, and not to large weather events such as draught, flooding, or heat stress. What’s more, these products do not address the risk from commodity price volatility and wider market pricing challenges resulting from systemic weather events.
By contrast, poor yields are typically considered a business contingency risk, with weather and supply chain often sighted in annual reports as a reason for reduced profits. Although certain specialist solutions may be available on an individual client basis, the response will again be limited to the loss of specific-client crop production. They will not address the macro impacts that natural catastrophe weather events may present to the global food and drink supply chain.
The role of parametric insurance
Fortunately, there are emerging solutions available in the market to respond to broader geographical areas and wider weather events and perils. These take the form of parametric insurance.
Parametric insurance is a transparent, data-driven form of alternative risk transfer solution based on pre-determined claims settlement following a specific triggering event. This type of cover can extend beyond growers to cover other key points in the supply chain, including covering critical parts of the supply change from weather risk.
Weather risk transfer via a parametric solution is not entirely new. But advancements in technology have allowed insurers to offer far more granular products to cover issues such as drought, low water levels, yield and commodity price risk. As a result, manufacturers can now purchase cover for key suppliers or regions. For example, a winery dependent on grape suppliers in frost-prone areas of southern France could use parametric insurance to offset increased costs when sourcing from alternative suppliers during a regional frost event.
Similarly, a food manufacturer heavily reliant on wheat could purchase a parametric policy triggered by prolonged drought in key wheat-producing regions like Ukraine. If the drought leads to reduced supply, this swing can be mitigated through a parametric policy covering price fluctuations in the derivatives market. If the trigger conditions are met – such as rainfall below a specified level over the growing season – the policy would automatically pay out, helping the manufacturer offset higher procurement costs or losses from reduced supply.
One example of a parametric insurance solution is ChAI Protect. This product is designed to help protect companies against unforeseen raw material price volatility across a wide range of ingredients. The policy can be purchased by either the buyer or seller and covers raw material price fluctuations on a rolling monthly basis or on a single transaction basis.
Towards a scalable solution
The challenges that food and beverage business face around raw input costs are likely to increase further, as climate change continues to drive rising temperatures, increased precipitation, and more frequent extreme weather events. It is clear that businesses in the global food supply chain will have to contend with growing crop volatility, and changes in supply chains and key growing centres over time.
Conventional insurance policies are limited in their ability to respond to the impact of these systemic risks and macro events on global commodity prices. Parametric insurance solutions are growing in popularity, and for businesses with specific well-defined exposures, in key geographies, they present a compelling risk transfer solution. However, parametric solutions can be complex and costly to procure. The affordability of innovative insurance products depends on economies of scale to develop a competitive market opportunity. New products must have a clearly addressable market and result in sufficient adoption. In their absence, cover remains out of reach for many businesses.
Delivering a working solution to protect against global crop volatility demands industry-wide collaboration. Lockton is seeking to work with industry partners on the development of solutions that can respond to commodity price volatility linked to specified perils and key areas of production, and the macro impact this has on market pricing of key commodities. In doing so, these solutions will help to smooth out the impact of fluctuating raw input costs for businesses. It is crucial that these solutions are easily accessible and affordable to encourage scalability and, over time, to establish a competitive market.
