#70 | Re:co Podcast – Greg Lowe on Financing Resilience (S3, Ep. 5)

#70 | Re:co Podcast – Greg Lowe on Financing Resilience (S3, Ep. 5)

This podcast is brought to you with support from

Today, we’re very happy to present the fifth and final episode of “Value Chains: Transparency and Market Linkages,” a session recorded at Re:co Symposium this past April. Acknowledging that this isn’t the first coffee price crisis, this session brought leaders together to ask: How successful were the tools we employed previously? What new tools offer potential solutions?

If you haven’t listened to the previous episodes in this series, we strongly recommend going back to listen before you continue with this episode. 

Insurance is a common financial instrument, but often misunderstood. Today’s speaker, Greg Low, asks: What is insurance’s role in building resilient business models? New developments in insurance solutions can transform how risk is managed, understood, and priced. From crop insurance to weather insurance, new financing models are unlocking possibilities for agricultural supply chains.

Special Thanks to Toddy 

This talk from Re:co Boston is supported by Toddy. For over 50 years, Toddy brand cold brew systems have delighted baristas, food critics, and regular folks alike. By extracting all the natural and delicious flavors of coffee and tea, Toddy Cold Brew Systems turn your favorite coffee beans and tea leaves into fresh cold brew concentrates, that are ready to serve and enjoy. Learn more about Toddy at http://www.toddycafe.com.

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Table of Contents

0:00 Introduction
2:15 The history of insurance and how it works
7:30 How insurance relates to the coffee sector
9:25 How the insurance industry helps agricultural producers generally
17:45 What do the initiatives in agricultural insurance mean for coffee producers?

Full Episode Transcript

0:00 Introduction

Peter Giuliano: Hello everybody, I’m Peter Giuliano, SCA’s Chief Research Officer. You’re listening to an episode of the Re:co Podcast, a series of the SCA Podcast. The Re:co podcast is dedicated to new thinking, discussion, and leadership in Specialty Coffee, featuring talks, discussions, and interviews from Re:co Symposium, the SCA’s premier event dedicated to amplifying the voices of those who are driving specialty coffee forward. Check out the show notes for links to our YouTube channel where you can find videos of these talks.

This episode of the Re:co Podcast is supported by Toddy. For over 50 years, Toddy brand cold brew systems have delighted baristas, food critics, and regular folks alike. By extracting all the natural and delicious flavors of coffee and tea, Toddy Cold Brew Systems turn your favorite coffee beans and tea leaves into fresh cold brew concentrates that are ready to serve and enjoy. Learn more about Toddy at toddycafe.com. Toddy: Cold brewed, simply better.

Re:co Symposium and the Specialty Coffee Expo are coming to Portland in April 2020. Don’t miss the forthcoming early-bird ticket release – find us on social media or sign up for our monthly newsletter to keep up-to-date with all our announcements.

Today, we’re very happy to present the fifth and final episode of “Value Chains: Transparency and Market Linkages,” a session recorded at Re:co Symposium this past April. Acknowledging that this isn’t the first coffee price crisis, this session brought leaders together to ask: How successful were the tools we employed previously? And what new tools offer potential solutions?

If you haven’t listened to the previous episodes in this series, we strongly recommend going back to listen before you continue with this episode.

Insurance is a common financial instrument, but often misunderstood. Today’s speaker, Greg Low, asks: What is insurance’s role in building resilient business models? New developments in insurance solutions can transform how risk is managed, understood, and priced. From crop insurance, to weather insurance, new financing models are unlocking possibilities for agricultural supply chains.

Also, to help you follow along in this podcast, I will chime in occasionally to help you visualize what you can’t see.

 

2:15 The history of insurance and how it works

Greg Low: Hello. I do not really come from the world of coffee, as you can imagine, working in insurance. I like coffee. I do drink it. I had a great time sampling some of the coffee during the breaks today, but I’m going to talk to you about insurance on and really about a journey that we went on in terms of how we understand the concept of risk and pricing and valuing that risk, which I think aligns with some of the themes that we’ve heard today.  And I’m also gonna talk a little bit about innovations in insurance, around how insurance is potentially being used to address challenges in agriculture more widely. And how that might be something that could be beneficial to the coffee industry at some point in the future.

