what every farmer needs to know - university of minnesota€¦ · what every farmer needs to know...

Risk Management BasicsWhat Every Farmer Needs to Know

1Developing Personal Risk Management Plans

A workshop for farmers and ranchers in South Carolina StrikeForce Counties

RISK MANAGEMENT BASICS

What Every Farmer Needs to Know

Dr. Albert E. EsselDelaware State University

Dr. Laurence M. Crane National Crop Insurance Services

Today’s Discussion

Risk and sources of risks in agriculture

Risk management principles

Risk identification and prioritization

Common strategies for risk treatment

Some important risk management priorities




Risk

• Chance of loss

• Likelihood /probability of adverse outcome

• Uncertain consequences

• Exposure to hazard, peril or potential loss

Two Components of Risk

• Frequency (probability) of Loss

• Severity (Size) of loss




The world according to risk…

Random assumptions (and thoughts) about risk:

• Risk is not inherently bad

• There is a risk—return trade off

• Risk can be managed

• If you can’t measure it, it is hard to manage it

• Accurate information is essential in formulating plans and strategies

• Individuals’ perceptions of risk differ, thus they respond differently to common risky events

• Often there is more than one “right way” of responding to risk

Where to begin

One common method of classifying risk is to look at risk as it affects the various functions on a farm:

•Production

•Marketing

•Finance

•Human Resources

•Legal

[Remember—there is tremendous overlap and interaction between these categories.]




1. In your opinion, which of the following categories of risk is the greatest for producers in North Carolina?

1. Production

2. Marketing

3. Finance

4. Human Resources

5. Legal

Production RiskWhat is it?

• Any crop or livestock production related activity or event that is uncertain.

– Variability in production caused by weather, disease, pests, genetic variation, machinery failure, timing, etc.




Production Risk

• Production uncertainty in crop enterprises is caused by variations in weather and by disease, insects, and other biological pests.

• Livestock enterprises also involve production uncertainty. Death losses from disease and adverse weather conditions are common.

2. Of the following production risks, which is the most threatening to your operation?

1. Drought‐too dry2. Excess moisture‐

too wet3. Temperature

(too hot or too cold)4. Disease5. Pests6. Old (unreliable) machinery7. Increasing input costs (diesel, fertilizer, etc.)8. Other




Marketing RiskWhat is it?

• Any marketing related activity or event that is uncertain leading to variability of prices for outputs and/or inputs.

– Fluctuations in farm input and product prices caused by basic supply and demand relationships, competition from substitutes, government interference, technological change, etc.

– Fluctuations in input prices (purchased inputs)

3. Of the following marketing risks, which is the most threatening to your operation?

1. Low commodity prices2. Lack of market access3. High input prices4. Meeting quality

requirements5. Market proximity

(distance to market)6. Lack of Value Added opportunities7. Competition8. Other




Financial RiskWhat is it?

• Any uncertainty that directly threatens the financial health of the farm business or results in financial loss.

• This includes:1. Cost and availability of capital

2. Meeting cash flow needs

3. Ability to maintain and grow equity

4. Ability to maintain family living expenses

4. Of the following financial risks, which is the most threatening to your operation?

1. Loan approval(Lender doesn't understandmy farm operation)

2. Poor debt structure—inadequate equity; asset life doesn’t match loan term

3. Poor asset structure—inadequate asset turnover rate; low rate of return on assets

4. Meeting cash flow and/orfamily living requirements

5. Current debt level too high6. Bad credit history7. High credit card/consumer debt8. Other




Human Resource RiskWhat is it?

• Any event relative to the human element of the farm that is uncertain.

– The character, health, behavior, and interrelationships of people are unpredictable

– Death, disability and divorce are critical risk factors

– Unpredictable family and hired labor relations

5. Of the following human resource risks, which is the most threatening to your operation?

1. Off‐farm employmentopportunities

2. Poor health/Disability3. Availability, reliability, and/or

the cost of hired labor4. No written operating plan for your farm

business5. No formal retirement plan or management

succession plan6. Working with family7. Exhaustion, stress, and/or burnout 8. Other




Legal RiskWhat is it?

• Any activity or event that threatens the legal standing of the farm or puts the farm in legal jeopardy.

– Business structure, estate planning, contractual arrangements, tort liability, statutory compliance, environmental issues, etc.

6. Of the following legal risks, which is the most threatening to your operation?

1. Contract requirements

2. Product liability

3. Personal or employee liability

4. Property title/ownership entanglements (heir, joint ownership)

5. Environmental regulations

6. Transfer to next generation

7. Urban/rural interaction issues

8. Other




7. Of the risk factors listed below which do you consider as most important in your operation?

1. Output price variability

2. Yield variability

3. Availability of credit, too much debt

4. Operator injury, illness, or death

5. Market access

6. Changes in environmental regulations

7. Costs of inputs

Risk Management

• All the things that a producer may do to influence the bottom line of the business and grow the long term value or net worth of the business.

