Captive insurance and farming: risks in agribusiness
In 1959, I got my first introduction to agriculture and agribusiness: cleaning chicken coops and milking cows. I did not grow up on a farm but my father was a university agriculture professor who ran the experimental fowl and bovine farms.
Needless to say, this first (and many subsequent) encounters with the farming side of agribusiness did not endear the industry to me. However, during the years to come, I learned a lot about how precarious and risk-filled farming can be: loss of crops or animals due to storms (eg, hail, flooding, and tornado); disease; fire; and even manmade risks (theft or intentional destruction). In the early years of farming, the farm business owners (farmers) accepted or self-absorbed these risks. In today’s world, the risks have not changed. In fact, they have increased and widened in scope.
The term ‘agribusiness’ encompasses a large number of distinct types of operations, each with common and separate risks. Here, I want to look at crop production farming. Every time a farmer plants a field, he or she risks the uncertainty of the weather that could limit the yield or destroy the crops.
Know the risks
One of the major hazards farmers face is production risk. Crop farmers deal with a significant amount of risk of loss due to severe weather such as drought excessive rain, tornado, hail, fire and frost. There are also non-weather risks such as plant disease and pests. Unlike manufacturing companies, a farmer does not know exactly how many units (crops) will be produced from a specific number of inputs (seed). The presence of any of these risks can reduce production levels and cause significant losses.
Many farmers rely upon shouldering risk (self-insuring) that an unexpected loss will not occur. If it does occur, they are hoping they will be able to cover it with their operating earnings or savings. Many others look to commercial insurance for protection. The most prominent insurance policies available are crop hail insurance and multi-peril crop insurance. The cornerstone of crop protection insurance starts with Multi-Peril Crop Insurance (MPCI).
In the 1930s the US federal government stepped in with the Federal Crop Insurance Corporation and the oldest federal crop insurance, the MPCI. By the 1980s, the commercial insurance market had entered this arena and provided most of the crop and crop-related insurance in the US.
As the oldest and most common form of federal crop insurance, MPCI protects against crop yield losses by allowing participating producers to insure a certain percentage of historical crop production. A single policy can protect crops against all natural perils including adverse weather, fire, insects, disease, wildlife, earthquake, volcanic eruption and failure of irrigation water due to unavoidable causes. It is delivered by private companies and reinsured by the federal government.
Over the years, Congress added to the federal programme revenue protection insurance, responding to fluctuating commodity prices and crop yield variances. For 2015 and 2016, United States Department of Agriculture (USDA) figures showed farm operations purchased 2,364,388 policies. Underlying that figure, USDA reported that farmers paid $7.5 billion in premium payments and retained $13.6 billion in losses as deductibles in the policies.
An extra tool
For farmers who want improved risk management, greater control of their risk dollars, and to mitigate high commercial premium prices, they can incorporate a third option into their risk management toolbag: captive insurance. Captive insurance is a risk management tool that is the alternative to self-insurance and traditional commercial insurance.
As with any industry, the farmer’s decision to form a captive must be based upon business, economic or insurance considerations. The farmer should consider the following factors when thinking about forming a captive insurance company:
- Does the farm have annual sales in excess of $75 million;
- Do you pay insurance premiums of $500,000 or more; and/or
- Is the farming operation profitable, and has it been profitable over the last two years?
There are many additional factors that relate to economic, business, risk management and legal considerations beyond those listed. With the aid of the appropriate professionals, the business, economic and risk management aspects of insurance should be the driver in undertaking the analysis of whether the farmer can benefit from forming a captive in light of the considerable costs of forming and operating a captive insurance company.
Once the decision is made to form a captive, what risk should the farmer include in the captive? Any business faces many of the same types of insurable risks—those that can be covered by commercial insurers as well as captive insurers. General liability, supply chain disruption and commercial vehicle coverage are some of the risks that the farm owner can consider for his captive.
However, as indicated above, farmers are also confronted with the risk of losses that go to the heart of the farming operation and production. Some sample coverages are:
- Weather-related business interruption;
- Excess or deductible reimbursement crop loss;
- Crop disease;
- Environmental loss due to pesticides and weed irradiation;
- Pollution loss and liability; and
- Equipment breakdown and engine repair.
As one of my favourite regulators is fond of saying: “When you’ve seen one captive, you’ve seen one captive.” Each captive is different and unique due to the types of risks that the owner faces, but the coverage provided by the captive should be rationally related to the risks that the farm operator faces.
Production risk is just one of the risks facing the farm operator. As with most industries, they face marketing, financial, legal and human risks. Within each common category, the farm operator encounters some unique variations that can cripple or ruin the business unless effectively managed. I will discuss some of these in subsequent posts.
John Talley is captive programme manager at the Division of Insurance Company Regulation of the Missouri Department of Insurance, Financial Institutions and Professional Registration. He can be contacted at: email@example.com