So, insurance: How many people think they’re experts in insurance? Because I also perhaps want to give you a little bit of an overview on how what is actually the largest industry in the world actually works. Do we have any insurance experts in the room? Good. Well, the first thing I should say is that the modern insurance industry that we know today, which is just about 400 years old, actually started in a coffeehouse. I’m sure you’ve all heard of Lloyd’s of London? I’m very privileged to work across the street from it. And Lloyd’s was originally Lloyd’s coffeehouse, and it was a place where people would drink coffee and share news about what was happening in the world of shipping. And people gradually realized that if they were to pull some of their money together to help protect these very exciting expeditions, they were going on, they wouldn’t necessarily suffer very harmful financial losses.

I think the way of thinking about insurance that people don’t typically think about it is that at its fundamental core, it’s a social institution of pooling our resources together to protect our lives and livelihoods for when things go wrong. Fire departments were also a creation of the insurance industry originally. And today, I said the insurance industry is the largest industry in the world. About one-third of the industry is actually made up of mutual insurance companies. So that means that they’re actually owned by the policyholders. State Farm in the US is an example of a mutual. And how insurance works: You pay your premium, it doesn’t stop there. That premium gets invested into the capital markets. And the capital markets create a return on that investment, which enables insurance to keep premiums at a reasonable price. But insurers don’t hold all that capital on their books. They then, to protect themselves from extremely dangerous risk, what we call “tail risk,” they go ahead and reinsure that. So they actually take usually between 20-30% of their book of insurance assets, and they reinsure that with a reinsurer.

How do we go about actually pricing some of this risk? Well, the reason I actually don’t have a presentation. I give a lot of talks, and normally they’re riddled with complex graphs and things called “exceedance probability curves.” I thought you probably really don’t want to see all that. But about 25 years ago, our industry was revolutionized when Lloyd’s nearly fell apart as a business. We had asbestos claims. We had Hurricane Andrew hit Florida. We had the Northridge Earthquake in California and Lloyd’s was on the brink of collapse. And historically, insurers priced premiums based on what had happened in the past. But this was not really working anymore. So we had to come to the world of science, the world of engineering and certainly actuarial science, which is something that our industry has done quite well.

So there was this development of something called a catastrophe model. Catastrophe models look at the exposure of a hazard. So when we talk about hazards in the insurance industry, we’re typically talking about something like a flood, a hurricane, an earthquake. Wildfire, which is very topical right now.  We look at how likely those things are to occur in a specific place. Then we look at the individual physical assets for a building. How does that perform with shaking with wind? With water? Then we take the actuarial science. Well, what’s the actual loss going to be? And you have an idea of how much this loss is likely to be and how often it’s likely to occur. And through a variety of different moments of arbitrage in the market, insurers arrive at a premium that they then charge you.

 

7:30 How insurance relates to the coffee sector

Greg Low: I talked about wildfires. I talked about floods, but I think there’s probably some hazards that are perhaps very relevant for the coffee industry that I didn’t mention. Water stress, drought, extreme heat: These are things that have often been considered to be traditionally uninsurable because they aren’t sort of a single event that happens at a moment in time. And the other challenge, of course, with something like coffee or any other agricultural product, is that it’s not a physical asset in the same way that a building, a television, a factory is. So how do we actually think about where agricultural fits into this challenge? And to give sort of a sense of what’s happening around disastrous finance, climate change, and the insurance industry, we are seeing certainly an increase in economic losses due to natural catastrophes.

2018 was the third largest year of economic loss in history. We had about a little over three hundred billion dollars in economic losses. 2017 was actually the biggest in history. And back to back, these have been the two costliest periods of natural disaster losses in history. Some of that is being driven by socioeconomic trends. So we have more and more people moving to more densely populated areas in very risky locations.

