RISK MANAGEMENT OVERVIEW: Five Sources of Risks and Mitigating Strategies

1. RISK MANAGEMENT OVERVIEW:Five Sources of Risks and Mitigating Strategies by Dr. Jerry White Department of Applied Economics and Management Cornell University Ithaca, NY Cornell Horticultural Business Management and Marketing Program

2. 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.

3. Table 1. Receipts per acre, price per ton, and yield per acre, Lake Erie Grape Farm Cost Survey, (1991 – 2000). Low High Average _________________________________________________________ Receipts per acre ($) 1,189 2,026 1,614 Price per ton ($) 203 338 254 Yield (T/Ac) 4.8 8.3 6.5 ________________________________________________

6. Factors which affect risk tolerance • Age • Family status • Debt level • Psychological makeup

7. Five sources of risk • Production • Marketing • Financial • Legal and environmental • Human Resource Management

8. Production Risks - major sources: • Weather • - drought • - freezes • - excessive rainfall at harvest • Pests • - insect damage • - disease damage • - wildlife

9. Tools and strategies to deal with production risks: • · Enterprisediversification - 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.

10. 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.

11. 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.

12. 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.

13. 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.

14. 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.

15. Tools and strategies to deal with marketing risks: • Developing a marketing and/or a business plan (White and Uva, 2000). • Futures and Options

16. 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).

17. 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.

18. Financial Risks - major sources: • Production risks • Price risks • Inflation, especially cost increases of key inputs • Increases in interest rates

19. 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”

20. 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

21. 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!

22. 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

23. Legal and Environmental Risks - major sources: • Tort liability (especially for direct marketers) • Environmental liability, business structure

24. 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.

25. 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

26. Human Resource Management Risks - major sources: • Loss of an essential owner, manager, employee • The three D’s • - divorce • - death • - disability

27. 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

28. 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

29. 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.