metadata: authors: 0: author: Skees, Jerry R.
1: author: Enkh-Amgalan, Ayurzana
count: Mongolia
docna: 0: docna: Examining the feasibility of livestock
            insurance in Mongolia
docty: Policy Research Working Paper
subtopic: Environmental Economics & Policies,Livestock and Animal Husbandry,Labor Policies,Payment Systems & Infrastructure,Banks & Banking Reform,Insurance & Risk Mitigation,Health Economics & Finance
teratopic: Agriculture,Environment,Finance and Financial Sector Development,Social Protections and Labor,Health, Nutrition and Population
abstracts: cdata!: Herders in Mongolia have suffered
            tremendous losses in recent dzud (winter disasters), with
            livestock mortality rates of over 50 percent in some
            locales. This study examines the feasibility of offering
            insurance to compensate for animal deaths. Such an
            undertaking is challenging in any country. Mongolia offers
            even more challenges given the vast territory in which
            herders tend over 30 million animals. Traditional approaches
            that insure individual animals are simply not workable. The
            opportunities for fraud and abuse are significant.
            Monitoring costs required to mitigate this behavior would be
            very high. This study focuses on the potential for using the
            livestock mortality rate at a local level (for example, the
            sum or rural district) as the basis for indemnifying
            herders. Applications of index insurance are growing around
            the world, although no country has so far implemented such
            insurance for livestock deaths. But few countries have such
            frequent and high rates of localized animal deaths as does
            Mongolia, and it is one of the few countries that perform an
            animal census every year. This concept may therefore be
            precisely what is needed to start a social livestock
            insurance program. Just as important, the insurance that is
            used in Mongolia should not interfere with the exceptional
            efforts that experienced herders take to save animals during
            severe weather. Using an individual insurance may, in fact,
            diminish these efforts. Herders may ask, "Why should I
            work so hard to save my animals if I will simply be
            compensated for those that are lost?" Since the index
            insurance would pay all herders in the same region the same
            rate, the incentives for management to mitigate livestock
            losses remain strong. No one would reduce their effort to
            collect on insurance. Those who increase their efforts
            during a major event (dzud) would likely be compensated for
            this effort even though they do not lose livestock. In some
            cases, they could reasonably expect to receive payments that
            would compensate for the added effort or the added cost of
            trying to save their livestock.
geo_reg_key: 517198,517191,119225
repnme: repnme: Examining the feasibility of livestock
            insurance in Mongolia
display_title: Examining the feasibility of
            livestock insurance in Mongolia
listing_relative_url: /research/2002/09/2014515/examining-feasibility-livestock-insurance-mongolia
publishtoextweb_dt: 2010-07-01T00:00:00Z
historic_topic: Agriculture,Environment,Finance and Financial Sector Development,Social Protections and Labor,Health, Nutrition and Population
origu: Rural Dev, Nat Res & Envmt (EASRE)
no_of_pages: 48
model_extractions: POLICY RI SEA\RiC-H WORKING PAI1E1 2886

# Abstract

Hcrders in Mongolial have suffercd tremenidous losses in recent _dzu,d_ (winter disasters), with livestock mortality rates of over 50 percent in some locales. This studv exainiiies the feasibility of offering insuranice to coompenisate for animial deatihs. Suchi **an** undertaking is challeniginig in any country. Mongolia offers CvCeI more challenges given the vast territory in which herders tend over 30 million animials. lTraditional approaches that insure individual annials are simply not workable. The opportLuitics for fraud and abuse are significanlt. Monitoring costs required to mitigate this hehavior wVouIld be vcry high.

This study focuscs on the porential for uising the livestock mortality rate at a local level (for example, the _sum_ or rural district) as the basis for indemnifying herders. Applications of index insurance are growing around the wvorld, although no COlintrNrhas so far implemilenited sucIh insuranice for livestock deatihs. Buit few cOuIntries have such frcqtLienr and high rates of localized animn-al deaths as does Mongolia, and it is once of the few countries that perform an animal census every year. 'rhis con cept may therefore he precisely what is needed to start a social livestock insurance program.

Just as importanlt, the instirance that is used in Mongolia shotild not interfere with the exceptional efforts that experienced herders take to save animiials durinig severe weathier. Using an individual insurance max, in fact, diminish these efforts. Herders may ask, "Why should I work so hard to save my animals if I will simplpy he compensated for those that are lost?" Since the index insurance would pay all herders in the same region the same rate, the incentives for management to mitigate livestock losses remain strong. No one would reduce their effort to collect on insuraice. Those who incrcase their cfforts during a major event (dZud) xvould likely be compensated for this effort even thotigh they do not lose livestock. In some cases, they could reasonably expcr tO rcceive payments that wVolI]d compensate for the added effort or the added cost of trying to save their livestock.

'lUhis paper-a produict of the Rural Development and NatLral Resources Scctor Unit, East Asia and Pacific Region-is part of a larger effort in the region to fostcr seCLirc and sustainable livelihoods throuigh analytical and operational support for risk management and asset diversification strategies. The work described in this paper is finding operational application ulider thc Mongolia Sustainable Livelihoods Project. Copies of the paper are available free from the World Bank, 1818 H Striect NW, Washinigtoni, DC 20433. Please contact Evelyn Lagucidao, roomil MC9-324, telephone 202-458-2450, fax 202477-27.33, eimail address elaguidaoC@,wvorldbanik.org. Policy Research Working Papers are also posted on the Web at http://econ.worldbank.org. Jerry Skees may be contacted at jskees@3qx.net. September 2002. (36 pages)

> _The Policy lResecarcf.' Working Paper Series disseminates the fiiidinigs of wvork in progress to entcoutrage the exchange of ideas about development issutes. An objective of/te series is to get the findinigs onut quickly. eve,, if the presenltationis are less thanl fuil) polished. The papers carrr the narmes of the authors anld should be cited accordim,g'v. The finzdzings, interpretations, and conclusions expressed in this paper are entirely those ofJ theauthbors. Tbev dli not niecessaril/ represent the Iieu' oLf the World Bank, its Executive Directors, or the counitries they represent._

IProduced by the Research Advisory Staff
Examining the Feasibility of Livestock Insurance in Mongolia Jerry R. Skees and Ayurzana Enkh-Amgalan' 'Skees is president of GlobalAgRisk, Inc. and H.B. Price professor of agricultural economics at the University of Kentucky, Lexington, Kentucky, USA ( jskees @qx.net ). Enkh-Amgalan is founding director of the Center for Policy Research in Ulaanbaatar, Mongolia. This study was supported by the World Bank during the preparation of the Mongolia Sustainable Livelihoods Project, under the overall guidance of Robin Mearns (Team Leader). The authors wish to thank the professionals at the Ministry of Food and Agriculture in Mongolia as well as the numerous other professionals in Mongolia who met with Skees during his visit from July 29-August 7, 2001.
# **Executive Summary**

Herders in Mongolia have suffered tremendous losses in recent dzud with mortality values of over half of the animals in a number of sum. This study examines three alternatives to insure livestock deaths in Mongolia: 1) traditional livestock insurance that pays individual herders based on their specific losses; 2) weather insurance that would pay when weather events that are likely to create serious losses occur; and 3) index insurance that would pay when livestock mortality rates exceed certain thresholds by sum.

No approach will be easy and none offers the perfect answer. However, after careful analysis, mortality index insurance appears to offer the best choice. This recommendation is made with several key performance criteria in mind: 1) the insurance should not reward poor managers; 2) the insurance must be affordable by a large number of herders and others at risk when major livestock losses occur; 3) the insurance must be sustainable and profitable for emerging private insurance companies; 4) the first products should focus on the most significant covariant risk; 5) a proper role for government should be to foster development of risk sharing markets without imposing large social cost; and 6) the insurance should work in harmony with other initiatives, including<sup>the</sup> vast array of emergency assistance that is provided.

The mortality index insurance concept meets most of the performance criteria. In particular, since this insurance would pay all herders in the same sum or bag at the same rate, the incentives for management to mitigate livestock losses remain strong. Noone would reduce their effort to collect on insurance. Those who increase their efforts during a major event (dzud) would likely be compensated for this effort even though they<sup>do not</sup> lose livestock. In some cases, they could reasonably expect to receive payments that would compensate for the added effort or the added cost of trying to save their livestock.

The mortality index insurance would pay anytime the mortality rate (adult livestock deaths divided by the total census number of livestock in the area at the beginning of the year) exceeds a well specified threshold. The payment would be a function of the mortality rate times the amount of protection (or liability) purchased by the herder. This insurance is 1) simple; 2) largely free of the common problems of adverse selection and moral hazard; 3) easy to administer with low administrative cost; and 4) largely effective for getting ready cash to herders in a region during a major event.

Data for a limited number of sum in nearly every aimag were available from 1969-2000. These data afforded the opportunity to perform an assessment of the risk associated with offering a mortality index insurance program across Mongolia. While anyone who knows the recent history of losses understands that a very high level of covariate risk is present, these data show that serious losses occur in livestock in about 1 in 5 years. This is the frequency of loss ratios (indemnity divided by pure premium) in excess of 200% in the simulated mortality index insurance program that would be spread
across Mongolia. And while 2000 is the worst year in the 30 years of data,<sup>1969 isnearly</sup> as bad. Historical records also suggest that 1944 was more serious with mortality<sup>rates in</sup> excess of 30%. These losses would make a mortality index insurance<sup>programcostlyand</sup> require some risk sharing in the intemational capital markets. The report<sup>providesideas</sup> about how this might occur with both traditional reinsurance and the emerging<sup>weather</sup> markets.

The analysis also demonstrates that there are great differences in the<sup>relativerisk</sup> of livestock losses across Mongolia. On a standardized basis, the risk<sup>index thatwas</sup> created for all species suggest that 6 of 27 aimags have risk that are 3<sup>timesor more</sup> higher than the risk in the lowest set of aimags. This magnitude of differences speaks to the need to set different premium rates across Mongolia for any insurance<sup>program.Such</sup> information also raises serious concerns about the current proposals regarding<sup>mandatory</sup> insurance that would charge everyone the same premium rates. This<sup>ideaisflawedand</sup> would create the wrong incentives with transfers from those herders in<sup>lowriskareasto</sup> those in high-risk areas. Such transfers not only raise equity concerns,<sup>butalsowould</sup> create significant inefficiencies. The report also discusses why mandatory<sup>individual</sup> insurance would run counter to the goal of improving risk mitigation strategies<sup>among</sup> herders.

At this stage, there are a number of additional items that<sup>wouldneedattentionas</sup> first steps in designing a pilot project to test the feasibility and acceptability<sup>of mortality</sup> index insurance. Some basic considerations and next steps follow:

1. **Collect data on mortality and adult livestock numbers for more**<sup>**sum;**make</sup> certain that these data are complete for all species of livestock<sup>foratleast30</sup> years; create a data set for as many sum as possible but, at a minimum,<sup>obtaina</sup> geographic spread of sum within a aimag and complete at<sup>leastfive sum foreach</sup> aimag.

2. **Investigate in some detail the statistical system that is being used**<sup>**todevelop**</sup> **the census of animals and the reporting of mortality of**<sup>**animals.**</sup> This investigation should be conducted with a clear picture of<sup>howthese datamight be</sup> used to make insurance payments. A number of issues should be<sup>investigated:1)</sup> what is the quality of these data? 2) Could the data be developed<sup>at thebag level?</sup> 3) Has the process for developing the data changed in any significant<sup>fashionin</sup> the last 30 years? 4) Have the data been used in the past to make<sup>emergency</sup> disaster payments and, if so, is there any evidence<sup>thatthiscreatedany</sup> misrepresentation in the data? 5) Given that a census is taken every<sup>year,arethere</sup> adequate safeguards and accounting systems in place to<sup>mitigatetheopportunity</sup> for manipulating the data? 6) What auditing systems might<sup>be addedto assurethat</sup> the data process does not change when a insurance payments<sup>arebeingmadeon</sup> the basis of the data? 7) How do herders and others view the quality<sup>of thedata?</sup> 3. **Select a sample of sum to offer the mortality index**<sup>**insurance.**Initially,the</sup> government could collaborate with the private insurers and make insurance<sup>offers</sup> in a select sample of sum. The sample should be selected<sup>withsome geographical</sup> spread in mind. Ideally, the offers would be made in about 30 sum.<sup>Giventhat</sup>
the mortality data are widely available, it<sup>maybepossibletomakeselecta</sup> representative sum in every aimag to begin the<sup>pilot.Thiswould giveasmuch</sup> geographic spread as possible and provide the needed<sup>publicityacrossMongolia</sup> for the concept. Great care should be taken<sup>in makingcertainthat the pricethat is</sup> charged reflects the relative risk. The premium<sup>rateschargedherdersandthe</sup> design of the contracts should be consistent with<sup>market principles. Initially,the</sup> govemnment could provide some level of reinsurance<sup>toprivateprovidestoget</sup> their involvement. Simultaneously, the concept and pilot design<sup>shouldbe</sup> presented to the intemational capital markets obtaining<sup>their inputandattempting</sup> to get their involvement in offering reinsurance.

