Risk Identification in an Uncertain World
Delton C. Gerloff University of Tennessee
Risk vs. Uncertainty
Uncertainty: probability of an event occurring
Drought. Disease.
Risk: impact of the event
Cash flow, profitability reduction. Family living, education, debt.
Managing Risk
Identify source. Calculate uncertainty. Calculate financial consequences. What would put the business in jeopardy? Is risk reduction possible? Cost of risk reduction.
Corn Yield/Acre
Obion County 1955-2004
150 125 Bushels/Acre 100 75 50 25 0
75 67 73 81 77 59 65 79 69 83 57 71 63 89 95 97 55 61 85 87 91 93 99 01
Year
Yield
5 Year MA
03
Production (Yield)
Uncertainty
12 out of 45 years yields < 5 year MA. 7 out of 45 years yields < 90% of 5 year MA. 8.5% average increase. 38% maximum increase. 44% maximum decrease.
Financial Risk
150 bu avg, 84 bu “minimum”. Loss = cash land, machinery, labor expenses.
Photo: National Severe Storms Laboratory Collection
Production (Yield)
Risk reduction possible?
Crop insurance: <$1 to >$6/acre. “Guarantee” up to 75% of non land cost? Irrigation. Cash reserves, equity.
Market (Price)
Based on 1985–2006 price data
Uncertainty
Current harvest contract price = $3.50. Avg corn price decrease from Jan to Oct, $0.21/bu. Largest increase, $0.80/bu, 1995. Largest decrease, $0.95, 1986.
Financial Risk
Depends on yield, price, expense. Farm Equity.
Market (Price)
Risk reduction possible?
Cash Forward Contract: Cost = opportunity. Hedge: Cost = opportunity + commission ($3.50). Option: Cost = $0.35/bu + commission ($3.10 floor). Revenue Protection via CRC, etc.
Agritourism Revenue
Uncertainty (Visitor Days)
Weather. General Economy. Competition.
Financial Risk
Inputs (Fixed labor, machinery, variable costs). Equity.
Agritourism Revenue
Risk reduction possible?
Diversification.
– Trans seasonal. – Indoor/outdoor facilities.
Target groups.
– Group discounts. – Differentiate visitors – “senior” discounts, “junior” tours.
Increase products, $ sales/visitor. Advertising.
Liability
Uncertainty
“Accidents”. May increase as laborers increase. May increase under value added enterprises.
Financial Risk
Unknown. Potentially devastating.
Liability
Risk reduction possible?
Liability insurance. Record keeping. Regulatory compliance.
Farm Operator Disability
Uncertainty
Unpredictable. Causes:
– Falls, machinery accidents, and livestock related injuries 32%. – Non-farm accidents, 24%. – Non-accident health related conditions, 44%.
Financial Risk
Operator’s labor and management input. Medical, rehabilitation expenses. Replacement labor.
Farm Operator Disability
Risk reduction possible?
Health, disability insurance. Safety management.
Farm Operator Death
Uncertainty
In the short run, low probability. In the long run, assured.
Financial Risk
Operator’s labor and management input. Medical, funeral expenses. Replacement labor.
Farm Operator Death
Risk reduction possible?
Life insurance. Record keeping. Written management plan. Business arrangements.
Death of Farm Operator’s Spouse
Uncertainty
In the short run, low probability. In the long run, assured.
Financial Risk
Spouse’s labor and management input. Spouse’s off-farm income. Medical, funeral expenses. Replacement labor.
Death of Farm Operator’s Spouse
Risk reduction possible?
Life insurance. Record keeping. Written management plan. Business arrangements.
Divorce
Uncertainty
43% of marriages will not survive 15 years. 75% of divorced people remarry, half within 3 years.
Financial Risk
Up to or exceeding 50% of equity. Legal expenses.
Divorce
Risk reduction possible?
Pre-nuptial agreements. Asset ownership. Business arrangement.
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