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by Louise Waterman, adapated from USDA/Risk Management Agency
For more information, contact Louise Waterman at (802) 828-6900
or e-mail waterman@agr.state.vt.us
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(Editor's Note: This is the first in a series of articles on crop insurance
and risk management. Articles will be contributed by both Louise Waterman
of the Vermont Department of Agriculture and Bob Parsons of the University
of Vermont.)
This series is part of the Vermont Department of Agriculture, Food & Markets'
(VDAFM) Risk Management Education Program to improve the risk management
skills of Vermont farmers. The urgent need for this program stems from
many changes in producers' business environment. In this environment,
opportunities have increased, but so have the risks.
In Part One we will define risk management and the benefits of an effective
plan.
It's A Whole New Ballgame
Risk has always been a part of agriculture. But farming in Vermont has
changed dramatically over the past few years. Increasingly, farmers are
learning that it is now a game with new rules, new stakes, and, most of
all, new risks.
Vermont's most successful farmers are now looking at a deliberate and
knowledgeable approach to risk management as a vital part of their game
plan. For them, risk management means farming with confidence in a rapidly
changing world.
"Risk management" is everything you do that can impact your bottom line
and your long-term growth in net worth.
Setting the stage for an effective risk management plan is important.
An appropriate definition of risk management is comprehensive. Risk management
is more than insurance; it is the effective use of the full range of tools
and strategies for dealing with risk.
It is important to note that risk management does not necessarily mean
eliminating risk. In fact, it may be very appropriate for some farms to
retain the risks they face or even to take on additional risks as they
strive for success.
Academically, one can speak of profitability as a function of the risk
taken and equate it to the expected returns of stocks and bonds in the
financial markets. Stocks have a higher risk than bonds and generally
have a higher expected return. In the same fashion, if a farmer were to
attempt to avoid every risk, they would also likely eliminate every opportunity
for profit. Thus, the goal is not to eliminate risk, but to manage it
effectively.
How Can You Better Manage Risk?
For starters, you can assess your risk management skills by conducting
a Risk Management Checkup -one that identifies the interactions between
one source of risk and another and causes you to take action.
We have identified five primary sources of risk:
- Production - risks that affect yield or quality including weather
and pests.
- Marketing - risks that affect price.
- Financial - risks that affect cash flow, expansion, estate and retirement
planning.
- Legal - risks related to regulatory compliance, liability and farm
succession.
- Human Resources - risks related to labor resources, health and safety.
When identifying the different sources of risk in your operation, it
can be useful to address them and analyze them together in a comprehensive
framework. By identifying the relevant sources of risk, you can see the
full comprehensive risk management needs of your operation.
A comprehensive risk management plan will not work well if some sources
of risk are successfully managed while other sources of risk are ignored
or not sufficiently addressed. By rating each source of risk on the basis
of how well it is currently managed, you can quickly identify priority
needs and address them through various risk management tools and strategies.
Understanding Goals and Risk Tolerance
While no two people share the same goals in life, all of the people involved
in a family business must share some common goals. Identifying those shared
goals, involving everyone in the goal-setting process, and then acting
together to achieve those goals should be a serious effort that focuses
both the individual and the organization.
Many times, the hardest thing about setting risk management goals is
reconciling different views about risk. People have different answers
for the same fundamental questions: What are my risks? What are our risks?
What is an acceptable level of risk? What should we do about the risks?
Recognizing and acting on opportunities as well as trying to minimize
losses can help shape agreement on fundamental risk management goals.
The Benefits of Goal Setting
Goal setting is a beneficial exercise in putting together your risk management
plan because it:
- Reflects your values, interests, resources, and capabilities. An honest
goal-setting session for yourself, your family, and your business will
cause you to take inventory of those things.
- Provides a basis for your decisions and a focal point for everyone
involved. Well-understood organizational goals allow every individual
in the organization to set realistic personal goals.
- Establishes priorities for the allocation of scarce resources. What
things will you do today and what things will you do in the future?
For example, what priorities have you established for using net farm
income? Buy land, pay for college, pay down debt?
- Provides a means of measuring progress. Which decisions made progress
toward your goals and which decisions need to be reevaluated?
Questions for Your Risk Management Check-Up
- Are my goals written and measurable?
- Are my goals attainable in my lifetime?
- Have I shared my goals with everyone involved in the business and
have they shared their goals with me?
- Will my short term goals mesh with my long term goals?
What is Your Risk Tolerance?
Your risk tolerance is reflected in the ways you choose to manage risks.
Understanding your choices and considering each of them may cause you
to change your management style to more closely reflect your tolerance
for risk.
Risks can be handled in one of five ways, or in certain combinations of
the five:
- Retain - With no protection from downside risk, as in holding an unpriced
commodity.
- Shift - A contractual arrangement where someone else takes on some
of the chance of a negative occurrence in exchange for a premium. Buying
crop insurance is an example of shifting risk. The more risk you shift,
the higher the cost.
- Reduce - Keeping fences in good repair to keep livestock off the highway
and a marketing plan that locks in some level of guaranteed return are
examples of reducing risk.
- Self-insure - Emergency reserves funded from previous years' profits.
- Avoid - Not selecting a particular enterprise; not pushing either
end of the planting windows, not increasing your debt-to-asset ratio
beyond your comfort level. Avoiding risk may be appropriate when the
risky event can be severe but cannot be effectively managed in other
ways. The threat of injury or death to children operation farm machinery
may be enough to avoid letting children near machinery until they are
old enough to safely operate the equipment.
Any risk must be evaluated for its frequency of occurrence and its possible
negative consequences. As a general rule, formal insurance strategies
are available for risks with low occurrences but with severe negative
consequences. Examples include disability insurance, health insurance,
crop insurance and life insurance.
Benefits of Identifying Your Risk Tolerance and Assessing
Your Risks
- Allows you to identify and exclude those alternatives that expose
you to unacceptable risks.
- Helps guide providers of risk management services to the best options
for you.
- Ensures that your insurance dollars will be spent wisely.
- Increases the likelihood that you will select the best combination
of risk management strategies.
Some Additional Questions for Your Risk Management
Check-Up
- Have I identified my risk tolerance?
- Have I communicated my tolerance for risk to the professionals who
provide me with risk management services?
- Which risks can keep me from attaining my goals?
- Which risks am I comfortable retaining and managing with my own resources?
Which risks will I shift to others? Which will I avoid?
- When was my last insurance check-up for health, life, casualty, property,
disability, and crop insurance?
- Have I established a confident relationship with my risk management
advisers so they can help me assess my business and personal risk?
General Benefits of Risk Management
- Risk management increases the value of your busines
- Businesses with an appropriate risk management plan are positioned
for future growth.
In the end, the outcome of a successfully developed and implemented risk
management plan should have a major impact on your businesses' bottom
line.
A successful plan increases the business's value because it effectively
manages the risks that the business faces. As an example, effectively
managing production and marketing risk should make your operation more
appealing to a lender and result in more favorable interest rates or borrowing
terms.
As another example, effective transition and estate planning can facilitate
the successful transfer of your operation from one generation to another,
without unnecessary financial stress or burdens resulting from large estate
tax bills due to poor estate planning.
Finally, an effective risk management plan positions your operation
for long-term growth in net worth, because it effectively manages the
impact that risk can have on your operation in the present. By being positioned
appropriately in the present, long-term opportunities become more attainable.
In Part Two we will look at tools and strategies for improved risk management
in the area of production.
For more information on risk management and crop insurance you can contact
Louise Waterman at the Vermont Department of Agriculture at (802) 828-6900
or e-mail waterman@agr.state.vt.us
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