4. **Develop an extended education and marketing**<sup>**program.**Anysuccessfulpilot</sup> must educate herders about the potential value<sup>anduseofthis insurance. Some</sup> considerable attention should be paid to an educational<sup>effort.</sup>

**5. Establish appropriate feedback and monitoring**<sup>**of thepilot.**Apilot program</sup> should be designed to allow for learning about<sup>theconcept.This learningmust</sup> involve a number of dimensions: a) how have<sup>theprivateinsurersrespondtothe</sup> opportunity? b) how have the herders responded?<sup>c)areherders thinkingof and</sup> using infonnal and formal mechanisms to share<sup>theindex paymentswithinthe</sup> community? d) has the introduction of the index<sup>insurancechangedthe data</sup> development process in any significant fashion?

Much of the effort for a pilot test of mortality insurance<sup>couldbesupportedin the</sup> pastoral risk management project. However, it would also be an opportunity to gain support from some traditional NGOs. They should<sup>be keen toseeprogressmadeinthis</sup> direction. If the pilot were offered in areas that<sup>comprisedabout5%of thelivestockin</sup> Mongolia, the total possible market would be<sup>5%of Tg1 TrillionoraboutTg 50 billion.</sup> Initial sales would likely not exceed 10% bringing<sup>thenumbertoTg5 billion.With</sup> premiums set at a 3% rate, it would require only<sup>about $US60,000tosetpremiumsat a</sup> break even rate for herders. This level of support may be wise in a pilot program. Additional financing would be needed for resources<sup>to examinethe issues outlinedabove</sup> and for education and marketing.
**Page 1**

**Livestock Insurance in Mongolia**

# **Examining the Feasibility of Livestock**<sup>**Insurance in Mongolia**</sup>

Livestock herds are a vital component of<sup>theMongolian economymakingup</sup> about one third of the GDP. Further,<sup>livestock herdersand their familiesmake up a large</sup> percentage of the poor in Mongolia.<sup>Eighty percentoftheherdershaveless than200</sup> animals. Herd sizes need to be greater<sup>than200tosustaina familyat a reasonablelevel</sup> of income. Added to the low levels of<sup>incomefor a vastnumber of the Mongolianherder</sup> families, are the persistent risks that<sup>plague livestock.Devastatinglivestock lossesare</sup> common in Mongolia. Natural disasters<sup>anddiseasenotonlycreateserioushardshipsin</sup> the short term but these type of risk<sup>alsolikelyretardthedevelopmentprocess.Given</sup> that there are few coping mechanisms<sup>otherthan theinformalfamilyarrangements,the</sup> high level of risk adds to the risk<sup>adversebehaviorofpoor herderfamilies.</sup> The development literature clearly shows<sup>thatthesetypeof risksbothslow theadoption of</sup> new technology and hamper the financial<sup>markets.BankersinMongolialistriskasthe</sup> number one reason they don't loan money<sup>to herders.</sup> Thus, it is clear livestock insurance<sup>could bean important innovationinMongolia</sup> for any number of reasons. However,<sup>therearefewsuccess storiesin theworldof wide</sup> spread livestock insurance. Many good reasons underlie the<sup>problemswithlivestock</sup> insurance. The opportunities for abuse<sup>aresignificant.Livestock managementiskey to</sup> mitigating losses. This creates opportunities<sup>foradverseselectionby those whoconsider</sup> the insurance a 'good deal' given<sup>theirmanagementpractices.Thosewhoarebetter</sup> managers will opt out. Further, once<sup>theinsuranceisavailable,moral hazard may occur</sup> as managers change their practices and<sup>become more risky.Controllingadverseselection</sup> and moral hazard requires investments<sup>indataand monitoring.Inacountrylike</sup> Mongolia, it is nearly impossible<sup>toenvisioneffectivemonitoringsystems.</sup> Vast distances separate the nomadic<sup>herdersacrossthecountry.</sup> Vast differences in management styles and risk among<sup>herdersarecommon.It isalsonearlyimpossibleto</sup> imagine risk classification systems<sup>thatwouldidentify thesedifferencesbeforethe</sup> insurance is sold. Finally, the large covariate risks<sup>thatarepresentinMongolian</sup> livestock herding operations make<sup>livestockinsuranceextremelychallengingforan</sup> emerging private insurance market<sup>thatisunaccustomedtousinginternationalcapital</sup> markets to share risk.

Despite these fundamental problems,<sup>the need for livestock insurancein Mongolia</sup> is very real. This paper takes on the<sup>challengesof makinglivestockinsuranceworkin</sup> Mongolia. It is organized into three<sup>primarysections:1) a brief discussion of impressions</sup> and the setting that raise concerns<sup>about theexistinginsurance systemandeventhe</sup> opportunities to introduce weather based<sup>insurance2;2)introducingtherecommendations</sup> and the reasons for the recommendations;<sup>and3)adetailedanalysisofthe</sup> recommendations. While any number of<sup>alternativesmay be tried,thelimitation of many</sup> of the choices leads to a relatively<sup>focusedrecommendation.</sup> The logic for this recommendation should emerge as the<sup>sectionsaredeveloped.Therecommendationis</sup> made with several key performance<sup>criteriainmind:1) theinsurance should notreward</sup> 2This section benefits from readings and<sup>reports prepared by others andinterviews conducted by the</sup> authors from July 30-August 7, 2001.
**Page** 2

**Livestock Insurance in Mongolia**

poor managers; 2) the insurance must be affordable by a large number of herders and others at risk when major livestock losses occur; 3) the insurance must be sustainable and profitable for emerging private insurance companies; 4) the first products should focus on the most significant covariant risk; 5) a proper role for government should be carefully identified; and 6) the insurance should work in harmony with other initiatives, including the vast array of emergency assistance that is provided.

Three classes of alternatives should be considered: 1) revamping the existing insurance that provide individual coverage to herders; 2) the introduction of weather insurance to protect against the most serious weather events that cause serious economic losses; and 3) the introduction of index insurance that would pay based on sum or bag mortality losses. Each has advantages and disadvantages. Yet, as will become clear, the first two options present significant challenges and run counter to some important performance criteria. The third alternative also has limitations; nonetheless, it appears to hold some promise as it meets many of the performance criteria. In addition, with modest funding this idea could be introduced relatively quickly on a pilot basis.

# **Impressions and Background**

Consecutive dzud, harsh winter conditions, in Mongolia have been devastating. High rates of livestock death marked both the winter of 1999-2000 and 2000-2001. Across Mongolia these rates averaged about 10% in 1999-2000 and about 7.3% as of April 25, 2001 for 2000-2001. Obviously, when the data are disaggregated to the aimags (provinces), sum (counties), or bag (communities within the sum) level some areas had significantly higher losses (in excess of 50 percent in certain sum).

Numerous theories have emerged as to why the losses were so high. No doubt a combination of explanations gives insights into the problem. Two general categories of explanations dominate: 1) the weather; and 2) the macro environment. Weather events include: 1) drought prior to winter; 2) heavy snow; 3) cold temperatures; 4) freezing and thawing of snow causing ice; and 5) the combination of these events. Macro environment explanations include: 1) the inexperienced herders that have returned to herding after reform; 2) the breakdown in the infrastructure of wells for water along the traditional routes of otor; 3) the lack of forage reserves that were supplied by the former regime; and 4) a general lack of capital to purchase needed feed during the dzud.

While it is common to express concern that the macro environmental events have created a structural shift and added to the risk in Mongolia, caution should be taken. As devastating as recent years have been, at least four or five years during the period of 1944-1993 had equal or greater mortality rates for livestock: 1944, 1967, 1969, 1983, and 1993. The 1944 dzud was the most severe by some measure with around one third of the livestock in Mongolia lost. Interviews with herders suggest that they work hard to mitigate risk. The incentives to do so are stronger today than in the past given private ownership of livestock. In short, it is simply too early to draw any strong conclusions regarding whether there has been a structural shift that makes Mongolia more risky on
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**Livestock Insurance in Mongolia**

average for livestock producers. Nonetheless, the prudent policy<sup>makersatvariouslevels</sup> are now focused on a host of solutions.

The World Bank Sustainable Livelihoods project is one such<sup>efforttofind</sup> solutions. Three core activities are being coordinated: 1) management<sup>of pastoralrisk;2)</sup> development of community investment funds; and 3) improving<sup>theroleofrural micro-</sup> finance services. This report is part of the pastoral risk management component, however, important linkages will be made to the other two<sup>components.Amajor thrust</sup> of the pastoral risk management component is to provide integrated<sup>strategiestoassist</sup> herders in managing the covariant risk in Mongolian pastoral<sup>livestockproduction.A</sup> host of strategies are being considered. Insurance is one. An extremely<sup>importantaspect</sup> of providing integrated strategies is that they not work at<sup>cross-purposes.Thisguiding</sup> principle plays a major role in the focus of this paper. Significant efforts are underway to provide herders the information<sup>andtraining</sup> necessary so that they can effectively mitigate risk. Investments<sup>inforageequipment,</sup> improved weather forecasting, skill development, etc. are all<sup>targetedathelpingherders</sup> mitigate the effects of devastating weather and dzud. Key<sup>tothese effortsis thatherders</sup> become better managers and that they have incentives to work<sup>hardtoreducelivestock</sup> losses. Losing large numbers of livestock creates a long-term<sup>problemasit takestime to</sup> recover from such losses. Thus, it is also in the interest<sup>ofthebroadersocietythat</sup> herders be given the proper incentives to reduce livestock<sup>losses.</sup> Poorly designed insurance products could negate the incentives that are being<sup>structuredsocarefully.</sup> Under certain conditions, some herders may choose to reduce<sup>their intensive management</sup> when they have insurance. Any insurance product that fits into<sup>theoverallobjectiveof</sup> improving the risk mitigation of herders must be designed with<sup>theseconcernsinmind.</sup> Successful insurance cannot pay for bad management. If the<sup>insurance compensatespoor</sup> managers who are not working hard to mitigate risk during<sup>majorweatherevents,two</sup> serious problems will emerge: 1) the insurance will fail and<sup>2)theinsurancewillwork</sup> against the other efforts underway to improve management.

# _Financial Markets in Mongolia_

The financial sector is emerging slowly. There are excellent professionals<sup>in both</sup> the banking and insurance sectors. While there may be strong interest in developing livestock insurance, the task will not be easy. Further, the<sup>privateinsurancecompanies</sup> understand fully how difficult such a task will be, given the<sup>high transactioncostsof</sup> monitoring for both properly classifying risk and for sound<sup>underwriting.</sup> They also understand that the covariate nature of this risk in Mongolia makes<sup>itnearlyimpossible</sup> given their limited capital reserves. The private companies will simply not offer livestock insurance on any significant scale. There may be<sup>as manyas10private</sup> insurance companies in Mongolia. One of those companies<sup>isofferingsome 20insurance</sup> products and makes extensive use of the international reinsurance<sup>markets.</sup> Still, that company has no interest in offering livestock insurance to individual<sup>herders.</sup>
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**Livestock Insurance in Mongolia**

The existing livestock insurance is offered<sup>by Mongol DaatgalCompanyand one</sup> other state owned company. This parastatal<sup>insuranceisacarryoverfromtheprevious</sup> regime. The participation is quite low,<sup>evenin the caseof an area whereit wasrequired</sup> as a condition after getting special loans<sup>for restocking.Fewherdersreallyunderstand</sup> the current program and the overall uptake<sup>appearstobeaslowasafewpercentage</sup> points. For those herders who have considered<sup>thisinsurance,premium chargesare</sup> considered too high. A 6 percent premium<sup>rateischargedtoall herders,regardless of</sup> where they operate. The relative risk<sup>oflivestocklosses varies greatlybyregion. The</sup> payments for this general herd insurance<sup>are100%ofinsuredvalue less anyproceed</sup> from sale of skin and bones when the animal<sup>diesfrom weather related causes.Evidence</sup> of poor weather must be provided by the sum<sup>Meteorologicaloffice.</sup> Even if the existing insurance company<sup>hadalargeuptake,itishighly</sup> questionable that the program would<sup>besuccessful.Thereisnoreinsuranceforthe</sup> program and management of the program<sup>freelyadmittedseriousconcerns aboutthe</sup> viability of the program even to the point<sup>ofindicatingthat therewaslittle desiretoget</sup> more participation for fear of major<sup>loss.</sup> These fears are well founded given<sup>the</sup> covariate risks that are present in livestock<sup>losses.</sup> This principle will be further described and analyzed below. However, the estimate of the losses<sup>for2000</sup> demonstrates the point. The premium<sup>valuewas roughlyTg40million.Indemnities</sup> were about 4 times the premium value<sup>atroughly Tg160million.</sup> Given that the livestock herd in Mongolia is worth in<sup>excessof Tg1 trillion,a Tg 40 million premium is</sup> an extremely small fraction of the value (far<sup>lessthan evenone tenth of1%).</sup> Given recent livestock losses, it is not<sup>surprisingtolearnthatinterestamong</sup> herders about livestock insurance is growing.<sup>TheGobiInitiativedidinterview146</sup> master herders from Umngovi, Dundgovi,<sup>Uvurkhangal andGovi-Altai aimagsabout</sup> their interest in livestock insurance. Only 5% of these herders had any<sup>previous</sup> experience with buying livestock insurance. When ask about their interest in such insurance: 49% said they were interested;<sup>32%wouldprobablybuy;and17%said they</sup> were not interested. However, the willingness<sup>topaywasrelativelylowwithpremium</sup> rates at around 3% of value insured. For<sup>the questionaboutwhatshould bea reasonable</sup> cost of insurance for those who said<sup>theywere interestedtheresponseswere:11%</sup> checked less than 1%; 51% checked<sup>1%to3%;25%checked4%to7%;and12%</sup> checked 10%.

