A major insurer explores the risks of using insurance to reduce climate shocks on global food supplies

By Evan Lehmann | 06/22/2015 08:02 AM EDT

A stress test prepared by Lloyd’s of London concluded that a chain reaction of floods, drought and related diseases could cripple the world’s food supply, leading to a crisis that could spark further unrest, including the possibility of rioting in major cities, a terrorist attack in the United States and even a Russian invasion.

A stress test prepared by Lloyd’s of London concluded that a chain reaction of floods, drought and related diseases could cripple the world’s food supply, leading to a crisis that could spark further unrest, including the possibility of rioting in major cities, a terrorist attack in the United States and even a Russian invasion.

Lloyd’s, a major global insurer, outlined the scenario in a report last week. It is seen as an unlikely but possible scenario that could cut across the insurance industry’s separate lines of underwriting, as economies are devastated by rising temperatures and hungry populations.

In the scenario, people in poorer nations suffer the most from failing small farms, rising risk of famine and damaging natural disasters that wreck already wobbly farming systems. In the United States and other wealthy nations, food shortages cause the price of groceries and gasoline to soar while stock prices tumble. Severe floods create further havoc along major rivers in the Midwest that ship food overseas.


"The food system’s existing vulnerability to systemic shocks is being exacerbated by factors such as climate change, water stress, ongoing globalisation, and heightening political instability," the report says.

The fragility of the current food system is already apparent. About 805 million people worldwide are undernourished, according to the United Nations, and scientists believe climate change will have a negative effect overall on crop yields and fisheries in the future, even if increased carbon dioxide levels encourage some additional production.

That’s possible because the population is rising from 7.3 billion now to a projected 9.6 billion by 2050, mostly in Africa and other developing regions. The United Nations says food production will have to grow by 70 percent to feed that number of people. Some experts warn that climbing temperatures are already shrinking crop yields.

Multiple crop failures begin the crisis

In the Lloyd’s scenario, a massive amount of food dies in fields around the world. A key culprit is strong El Niño conditions that contribute to widespread drought in Australia, severe flooding in Pakistan, India and Bangladesh, and crop reductions in the breadbaskets of South America. Altogether, corn production drops by 10 percent, soybeans by 11 percent and rice by 7 percent.

"In summary, quadrupled commodity prices and commodity stock fluctuations, coupled with civil unrest, result in significant negative humanitarian consequences and major financial losses worldwide," the report says.

The study projects an unlikely cumulative desperation in the real world, but it’s possible, said Tim Wheeler, an expert on crops and climate change at the University of Reading in the United Kingdom.

The chances of such a scenario are low, he said in an email. "But the important conclusion from this study is that dramatic shocks to the global food system in the near future are unlikely, but not impossible."

Lloyd’s estimated that its scenario has a one-in-200-year return period, meaning that there might be a 0.5 percent chance of it occurring annually.

The threat to the insurance industry is the potential scale of such a disaster, It would challenge insurers across multiple dimensions of business, even those that seem unrelated to food shocks. The report warns that the industry might have to pay "significant claims" related to terrorism, political violence, business interruption, marine, aviation, agriculture, environmental liability and product recall. There could be more, it notes.

"One billion people go hungry every year, and this figure could treble by 2050. We need to close the gap between production and supply to improve food security, protect supply chains, and feed the world’s population," Tom Bolt, Lloyd’s director of performance management, said in a statement. "The effects of these kinds of environmental catastrophes could generate major economic and political impacts, and create a wide range of insurance claims."

Food prices soar, but so do risks to farming

Food security has taken on new emphasis as scientists and policy advocates seek to understand how climate change might affect crop production in areas where extreme weather is expected to have large impacts. That includes nations in Africa and Asia predominantly.

The Intergovernmental Panel on Climate Change highlighted the risks to food production for the first time last year. It found that a variety of climate impacts could erode yields, including changing water quality, migrating fisheries, climate stress on traditional crop areas, more or less rain, and increased weed growth. Some northern areas in China and the United Kingdom could see productivity increase because of higher concentrations of carbon dioxide, but scientists agree that negative outcomes elsewhere will eclipse those benefits.

The challenges of growing traditional crops could discourage some farmers from trying again, even though rising populations increase demand for crops 14 percent per decade, according to the IPCC report.

"Increased incidence of climate extremes reduces incentives to invest in agricultural production, potentially offsetting positive impacts from increasing food price trends," the fifth assessment report said last year. "This is particularly true for poor smallholders with limited or no access to credit and insurance."

Widespread access to insurance is unusual in developing nations. As climate risks grow, the absence of coverage could lead farmers to plant lower-risk subsistence crops, which generate smaller returns, the U.N. report warns. It could also discourage them from investing in fertilizers and adopting new technologies that could help them adapt to rising temperatures.

"All of these responses generally lead to both lower current and future farm profits," the U.N. report says.

Could more insurance coverage reduce Third World vulnerability?

Global reinsurers are looking for inroads into developing markets. They’re experimenting with index insurance programs that rely on climate thresholds like the amount of rainfall to allow policy claims, rather than sending adjusters to individual farms.

That can be cheaper than traditional coverage, and insurance policies are sometimes used as collateral for loans for seed or other equipment. The Group of Seven nations approved language this month setting a goal of providing insurance to an additional 400 million people in developing nations.

Some say that insurance is an underused tool that can be used to encourage policyholders to undertake climate adaptation efforts. The Lloyd’s report notes that farmers, especially those in poor nations, can benefit from having insurance by being compensated when crops, or the rain, fail. Insurance could also help them receive loans to make their farms more productive as the climate changes, the report says.

Still, the insurer admits that it knows too little about the potential impact of food shocks on the industry. In addition to paying a wide range of claims, companies could face "major consequences" on their long-term investments if political instability limits access to traditional markets.

On the other hand, a lot more food will need to be produced as the world faces the twin challenges of higher populations and rising temperatures, and much of it will need to be insured, creating new business opportunities.

"The insurance industry is in a position to make an important contribution to improving the resilience and sustainability of the global food system," the report says. "Further research should seek to quantify the impacts of a systemic shock to the food system to insurers’ portfolios, so that estimations of loss can begin to be made."

Click here to read the Lloyd’s report.