How Index-based Insurance will Restructure Agriculture in Kenya

The government has proposed to amend the Kenyan Insurance Act to introduce an index based insurance. This is a laudable move, that will facilitate uptake of agricultural insurance in the country

Index Based In
Index Based Insurance will facilitate uptake of Agricultural Insurance. Photo: Courtesy

By gatuyuriana journal

In the Budget Statement for the year 2018/19, Cabinet Secretary Henry Rotich made various policy declarations in relation to the insurance sector. One, was to do away with insurance brokers. Such a move will render multitudes in the industry jobless.

There was another thing. He has proposed to amend the Insurance Act to introduce an insurance system known as “Index-based Insurance.” This is applicable move. An amendment Bill to the Insurance Act has been published to actualize these policy proposals.

In your business class, you may have been taught. Key principles in insurance include risk, insurable interests and indemnity. It is the last one, where there is a problem. The Kenyan insurance sector is indemnity-based. In this, an insurer is only obligated to “return” the insured to their status before the occurrence of the risk insured.

Well, for tangible such as a car, it is easy because an insurer will indemnify, in cases of an accident, with another car with equal valuation.But what of circumstances where you insure properties like crops in a farm, and they are wiped out by calamity such as drought?

What do you indemnify? This is a challenge. An assessment of losses cannot be conducted before payment is made. This predicament has led to low uptake of agricultural insurance by farmers.

Again, indemnity insurance has other problems that have made it commercially unsustainable. One is “moral hazard”. Insured become more negligent in protecting their insurance against loss, since the insurance guarantees payment anyway.

There is also an issue of “adverse selection”, where more risk-prone individuals will self-select into the contract. Hence, like a boss, comes the alternative, the index-based insurance.

Index-based insurance is one under which the payment to the insured is based, not on the assessment of the insured’s actual loss, but on determined amount based on an objective and independent index.

In such a case, the index serves as a proxy for the actual loss. If you are a farmer for instance, and there is drought, the compensation may be based on expected yield.

For index insurance to work there must be a suitable indicator variable (the index) that is highly associated with the event being insured but is not prone to manipulation by either the insured or insurer.

For example, if one is insuring against animal feed scarcity, an indicator such as rainfall or forage availability may be suitable. The idea would be that rain failure during the rainy season, shortage of available forage, or a combination of the two would result in some level of livestock stress.

The insurer will thus make a payment when a geographic area based indicator that is highly associated with the risk outcome being insured against is triggered. This differs from traditional insurance which requires that the insurer monitor the activities of their clients and verify the truth of their claims on a case by case basis.

When this comes into force, we expect actuarial experts will have a boom in making determining of premiums that will be payable.

Java House should do an IPO to avoid Private Equity Vultures

Java House image
Java House, Nairobi. Photo: Courtesy

By gatuyuriana Journal

This blog always try to avoid hindsight bias. This is a ‘knew-it-all-along effect’, where after an event has occurred, people tend to claim they saw it coming, despite there having been little or no objective basis for predicting it.

You will detect such a creeping determinism by refrains people make, “I told you” “I knew” “I saw it”. I knew that team will lose. I could tell that union will break. Bonkers. Your blogger will avoiding falling onto the same pitiable drain.

But it has to be noted.When the Emerging Capital Partners, a Private Equity (P.E) fund that owned Java was exiting, this blog took a view that it was risky for Java to do a secondary sell of all her equity stake to another PE firm..

We recommended they diversify, by offering 40% equity to the public markets through the Nairobi Securities Exchange. It did not happen. They cited illiquidity of Public markets as a put off.

So, the entire equity of Java was sold to another high flying PE firm, Abraaj, incorporated in Cayman with operational base in Dubai.Things have fallen apart for Abraaj. Bill Gates and his wife, having pumped money into this PE fund, suspected books were being cooked. They hired a forensic auditor. The forensic auditor opened a Pandora’ s box, tonnes of filth was outed.

Caught out, Abraaj has filed for a provisional liquidation. This is unlike our Nakumatts and Uchumis, who cling on to the investment, even when their thieving ways are revealed. There will be ripples with Abraaj going under.

Apart from Java, which Abraaj has 100 percent ownership, the firm has majority shareholding in Nairobi Women’s Hospital, Avenue Hospital, and a further sizeable shaholding in Uhuru’s Brookside Dairy and Seven Sea Technology.

PE funds operate like vultures. Unlike normal equity investors, they barely have attachment to an investee. Their mantra is to maximise value and quit with king size capital gain.

Upon the fall of Abraaj, scavengers have come roaming for the remains. The Kenyan investment segment of Abraaj (the specific fund) will be taken over by Colony Capital. A Disaster.

Colony Capital is a bad ass PE fund. It focuses on turnarounds, non-performing loans, and distressed assets. By way of an analogy, if the fund was a medic, it would be operating at the ICU or causality. They revamp and dump.

So Java and other investees will find their operational environment changed, for bad. To prevent being tossed from one vulture to another, Java has one option.

To release half of its equity for the public markets. We understand this coffee house is valued at sh 10 billion. They can do an IPO at the main market segment.

Your correspondent has never been awarded a NYS tender. Your blogger is human being of straw. But if Java was to do an IPO, they would participate, and get slice of coffee. We have avoided hindsight bias, haven’t We?

Why Kamau Thugge’s definition of ‘national debt’ is evil

Pic National Assembly
Kamau Thugge has asked the National Assembly to open floodgates for borrowing

The Public Finance Management Act (PFM) is the framework that regulates fiscal policy (income and expenditures) in the country. It bars the country from accumulating debt load over half of the GDP.