While these results are interesting, it is<sup>importantnotto make too muchof them.</sup> First, this is not a random sample. These are the master herders who were<sup>seeking</sup> information by attending a conference.<sup>If there isa biasitis likelythat theinterestand</sup> willingness to pay are biased upward above<sup>the generalpopulationof herders. Second,it</sup> is not surprising to see large uptakes in<sup>agricultural insurance immediatelyfollowinga</sup> disaster. Several references are made in a number<sup>ofreportsabout herders being</sup> complacent about natural disaster after<sup>experiencingseveralyearswithnoproblems.</sup> This is also quite common with agricultural<sup>insurance.Thisalsospeaks totheneedto</sup> design an insurance alternative that will<sup>makerelatively frequent paymentsifpossible.</sup> Having some level of payments frequently<sup>willhelp assurethatherderscontinueto</sup>
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**Livestock Insurance in Mongolia**

purchase the insurance. Third, it is really difficult to gauge the true<sup>willingnessto payfor</sup> insurance until someone is provided the specific details about<sup>howtheinsurancewill</sup> work. That being said, a target premium rate in the 3% to 5% range<sup>isa reasonabletarget</sup> for herders who are short on cash. The current insurance is not<sup>aggressivelymarketed</sup> even though there are 27 branches of the Mongol Daatgal<sup>Company, withatleastone</sup> branch in every aimag. We were told that these agents currently<sup>concentrateonother</sup> lines of insurance. Their presence in each aimag is important<sup>nonethelessforanynew</sup> initiatives in livestock insurance.

The parliament recently rejected an expanded livestock<sup>insuranceprogramthat</sup> would make it mandatory for livestock herders to<sup>insuretheir breedingstock.Two</sup> reasons were given for this decision by parliament: 1) livestock<sup>are nowprivately owned</sup> and the government can't force owners to insure;<sup>and2)thegovernmentcan'tforce</sup> private companies to offer insurance that is too risky and<sup>willbankruptthem. One herder</sup> summed the concerns up best when he said, "maybe<sup>it isbetterforme tospendmy</sup> money on forage than insurance". Forage is a form of insurance and this herder's instincts are likely correct.

The livestock insurance legislation is currently being redrafted<sup>withinthe Ministry</sup> of Food and Agriculture (see Appendix A for an unofficial<sup>translationof thecurrentdraft</sup> legislation). As will be more fully developed below, mandatory<sup>insuranceishighly</sup> questionable given the likely problems with actually<sup>classifyingherderrisk.</sup> Some herders have a higher likelihood of loss than others,<sup>evenhigher thantheir neighborswho</sup> are herding in the same region. These higher risk herders<sup>aredifficulttoidentify.The</sup> current system makes no attempt to differentiate these<sup>risksand priceaccordingly.Thus,</sup> if all herders did purchase the current insurance policy,<sup>theherderswhoarebetter</sup> managers would be paying for the losses of those who<sup>arepoorer managers.Thecurrent</sup> draft of legislation would charge a flat 2% rate<sup>3</sup> . Given<sup>thedataonmortality,thisrateis</sup> highly questionable. The rate appears to be woefully inadequate for the risks<sup>thatare</sup> being insured. No private insurance company is likely<sup>towanttoengageinsellingthis</sup> insurance. Furthermore, it is highly unlikely than any<sup>reinsurerwouldbeinterestedin</sup> coming to Mongolia with these rates and this<sup>system.</sup> While the argument is that with full participation there<sup>wouldbe someeconomies</sup> of scale and an improved pooling of risk, neither of these<sup>benefitsislikelytobe realized</sup> with mandatory livestock insurance. The incremental costs<sup>of deliveringand monitoring</sup> an individual insurance program are likely to be similar<sup>regardlessofthenumberof</sup> herders insured. Further, while there are some gains<sup>to bemadeinpoolingtherisksof</sup> livestock losses across Mongolia, there is still a very<sup>largecovariantrisk thatwould</sup> create serious reinsurance problems for the current system.

3 There was some indication that the 2% value had been increased<sup>to 4%.However,thisisnot confirmed.</sup> Even 4% is unlikely adequate to support a totally private<sup>market policy withthe coverageoutlinedin</sup> Appendix A. Someone inside the Ministry has done some analysis<sup>onthis issue.However,wewere not</sup> able to locate them and learn about this analysis.
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**Liv2stock Insurance in Mongolia**

The banking community is very hesitant to loan money<sup>toherders.TheAgBank</sup> of Mongolia is involved in the new micro-finance<sup>initiativetomakea fewselectloansto</sup> herders. Managers of private banks in Mongolia<sup>appear to makeveryfewloans to herders</sup> and cite the risk as the major reason. Bankers who were presented with the idea of insuring based on mortality losses within the<sup>sumexpressedakeeninterestinthis</sup> alternative insurance. They understood the potential<sup>valueandindicatedthatif such</sup> insurance were available they would consider<sup>loaning toherders.</sup> Given the strong reactions from managers of private banks, the<sup>possibilityoflinkingsuch insuranceto</sup> loans with the micro-finance initiatives underway<sup>is worthfurther consideration.</sup>

# _Potential Opportunities for Weather Based Insurance_

There is a growing interest in weather based<sup>insurance aroundtheworld.These</sup> new markets and insurance products may offer<sup>somepotentialinMongolia.The World</sup> Bank has been involved with investigating<sup>theopportunityforsuchinsurancein</sup> Morocco, Mexico, Tunisia, Ethiopia, and Nicaragua.<sup>Moroccoisveryclosetooffering</sup> sunflower and cereal grain farmers insurance<sup>thatwould paywhenrainfallisbelow</sup> certain thresholds during critical growing periods.<sup>Mexicoisconsideringusing similar</sup> rainfall policies to finance natural disaster relief<sup>efforts by provinces.</sup> The Mongolia Meteorology Agency is a<sup>professionallymanagedagencywitha</sup> long history of collecting detailed weather data.<sup>The current directoris also thepresident</sup> of the World Meteorology Organization of Asia.<sup>MongoliafollowstheWMOstandards</sup> and has done so for several decades. Quality data<sup>shouldbeavailableformostweather</sup> statistics. Further, the Meteorology Agency has conducted<sup>numerousstudiesand</sup> developed detailed maps of a great number<sup>ofweatherdata.</sup> The data have been processed into useful information and it is<sup>clear thatthe agency playsa major rolein both</sup> early warning systems as well as helping explain<sup>causesaftermajor eventsin Mongolia.</sup> Drought is a significant problem in Mongolia.<sup>Thus,thereissomepotentialto</sup> investigate offering insurance against rainfall<sup>shortfallsduringthecriticalmonthsof June</sup> and July. As John Morton points out in his report,<sup>suchinsurancecould provide timely</sup> payments that would be used to purchase fodder<sup>andotherfeedspriortogoing intothe</sup> winter. Further, the combination of drought<sup>duringthesummermonths followedby</sup> extreme cold during the following winter<sup>maybeanoptionworth consideration.</sup> However, it is also true that a multitude of weather<sup>eventscreateadzud.Thedescription</sup> from "Lessons Learnt from the Dzud 1999-2000"<sup>bytheUJNDPprovidesanexcellent</sup> summary of the multitude of causes: "The main cause of Dzud disaster in affected<sup>areashadresultedfroma</sup> combination of the following factors. Firstly the livestock had become exhausted due to both **black dzud** (lack of<sup>precipitationwhichleaveslivestock</sup> without any water supply) and **white dzud**<sup>(thesnowfallistoodeepforthe</sup> livestock to reach the grass below), in the wither<sup>of1998-1999,aseveresummer</sup> **drought** in 1999 led to further weakness of<sup>livestock.Thissituationwasfurther</sup> aggravated by poor pasture and lack of hay.<sup>HeavysnowfallinNovemberand</sup>
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December was followed by its melting and icing, leading to the so-called **iron dzud** (an impenetrable ice-cover forms over the pasture<sup>that makesgrazing</sup> impossible). In late December the snow cover became much thicker making<sup>it</sup> impossible for the livestock to graze on pasture **(white dzud).** Due to the extreme coldness in January and February and insufficient<sup>bodyweightmany</sup> thousands of livestock died from starvation and freezing."

**Hoof dzud** is also mentioned as a problem. A hoof dzuf<sup>occurswhenthereare</sup> too many hoofs in one area as herders from a problem area have<sup>movedtheir animals</sup> in an attempt to find forage. The result is over grazing.<sup>Obviouslythisproblemis</sup> not created by local weather events. In short, there are<sup>anoverwhelmingnumberof</sup> weather conditions and other factors that create dzud in<sup>Mongolia.</sup> In his 1997 master's thesis, Enkh-Amgalan created statistical models<sup>toexplain growthrateof</sup> livestock between 1969 and 1990 for 36 sum spread across Mongolia.<sup>Heattempted</sup> to explain variation in the growth rate (basically the birth rate minus<sup>themortality</sup> rate) using weather variables. This work is discouraging regarding<sup>thepotentialof</sup> any weather-based insurance for protecting against livestock losses.<sup>Enkh-Amgalan</sup> had to create a myriad of weather variables and then use stepwise<sup>regressionto</sup> obtain explanatory power with his models. Each sum had unique weather<sup>events that</sup> helped explain the growth rates.

The combination of the general descriptions of a variety of sources about the cause of a dzud and the detailed work of Enkh-Amgalan create<sup>serious concerns</sup> about the use of weather based insurance for managing herder losses.<sup>Further,while</sup> the Meteorology data appear to be of high quality, the basic stations<sup>maybetoofar</sup> apart in many regions to satisfy the requirement of weather insurance<sup>ata locallevel.</sup> Weather insurance should be considered as a means<sup>of reinsuringthealternative that</sup> is recommended in this paper. It is likely that an index of weather events<sup>couldbe</sup> created to explain the most serious insurance losses across Mongolia.<sup>Giventhat</sup> weather can now be traded in a global market, this option<sup>may offeraworkableand</sup> affordable reinsurance complement (see Skees 1999 for further details).

# **The Focused Recommendation**

Given the problems with the existing insurance program and the likely limitations of using weather insurance directly with herders,<sup>it becomesimportantto</sup> recap the overall problem.

- / It is logical that the current livestock insurance program has<sup>problems.</sup> Given the importance of understanding the core reasons for these problems, the references at the end were expanded to add other material<sup>that highlights</sup> the difficulty of providing agricultural insurance anywhere in the world.<sup>In</sup> particularly Skees and Barnett go into many of these practical<sup>and</sup> conceptual problems. Skees and Barnett provide much more detail about the conceptual problems and the literature to support the concerns<sup>about</sup>
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supplying individual insurance. Mongolia has unique characteristics that make these core problems even more challenging.

