Grain-growing businesses are placing an increasing amount of ‘dollars on the table’ each season to grow and harvest a crop.
For example, in the 1990s a Victorian Mallee dryland farm typically invested $300,000 to generate income of $400,000. In 2016 it is expected that investment will be $900,000 to produce income of $1 million (see Ground Cover, May–June 2015).
These increasing stakes, against a backdrop of seasonal volatility, have heightened growers’ awareness of risk management – and multi-peril crop insurance (MPCI) has emerged as one of the tools to assist businesses with this.
MPCI insures against hazards that have historically been borne by the grower. These can include, but are not limited to, rainfall, frost, heat shock, wind damage, insect or pest damage, and plant disease.
MPCI can essentially be viewed as income protection insurance.
Policies are offered to insure between 40 and 70 per cent of average farm income. Some companies cover income in bands, for example, a lower and upper range. Policies are also available that insure against single events such as rain or temperature extremes.
Insurance policies that cover 70 per cent of income have premiums generally between 5 and 15 per cent of the sum insured. Premiums are determined on an individual basis and vary with each application. Reasons for the variations include geographical location, historical performance, seasonal weather forecasts and stored moisture levels.
One of the difficulties for companies offering MPCI is that growers are insuring a situation that can be influenced by farming practice and, as such, is subjective and not a straight ‘act of god’, as, for example, fire or hail damage, which are defined. Establishing the policy criteria is more difficult for the insurer and in some instances open to interpretation by the grower.
A case study of two Victorian Mallee farms
Both case-study farms crop about 3000 hectares annually.
Figure 1 Income ($/crop ha) on the two case-study farms, 2007–15.
Figure 1 shows the wide variation in income between seasons during the period. Enterprise mix and farming practices have played a large role in the performance of the two businesses. For the 2007 to 2015 period both farms have similar average income/ha, however, the range of income is significantly different. Farm 1 has income ranging from $661/crop ha to $140/crop ha, with an average income of $360/crop ha.
Farm 2 has income ranging from $469/crop ha to $324/crop ha, with an average income of $367/crop ha.
Some MPCI policies insure direct costs such as those illustrated in Table 1. Other amounts can be insured but for this example we will cover $260/ha (about 70 per cent of typical income).
Figure 2 Income ($/crop ha) for the two farms with insurance payouts included.
Insurance policies use words such as ‘best practice’. Both of the above businesses consider they are ‘best practice’ businesses.
If insured at $260/ha (or 70 per cent of income) payments would result in years where income was below $260/ha. For Farm 1 these were: 2007 ($73/ha), $2008 ($85/ha), 2009 ($8/ha) and 2015 ($120/ha). This equates to total accumulated payouts of $858,000 over the nine-year period. If assuming a premium of 10 per cent, the total premium cost would be $702,000. By having MPCI over this nine-year period, Farm 1 has increased income by $156,000 after allowing for premium costs.
If it is assumed that Farm 2 pays the same premium of $702,000 over the nine-year period and it received no payouts, due to income being more consistent, then Farm 2 would have a net cashflow loss of $702,000.
While utilising MPCI, Farm 1 increased average income by $6/ha (after deducting premium costs) and removed the low-income years, which improved viability through a more secure cashflow and higher average income. In contrast, Farm 2 has reduced its viability because of the premium paid and no increase to income (no claims made).
In the example above Farm 1 has benefited from MPCI whereas Farm 2 has not.
Table 1 Actual cost structures of case-study farms based on five-year average data
||Farm 1 $/crop ha
|Farm 2 $/crop ha
|Farm input costs
|Machinery operating costs
Other risk-management options
MPCI is one of the risk-management tools available to grain growers. Other risk-management tools that may beconsidered include:
- spreading time of sowing and crop type/variety mix – growers can spread their risk by sowing a variety of crops at a variety of times;
- livestock – these typically make up a smaller percentage of total farm income but a larger part of profits due to lower associated costs. Livestock income is less affected by dry seasons;
- hay – capability to convert grain crops into hay reduces reliance on spring rainfall; and
- building ‘financial buffers’ – these should ideally be large enough to cover all business costs for at least one season. Financial buffers include farm management deposits, cash in the bank, shares or real estate, and equity in farmland, which is available security to increase borrowings when needed.
MPCI is a new, emerging option among the tools available to manage business risk. Assessment of the relevance and benefits of MPCI to a business should include analysis of the business’s current financial position and owners’ personal attitudes to risk. MPCI will appeal most to businesses receiving the majority of their income from grains with low financial buffers and high seasonal-income volatility. For these businesses MPCI can reduce the cashflow loss in low-income years. Undertake a thorough assessment of the merits of MPCI before purchasing policies.
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