Kennedy explains risk management to WyFB members during legislative meeting
Cheyenne – “Risk is a chance, possibility or probability of a bad outcome occurring,” said Keith Kennedy of Custom Ag Solutions. “The question that needs to be asked is whether an individual is a risk taker or risk averse.”
Kennedy spoke at the Wyoming Farm Bureau Federation 2014 Legislative Meeting in Cheyenne on Feb. 27.
Managing risk is a balancing act between risk, reward and choosing better alternatives.
Kennedy noted that the hardest factor in determining risk is an individual’s personality trait and attitude toward taking risk.
“Sometimes risks bring great rewards, and other time losses are suffered,” explained Kennedy.
Risk can be managed through training, experience and the use of equipment and tools.
However, no matter how many precautionary measures are taken, there is always going to be a level of risk involved.
Kennedy stated that it is not a common practice for producers to provide their financial information to a banker as a method to manage agricultural risk.
“It is not about a producer managing their risk. Rather, it’s about the banker managing their risk,” he added. “Producers need to remember that a banker is always selling something for a business.”
Categories of risk
Kennedy explained that there are five categories of risk – production risk, market risk, financial risk, human risk and legal risk.
Contributing factors to these risks are uncertainty in yields for crops or size of calf crop, commodity prices, rising input costs, climbing interest rates, dependability of employees and successors of an operation and future of state and federal laws.
Producers can utilize more tools to manage risk more effectively by diversifying, becoming more flexible and transferring risk to someone else.
“There is always a cost for diversification,” Kennedy added. “If producers have more than one enterprise, they have to give up something, even if they think they only have one enterprise.”
As an example, Kennedy looked at a cow/calf operation that also does their own hay production.
These are two different enterprises, and they will have tradeoffs occurring between them. For example, there may be a choice as to whether the producers begins haying or moves cows to another pasture on a particular weekend.
“Those tradeoffs are made all the time, and that’s where the loss is seen from diversification,” he replied. “This has been happening in the U.S. over the last 30 years with people becoming more specialized.”
Producers can also manage risk by becoming more flexible with assets on their operation that they utilize only at certain parts of the year.
“Producers can also transfer risk to someone else,” Kennedy added as another tool to manage risk.
Kennedy mentioned three ways to transfer risk to someone else – utilizing production and pricing contracts, futures and options, and crop insurance.
In Wyoming, production contracts are most common in crop agriculture.
“Livestock production contracts are very uncommon with cattle and sheep,” described Kennedy. “However, over 90 percent of swine and poultry operations in the U.S. have a production contract model that they use.”
Pricing contracts are contracts that use an order buyer or when a producer sells their livestock through methods such as Western Video.
“One thing to remember with cash contract markets is that there is a private contract risk,” explained Kennedy. “The other person has to perform and hold the stakes.”
Kennedy added, “The exchange where that contract is traded is the one that holds the stakes.”
“The nice thing about options is what a seller pays upfront is all they will ever pay,” said Kennedy. “Producers should know what their costs are upfront and realize that part of the profit will be given up.”
Future prices virtually have unlimited risk because of margin calls that rule against the futures market.
“Producers can also roll their position and take cash out as the market moves against them,” stated Kennedy. “They can harvest some of that money along the way, and that’s perfectly permissible – even for a true hedge.”
In 2013, federal crop insurance programs covered over $145 million in crop liability for Wyoming farmers and ranchers. Producer-paid premiums totaled $7.65 million, and paid indemnities totaled $22.3 million in 2013.
“Crop insurance purchases protect against a specific loss over a defined period of time,” assured Kennedy. “All crop insurance works that way, as long as the loss was from a natural event and not from a man-made event.”
For disasters that are from man-made events, Kennedy suggested having a farm liability policy.
“Producers should be very aware of when the insurance expires and compare that to when they actually goes to sell their livestock,” warned Kennedy.
“In a very short time, a huge market dump can occur, and if the insurance has expired the day before that market dump, the insurance didn’t do the producer any good,” warned Kennedy. “Producers need to tie those closely together.”
Insurance coverage prices generally are between 70 to 95 percent of the expected end value with an insured time period of 13 to 52 weeks.