- / Multiple and complex weather conditions create the dzud. Actually documenting and understanding these events is important for risk mitigation and early warning efforts. However, after the fact the events are not as important as the outcome - extremely high livestock losses.

An attempt to construct a performance checklist will help the discussion. Table 1 makes this attempt and provides a subjective assessment for each of our three alternatives. These assessments are solely based on professional judgment and should not be taken as the final word. The table is provided as a quick guide to the reader so that they can more fully understand why this paper recommends the use of mortality index insurance.

|**Table**1:<br>**SubjectivePe**|**rformanceAssessm**|**entsforAlternat**|**ive Approaches**|
|---|---|---|---|
|**PerformanceGoals**|_Traditional_<br>_Insurance_|_Weather_<br>_Insurance_|_Mortality_<br>_Index_<br>_Insurance_|
|Insuranceshouldnot<br>rewardpoormanages|Fails|Pass|Pass|
|Affordabilityforpoor<br>herders|No|Couldbe|Couldbe|
|Effectiveriskprotection<br>forindividualherders|Forthemost<br>riskyyes|Insome<br>cases|Mostlikely|
|Focusedonthemost<br>significant covariantrisk|No|Couldbe|Likely|
|Sustainable&profitable<br>forprivate companies|Highly<br>unlikely|Possible|Possible|
|Fitswithotherformsof<br>emergencyaid|No|Possible|Possible|
|Low transaction costs|No|Shouldbe|Shouldbe|
|Acceptancefrom<br>intentional risksharing<br>markets|Notlikely|Shouldbe|Canbe|
|Opportunitiesforwell<br>definedrollsfor<br>governmentandmarkets|Withgreat<br>care|Possible|Possible|

It is clear that traditional approaches are scored the most poorly. A careful reading of Skees and Bamett will give more insights into the basis for that judgment. Traditional insurance scores best for providing specific protection to individual headers. However, in the current system the most risky herders who are in the most risky areas will receive this benefit since everyone is charged the same flat rate. These are precisely the wrong incentives given the desire to motivate herders to adopt risk mitigation methods. Further, if there were a large uptake in this insurance
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due to a major campaign to educate herders,<sup>it islikelythatthemajor participants</sup> would be those who are most risky. This<sup>couldcreateseriouslossesforthe pool,</sup> especially given the covariate risk problem.<sup>Whilesome believethatcompulsory</sup> insurance will fix this problem, they are<sup>very likely mistaken.</sup> Further, it is ill advised to require the best herd managers<sup>tousetheirpreciouscash for insurance</sup> that likely will not work for their operation.<sup>This only reducestheiropportunityto</sup> invest in more effective risk mitigation strategies.

Both the weather index and mortality index<sup>insurancescorebetter onseveral</sup> criteria. Weather insurance is unlikely to<sup>protectagainst thegreatnumberof unique</sup> weather conditions that can create a problem<sup>with livestockmortality.This led to the</sup> recommendation to pursue insurance mortality<sup>rates directly.</sup> This idea is also limited on at least three important fronts:<sup>1) anindividual herderwhoisagood</sup> manager can have a loss and not get paid;<sup>2) thequality of themortality data might</sup> change once insurance is being sold based<sup>onthese numbers;and3)it willstillbe</sup> difficult to manage the covariant risk that<sup>arepresentinMongolia.Each ofthese</sup> points will be discussed further below.<sup>Additionally,someverycareful attention</sup> must be paid to numerous details to have successful<sup>mortality index insurance.</sup>

# Description of the mortality measure

The work by Enkh-Amgalan used data from<sup>36sum for the period1969-1999</sup> on mortality rates and birth rates<sup>4</sup> . These data are fairly reliable and afford<sup>the</sup> opportunity to performn a rather complete analysis<sup>ofthe riskand thepossibilitiesfor</sup> insuring based on mortality rates within<sup>eachsum.Thedatawereupdatedforthe</sup> years 1991-2000.

While statistics are developed for adult animals<sup>and offspringwithintheyear,we</sup> chose to use the adult mortality statistics to develop<sup>the insurance index.The censusof</sup> animals is performed every year. The mortality<sup>rateistheratioof totallossesof adult</sup> animals divided by the number of animals reported<sup>in the end of the previousyear census.</sup> _adultlosses total animals_

# Offspring losses are excluded on the following<sup>grounds:</sup>

1. Compared to other age groups offspring<sup>arehighlyvulnerable and lossratesare</sup> usually high. The offspring loss rate is<sup>calculatedasa ratioofoffspringlostto the</sup> total number of born. When losses associated<sup>withimmaturedeliveryareincluded,</sup> the losses increase further. Therefore,<sup>inclusionofoffspringlosseswould</sup> significantly increase the premium rates<sup>makingit less likely that herderscould afford</sup> the insurance.

- 4 1975 and 1979 are missing from the data.
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2. Recording and monitoring of offspring losses are more difficult compared<sup>tothatof</sup> adult animals. In Mongolia, statistics on animal numbers are based<sup>on thelivestock</sup> census data carried out in December each year. However, data on offspring,<sup>whichare</sup> delivered from February to June, are based on reporting during the<sup>year, whichare</sup> less reliable than the final livestock census data.

3. Inclusion of offspring loss rates makes the calculation of the<sup>lossratemore</sup> complicated. Calculation of the loss rate as a ratio of total losses incorporating<sup>losses</sup> of both adult animals and offspring to the number of animals at the beginning<sup>of year</sup> might be criticized mathematically. The number of offspring does<sup>nothavedirect</sup> relationships with the number of animals at the beginning of year. A<sup>separate index</sup> relating the ratio of offspring losses to the total number of offspring<sup>births mightbe</sup> possible but is well beyond the scope of any recommendation at the<sup>presenttime.</sup> All the data on animal numbers at the beginning of year and<sup>animallossesare</sup> collected from the Central Statistics Board of Mongolia. The process of collecting<sup>datais</sup> quite involved and has been in place for well over thirty years. Each<sup>sumhasrecordsof</sup> the herder household and animal numbers by species for each household.<sup>Sum and bag</sup> governors are responsible for administering the census and for maintaining<sup>these records</sup> in good order.

Individual herders are responsible for reporting losses to the bag officials.<sup>Losses</sup> include all animals that have died due to dzud or other natural disasters<sup>(flashflooding</sup> was mentioned as being a problem as well). Losses also include death<sup>ofanimalsdue to</sup> disease, theft of animals, and animals who have wondered off during<sup>stormsneverto</sup> retum. While there may be some initial concem about including all of these<sup>numbersin</sup> the insurance index, since this is an index and not individual insurance,<sup>thereshouldbe</sup> no real problem. The theft and lost animals values are a relatively small<sup>percentageof</sup> the total number of animals lost during a year. Professionals in the sum of<sup>Undurshireet</sup> estimate the value at about 10% of the total number of losses.

Theft is rightly considered an uninsurable risk in the current<sup>system.Noone</sup> wants to encourage herders to be careless in protecting their animals from<sup>theftsorin</sup> making certain that animals do not wonder off. Offering insurance based<sup>ontheaverage</sup> losses for the sum or bag will not encourage this behavior. The watchful<sup>herderhasthe</sup> same incentives to be diligent since they will be paid only based on the<sup>sum averageloss</sup> rate. By the same token, the negligent herder who allows large numbers<sup>of animalsto</sup> wonder off or be stolen will not be compensated beyond the sum average<sup>loss rate.Thus,</sup> the incentives for good management remain soundly in place. Furthermore,<sup>thetheft</sup> rates are likely relatively constant from year to year. Thus, their inclusion in the insurance index neither creates an incentive problem nor a rate making<sup>issue.One would</sup> not want theft variation to cause rates to increase since the index is being<sup>constructed</sup> primarily to compensate herders for losses due to natural disasters and disease.

It is extremely important that the data integrity be maintained. It<sup>isalsohighly</sup> significant that Mongolia does a complete census of all animals each<sup>year.Thisaffords</sup> the important opportunity to audit reported losses from one year<sup>tothenext.</sup> Bag
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governors give monthly reports on livestock, including information on movement from one sum to another. Records are kept of where the animals have been moved. Thus, by all counts, it should be quite difficult to create grossly false numbers to trigger an indemnity payment. Nonetheless, it is reasonable to implement an outside auditing process should this index insurance be adopted. Local and aimag politics may still provide enough incentives to government officials that they may be tempted to 'create losses'. The systems for developing the census and the reporting of losses are standard across Mongolia. These systems should not be changed. The historic records are the basis for rating any index on mortality rates.

The only recommended modification is that some thought be given to using auditors from nearby aimags. It would be better to have these professionals involved for a variety of reasons: 1) local officials are more likely to trust and cooperate with these professionals than someone form an insurance company or the national government; 2) these professionals know the systems; and 3) they also have a stake in any potential fraud that may be emerging within a particular region. If anyone is 'creating losses' it is likely that the whole system will have to pay for such fraud at some point. Importantly, the loss experience within region should be used for rate adjustment. Thus, any cheating will first result in higher rates in the region where the cheating occurs. This, of course, will be a slow process and should not be relied on to provide the only due diligence incentives.

# _How might mortality insurance work?_

The sum of Saintsagaan in the aimag of Dundgobi is used to illustrate how such mortality insurance may work. There were 2,800 cattle, 63,200 sheep, 43,300 goat, and 11,100 horses in this sum in 2000. This sum had extremely serious losses in 2000 with the mortality rate on cattle at 72%; sheep at 41%; goats at 44%; and horses at 33%. The simple fact that each of these species had serious losses in the same year illustrates the covariant risks that are present within a sum. More importantly the fact that many other sums across Mongolia experienced serious losses in the same year further makes the point about covariant risk. The correlation of losses was strong among species with an aimag and across aimags.

Figure 1 and 2 show the statistics for the 30 years of data for mortality rates for sheep in this sum. Sorting the 30 years of data from the minimum to the maximum creates the cumulative distributions. Since there are thirty years, each year represents a 1 in 30 frequency. Thus, the minimum value is a 1/30 event, the percentile on the second value is the previous value + 1/30, and so on until the maximum event is achieved and set as the 100'h percentile. This array can now be used to establish a number of possible triggers that represent frequency of the event. Using frequency to define a disaster is an important criterion. Public policy makers should be able to relate to frequency. In simple terms; How often does an event have to occur before it is a disaster? If one thinks of living in the desert, the rainfall is always very low. Noone should decide that every year is a disaster because it never rains in the desert. A 1 in 5 year event may be a reasonable trigger. Such events are generally serious in Mongolia and getting paid 1 of 5 years should be frequent
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enough to keep herders engaged in purchasing<sup>theinsurance.</sup> corresponds to the 80 th percentile.

A 1 in 5 year Clearly two extreme years stand out in<sup>thesheepmortalitydatafor</sup> Saintsagaan sum: 1971 at 34% and 2000 at 41%.<sup>The80h percentile beginsata</sup> more modest mortality rate of 6.5%, which occurred<sup>in1981.Thedata appear below</sup> for the 80 th percentile and above. This contract<sup>wouldpay only for valuesabovethe</sup> 8 0<sup>th percentile,thus only values above6.5%mortalitywould triggera payment.Any</sup> number of contract designs can be considered.<sup>Someofthesewillbepursuedin</sup> another section.

|Percentile<br>|Mortality<br>|Year<br>|
|---|---|---|
|80%|6.5|1981|
|83%|6.8|1994|
|87%|7.9|1980<br>|
|90%|10.8<br>|1977<br>|
|93%|12.4|1993<br>|
|97%<br>|33.8<br>|1971<br>|
|100%|40.6|2000|

A contract that would simply pay the mortality<sup>rate timesthevalueof</sup> liability purchased would have an average payout<sup>overthe30yearsofabout3.7%</sup> (the sum of the positive numbers above 6.5%<sup>divided bythe totalnumberofyears</sup> 30). This is a very straightforward way to calculate<sup>premiumrates. Morecomplex</sup> methods would need to be implemented should<sup>aprogrambeconstructed.These</sup> methods would rely on putting more structure<sup>intotheassumptionsabout theshape</sup> of the parent distribution. Several tests were<sup>performedonvarious sumdatasets.</sup> The smoothed distribution that is presented below<sup>is anexample of thetype of work</sup> that is needed. This distribution is fitted with special non-parametric<sup>kernel</sup> estimators. More importantly, one should consider<sup>fittingthesetypeof distributions</sup> by sum and then using spatial procedure to smooth<sup>thefitted distributionsacross</sup> space.

