Transcript Risk Management Overview

RISK MANAGEMENT OVERVIEW:
Five Sources of Risks and Mitigating
Strategies
by
Dr. Jerry White
Department of Applied Economics
and Management
Cornell University
Ithaca, NY
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All through this presentation, the focus is
on reducing variability in net income,
not increasing net income!
Stability of income, so that the grower
can meet financial obligations (both
personal and business), is the goal of
risk management.
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Table 1. Receipts per acre, price per ton, and yield per
acre, Lake Erie Grape Farm Cost Survey, (1991 – 2000).
Low
High
Average
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Receipts per acre ($)
Price per ton ($)
1,189
2,026
1,614
203
338
254
Yield (T/Ac)
4.8
8.3
6.5
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LEGFCS Gross Income per Acre
3500
$ per acre
3000
2500
High
2000
Average
1500
Low
1000
500
0
1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001
est.
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Real Life Results From Two Co-operative Farms, Even With "Smoothing" of
Income Stream From Co-operative Payment Schedules
2500
$ per acre
2000
1500
1000
Farm A (CV = .22)
Farm B (CV = .18)
LEGFCS Ave. (CV = .13)
500
0
1991
1992
1993
1994
1995
1996
1997
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1998
1999
2000
2001
Factors which affect risk tolerance
• Age
• Family status
• Debt level
• Psychological makeup
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Five sources of risk
• Production
• Marketing
• Financial
• Legal and environmental
• Human Resource Management
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Production Risks - major sources:
• Weather
- drought
- freezes
- excessive rainfall at harvest
• Pests
- insect damage
- disease damage
- wildlife
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Tools and strategies to deal with
production risks:
Enterprise diversification - grow more crops, more
varieties of grapes, get off-farm employment for the
owner (small farm) or the spouse to diversify income
sources.
 Crop insurance - when used with a sound marketing
program, can stabilize income.
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Tools and strategies to deal with
production risks: (continued)
Adjusted Gross Revenue Insurance (AGR) protects against both yield and price risk by insuring
revenue based on the average of the past five years of
revenue as determined from Schedule F.
 Multiple-Peril Crop Insurance (MPCI) - protects
vs. yield shortfall by coverage against most natural
disasters.
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Tools and strategies to deal with
production risks: (continued)
 The combination of AGR and MPCI - Benefits and
premiums are coordinated in such a way that you
don’t pay double premiums, but do not receive double
coverage, either.
 Subsidized premiums and cost share such that the
grower pays only about 25 percent of the actuarial
costs of the policy.
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Tools and strategies to deal with
production risks: (continued)
 Catastrophic Risk Protection (CAT) coverage the lowest level of MPCI.
 Technology to protect vs. weather events:
irrigation, tile drainage, frost protection.
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Tools and strategies to deal with
production risks: (continued)
 Site selection - consider rented acreage which is
less susceptible to freeze related events, or, for
new plantings, buy superior sites close to the
home base.
• Timeliness of operations - insure that inputs are
applied and operations occur at the optimal time
for attaining high yield and quality fruit.
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Marketing Risks - major sources:
• Price risk due to increases in supply,
changed demand
• Loss of market access due to plant
relocation or closing
• Loss of marketing power due to
small size of farm sellers relative to
buyers, etc.
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Tools and strategies to deal with
marketing risks:
• Developing a marketing
and/or a business plan (White
and Uva, 2000).
• Futures and Options
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Tools and strategies to deal with
marketing risks: (continued)
• Form or join a marketing cooperative.
- May enhance prices
- Guarantees a market
- Evens out cash flow through deferred
payments (there is a cost for deferred
payments - interest - but then most risk
management strategies have costs).
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Tools and strategies to deal with
marketing risks: (continued)
• Direct Marketing - Your receipts are
likely to vary less than if you sell to
processors or fresh market wholesalers.
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Financial Risks - major sources:
• Production risks
• Price risks
• Inflation, especially cost increases
of key inputs
• Increases in interest rates
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Tools and strategies to deal with
financial risks:
• Monitor and try to control key financial
ratios and expenses
• Trend analysis (E.G. receipts, expenses,
yields, net worth)
• Increase solvency - debt-to-asset ratio pay down debt in a “good year”
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Tools and strategies to deal with
financial risks: (continued)
• Maintain liquidity - current ratio, or
current assets/current liabilities at 2.0 or
above
• Maintain credit reserves
• Invest in making the business more
efficient, or lowering cost/unit
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Tools and strategies to deal with
financial risks: (continued)
• Family expenditures - There is an interaction
between family and business obligations in most
farm businesses. Defer some household
expenditures when income is low.
• Off-farm employment for a spouse or other family
member-preferably in a business that is not directly
related to agriculture. Benefits such as health
insurance, group life insurance, and a retirement
program are helpful!
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Tools and strategies to deal with
financial risks: (continued)
• Non-farm investments (IRA’s, mutual
funds) to diversify the asset portfolio
• USDA provides emergency assistance
and loans or loan guarantees through
FSA
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Legal and Environmental Risks major sources:
• Tort liability (especially for direct
marketers)
• Environmental liability, business
structure
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Tools and strategies to deal with
legal and environmental risks:
• Carry sufficient farm or business
liability insurance.
• The best advice is to be forthcoming
with your insurance agent about all
direct marketing activities so that you
can be assured of adequate coverage.
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Tools and strategies to deal with legal
and environmental risks: (continued)
• Use “good agricultural practices”
• Good neighbor relations
• Don’t automatically assume that sole
proprietor is the best business
organization. Consider, e.g., LLC’s or
corporations
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Human Resource Management
Risks - major sources:
• Loss of an essential owner,
manager, employee
• The three D’s
- divorce
- death
- disability
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Tools and strategies to deal with
human resource management risks:
• Good Human Resource
management practices (for family
as well as outside employees)
• Life insurance for key owners to
insure business continuity
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Tools and strategies to deal with human
resource management risks: (continued)
• Formalizing planning and management
can improve business performance as well
as improving safety performance and
reduce legal risk arising from employee
relationships (Maloney and Petracek).
• Control liability of employees
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Points to Remember:
• Business and family finances are intertwined
in most farm businesses
• The focus of risk management is to reduce
variability of net income so that business and
family financed obligations can be met
• Tolerance for risk is different from one farm
family to another depending on factors such
as age, family status, debt levels, and
psychological makeup.
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