The Risks of Not Managing Risk
By Laura Temple
Farming is the original risky business. And it seems to become less predictable every year.
Generational weather events. Unpredictable trade policy. Extreme commodity price swings. Political uncertainty. Changing global dynamics.
Countless risk factors are beyond producer control. But the risk of doing nothing is very real and carries significant costs.
“The biggest risk for farmers is not taking one,” says Tanner Ehmke, manager, CoBank Knowledge Exchange, which provides research and knowledge sharing for the agriculture industry. “When you are not taking risks and being proactive, you leave the door open to becoming a victim of circumstances. And that actually elevates your risk.”
Ehmke explains that risk analysis requires a long-term view of an operation.
“Start with questions like, ‘What is our business model? Our future goals? And how will they be achieved?’ to begin to see risks,” he says. “Then identify the team that will help reach those goals and manage risks.”
That team is critical, as different perspectives help producers understand the real costs of not proactively managing business risks.
“Producers write checks for things they are comfortable with and understand, and production issues are among those things,” says Eric Osterhaus, principal, K·Coe Isom food and ag consulting and accounting firm. “When uncomfortable, the tendency is to do nothing or delay decisions. We see this more often with managing price risk and marketing than with production.”
For example, farmers rarely choose to cut costs by skipping a key production input without carefully penciling out potential yield losses.
“Price risk management does not always get that same amount of focus,” Osterhaus continues. “Better understanding the risk management tools available, focusing on knowing costs, and using outside advisors can all help producers make more proactive decisions that reduce risk.”
The advisor team should include a banker, crop insurance expert, local co-op supplier and others. Their insight and support can prevent producers from falling victim to scenarios like these.
What if producers don’t plan for variable input and crop prices?
Financial management of input costs and crop marketing ties directly to profitability.
“Emotion is one of the biggest obstacles to effective marketing for soybean profitability – specifically fear,” says Osterhaus. “With taking advantage of profitable prices, there are two ‘fears’ that prevent most producers from moving forward…production fear and price fear.
“Production fear is ‘Will we raise the soybeans?’ Often we see the best marketing opportunities occurring at the exact time when producers are most uncertain of their crop,” he says. “Price fear is the risk of selling today and seeing the price go higher tomorrow. These two fears tend to paralyze producers, and they see profit levels slip away.”
Osterhaus says that without proper planning and the ability to use available risk management tools, emotion can take over such decisions – especially when under stress.
“Is the true cost per acre known? That’s a great tool for business profitability decisions,” he adds. “Without understanding at what point the crop makes a profit, farmers can go broke saving money on inputs or holding on to crop too long.”
A financial management strategy for inputs and crop marketing helps producers look at all tools and options to reduce fears and keep moving in uncertain seasons, instead of doing nothing.
Working with a team to execute that strategy also helps manage and spread financial risk, notes Ehmke. “Advisors can uncover new options when dealing with challenges,” he says. “They can bucket out input, market, technology and other risk to minimize the bad and optimize the good.”
He offers specific examples for inputs.
“A supplier, like the local cooperative, knows the risk of getting inputs,” Ehmke explains. “Working together, producers and suppliers can figure out how to help each other minimize risks. That’s what early purchase, buyer’s groups or local warehousing do.”
A similar concept works for crop marketing.
“When trade for soybeans was lost, what did you do in advance?” he asks. “Those who did nothing had to accept local bids or find storage. A team helps uncover new options to add value.”
What if producers don’t have crop insurance?
“Last year is one of the best illustrations of what could go wrong without crop insurance, and the value it brings,” says Bruce Sherrick, University of Illinois agriculture and consumer economics professor and member of the FarmDoc team. “Crop insurance worked as it was supposed to last year, despite everything that couldn’t be predicted.”
For farmers without crop insurance in 2019, they may have had access to support in counties labeled disasters. But for those in other counties, crop insurance may have been the difference between having opportunity to plant in 2020 or not.
Sherrick describes crop insurance as a cornerstone of managing financial risk. It’s counter-cyclical nature ensures basic revenue and opens the door for additional support in tough years. For producers considering cutting back to save input costs, his advice is a categorical “no.”
“That’s not a bet to take,” he explains. “The government programs announced this year tied to crop insurance. Support is being offered to those already managing risk.”
According to Sherrick, revenue insurance is chosen most often, with options that allow producers to proactively price crops. While the government terms and acronyms change with new farm bills, tools are made available to help navigate it.
“As we look ahead, any real support for producers in challenging years like 2019 is likely to be tied to the crop insurance and conservation titles within the farm bill,” he says. “Crop insurance records are tied to many other production and business management risks. Without crop insurance, additional support may not be accessible.”
What if there is no succession plan for the operation?
“The risk of not having a succession plan is that the operation may not be a farm in just a couple years,” says Curt Ferguson, estate planning attorney for The Estate Planning Center in Salem, Illinois. “Any error in planning can force the sale of the farm, so you have to plan appropriately.”
Ferguson says planning is about more than just documents. Unexpected death or disability leaves an empty chair. True planning is knowing who will fill that chair to make farm decisions and then equipping those people to be prepared.
“How involved is the next farm operator in decisions?” he asks. “Are they engaging with the operation’s outside advisors so they are prepared to get help and information they may need?”
He adds that a well-thought-out plan protects the farm legacy in more circumstances than just death. Key concerns and potential threats that he discusses with his clients include divorce, accidents – including those with lawsuit implications, looming long-term care needs like assisted living or nursing home care, and navigating estate taxes.
“The process of transfer of assets is a huge opportunity to create protection of those assets that otherwise would not exist,” he explains. “If you look for ways to protect assets when divorce or lawsuit proceedings are underway, you’re too late. But with succession planning, assets can be passed on to the next generation in such a way that they are protected from those threats.”
Worth the Risk?
“When looking at 2020, remember that it starts where 2019 ended,” says Sherrick. “For example, however long trade issues last, the half-life will be twice as long as the event. In other words, we might only get halfway back in twice the amount of time.”
And who can afford to not manage those risks?