Given that this is an index contract that pays based<sup>only on thedata for thesum5, the</sup> question of insurable risk becomes the only significant<sup>underwritingconcernfor the</sup> individual herder. Even here it would not create<sup>significant problemsif herderswere</sup> allowed to purchase liability values that are greater<sup>thanthevalueof theirherd.Use</sup> of an example will make the issues clear. Let's<sup>assumethat a herderhas500sheep.</sup> The value of an average sheep at the end of 2000<sup>wasaboutTg22,000.Thus,this</sup> herder might purchase an insurance policy<sup>withavalueof Tg11million.Ifthe</sup> policy were rated at 4%, the herder would pay Tg<sup>440,000.</sup>

> _5_ One local sum leader from Undurshireet liked<sup>the concept very much.However,he insisted that their data</sup> was good enough to offer such insurance at the bag level<sup>and rightlyunderstoodthat offeringthe policyat</sup> that level would offer superior risk protection<sup>tothe individualherder.The discussion quicklyturned to</sup> difference in mortality rates among the four bag<sup>in Undurshireetfor the2000 dzud.</sup>
Page 13 Livestock Insurance in Mongolia Premium paid = liability x premium rate Tg 440,000 = Tg 11,000,000 x .04 <!-- Start of picture text --> Figure 1: Smoothed Mortality Rate for Sheep in<br>Saintsagaan Sum I Dundgobi Aimag<br>6%<br>5%<br>-<br>,4%<br>3%<br>0)<br>LL 2 %<br>1%<br>0%-<br>0 10 20 30 40 50 60 70<br>Mortality Rate<br><!-- End of picture text -->
Page 14 Livestock Insurance in Mongolia <!-- Start of picture text --> Figure 1: Mortality Rates of Adult Sheep: Saintsagaan<br>Sum I Dundgobi Aimag<br>45-<br>40-<br>35 -<br>30<br>25<br>20<br>15<br>10<br>5-<br>O-<br>9 P V6p\ ) &$ 4 eb9d\ 'lb b A<br><!-- End of picture text -->
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Again, the herder should be allowed to select any liability value within some reasonable limits. Any lower value should be allowed and an upper bound of 150 to 200 percent the value of the sheep herd may make sense. Allowing any value will give the herder significant choice and increase the likelihood that some who have little cash can purchase some level of insurance. Obviously, the sales agent needs<sup>to</sup> make certain that such decisions are made with full knowledge of how the payment will be made.

The fact that the contract integrity is not a function of the liability for the individual herder is very important. It also means that the value of an individual species is not nearly as important as it is when insuring the individual animal. This means that any reasonable number can be used to value livestock, especially if herders are allowed to 'scale up' on the contract and select values at 150 or<sup>200</sup> percent of the average value of their herd. Keep in mind that both rates and payouts are driven by the value insured (liability). The value insured has no impact on the outcome of the statistic (the sum or bag mortality rate).

- The payout structure for this policy in the years with sum mortality rates at

- 6.5% and above would be the product of the mortality rate and the liability. Thus,<sup>in</sup> 2000 this herder would have the following payment calculation: if mortality rate is > the strike level of 6.5% then Payment = liability x mortality rate Tg 4,466,000 = Tg 11,000,000 x .406

By now it should be clear that this payment would be made to the individual holding this policy regardless of the mortality rate for the individual with the policy. While such insurance may seem strange there are distinct advantages of this type of policy and there is ample precedent for such policies. Skees, Black, and Barnett explain the motivation and design for the U.S. crop insurance program that is an index contract paying only when county yields drop below certain thresholds.

Besides the low administrative costs and the lower likelihood of abuse associated with the contract, a major advantage of using the mortality rate is that it rewards good behavior. Those herders who have been successful in having lower mortality rates than their neighbors through hard work and investments during the year to mitigate risk receive the payment based on the average losses of the sum. Those who have greater losses still receive a payment in the years that are bad. However, that payment gives them no incentives to relax in trying to save their animals since any rate of mortality beyond the average will not be paid. Once an index contract system is in place, the private insurance market would have better opportunities to offer individual insurance that pays for losses to individuals that are beyond those paid by the sum or bag mortality policy. Such individual insurance will now be more independent in nature since the index contract will remove much of the covariant risk. But more importantly, the private sector would have the proper incentives to charge for and perform individual underwriting.
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With the mortality index insurance there<sup>islittleopportunityforadverse</sup> selection and moral hazard. The administrative<sup>costsshouldbeconsiderablyless</sup> than traditional insurance. Thus the major<sup>loadsthatwill beaddedto theprernium</sup> rates will be almost totally a function of the<sup>commissionpaidsalesagentsandthe</sup> premiums that are needed to build reserves<sup>andpayreinsuresforthecovariaterisk.</sup> More will be said about these important issues<sup>inthenextsection.Another major</sup> advantage of this recommendation is that<sup>qualityhistorical dataexistandgood</sup> systems are in place to develop these data all<sup>across Mongolia. Thereisno needto</sup> start a new system.

# **How might a contract appear to the**<sup>**herder?**</sup>

While neither author is a lawyer, it may be helpful<sup>to showhowsimplethe</sup> language might be for an index insurance contract<sup>witha herder in Saintsagaan.</sup>

# _DRAFT LANGUAGE FOR ILLUSTATION ONLY_

_This insurance is solely based on the official sum statistics_<sup>_onadult_</sup> _livestock losses for cattle and yak in sum Saintsagaan_<sup>_in aimag Dundgobi._</sup> _The insurance will pay you when the mortality rate_<sup>_(theratio of adult_</sup> _losses during the year 2002 divided by the total herd_<sup>_population at the_</sup> _beginning of the year) exceeds a rate of 6.5%._<sup>_Tobeeligible, you must_</sup> _register for this insurance by May 1 of 2001._<sup>_Registration involvesa_</sup> _statement of intent to purchase and a reporting of your animal_<sup>_numbers at_</sup> _that time._

# _Value of Insurance_

_While we believe the average value of cattle and_<sup>_yaktobeaboutTg_</sup> _100,000, you may purchase any value of insurance_<sup>_betweenTg 20,000 and_</sup> _Tg 200,000 per animal reported._

# _Paying Premium_

_You will pay a premium rate of 4% times the value of insurance_<sup>_you chose._</sup> _The premium payment is due on January 1 of 2002. Should_<sup>_no payment be_</sup> _received by that time, we will cancel this insurance_<sup>_policy._</sup>

# _Paying for losses:_

_If the mortality rate for the sum of Saintsagaan_<sup>_inaimag Dundgobi_</sup> _exceeds 6.5%, we will pay you the product of the mortality_<sup>_rate times the_</sup> _value of insurance you have chosen. Please understand_<sup>_that you may have_</sup> _livestock losses when the sum mortality rate does not_<sup>_trigger a payment._</sup>
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**Livestock Insurance in Mongolia**

# **Analysis of the Risk Profile Across Mongolia**

Data were obtained for 36 sums with at least one sum in nearly<sup>everyaimag</sup> in Mongolia. These data were mostly complete for cattle, sheep,<sup>and goatsfrom</sup> 1969-2000 (year 1975 and 1979 are missing). Camel and horse mortality<sup>rateswere</sup> obtained for 1991 to 2000. Special procedures were used to fill in the<sup>dataseries for</sup> camels and horses. Regressions of the following form were<sup>fitusing the available</sup> data: Camel Mortality, = C + b,x Cattle Mortality, + b2 x Sheep Mortalityt + b3 x Goat<sup>Mortality,</sup> Horse Mortality, = C + b,x Cattle Mortality, + b2 x Sheep Mortality,+ b3 x Goat<sup>Mortalityt</sup>

# where t = years 1991-2000.

These regressions had reasonably high R squared values and<sup>forthosefew</sup> that did not, a simple procedure was used to scale the cattle mortality<sup>inthesame</sup> fashion as existed in the 10 years that were available (the ratio of<sup>camelmortality</sup> over cattle mortality). Missing years were replaced with estimated data.<sup>Whilethis</sup> may introduce some problems, the likely bias is in the direction<sup>ofaddingslightly</sup> too much covariate risk. The intent is to get a complete cost accounting<sup>of offering</sup> this insurance for all species in every sum and aimag in Mongolia.

Once the data adjustments were complete, there was a complete<sup>matrixfor all</sup> five species for each of the 30 years and in each aimag. The aimag estimates basically assume that all sums within the aimag will have similar relative<sup>riskasthe</sup> ones that were available. There may be some spreading of risk<sup>withinanaimagthat</sup> are not reflected using this approach. However, again the intent<sup>ittogivesome</sup> indication of how a mortality index might perform across Mongolia.<sup>Thebiasthat is</sup> introduced with the methods employed here is in the right direction<sup>forthis typeof</sup> work. The covariant risk will be slightly overstated due to this bias.

Given the matrix of mortality rates, any number of index<sup>policiescanbe</sup> designed. The 1999 value of number of head by aimag are used to represent<sup>valueat</sup> risk throughout the time period. This is a common practice to use today's<sup>valueat</sup> risk with a time series of events in order to model the losses. Since<sup>therisksare</sup> spatial in nature it is important that they be calculated using the current<sup>valuesat</sup> risk. This effectively weights the risk spatially by the location of<sup>thelivestockin</sup> Mongolia. The underlying assumption is that the 30 years represent<sup>thelikelyfuture</sup> distribution of events. Also, using the actual events for the 30 years<sup>maintainsthe</sup> spatial correlation among aimags. This is very important as it allows<sup>foramore</sup> complete picture of the covariate risk across Mongolia. Again,<sup>theassumption,as</sup> with most statistical data work, is that the past is a good predictor<sup>ofthefuture.</sup> There are no apparent trends in the mortality rate data. And while<sup>2000and 2001are</sup> unusual events, there are similar events in longer series of data for<sup>Mongolia.Itis</sup> too early to tell if there are any structural changes that make Mongolia<sup>more riskyfor</sup> livestock herders.
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**Livestock Insurance in Mongolia**

The matrix of mortality rates is 30 by 22 by 5 (30 years, by 22 aimags, and<sup>5</sup> animal species). The matrix for animal values is simply a 1 x 22<sup>x5(1= 1999</sup> values that are imposed over the 30 years, by 22 aimags, by 5 animal species). Value at risk is calculated as follows: Value at riska, = Number of animals in 1<sup>9 9 9</sup> a, * Average value of animal in 2000 where a = aimag and s = animal species

|**AnimalValuesUsedintheAnalysis**|
|---|
|**Species**<br>**Value(Tg)**|
|Cattleandyak<br>100,000|
|Sheep<br>22,000|
|Goat<br>14,000|
|Camel<br>100,000|
|Horse<br>70,000|

Given these calculations, the estimated value for all livestock in Mongolia is about Tg 1.1 trillion (see table 3). If the policy were made available at an average premium<sup>rateof</sup> 3%, the total premium would equal about Tg 32.8 billion. This also makes the strong assumption that all livestock would be insured at the full value. The analysis will<sup>makethis</sup> assumption to give the full scope of this insurance. However, it is quite simple to<sup>factorall</sup> numbers down with any assumption one wishes to make about the rate<sup>of participation.For</sup> example, at 10% participation the premium would equal Tg 3.3 billion.

To begin the analysis it was assumed that the premium rates would<sup>needtobe</sup> loaded at least by about 40%6. Further, a target of about 3% average premium rates was used. Therefore, the contracts needed to set the coverage or trigger mortality rates for each aimag and species so that the average pure premium (before loads) would equal roughly 2.15%. There will be variations around this rate and these are reported<sup>insummary statistics</sup> below to give some idea of the relative risk across aimags.

The trigger values were set by each animal species so that the average pure premium rates would equal the target of 2.15%. To accomplish this task the following strike percentiles were used by species; 1) cattle = 86%; 2) sheep and goats = 80%; 3)<sup>camel=</sup> 76%; and 4) horses = 70%. The contract design used the principle of paying at the mortality rate for values above the strike. The strike mortality values are reported in Table 4. Corresponding values of the insurance or the pure premium rates are reported<sup>in Table5.As</sup> is quite evident there are large differences across Mongolia for these risks. The pure premium rates are each multiplied by 1.4 to load for some administrative costs and for reinsurance. Should a mortality index insurance be constructed one would want to put the structure of parent distributions in place and not have as large of differences in the<sup>premium</sup> rates across Mongolia. Still, the differences are important as they do reflect the risk profile of the country.

