For Farmers, Risk Comes in Many Forms

October 2013

When thinking about the risks faced by farmers as a part of their daily lives, what is first to come to mind are the risks related to Mother Nature, like drought, flooding, freezes and hail. But there are many other obstacles that farmers face in addition to the elements that they must manage in order to produce the feed, food, fuel and fiber that we need.

The May issue of Crop Insurance TODAY provides a broad overview of the tools farmers have at their disposal to manage the risks they face, examining where specific strategies are useful, the risks they can and cannot mitigate, as well as assessing their limits and overall value to farmers.

While crop insurance is the most ubiquitous risk management tool used by farmers – 89 percent of total planted acres in 2013 are insured – there are other tools that many farmers use as well. These tools are, by category:

Agricultural Practices

• Crop rotation. Crop rotation is the practice of growing different types of crops on the same field in different years or growing seasons. One of the most common crop rotations in the U.S. is interchanging corn with soybeans.

• Crop diversification: Crop diversification is a strategy whereby farmers diversify geographically, or by crops, or both.

• Seed varieties. Hybrid seed varieties have been developed that produce plants that are tolerant to different kinds of stresses.

• Irrigation. Irrigation is the practice of bringing water to plants using various methods, including flooding the fields, overhead, pivot-irrigation and drip irrigation.

• No-till planting. No-till planting is a way of planting crops without breaking the soil through tillage. This practice increases the amount of organic matter and water maintained in the soil while decreasing overall erosion.

• Timing of planting and harvesting. Farmers must hit the window for the best time to plant to maximize the potential of their crop. The same is true for the harvest. For example, harvesting during a dry spell reduces the costs of drying the grain before storage.

• Pest management. Farmers and ranchers can use various herbicides to reduce competition from weeds and use insecticides and fungicides to combat unwanted insects and disease in farming operations. They may also employ scouting to detect pests to best time their applications.

• Use of advisors. Agriculture extension agents or professional crop advisors are present in most states to advise farmers and ranchers on a wide variety of topics, such as marketing, nutrient use or pest management. Usually, this advice is “free” or requires a “small” charge.

Marketing Instruments

• Product differentiation. Product differentiation is the process whereby farmers or ranchers manipulate the quality, characteristics or inputs involved in the production of their product in hopes of attaining a premium from the consumer. Examples of this in ranching would be “humane raised” or “free range.” Examples in farming would be “organic”, “certified natural” or use of specific varieties that improve processing performance (high oil, high fermentable starch, etc.).

• On-Farm Storage. For storable crops, farmers can invest in on-farm facilities to store their production allowing sales to be prolonged until prices improve.

Financial Instruments

• Crop insurance. Crop insurance is a private insurance policy, purchased by a farmer or a rancher – partially underwritten by the federal government – that insures crops or livestock against price volatility and/or weather losses.

• Marketing Contracts. Marketing contracts include the various types of contracts between producers of commodities and buyers that lock in prices in advance, including forward contracts. The product is owned and controlled by the producer during the production process. Similar marketing contracts may also be used by producers to acquire production inputs and reduce input price risk.

• Options and futures contracts. Both options and futures contracts are specific types of marketing contracts – that protect against price risk only – between the producer and a specific buyer at a price on a given date. The basic difference between the two is that options give the holder of the contract the right to buy or sell the asset during a given time period, while the holder of a futures contract is obligated to take delivery or deliver the asset by the end of a given time period under the terms of the contract.

• Production contracts. A production contract is a legally binding agreement made between two parties, generally a producer and a contractor, where the producer transfers ownership or control of the product to the contractor. For example, the producer may agree to sell the output prior to production or agree to produce the ouput that is owned by the contractor in exchange for a payment. The agreement is for a fixed period of time – either one crop year or several production cycles – and begins prior to production.

Financial Strategies

• Share rent and variable cash leasing arrangements. Rather than own farmland, a producer may rent farmland under various rental arrangements. For example, land may be rented just for cash or rented under a flexible-cash arrangement where the landlord may pay some expenses or bear some risk. Or farmland may be rented under a share rent arrangement where the landlord receives a share of production as rent.

• Maintaining cash reserves and liquidity. Holding cash or near-cash allows farmers to weather adverse events. Essentially this tool is self-insurance.

It should be noted that most farmers use many of the above strategies to protect against the many risks they face during any typical year. The question for the farmer is one of profitability: How many risk mitigation strategies can be employed while maintaining the profitable margins needed to keep the farm running?

Also, most of the strategies above only mitigate fairly specific threats, and not the whole gamut of risks faced by farmers. Crop insurance is the only tool available that helps farmers mitigate both natural disasters and market fluctuations, which is why it’s a complimentary risk management tool to all of the above strategies.

In 2013, nearly 294 million acres (more than 89 percent of total acres planted to crops) are protected by crop insurance, which, along with some of these other strategies listed above, will help farmers and ranchers manage their risks. That statement alone underscores the fact that crop insurance has become the preferred risk management tool for America’s farmers, and underpins the stability of the nation’s food supply.