Multi-peril insurance can take the stress from risk
GroundCover™ Issue: 121 | Author: Rebecca Jennings
South Australian consultant Patrick Redden, at a GRDC Update, walked growers through the pros, cons and considerations of using multi-peril crop insurance as a farm risk-management tool
Drought, frost, fire, hail and rain can all erode yield potential, and if the spring of 2015 is anything to go by a combination of these events can devastate production.
Grains research has delivered new varieties and information to guide growers through managing frost risk or dry finishes, but other management practices can remove stress at ‘the pointy end’ of the season.
South Australian agronomist and Rural Directions consultant Patrick Redden spoke about the role of multi-peril crop insurance (MPCI) in risk management at a GRDC Farm Business Adviser Update in Adelaide in 2015.
Historically, Australian crop insurance has been based on single-peril cover, such as for fire or hail. These products are simple to assess and have low levels of ‘moral hazard’ associated with them, meaning that the risk to the insurer is independent of how the grower manages the crop.
More complex, multi-peril insurance products are not new in Australia’s cropping landscape but have waxed and waned with poor grower uptake and limited geographical coverage.
In the past two years, several MPCI products have entered the broadacre market, offering cover against perils such as frost or heat shock that were historically uninsurable.
“In some ways, MPCI can be thought of as income protection insurance,” Mr Redden says. “Essentially, it involves purchasing a policy that provides a guaranteed level of income per cropped hectare. The grower can choose the level of cover they wish to purchase based on their cost structure and the need for subsequent cashflow following a low income year.”
Mr Redden says the role of MPCI is to avert a severe or catastrophic loss from occurring. It does not insulate a business from low profitability, but acts as a ‘stop loss’ when triggered.
He says MPCI can offer farm businesses a level of certainty in income that will be attractive to financiers and useful for businesses undergoing expansion or for young growers who are limited by capital to secure finance.
The ability to ‘stop loss’ rather than being at risk of a large financial blowout could also be attractive for growers nearing the end of their business life cycle who want to reduce the amount of business wealth at risk from seasonal peril.
MPCI can also have the intangible benefit of reducing stress levels for growers, by reducing financial exposure to frost and heat.
One of Mr Redden’s clients, upper north SA grower Kerry Modystach, can attest to this.
Mr Modystach, his wife Gill and their son Matt farm 4000 hectares at Wilmington and Hammond. They took out MPCI in 2014 and had the dubious honour of being the first SA growers to make an MPCI claim after a run of devastating frosts.
“We definitely slept better at night knowing we were insured. It took the volatility out of our farming income that year,” Mr Modystach says. “But while MPCI is a good idea and provided peace of mind, and the banks love it, it is a complicated process and expensive.”
The product he bought involved a detailed up-front audit (which cost $5000), with the premium based on 10 per cent of their five-year average income from cropping, plus stamp duty.
The Modystachs made their claim after 10 frosts in August 2014 wiped out a substantial amount of their wheat – 100 per cent of some paddocks. The cover paid out 80 per cent of their five-year average, after assessments by their agronomist and the insurance company’s assessor.
Mr Modystach opted not to take out MPCI in 2015, as he felt entering the season with substantial stored soil moisture would reduce the risk of a dry season.
After the poor 2014 harvest, their five-year average meant the crop could only be insured for a minimum of 0.8 tonnes/ha, and he was confident they would achieve this. The decision paid off, with wheat averaging 1.8t/ha in 2015.
Mr Redden says it is important to consider the merits of MPCI based on individual farms, as it does come at a cost and may not benefit every farm business.
- MPCI reduces the severity of losses in poor seasons, so in seasons where no claim is required it adds extra cost, reducing profit.
- It is unlikely to provide a substantial benefit for farms with low variability in income, as the likelihood of a claim is low.
- If a business is struggling to be profitable based on high-cost structures, adding additional costs in the form of MPCI could further reduce the likelihood of profit. However, if profitability is threatened due to large fluctuations in income then MPCI could have a fit.
- Each season should be considered on its merits.
- MPCI is currently only available for cropping enterprises, so businesses with a substantial livestock enterprise or off-farm income may not justify MPCI solely for the cropping component of business risk.
Understanding profit drivers and risks is critical to evaluating whether MPCI is a good fit for your business.
“MPCI decisions should go hand in hand with historic self-insurance strategies (farm management deposits, strong equity levels and flexible in-season tactics), sound agronomic practices and enterprise diversity to reduce a farm’s risk profile,” Mr Redden says.
Weather-related indexes serve a similar purpose to MPCI, but growers take a position on the occurrence of a certain weather event, rather than the outcome of it as is the case for more traditional MPCIs.
Unlike in the US, where growers access heavily subsidised insurance, the complex nature of MPCI in Australia means it can be difficult to balance commercial return for insurers and attractive premiums for growers. MPCI is challenged by achieving enough geographic diversity to increase uptake, high costs of assessing, processing and administering complex insurance policies, sourcing ongoing funding and reinsurance, and the moral hazard of grower management influencing production outcomes.
With a history of short-lived MPCI products, Mr Redden says long-term business plans should be sustainable without the guarantee suitable schemes will be offered beyond any given year.
However, despite these challenges and the unstable history of MPCI, there remains interest in getting viable products off the ground.Mr Redden recommends growers speak to their farm adviser to determine if any of the MPCI and weather index products
currently offered in Australia will suit their individual enterprise.