**6** This load is likely low. However, a lower number is used with the assumption that the factors that<sup>cause</sup> this work to over estimate the spatial risk have already loaded the rates to some extent.
**Page 19**

**Livestock Insurance in Mongolia**

Table 3: **Values of livestock used**<sup>**byAimag(all**values are in Tg 1</sup><sup>**Million)**</sup>

|**Aimag**<br>|Cattle<br>Sh<br>|eep<br>Go<br>|at<br>Cam<br>|el<br>Ho<br>|rse<br>|
|---|---|---|---|---|---|
|Arhangi<br>|46,400<br>|12,122<br>|14,294<br>|100<br>|20,860<br>|
|Bayan-Oligii<br>|11,400<br>|11,352<br>|9,030<br>|800<br>|5,530<br>|
|Bayanhongor<br>|19,800<br>|26,378<br>|12,292<br>|4,000<br>|11,200<br>|
|Bulgan<br>|26,400<br>|7,392<br>|11,172<br>|100<br>|14,700<br>|
|Darhan_UnI<br>|3,300<br>|946<br>|1,260<br>|500<br>|17,640<br>|
|Domod<br>|14,600<br>|2,728<br>|6,048<br>|600<br>|7,280<br>|
|Dornogobi<br>|10,400<br>|8,272<br>|6,678<br>|3,000<br>|8,610<br>|
|Dundgobi<br>|12,700<br>|16,874<br>|13,538<br>|50<br>|1,050<br>|
|Gobi-Altai<br>|7,900<br>|22,638<br>|12,138<br>|3,500<br>|7,280<br>|
|Govisumber<br>|1,400<br>|924<br>|896<br>|10<br>|1,540<br>|
|Hentii<br>|22,900<br>|7,788<br>|9,492<br>|2,500<br>|7,560<br>|
|Hovd<br>|15,100<br>|17,512<br>|11,032<br>|400<br>|21,280<br>|
|Hovsgol<br>|48,200<br>|14,938<br>|14,000<br>|2,300<br>|8,120<br>|
|Omnogobi<br>|4,000<br>|19,976<br>|6,216<br>|1,900<br>|20,160<br>|
|Orhon<br>|2,800<br>|990<br>|1,106<br>|10<br>|910<br>|
|Ovorhangii<br>|29,600<br>|20,460<br>|19,922<br>|1,100<br>|13,440<br>|
|Selenge<br>|11,000<br>|3,036<br>|4,592<br>|10<br>|910<br>|
|Suhbaatar<br>|21,100<br>|7,678<br>|9,660<br>|9,900<br>|8,330<br>|
|Tov<br>|24,100<br>|10,868<br>|16,450<br>|1,300<br>|13,160<br>|
|Ulaanbaatar<br>|5,300<br>|1,210<br>|1,540<br>|700<br>|13,580<br>|
|Uvs<br>|16,800<br>|13,420<br>|13,622<br>|100<br>|3,220<br>|
|Zauhan|27,100|15,268|17,696|2,800|15,190|

Figure 1: Map of Share of Livestock<sup>by</sup><sup>**Aimag**as a Percentof Total Country Value</sup>

**L**

<!-- Start of picture text --> 1 'X,<br>t ~ 's F ' '<br><!-- End of picture text -->
Livestock Insurance in Mongolia Page 20 To illustrate the relative risk across Mongolia in more detail, a special analysis was performed that fixed the average strike for each aimag at the average value for each species. Thus, all aimag would begin making payments at the same mortality rates. Those rates are: 1) 9.1% for cattle; 2) 6.2% for sheep; 3) 6.5% for goats; 4) 5.6% for camels; and 5) 3.2% for horses. This relative position of these values also shows the relative risk for different species. The pure premium averages about 2.5% for each of these species of livestock.

# _Loss_ cost _= pay_ E _Liability_

the sum of all payouts for all years and all species is simply divided by the sum of all liabilities for all species and years. This normalizes the risk picture and allows for a more appropriate comparison of the relative risk position of the different aimags given today's livestock values.

> Figure 3 shows large differences in the relative risk of the various aimags - from about 1% to 5% given these strikes and the insurance design. This table can be

> used for a variety of purposes as it reflects the current risk profile given the relative risk different livestock in the different aimags with the current values at risk.

Given the principles laid out above it is possible to develop estimates of the 30 year loss experience for a book of business that is equally spread across Mongolia. This analysis has driven the data and procedures described above to
Page 21 Livestock Insurance in Mongolia Figure 3: **Risk ranking of aimags for all**<sup>**livestock speciesusing the same strike**</sup> **mortality rate and calculating the weighted**<sup>**averagelosscost**</sup> <!-- Start of picture text --> Dundgobi<br>Dornod _<br>Suhbaatar No<br>Uvs _<br>Bayan-Oligii no<br>Ovorhangli 'to<br>Bayanhongor<br>Tov _<br>Ulaanbaatar *W<br>Hovd _______<br>Darhan_Uni M<br>Zauhan _<br>Hentii O<br>Govisumber =<br>Orhon on---<br>Selenge<br>Omnogobi<br>Hovsgol No<br>Dornogobi<br>Arhangi<br>Bulgan IRW3<br>Gobi-Altai<br>0.0% 1.0% 2.0% 3.0% 4.0% 5.0% 6.0%<br><!-- End of picture text --> create Tables 3-5. Loss ratio is the experience<sup>withina given year.Such datagivea</sup> good estimate of the covariate risk that remains<sup>afterpooling the risk acrossaimags</sup> and species.

<!-- Start of picture text --> E Payouts<br>E Pr emiums<br><!-- End of picture text -->
Page 22 Livestock Insurance in Mongolia Figure 2: Map of Livestock Risk Index Across Mongolia <!-- Start of picture text --> .23~~1<br>'I~~~~~~~~~~~~~~~~'<br>r0 1<br>> ,#J zI--r -- ?\ 1 2 (<br><!-- End of picture text -->
Page 23 Livestock Insurance in Mongolia Table 4: Mortality Strike Values Used - By Aimag and Species

|**Aimag**|**Cattle**<br>Sh|eep<br>G|oat<br>Ca|mel<br>Ho|rse|
|---|---|---|---|---|---|
|Arhangi|6.0%|7.5%|7.2%|3.8%|1.4%|
|Bayan-Oligii|20.1%|4.8%|6.7%|3.0%|3.4%|
|Bayanhongor|9.2%|7.2%|7.5%|4.3%|3.8%|
|Bulgan|5.4%|6.3%|6.4%|6.9%|3.1%|
|Darhan_Unl|8.2%|6.1%|6.5%|5.4%|4.1%|
|Dornod|11.8%|9.2%|12.4%|8.9%|4.2%|
|Dornogobi|8.9%|5.9%|5.8%|7.2%|2.9%|
|Dundgobi|10.5%|6.5%|7.8%|6.1%|5.2%|
|Gobi-Altai|7.0%|4.9%|4.8%|3.0%|3.6%|
|Govisumber|8.2%|6.1%|6.5%|5.4%|4.1%|
|Hentii|6.3%|7.9%|8.1%|6.0%|3.1%|
|Hovd|6.4%|7.1%|5.0%|3.7%|4.4%|
|Hovsgol|4.3%|7.0%|6.3%|2.9%|1.9%|
|Omnogobi|9.9%|5.4%|6.3%|2.8%|2.2%|
|Orhon|8.2%|6.1%|6.5%|5.4%|4.1%|
|Ovorhangii|10.1%|7.9%|7.9%|5.3%|6.3%|
|Selenge|7.0%|6.7%|6.9%|8.4%|3.5%|
|Suhbaatar|14.2%|9.7%|11.6%|7.5%|3.2%|
|Tov|10.5%|6.6%|6.4%|8.1%|3.1%|
|Ulaanbaatar|10.5%|6.6%|6.4%|8.1%|3.1%|
|Uvs|10.6%|6.4%|6.9%|7.5%|9.5%|
|Zauhan|6.5%|5.8%|5.1%|3.8%|3.6%|

Table 5: Pure Premium Rates By Aimag and Species

|**Aimag**|Cattle<br>Sh|eep<br>Go|at<br>Camel|Horse|
|---|---|---|---|---|
|Arhangi|1.1|2.2|2.1<br>1.2|0.7|
|Bayan-Oligii|3.8|2.7|3<br>2.4|2.5|
|Bayanhongor|2|1.9|2<br>1.7|2.2|
|Bulgan|0.8|1.9|1.9<br>3.2|1.3|
|Darhan_Unl|1.6|1.6|1.7<br>1.5|1.8|
|Dornod|2.2|3|4.3<br>3.1|2.4|
|Dornogobi|1.3|1.5|1.5<br>1.8|1|
|Dundgobi|5.9|3.7|4.1<br>3.5|4.3|
|Gobi-Altai|1.3|1.3|1.1<br>1.3|1.8|
|Govisumber|1.6|1.6|1.7<br>1.5|1.8|
|Hentii|1.8|2.3|2.2<br>2.4|1.7|
|Hovd|1.5|2.1|2.2<br>1.4|2.6|
|Hovsgol|1.2|3|2.6<br>1.4|1.1|
|Omnogobi|2.2|1.4|1.6<br>1.4|1.9|
|Orhon|1.6|1.6|1.7<br>1.5|1.8|
|Ovorhangii|2.6|2.5|2.2<br>2|3.8|
|Selenge|1.5|1.9|1.5<br>3|1.5|
|Suhbaatar|2.1|2.5|3.3<br>3.1|1.9|
|Tov|3|2.2|1.8<br>3.4|1.9|
|Ulaanbaatar|3|2.2|1.8<br>3.4|1.9|
|Uvs|2.8|1.8|2.2<br>2.1|4.6|
|Zauhan|2.9|1.9|1.8<br>1.7|2.3|
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**Livestock Insurance in Mongolia**

In essence any value greater than 100 suggests that premiums in that year would not cover the payouts. As one would expect, the aggregate values are generally lower than some of the values by species. While there is some risk spreading and diversification, there remain some serious losses. The year 2000 exceeds 400 % loss ratio. The next worse year is 1969 at 357%. Another way to highlight the bad years is to show excess losses as is done in figure 4.

At this stage all the information that is needed to operate an insurance company to insure all species in every aimag of Mongolia is organized. To simplify things, we return to some basic principles and use some rounded numbers. It is very important to understand that this analysis is being performed to give insights into the overall risk profile in Mongolia and to spur thinking about what the actual cost might be to run a complete insurance program using the mortality index insurance. Above all, the methods for reinsurance and administrative cost _are not recommendations._ They are simple abstractions designed to motivate thinking and give the needed insights.

We assume that the total liability for the insurance company is Tg 1 Trillion (note the value in the work above is Tg 1.09). We use the average pure premium rate that is 2.15%. With a load of 40 percent, the premium at would be very close to 3%. Again, another simplifying assumption is that this insurance company will ask an international reinsurer to pay for all losses beyond those that can not be covered with the unloaded pure premium. Table 7 gives the complete profile of how this might work. The pure premium value is roughly Tg 21.5 billion. Our hypothetical Mongolian insurance company pays this sum first and then any losses beyond that point would be paid in a simple stop loss by an international reinsurer. The column "Reinsure Pays" gives the estimated payments under this system. These average Tg 9.1 billion per year. Since the pure premium is used the net receipts before any expense beyond pure premium for the company also average Tg 9.1 billion per year. These measures are an excellent proxy for the degree of covariant risk that remains in the system.

It is assumed that with this type of primary insurance and with some opportunities for added efficiency in weather markets, the reinsurance can be negotiated at a favorable rate. For simplicity and given this assumption, the pure reinsurance cost of Tg 9.1 billion is loaded by 50%. Thus the annual cost for international reinsurance is set at Tg 13.5 billion (9.1 x 1.5).

