Topic #3 Business Risk Management

[pandiana]

"Risk management systems (including Saftey Net Programs) in Canada only help smooth out the fluctuations in income, but overall do not add a significant income flow to the farms's bottom line in the long term."

Hedging is really no different, a net income from risk management is very small, after all is said and done!

"Yet it is critical for a large farm business to employ this tool as a large fluctuation in income can destroy it very quickly... much more so than the smaller farms of 25 years ago... the margins are much less now, it is even more crytical to stabilize income."

I think these statements have very aptly described the problem. The bottom line that farmers in most sectors are walking a fine line. One mistake, one risk not well managed, one unpredicted risk will take many farmers years to recover from. In order to make the cushion a little softer only higher prices for our product will work in the long run. Short term solutions are doomed to failure for all but the very few.

[TOM4CWB]

Kernel,

I see one of the most interesting new risk management tools is rainfall options!

A person can pick any Environment Canada weather station that records rainfall, and have this point insured with a weather put option. Call options are also available for too much rainfall!

The put option would hedge you against a low level of precipitation during a specified period. The index is the total precipitation at the Environment Canada weather station that you choose.

If there is less precipitation than the pre-agreed trigger during the period, the option would pay you a specified amount per mm below the strike price of the option , up to a maximum specified.

Example :

Location : Wainwright, Alberta EC# 301S001
Index : Total precipitation in Season at Station
Season : 1 May 2002 – 30 June 2002
Payout : Max (Strike – Index, 0)*Amount per mm subject to Maximum Payout
Strike : 70 mm
Amount per mm : CAD $2,850.
Maximum Payout : CAD $200,000.
Premium: CAD $11,000.

The rainfall at this station varied between 48mm and 230mm during the May 1st and June 30th time period over the last 40 years, with the average being about 140mm.

Alberta Crop Insurance bought about $10 million of this type of insurance last year, and it paid about $40 million towards Alberta losses incurred in the 2001 season.

The point is that there are many types of risk management, and each one of them has a cost attached to it. Again the astute manager with “good timing” can pick the most efficient tool.

But the formula between a business cost that drags the farm down and an effective risk management tool is not an exact science!

My experience on options is, and my training indicates, that on average a payout occurs once every 5 years! It doesn’t matter if they are pricing options, or weather options, risk management has a cost.

Any farm can spend resourses on risk management until this farm is bankrupt!

I believe the conventional wisdom is that over 80% of them expire without any face value being paid to the purchaser. Now where does an astute manager spend limited capital funds when unlimited courses of action are available?

The only reason my farm can afford Crop Insurance in because of the subsidized Hail Rider, as the Crop Insurance portion has cost well over 10 times what I have been paid over the last 25 years!

Few farms can afford a big hail event today, and survive without good hail insurance!

Yet the facts would point out that if we self-insured over the long run it would be cheaper if we had the capital to fund this risk management in the beginning.

In reality the APF is encouraging self stability financial strategies, at the overhead cost that risk management always creates for our farms!

Just what is the most effective and efficient use of the limited resources our farm management has to manage?

Isn’t the answer that every farm will be different?

Isn’t it like for some the CWB pooling is the perfect risk management tool, while for others Pooling is a unneeded cost that restricts and distorts business decisions?

Isn’t the freedom to choose, which means the freedom to lose, the only farm management answer?

[TOM4CWB]

Charlie,

CFIP/FIDP are a saftey net for profitable farms, (those with positive margins get the payments), when risk management scheemes have been overtaxed or overwhelmed by disaterous events.

Therefore CPIP/FIDP themselves are risk management tools!

Why couldn't they be offered with a top up above 70% coverage with a premium attached?

We must have real market signals determine what we grow, distorting these signals is very counter productive.

I simply look at my NISA account as a risk management funding source, which may be a good idea in the new saftey net system, that it fund self administered risk management costs?

[countryguy]

Nisa is definitely one program that did not work.All it turned out to be was an investment/retirement fund to those who could afford to put money into the program.The reason the gov't is not offering anymore aid these people still have their money sitting in their accounts.The problem is the money is sitting in the accounts of people who don't need any help while the rest of the farmers in this country slowly go bankrupt.

[wedino]

I think NISA is a good program.(as was GRIP) If a farm can't afford to participate it is doomed to failure from the start. IMHO

[countryguy]

Wedino,Nisa would be a good program if the money given out would go to where it was intended to go.But in reality in probably 8 cases out of 10 the money sits in accounts as retirement funds.Actually I think those people are going to be the big losers when the program ends because they will in all likelyhood be forced to take it all out at once and everything in fund 2 will become investment income.If I am correct this will be in 2003.