Recently, the CBK announced that the borrowing spree has broken this limit. Thus, no more borrowing by the national government could be legally tenable. After the CBK announcement, Kamau Thugge, a National Treasury honcho and principal secretary, has come out out the woodwork with a quiver of mischief.

Before the National Assembly, he has submitted an amendment to the PFM. He is seeking for the amendment of the PFM to clarify the meaning of national debt.

He argues that internal debt should be excluded from computation of national debt limit. Internal debt include government bonds and other local borrowings.

If local debts are excluded from computation of national debt limit as per Kamau Thugge proposal, the overall percentage, of national debt will reduce to about a percentage of 30 to the GDP.

This will leave a huge room for the national treasury to do more borrowing without violating the PFM bar. With floodgates for borrowing open, the national treasury will certainly go into borrowing spree, as they have done in the past.

The proposals by Kamau are evil.The debt load has just become ridiculous. It looks like a spell of accumulating debt, most of which will soon become odious debt, has been cast upon the National Treasury.

Why Parliament should reject the proposed Income Tax Bill

CS Rotich
National Treasury CS, Henry Rotich.

The Income Tax Bill, 2018 proposed by the National Treasury is an underwhelming legislative proposal and a failed project of imagination. It fails to re-engineer the tax principles and only runs amok in tapping low hanging cherries. It should be rejected.

By gatuyu t.j

The National Treasury has proposed the Income Tax Bill 2018, which aims at creating a progressive and productive income tax regime and to support growth of the economy.

Generally, tax design is a challenging task. It has to balance political and economic objectives while limiting welfare reducing side effects. It has to raise revenues for the government while being careful not to depress citizens’ earnings, savings and consumption or negatively impact on their housing decisions and general welfare.

It is why any comprehensive tax reform ought to be well thought. Unfortunately, in the proposed bill, the National Treasury has missed the opportunity of creating a productive and conducive income tax regime.

The proposed law is not clear, as income tax proposals should be, on how it would lead to promotion of savings and investments in the economy, how to remove disincentives, seal revenue leakages, tap digital and informal economies and grow the financial markets.

As a start, enactment of an important law such as income tax should be backed by a well thought out policy framework. Unfortunately, the National Treasury is yet to come up with any tax policy for the country.

Proposing legislation without a guiding tax policy framework is an improper way of doing things. It makes it difficult for the public to evaluate what has informed various choices, such as the nature of taxes levied, amounts, and subjects. Such determinations are made at the policy level, where consensus is built on structure of the tax code, before such is given effect by tax laws.

Creating tax rules without an agreed policy leaves unchecked discretion at the hands of bureaucrats. This encourages self-serving lobbying that eventually breeds corruption. This has been the bane with the current Income Tax Act, which has been whimsically amended by annual Finance Acts.

For instance, the bill proposes to adjust capital gains tax from a rate of 5% to 20%, though with indexation mechanisms. Without hindsight of a background, general public is not able to appreciate the basis for this proposed change.

Some of the question that linger include: has there been any macro-economic modelling on how the proposed rates will impact on property markets? Have the property markets substantially enlarged and are untapped?

In addition, the Bill has made minimal efforts to re engineer current traditional tax principles anchoring taxation of persons and businesses in the country. The current tax principles are predicted on brick and mortar economy and are hugely ineffective in addressing tax challenges in a modern economy.

It was expected that in the review, the National Treasury would benchmark and incorporate international tax principles, such as the OECD Base Erosion and Profit Shifting (BEPS) actions plans, to help in averting revenue leakages from cross boarder trading. However, little attention has been given on the developments of tax law at the international front.

The bill ought to have considered and addressed at least the following issues.

First, to incorporate BEPS action plans, such as those addressing tax challenges in the digital economy, preventing artificial avoidance of Permanent Establishment (PE) status, treaty abuse, aligning transfer pricing outcomes with value creation, and broadening provisions on intangibles taxation.

Second, the definition of PE, this loosely being a fixed place of business which gives rise to income tax liability and allocates taxing rights, ought to have been broadened to introduce aspects of digital PE. With growth of digital technologies, businesses are able to have a significant economic presence in a market without necessarily having a substantial physical presence.

Other countries have begun considering aspect of a digital PE, which could arise when a non-resident taxpayer provides access to or offers a digital platform or advertising services on a website, in the country.

Third, the bill should have reformed the modalities for the taxation of corporate entities. The scope of activities by corporations, including rise of new capital markets products and Islamic finance, among others, have since emerged and require a unique tax treatment.

A further issue with the current corporate tax structure is it encourages accumulation of debt over other sources of finance such as retained profits or new equity for corporate investment. This because debt interest payments are a tax deductible expense, subject to thin capitalisation rules.

Having interest expense being tax allowable has encouraged firms to pile debt, exposing them to a risk of insolvency. It has also become a disincentive for the equity markets. There is therefore need to eliminate the current tax bias in favour debt and to treat both debt and equity financed investments in the same way.

An appropriate income tax system ought to pay fidelity to tax canons of neutrality, simplicity, and stability.  Sadly, the National Treasury bill is a case of legislative short termism.

It concentrates on tapping low hanging fruits, such as capital gains and assumed high profits of some corporate entities, while failing to address tax principles. It is unclear on how it would boost citizen’s earnings, encourage savings and consumption and improve on housing.

It not being backed by policy, it risks sinking the tax regime into a hole of instability and unpredictability. The National Treasury should address these inadequacies before forwarding it to the national assembly.