Given our structure of reinsurance, it is now possible to determine how the rest of the funds may be spent. First, we return to the pure premium and load that value by 40%: 21.5 x 1.4 = Tg 30 Billion. Next we account for the average value of the indemnities that the insurance company must pay: 21.5 - 9.1 = 12.5. Finally, we assume the residual premium income is available for all remaining cost (profits, administrative costs, etc.). This value is about 14% of the loaded premium and should reasonable. Some may be concerned that this is a low value. However, keep
**Page** 25

**Livestock Insurance in Mongolia**

**Table** 6: **Estimates Annual Loss Ratios for All**<sup>**SpeciesGivenPure Premiums**</sup>

||Aggreate|Cattle|Sheep|Goat|Camel||
|---|---|---|---|---|---|---|
||Loss Ratio|LossRatio|LossRatio|LossRatio|LossRatio||
|1969,1<br>|357|453|272|254|330<br>|404<br>|
|F19 <sup>7 </sup>0-i|82|86|45|77<br>|72<br>|128<br>|
|'197.1|288|309|267<br>|327<br>|280<br>|235<br>|
||48|0|90|102|25|28|
||**69**|10|90|126|34|94|
|i1974~-24||0|30|79|13|0|
|;1i976C|46|0|87|107<br>|5<br>|19<br>|
|~1977-j|282|227|389|327|145|228|
|1978|0|0|0|0|0|0|
|1e98<br>**_-;_**|107|115|80|101|273|103|
|i981.|52|72|18|35|28|81|
|19'82'-!|44|68|0|15|204|55|
|**I98**39|252|231|259|253|383<br>|255<br>|
|1984i|45|0|96|65|31|44<br>|
|:i985,|85|29|130|167|60|45|
||47|10|100|70|40|24|
|'1987'~<br>- -|60|51|64|67|209|35|
||98~-|68|46|66|122|69|50|
|I1989;.|0|0|0|0|0|0|
|199V0|79|61|110|109|62|44|
|1991s,|69|58|64|61|169<br>|84<br>|
|,i992,..|**44**|**47**|17|13|69|100|
|1993.|241|316|213|121|162|287|
|1994**_1-_**|**74**|88|80|25|176|77|
|1995|13|0|16|0|109|32|
|1996|5|0|0|0|0|26|
|**-1997**|57|44|78|34|2|90|
|1998:,<br> <br>|12<br> <br>|0<br>|20<br>|23<br>|14<br>|13<br>|
|k**999**<br>@-|**:L]**<br>6|7|0|0|0|18|
|**2000**|434|663|307|308|24|386|

in mind that the primary administrative cost is<sup>marketingand sales, collecting</sup> premiums, and making indemnity payments. All<sup>other statisticsand lossadjustments</sup> should occur within the existing system. Thus,<sup>14%may be well withinthe rangeof</sup> the cost needed. The total annual average position<sup>of the Mongolianinsurance</sup> company follows:

- V *Load premium by 40% to pay for other cost

- / *2.15 x 1.4 = 3% premium rate

- / *Revenue = Tg 30 Billion premium

- / *Reinsurance = Tg 13.6 B

- / *Loss paid by insurer = Tg 12.4 B / -AIl other costs = Tg 4.0 B
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**Livestock Insurance in Mongolia**

**Table 7:Balance sheet activities for hypothetical insurance company**

|Year|PureLoss<br>Ratio|Payoutsor<br>Indemnities|OverallPure<br>Premium<br>lessIndemniities|Reinsurer<br>Payments|Co.Pure<br>Premless<br>Indemnities|**s:IOJIIII**<br>**:ljiutiii**|
|---|---|---|---|---|---|---|
|1969|357%|76.8|(55.3)|-55.3|0|-9.1|
|1970|83%|17.8|3.7|0.0|3.7|-5.4|
|1971|289%|62.0|(40.6)|-40.6|0.0|-9.1|
|1972|48%|10.3|11.2|0.0|11.2|2.1|
|1973|70%|15.0|6.5|0.0|6.5|-2.5|
|1974|24%|5.2|16.3|0.0|16.3|7.3|
|1976|46%|9.9|11.6|0.0|11.6|2.5|
|1977|283%|60.7|(39.2)|-39.2|0.0|-9.1|
|1978|0%|-|21.5|0.0|21.5|12.4|
|1980|108%|23.2|(1.7)|-1.7|0.0|-9.1|
|1981|53%|11.3|10.2|0.0|10.2|1.1|
|1982|44%|9.5|12.0|0.0|12.0|2.9|
|1983|252%|54.2|(32.7)|-32.7|0.0|-9.1|
|1984|45%|9.7|11.8|0.0|11.8|2.8|
|1985|85%|18.3|3.2|0.0|3.2|-5.9|
|1986|47%|10.1|11.4|0.0|11.4|2.3|
|1987|60%|12.9|8.5|0.0|8.5|-0.5|
|1988|68%|14.7|6.8|0.0|6.8|-2.3|
|1989|0%|-|21.5|0.0|21.5|12.4|
|1990|79%|17.0|4.4|0.0|4.4|-4.6|
|1991|69%|14.9|6.6|0.0|6.6|-2.4|
|1992|45%|9.6|11.9|0.0|11.9|2.8|
|1993|242%|51.9|(30.4)|-30.4|0.0|-9.1|
|1994|75%|16.0|5.5|0.0|5.5|-3.6|
|1995|14%|2.9|18.5|0.0|18.5|9.5|
|1996|5%|1.1|20.4|0.0|20.4|11.3|
|1997|57%|12.3|9.2|0.0|9.2|0.2|
|1998|13%|2.7|18.8|0.0|18.8|9.7|
|1999|6%|1.3|20.2|0.0|20.2|11.1|
|2000|434%|93.3|(71.8)|-71.8|0.0|-9.1|

Averages can be deceptive however. The net position of the values above is zero. Table 7 provides a clear indication that there is great variation around zero. When the losses exceed the pure premium, the insurance company will pay out Tg 9.1 billion. In the years when there are no payments, the net gain will be Tg 12.4 billion. Clearly our insurance company must have capital reserves to manage the risk that remain. Nonetheless, the system designed here does limit the losses.

# **An Alternative Payout Structure**

One concern with the contract designed above is that once the trigger mortality rate is crossed there would be a payment at that rate. This may encourage moral hazard on the part of the officials who are developing the statistics for mortality rates. If they believe that the numbers are close to trigging a payment, they may 'create losses' by
**Page** 27

**Livestock Insurance in Mongolia**

making certain that the values will trigger a payment.<sup>Thisincentiveis stronger given the</sup> fact that levels of payment are high once the trigger<sup>iscrossed.Analternativeto reduce</sup> these incentives would be to scale the payments<sup>inoncethetriggeriscrossed.</sup> For example, if the trigger were set at a 10% mortality<sup>rate,each1 percentagepointabove</sup> that level could be considered what is referred<sup>toasa'tick'andacertainlevelof</sup> payment could be tied to each 'tick'.

With a tick system, payments would only begin when<sup>the mortalityrateis equalto</sup> 1 1% and they would be made more gradually.<sup>For example,if the correspondingvalueat</sup> risk for cattle is 100,000 Tg and a herder has<sup>100cattle,theywouldwantinsurance</sup> values of 10,000,000 Tg. If we consider that the<sup>maximummortalityrateinasummay</sup> be 60%, then we have 50 ticks between the<sup>triggervalueof10%and60%. Wecan</sup> divide the 10,000,000 Tg by 50 ticks to get<sup>a</sup> value<sup>pertickof2,000,000Tg.Thus,at</sup> 11% mortality the herder with 100 cattle would<sup>receive2,000,000Tg.If themortality</sup> rate is 12%, the payment would be 4,000,000 Tg,<sup>and so on.</sup> Payment = (Mortality rate - Trigger) x Tick Value = (12% - 10%) x 2,000,000.

This system may also be more easily explained<sup>toaherder.The explanationis</sup> simply - for each point above the trigger you<sup>willreceiveapaymentof2millionTg.</sup> Premium rates and all other considerations could<sup>berecalculatedusingproceduresthat</sup> are similar to those presented above with the new payout<sup>rules.</sup>

# **Other Considerations**

# _Concerns Regarding Ability to Predict Bad Years_

A number of other considerations should be discussed. The ability of both herders and insurers to know something about<sup>theriskof livestocklossesinthecoming</sup> year is a problem. Everyone agrees that in a very<sup>drysummerwhengrassdoes notgrow</sup> to adequate height, the likelihood that heavy snow<sup>willcover thegrassandcreateadzud</sup> is much greater. Thus, either party can use this information<sup>ina fashionthat isharmful to</sup> the intent. For example, the insurer may decide<sup>not toofferinsurancegiventhistypeof</sup> season prior to winter. By the same token the<sup>herdermaydecidethat thisistheyearto</sup> purchase the insurance whereas in other years they<sup>do not.Thisis intra-temporaladverse</sup> selection. Either form of behavior is undesirable.<sup>The ratescould be adjustedfromyear</sup> to year. However, this is cumbersome and would<sup>likelylower participationin precisely</sup> the years when it is needed.

_Recommendation:_ Offering a three-year sequentially<sup>updated contractmaybethe best</sup> option to deal with the knowledge that is available<sup>about likelylosseswell inadvance of</sup> the year beginning. The herder would sign a contract<sup>stating that they would be obligated</sup> to pay the premium in January for each of the next<sup>threeyears.A renewal of thecontract</sup> in the following year would also obligate the<sup>herderforthreemoreyears.The contract</sup> would simply roll forward in time with each sign<sup>up unlesstheherder explicitlychoseto</sup>
**Livestock Insurance in Mongolia**

**Page** 28

cancel. This would prevent either the herder or the insurer from changing their behavior when information going into the winter gives an indication of the likely loss. Premium surcharges could be imposed for herders who chose to take only a one-year contract. Other penalties may be in order for herders who cancel before the contract expires.

# _A dual Payment System_

_Recommendation:_ Given that most dzud create the serious livestock losses in the spring, it may be possible to structure a dual payment system. A preliminary payment could be made in June when conditions clearly show that a serious loss has occurred. The remaining payment would be made at the end of the year.

# _Linkages to micro-finance_

In discussions with herders we asked about the nature of collaboration they engage in with neighbors, farmer associations, cooperatives, etc. While the herders we visited did not belong to associations or cooperatives, they were involved with their extended families and neighbors in a number of joint activities. We described a concept whereby they might collaborate with these same neighbors in buying the mortality index. In this fashion, they could each buy the index based on their own herds and then collectively decide who among them needed the most assistance when the index paid. Such agreement would need to be worked out early and negotiated as the event occurred. The herders we visited felt that this was workable and something they may consider. In effect, such an arrangement would be like a mutual insurance that could even be turned into an effective micro-finance group. If a group of herders in the same region had such arrangements, some of the emerging micro-finance banks may be willing to make loans to the group or to individuals in the group. The index contract should remove the major risk that these herders face.

More formal structures could also be facilitated under the micro-finance component of the World Bank and FAO projects. Farmer associations or cooperatives could be encouraged to follow this model with the promise of loans. The goal would be to get these associations to begin to offer these services of collective and mutual insurance coupled with micro-finance loans. The mortality index contract could be a key component of this activity.

# _Linkages to Community Investment Funds_

When visiting with sum officials about how such index contracts could and should be sold to others who have value at risk when there is a livestock disaster, the immediate question was 'could the sum purchase such a contract?' The answer should be yes. Sum governments undoubtedly suffer fiscally when there is a major loss in livestock. In addition, they are struggling to provide assistance to families in the sum who have suffered the most. Thus, one can envision allowing the sum government to purchase this insurance. It would be a clear indicator of problems and it is scaled in such a fashion that the more serious the problem, the greater the payments. Some share of
**Page** 29

**Livestock Insurance in Mongolia**

community investment funds might be used by<sup>sumsto purchase thesecontracts.The</sup> important issue for the community is what are the<sup>relativecostsofpurchasing these</sup> contracts versus holding some fiscal reserves for these<sup>typeof livestock disasters?</sup> Given the design of these contracts, there is every<sup>reasonto allowany entitythat</sup> has an insurable risk to purchase a mortality index<sup>contract.This wouldnot createan</sup> underwriting problem and it cannot create extra losses<sup>sinceit is an index.The banks and</sup> input supplies may be interested in directly<sup>purchasingthiscontract.</sup> Both have a portfolio of risk that is directly tied to the well<sup>beingof the herders.Many others in the</sup> community may also have their income and well-being<sup>directly tiedtothewell-beingof</sup> the herders.

# _Alternative Roles for Government_

What is presented here are some basic ideas. There<sup>aremanypossibleroles for</sup> government. Until there is more interaction with<sup>policy makers andothersaboutthe</sup> desired course of action, it is premature to develop<sup>this muchbeyond somebasicideas.</sup> Work performed for the government of Argentina<sup>couldbeusedasabasicmodel for</sup> government role. The key aspect of whatever<sup>rolethegovernmentplaysisthatitbe</sup> limited and that it be structured to spur private<sup>insurance marketswithoutgivingthe</sup> insurance markets too much opportunity for<sup>rent seeking.</sup> A number of alternative roles for government are<sup>possible.Atoneendofthe</sup> spectrum, the only involvement may be to continue<sup>tosupportdevelopmentoftheloss</sup> data and the census coupled with the appropriate<sup>regulatoryframeworkthat allows these</sup> index contracts to be developed and sold by the<sup>privatesector.Atthe otherendof the</sup> spectrum, a relatively basic (and low value) index<sup>contractcouldbe soldandreinsured</sup> directly by the government in such a fashion<sup>thatwould facilitate some catastrophe</sup> protection for herders and at the same time<sup>spur privateinsurance companiestooffer</sup> additional insurance coverage. No matter what<sup>course is takenthegovernmentmust</sup> remain involved in developing the loss data<sup>andthecensus population.</sup> This infrastructure is key to the success of this concept.