[countryguy]

Lets dump the government and their $26.00 an acre subsidy. That $26.00 doesn,t pay for the canola seed I,am growing this year. Besides I haven,t seen the $26.00 cheque. Why should anyone believe they are honestly going to put an fix on agriculture. I can bet that in 10 years nothing will have changed because of government involvement in the industry. Its just awhole lot of politics that is going no where as usual.

The agricultural industry would be alot better off if goverment backed off its involvement and give farmers a freer hand in determining their own destiny.

If you can,t make farming pay, find another job and I,ll bet someone else will take over and make it pay.

Let's face it with goverment, farmers have no imput into what they decide to do anyway. AMEN.

[cakadu]

Kernel, you just may be on to something there. If you take a look at what happened out in the Maritimes with the government getting out of the agriculture industry and the subsequent formation of the Agriculture Development Institute (ADI) that is pretty much what you are alluding to.

The best part about it is that they are partnered with Agri-ville and we get to watch the experiment unfolding right in front of us.

While still in the beginning stages, I think ADI is doing quite well.

[Steve]

Farm managers don’t just sit back and tell each other how bad things are on the farm, is Government interference that is the main problem or should you look in the mirror.

Solutions are in the works on “ rural issues thread see Farmers get united.”

[ianben]

Nice try Steve but they all know up here without the CWB and EU/US subsidies everything would be just fine!!!
Soma chance!!!
Cant think about anything else till they are free

[TOM4CWB]

ianben,

On risk management I said:

"Isn’t it like for some the CWB pooling is the perfect risk management tool, while for others Pooling is a unneeded cost that restricts and distorts business decisions?

Isn’t the freedom to choose, which means the freedom to lose, the only farm management answer?"

Did you miss this part Ianben?

I hope the point of risk management is that we are actually allowed to choose... for if we cannot choose to manage our risk, we are helpless to improve our management.

I was just thinking, what about buying rainfall calls during harvest to insure quality?

[ianben]

Tom
I have admired your skills as a manager and see your points on on the CWB but neither of us seems to have improved things since we met on this site.
I stll believe we could achieve something by comparing prices like we did with canola.

Are there not two ways of managing risk?

Insuring it or reducing it.

Your harvesting risk could be reduced with more combine power or perhaps a dryer

This is what I would like us to try to do with prices.

Find a way to reduce risk.

I think this an area where could make some real improvments using the comunication technology avaiable today.

I am not saying we will no longer need insurance but if we reduce the risk we also reduce the premium.

If it worked real well the CWB might just fade away or everyone would agree it was nolonger necessary.

[TOM4CWB]

ianben,

I believe that improvement has occured on Canola for example.

We said that $7.00/bu was a price that we could make a profit at, yet this price has been avaliable for many months for fall 2002, and how many people have priced canola?

The opportunity to control risk does not mean that we must, the prudent control of risk, when it is appropriate is the recipe for sucess.

Figuring out when risk management is needed and when it is too expensive is the trick.

No formula can tell us when to make these decisions, intuition and farming are hand in hand, those with these giftings to "know when to hold, and when to fold", will be most sucessful.

I believe this is the biggest loss to the farming industry, our younger generation.

How do we create enough wealth to rightfully deserve our younger generations interest in the farm?


Feeding the worlds hungry is a big responsibility, even if the G8 countries don't think it is important.


Injustice has and will always be with us, how do we make the best of what we have?

If I see looming weather on the horizon that could cost my farm big $$$, wouldn't it be prudent to buy some quality insurance so I can pay the drying and extra harvest costs?

[ianben]

Tom
Canola is better at the moment because of weather events curbing production in both our counties,
We did nothing to influence it. You may have taken better advantage of it than me and good luck to you!!

Earlier you asked if the present situation was sustainable.

I guess my answer to that is, it must also depend on the weather. As in my view it is the only thing fixing our prices.

Like you I would like to see the hungry fed and my family able to consider taking over the farm.

Again are we getting any nearer to that happening?

Until we learn a way to reduce some of our risks the premium to insure them will be too great and the young unable to afford to take the risk
There is a thread in rurral issues on moaning about bank charges to farmers.
High risk loans have high costs, while we are high risk we will have to pay.

In an ideal world the best way to manage risk is to remove it.
The next is to reduce it then insure it.

Take auto insurance
The all inclusive, any driver,replacment car package is expensive. Name the driver, small excess, and a few minor exemtions and the cost halves.

This is how if we reduced risk on price by price monitoring we would reduce costs for the next generation.

Something together we could really do and see results!!!

[TOM4CWB]

Charlie and Lee,

I sure hope the AB gov/AFSC crop insurance had their risk management together... how much are the outstanding liabilities on crop insurance, maybe a $billion???

I will start a new thread on this one, I think a good discussion is needed!!!