• Risk and return (or profitability) are related and the relationship must be managed.




Risk Management Steps

• Identification

• Assessment

• Treatment

• Implementation

• Evaluation

Identification

• Know (inventory) and document your farm

• Identify the different sources of risks in the farm operation:

– Production risks

– Marketing risks

– Financial risks

– Human resource risks

– Legal risks




Assessment

• Determine implication of each risk on farming operation

– Two measures used for assessing risks are:

1. Frequency (probability) of loss

2. Severity (size) of loss

– Frequency – How often a risky event may happen over a given period

– Severity – How large/small is the potential loss arising from the event

AssessmentPlace each risk into a quadrant

High frequency

Low severity

High frequency

High severity

Low frequency

Low severity

Low frequency

High severity

Severity

Fre

qu

ency




Treatment: Mitigating Strategies

Tools for alleviating (handling) risks Avoid

Control (Reduce)

Retain (Accept)

Transfer

Treatment

High frequencyLow severity

High frequencyHigh severity

Low frequencyLow severity

Low frequencyHigh severity

Severity

Fre

qu

ency

RETAIN/CONTROL

RETAIN/CONTROL

TRANSFER

AVOID




Implementation

Select appropriate tool to manage risk

Choose your risk management team

Common Tools for Managing:Production Risks

• Enterprise choice / Diversification (Control)

• Contract production (Control)

• Yield (crop) insurance (Transfer)

• Revenue insurance (Transfer)

• Technology‐Irrigation, inputs, etc. (Control)

• Best management practices (Control)




Common Tools for Managing:Marketing Risks

Marketing plan (Control)

Revenue insurance (Transfer)

Vertical integration/Value addition (Control)

Contract production (Control)

Hedging (futures /options contracts) (Control)

Marketing cooperative (Control)

Direct marketing (Control)

Common Tools for Managing:Financial Risks

• Recordkeeping and analysis (Control)

• Budgeting (Control)

• Insurance (Transfer)

• Pay down debt (Control)

• Family living expenses (Control)

• Estate planning (Control)

• Off farm employment (Control)




Common Tools for Managing:Human Risks

Develop and maintain operating procedures for farm (employee procedures and management practices) (Control)

Good family and labor relations (Control)

Disability, Health, Life insurance (Transfer)

Estate and transition plan (Control)

Common Tools for Managing:Legal Risks

• Legal business entity (Control)

• Insurance (Transfer)

• Contracting (Control)

• Estate/Transition plan (Control)

• Government actions and regulations affecting your operations (Control)




Implementation

• Select appropriate tool to manage risk

• Select your risk management team• Extension educators

• Loan officers/bankers

• Crop insurance agents

• Cooperatives

• Lawyers

• Commodity organizations

• Accountants, private consultants…

• Commodity brokers, marketing advisors…

Evaluation

• Evaluate annual successes and challenges of your risk management plan

• Compare your performance to your goals

• Adjust your risk management plan




So where do we go from here?

• Overview of a few “special concerns” for small farmers

• Suggest some common sense priorities/ practices that all small farmers should be able to incorporate into management practices to reduce their risk exposure.

Risk Management Priorities

Minimize safety risks—nothing is more important than safety!!

• Take the time to do things right

• Don’t move faster than you can think

• Wear protective gear

• Properly store chemicals, fuel, pesticides, etc.

• Maintain equipment

• Adopt a stress management plan

• Teach your children (and others) about safety– Age appropriate tasks

– Friends and visitors





Use good agricultural practices

• Follow industry and university standards

– IPM, nutrient management, rotational grazing, herd health, chemical & fertilizer application rates, etc.

• Record and maintain adequate records

– Documentation required for some chemicals

– Limit legal liabilities in some cases

– Required for insurance purposes

– Improves management skills and decisions


Support your neighbors

• Develop a strong network of friends

• Share labor, equipment, knowledge

– Reduces costs

– Increases satisfaction

• Make emergency plans in case of illness, etc.

– Write down procedures so someone else can follow

• Create study group/club





Property, liability, and health insurance

• Review policies and know their terms

– Pay attention to “exclusions”

– Evaluate coverage levels and deductibles

– Shop around and compare

• Get a good agent who gives you the service you need

• Pay attention to your liability exposures


Pay attention to business management

• Analyze in writing the impact of decisions

– What, how, why, expectations, results

• Maintain orderly records

– Keep and file receipts

– Keep and file ownership manuals and paperwork

– Create “memory aids”

• Document, Document, Document

• Engage in formal farm business planning




8. In your opinion, which of the following best describes the trend in South Carolina agricultural production?

1. More specialization

2. More diversification

3. Going organic

4. Value added increasing

5. Farming is a respected profession

6. Increased opportunities

7. Other

9. In your opinion, which of the following is the greatest constraint to successful agriculture in South Carolina?

1. Population growth

2. Environmental conflicts

3. Food safety

4. Competition from____________

5. Public attitude

6. No next generation

7. Other

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