Topic #3 Business Risk Management

[TOM4CWB]

ianben,

The economic principal of diminishing returns, that at a point more expences return less income than the input cost still is reality in agriculture, particularily grain farming.

The higher the farms capital cost, the more likely farmers will over spend on inputs like weed control and fertiliser.

This is a tread mill that does lead to higher production, and sometimes at an environmental cost as well.

Inputs are a form of risk management as well, if I spend $1 I can expect $2 back if I have a stable environment.

That subsidies get capitalised into overhead is a given in time, hence the EU/US problem you speak of.

This inflationary pressure then puts pressure on the next generation of farmers, with the tempation of cashing out the farm because economics cannot justify the farm business.

Yet as you have correctly stated in most countries the land does not lay idle, as should be the case.

What is the answer?

Are we gaining anything?

The general population has never been better fed, with safer, cheaper food than we have today, therefore civilisation in general has gained, and the standard of living for farmers in the G8 countries is better than ever before as well.

Is what we are doing sustainable, I believe this is the question?

[TOM4CWB]

Farming is a business! was there any doubt. Because you do it with your family makes it a life style.

Now business risk management is just a fancy catch phrase for being a good manager. Most anybody who has farmed for any length has been good at business risk management or had a Pappy who was a good manager.

The best and only thing that would improve are risk management would be a better crop insurance plan with higher coverage per acre. The Alberta government went along way in providing that in this year's coverage(up $50 to $100 per acre more coverage). Now we need a clause to protect against fraud(or farming the system to be polite). This could be accomplished by having farmers producing imput receipts. I believe this policy would actually allow our premiums for insurance to go down went fraud was removed as a cost of doing business. But we must be careful that we done take all the risk out of farming as it will open the door to public investor corportations to move into farming. Then it would be goodbye family farm.

I agree with ianben's comments on how the business of farming operates world wide. His statement of setting a price for our products is obtainable these days through the use of the commodities markets by farmers using Grain Pricing Orders. If more farmers would just use them to ask for .50 cents or $1.00 more per bushel than what the market is giving, we just might push the markets to a higher level. With this option a better income would not get capitalized into land or rental prices.

We have got to stop being price takers and start asking for a price.

Get those Grain Pricing Orders in today for new crop deliveries in Oct. 02.

The Kernel

[countryguy]

Kernel,to add to your crop insurance improvements,I think ones farming practices should also be examined before a claim is paid.We had a guy here,knowing it was a risky move,put all his fertilizer down with his canola seed and had a crop failure.He knew like everyone else that this is a no no and should not have been paid for his disaster.

[charliep]

Would it be appropriate to say that crop insurance is one program that should be left under the ag. policy framework? I hear you say there are changes that could be made to improve it but on the whole is a beneficial program that helps western Canadian crop farmers manage their production risk. I realize there are other threads that have dealt with this topic.

I see more comments in the press about support programs to offset EU/US subsidies. Realistic? Per bushel payment? Per acre? Cropped land only? Would these payments simply get bid into rent and land values? Would a program like this help all farmers or would it mainly benefit bigger commercial farms?

[charliep]

I may as well ask for comments on FIDP and CFIP as well (I could toss in NISA). From your view, what were these programs meant to accomplish? Are they working?

[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