If the government could afford to make this index<sup>insurance availabletoall</sup> herders at a pure premium rate, the total cost to<sup>the governmentmaybeaboutTg10</sup> billion. Under such conditions, the herder would<sup>payforabasicpolicywith premiums</sup> that just equal the expected payouts (indemnities).<sup>Thegovernment would payforthe</sup> reinsurance and the administrative cost. If such<sup>anapproachweretriedit wouldbe</sup> critical to offer insurance only at the expected<sup>valueoftheanimalsforthebasic</sup> government policy. Further, it would be important<sup>tocreateincentivesfor theprivate</sup> insurers to offer more insurance. For example<sup>theprivatecompaniescould beallowedto</sup> sell the government insurance only if they offered<sup>some additionalvalue.Otherwise,the</sup> basic policy would be available for herders who<sup>wantno more insurance coveragethan</sup> what is provided with the government policy.<sup>Otherdelivery channelsforthe basic</sup> policy may be considered.
**Page** 30

**Livestock Insurance in Mongolia**

Once the basic policy was in place, much of the covariant risk would be removed from the market. The private companies could offer individual insurance that would pay for losses not paid for by the basic policy. For example, once the index policy payment is made, herders could file a claim for any remaining losses suffered that are not paid. Another policy could be offered at a lower level or layer of risk. For example, if the basic policy begins paying for mortality rates above 10%, the private policy could pay for mortality rates between 7% and 10%. With this type of layer, the covariant risk would not be nearly as serious as for the upper layer (the basic policy pays the upper layer - losses between 10% and 100%).

# **Conclusion**

The need to carefully consider how livestock insurance may influence the incentives of herders in Mongolia is significant. The overriding goal of maintaining and enhancing the risk mitigation strategies used by Mongolia herders mandates that careful thought be given to how livestock insurance might be structured. This report has provided some thinking to that end. This is at the core of the recommendation that a livestock mortality index be used to provide insurance on a sum or bag level. Such insurance would pay every herder based on the mortality levels within the region, regardless of the individual herder losses. Consequently, the individual herder who works hard to sustain their livestock during a dzud would be rewarded. By the same token, the herder who does not work to sustain their livestock will only be compensated at the losses for the community. This system will not reward the herder who has heavy losses when the community does not. Using the area mortality index to pay nearly eliminates moral hazard and adverse selection. The major concern will be to maintain quality statistics for mortality rates.

Even if a mortality index is used, this study also reveals the high level of covariate risk that would remain. The models developed here highlight the need for risk sharing in the international community. Just how that risk is -shared would depend heavily on the ultimate structure of government involvement in providing some level of reinsurance. In early stages some level of government involvement is needed to spread the risk across Mongolia to the extent possible. However, this role should be as a risk aggregator only so that private providers can combine their risk with others across Mongolia.

Should there be a desire to proceed with a pilot test of the mortality insurance concept, there are a number of additional items that would need attention as first steps. These steps should be taken to test the feasibility and acceptability of mortality index insurance. Some basic considerations and next steps follow:

**1. Collect data on mortality and adult livestock numbers for more sum;** make certain that these data are complete for all species of livestock for at least 30 years; create a data set for as many sum as possible but, at a minimum, obtain a geographic spread of sum within a aimag and complete at least five sum for each aimag.
**Page** 31

**Livestock Insurance in Mongolia**

2. **Investigate in some detail the statistical**<sup>**systemthat isbeingusedtodevelop**</sup> **the census of animals and the reporting of**<sup>**mortality ofanimals.**</sup> This investigation should be conducted with a clear<sup>pictureof how thesedatamight be</sup> used to make insurance payments. A number of<sup>issuesshouldbe investigated:1)</sup> what is the quality of these data? 2) Could the data<sup>be developedat thebag level?</sup> 3) Has the process for developing the data<sup>changedinanysignificantfashionin</sup> the last 30 years? 4) Have the data been used<sup>inthepasttomakeemergency</sup> disaster payments and, if so, is there any evidence<sup>that thiscreatedany</sup> misrepresentation in the data? 5) Given that a census<sup>is taken everyyear,are there</sup> adequate safeguards and accounting systems in place<sup>tomitigatetheopportunity</sup> for manipulating the data? 6) What auditing systems<sup>might beadded toassure that</sup> the data process does not change when a insurance<sup>paymentsarebeingmadeon</sup> the basis of the data? 7) How do herders and others<sup>viewthe qualityof the data?</sup>

**3. Select a sample of sum to offer the mortality**<sup>**indexinsurance.**Initially, the</sup> government could collaborate with the private insurers<sup>and make insuranceoffers</sup> in a select sample of sum. The sample should<sup>beselected with somegeographical</sup> spread in mind. Ideally, the offers would be made<sup>inabout30sum.Giventhat</sup> the mortality data are widely available, it may<sup>bepossibletomakeselecta</sup> representative sum in every aimag to begin the pilot.<sup>Thiswouldgive as much</sup> geographic spread as possible and provide the needed<sup>publicityacrossMongolia</sup> for the concept. Great care should be taken in making<sup>certain thatthe pricethatis</sup> charged reflects the relative risk. The premium<sup>rateschargedherdersandthe</sup> design of the contracts should be consistent with market<sup>principles. Initially,the</sup> government could provide some level of reinsurance<sup>toprivate providesto get</sup> their involvement. Simultaneously, the concept and pilot design should<sup>be</sup> presented to the international capital markets obtaining<sup>their inputand attempting</sup> to get their involvement in offering reinsurance.

4. **Develop an extended education and marketing**<sup>**program.**Anysuccessful pilot</sup> must educate herders about the potential value<sup>anduseof thisinsurance.Some</sup> considerable attention should be paid to an educational<sup>effort.</sup> _5._ **Establish appropriate feedback and monitoring**<sup>**ofthe pilot.**Apilot program</sup> should be designed to allow for learning about the<sup>concept.This learningmust</sup> involve a number of dimensions: a) how have the<sup>privateinsurersrespondto the</sup> opportunity? b) how have the herders responded?<sup>c)areherdersthinkingofand</sup> using informal and formal mechanisms to share<sup>theindex paymentswithinthe</sup> community? d) has the introduction of the index<sup>insurance changedthe data</sup> development process in any significant fashion?

In a pilot test, one may attempt to offset the cost of<sup>theinsurancetoherders</sup> so that herders would just pay the pure premium of<sup>the program.Thiswould require</sup> some budget obviously. Additional financing would be needed for resources<sup>to</sup> examine the issues outlined above and for education<sup>andmarketing.Thus,careful</sup> thought must be made as to the scope of a pilot<sup>and thetotal amountoffunds</sup> available for running such a test.
page 32

**Unofficial Translation of Main Articles of Draft Law**

**Appendix A:**

# **Main articles of the draft law on livestock insurance**

# **1. Purpose of the law**

- 1.1 Purpose of this law is to regulate the relationships between insurance companies, citizens and legal bodies on compulsory insurance of livestock

# **4. Scope and forms of livestock insurance**

4.1 Livestock insurance can be compulsory and voluntary

- 4.2 Citizens and legal bodies shall insure breeding animals and young<sup>animalstoreplace</sup> aged breeding animals on a compulsory basis

/There were proposals from Mongol Daatgal company and Tushig Daatgal company that livestock insurance should cover all animals not only breeding but this was not<sup>accepted</sup> in the final draft/

# **5. Livestock insurance**

5.1 Livestock shall be insured on a compulsory basis against the following<sup>risks:</sup> 5.1.1 Drought and _dzud_ 5.1.2 Sudden disasters such as flood, strong storns, cold showers, fires 5.1.3 A class contagious diseases

- 5.1.4 some serious diseases in B and C classes

# **6. Insurance agreement and guarantee**

6.1 Livestock insurance agreement and guarantees shall be regulated by the articles<sup>9.1</sup> and 9.2 of the Law on Insurance.

6.3 Livestock insurance agreement shall be based on the livestock census<sup>dataattheend</sup> of year and shall be established by 1 April.

6.4 An insurance company can partly or wholly reinsure livestock<sup>risksby domesticand</sup> international companies.

# **7. Insurance duration**

7.1 The duration of livestock insurance agreement shall be for 365 days since the date of signing.

# **8. Insurance value and premiums**

- 8.1 Value of animals insured shall be established through negotiations<sup>between2parties</sup> 7

8.2 Premium for compulsory livestock insurance shall be 2% of the value7.

8.3 Premium shall be paid by 1 April in cash.

# **9. Insurance indemnities**

9.1 Citizens and legal bodies shall report about animal losses within 72<sup>hoursincasesof</sup> sudden disasters and 2 times per month during droughts and _dzuds._

> 7 There was some indication that the 2% value had been increased to 4%. However, this<sup>is not confirmed.</sup> Even 4% is unlikely adequate to support a totally private market policy with the coverage<sup>outlinedin</sup> Appendix A. Someone inside the Ministry has done some analysis on this issue. However,<sup>wewere ner</sup> able to locate them and learn about this analysis.
page 33

**Unofficial Translation of Main Articles of Draft**<sup>**Law**</sup>

**Appendix A:**

9.2 Working group in charge of identifying and certifying<sup>reasons,scopeanddurationof</sup> events that caused animal losses shall be appointed<sup>by</sup><sup>_sum_Governors.Workinggroup</sup> shall be composed of representatives of insurance<sup>companies,citizensandlegalbodies</sup> /clients/, livestock expert, weather expert and other<sup>relevant bodies.</sup> 9.3 Whether the event can be considered, as drought<sup>and</sup><sup>_dzud_shall be determinedby the</sup> Government.

9.4 Insurance companies shall disburse indemnities<sup>within30daysfromthe dateof</sup> conclusion by the Working group.

9.5 Indemnities shall by determined on the following<sup>ratebasedonthevalueunder</sup> insurance: 9.5.1 100% for sudden disasters, 70% for droughts<sup>and</sup><sup>_dzuds_</sup> 9.5.2 100% for A class diseases, 80% for B and C class<sup>diseases.</sup> 9.6 Relationships regarding indemnities shall be<sup>regulatedbyarticles13.1-13.6,13.5.5,</sup> 13.9-13.10, 13.12-13.15 of the Law on Insurance.

9.7 Insurance companies shall not pay indemnities in the<sup>followingcases:</sup> 9.7.1 Livestock losses due reasons not indicated<sup>in the Agreement</sup> 9.7.2 Due to failures by citizens and legal bodies<sup>totimelyreportanimal lossesand</sup> resulting impossibility to determine reasons and scope<sup>of losses</sup> 9.7.3 Duration of agreement /insurance/ is expired

# 10. **Concessions on insurance premiums**

10.1 In cases of citizens and legal bodies are not<sup>paidindemnitiesfor3 consecutiveyears</sup> they shall pay insurance premiums reduced by 20%<sup>from thefourth year.</sup>

# 11. **Insurance companies**

11.1 Compulsory livestock insurance shall be run by<sup>insurancecompaniespartlyor</sup> wholly owned by the state.

11.2 Companies in 11.1 shall have capacity to<sup>bereinsured by international companies.</sup>

# 12. **Responsibilities to violators of the law**

12.1.1 Insurance companies that fail to pay<sup>indemnities whollyor partlytheyshall</sup> compensate them and pay penalty in the daily rate<sup>of0.1%fromtheexpireddatebased</sup> on the value of liability.

12.1.2 Citizens and legal bodies that fail to insure<sup>livestockshall payinsurancepremiums</sup> and penalty 10 000-25 000 _tugrug_ in the case of<sup>citizens and1000040 000inthe case of</sup> officials and 50 000-200 000 in the case of<sup>legalbodies.</sup> 12.2 Costs caused by wrong reporting shall be paid<sup>by body who is responsible for</sup> wrong reporting.
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- Walter, A. S. "Risk Management in Agriculture." Testimony before the U.S. Senate Committee on Agriculture, Nutrition, and Forestry.
**Policy Research Working Paper Series**

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|---|---|---|---|---|
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|---|---|---|---|---|
|WPS2882|PoliticallyOptimalTariffs:<br>AnApplicationtoEgypt|DorsatiMadani<br>MarceloOlarreaga|September2002|P.Flewitt<br>32724|
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