But certainly there’s a climate change signal here. And a lot of my work is focused on looking at climate risk and how the insurance industry can play a role in addressing that. And I was really taken with Andrea’s presentation earlier on how perhaps the coffee industry started thinking about the challenge of climate change.

 

9:25 How the insurance industry helps agricultural producers generally

Greg Low: So a little bit about how the insurance industry prices risk through analytics, a little bit around what’s happening around economic losses. Let’s talk about agriculture. There are insurance schemes for agriculture. In the US, for instance, there is a national crop insurance program. And we have a private market for agriculture in Australia. There are typically based on crop yields. So you get a payment if the yield is insufficient, basically. But this is quite difficult to price, and it means that premiums tend to be high. And I think those two examples are certainly not places where coffee is grown, or at least to my understanding. And they’re also fairly wealthy countries were even in the US that’s subsidized by government.

So how do we think about alternative ways of protecting agricultural producers? There’s something that’s really developed, I would say in about the past 15 years. And it’s something called parametric insurance or index-based insurance. And instead of actually looking at the risk of a specific event happening to a specific asset, it asked the question of, “Well, how likely is a condition to be met?” Is there a twenty percent chance that it might rain tomorrow? A ten percent chance? And you can actually then think about well, how would I price that likelihood of this particular situation occurring? And if I create an insurance program around it, it means that if a particular condition is met, I get a payout.

So we have the growth of what’s called weather insurance, which isn’t really all that different from a weather derivative. There’s a little bit of regulatory difference between the two of them. But basically what weather insurance is, is an insurance contract that stipulates you will get a specific amount of money under these conditions met. And I think in the whole context of climate change, many of these more chronic climate risks are really being challenged by the insurance industry’s approach to traditional products and whether insurance is certainly becoming something much more interesting.

But again, we have this challenge of how do you protect agricultural producers in parts of the world that do not have access to products like this? These are fairly complex products. Most of our clients who buy weather insurance tend to be in the energy industry. So they’re worried about how weather may impact demand for energy. Construction, things that are impacted by weather on day to day basis. But certainly there’s a lot of hope for agriculture.

Some of the solutions might be around development finance. I was just at some of the Spring meetings at the World Bank in Washington earlier this week. But I have to say as much as there was talk about insurance and development finance, I would say that the discussion on agriculture was not as vibrant as it should be. And I think that’s quite concerning. There’s a lot of attention from the development finance community on the role of agriculture in protecting the lives and livelihoods of communities. But there still really isn’t a lot of innovative thinking around how financial solutions must be developed to help these agricultural producers.

I’m gonna use a little bit of an example of an agricultural product. I’m particularly fond of, and that’s wine. Wine is also being affected by climate change. And when speaking to the wine industry, you have again many small producers, some very large commercial companies, but they’re usually buying grapes in from farmers who you know, are not large producers of grapes. And what we’ve seen with wine industry is many of the industry associations or cooperatives representing a particular region have begun to pull those resource is together to try and access the insurance markets. Another approach that we’ve seen has been to actually work with large food and beverage companies, and this has not been for coffee, but for a couple of other commodity crops, where they said “it’s in our interest to protect the lives and livelihoods of our suppliers, because if we don’t have suppliers, we don’t have a business anymore.” So they’re actually putting together insurance programs collectively to provide coverage for their suppliers, who again are usually fairly poor farmers in various parts of the world.

But what can insurance do and what can’t it do? It doesn’t replace food supply, so it’s not going to necessarily address famine. It’s not going to replace that coffee that might be lost. But what it can do is smooth financial impacts for farmers. So what we found in Africa, there’s an insurance pool called the African Risk Capacity, which is an agricultural drought program basically. We found with the Africa Risk Capacity, which has donor development finance money, that instead of farmers exiting the markets, potentially immigrating, rather emigrating, or moving to cities in their own countries to seek a better future – which would actually take supply out of the market, which impacts the wider market for that particular commodity, it’s helped them stay in business. And it’s smoothed their financial volatility. And it’s kept a supply of food in the system. And I think you know if we were to apply the same lessons to coffee, some of the issues around where are those growers going to be in the future, this could very much be something that allows them to have a future. But it’s not gonna replace coffee that’s been impacted on. And it’s not going to necessarily address the problem of climate change as coffee needs to move from a location perspective.

But I think on that question of where will we be able to grow coffee in the future? You probably know much better than I do around some of the questions that are being asked and some of the locations that are being explored. But again, I think some of the firms that we use as an industry specifically around weather data and where we don’t have access to good data and people are trying to find really sophisticated ways on through satellite imagery, etc, to get better information on weather. Some of those analytics can be taken out of places like the insurance industry and applied to other industries. And we’re working with a variety of climate analytics startups that are doing some incredible work. And I think this is where insurance is not this single-handed solution to anything, but it provides lessons on how to think about risk on how to look at data and make better decisions about how we protect our assets and the people who own those assets and their livelihoods.

And the final thing, I’d say, is that in a wider financial sense, the financial community, particularly the Financial Regulators, are taking a much greater interest in this topic. There is something you may have heard of, perhaps not, called the Task Force on Climate-Related Financial Disclosures, which I spent a lot of time speaking to our corporate clients about, and it’s very high on their radar. But essentially the idea that businesses should be disclosing the impacts of climate change on their balance sheets. And while I wouldn’t say that perhaps from a small coffee growers perspective that necessary seems material, I think we heard earlier about what McDonald’s is doing and the whole partnership model. Those companies will be thinking about some of these risks, and I think you know, if there’s to be a collaborative partnership, thinking about climate risk and its impact on the financial viability of an industry is something actually that really makes a lot of sense.

 

17:45 What do the initiatives in agricultural insurance mean for coffee producers?

Greg Low: So we’ve heard a little bit about how insurance is priced, how it works, how there’s been innovations and weather insurance for agricultural commodity products. I think, what does this mean for the coffee industry? I think it means asking better questions about risk. And I think from a roaster or distributor or trading perspective, those are important questions. And also supporting the farmers that you’re working with to help educate them. I think, again, where we’ve had really successful partnerships with our clients around the topic of climate change and disaster risk, it’s been helping them to share that information with their suppliers. And while most of that work has certainly been around, you know, complex supply chains for manufacturing, etc, I think the same lessons, you know, could be applied to agricultural commodities as well.

And the final thing I’d say is the development finance community is really important, I think, in helping us arrive at a more financially resilience economy in the context of climate change. I think we need to engage that community a lot more. And I’m not sure if anyone in this room is speaking to people at the multilateral development banks like the World Bank or the Interamerican Development Bank, the African Development Bank. But I would love to actually have that perspective in the room as well, because I think if we’re to keep a resilient and sustainable coffee industry, we’re going to need the partnership of a variety of communities from the financial sector to make sure that farmers continue to have access to financial products and solutions to keep them in business and also give them the right incentives to avoid things like deforestation, and that’s a really important conversation to have. So I’m out of time. I hope that you’ve perhaps realized that insurance isn’t quite as boring as you may have thought it is, but I will leave you to perhaps have one more cup of coffee if it’s not too late. And I’m of course happy to to answer any questions you may have in the margins of the meeting. So thank you very much and have a wonderful rest of your day.

 

20:00 Outro

Peter Giuliano: That was Greg Lowe at Re:co Symposium this past April.

Remember to check out our show notes to find a link to the YouTube video of this talk, a full episode transcript, and a link to speaker bios on the Re:co website.

Re:co Symposium and the Specialty Coffee Expo are coming to Portland in April 2020. Don’t miss the forthcoming early-bird ticket release – find us on social media or sign up for our monthly newsletter to keep up-to-date with all our announcements.

This has been an episode of the Re:co Podcast, brought to you by the members of the Specialty Coffee Association, and supported by Toddy.