"The real value of insurance to a farm business is not in the claims that can be made, but the long-term confidence it can provide when making major business decisions."
This is the message from GRDC-invested 2018 Nuffield scholar and Western Australian grain grower, Dylan Hirsch, who travelled extensively around the globe researching the structures of insurance schemes in agricultural industries.
Based on this research, Dylan believes opportunities exist in Australia's grains industry to develop data-based insurance systems that could provide tailored risk-management products, allowing growers to better manage volatile climatic conditions.
Dylan says most insurance coverage in Australian agriculture, particularly multi-peril crop insurance, is based on individual production information, meaning administration costs are high. This often makes the products financially prohibitive.
"Drought and frost are arguably two of the biggest risks facing Australian grain businesses, and can have long-term impacts, not only on a farm business, but the community surrounding it," he says.
"Multi-peril crop insurance products in Australia are attempting to provide coverage for these events. But the administrative burden of working through individual business production and financial information, plus the burden of moral hazard, makes these schemes incredibly complex."
Dylan says his research has demonstrated that individual production-based insurance schemes need a critical mass of grower acceptance to make them financially accessible across the industry and, while this is achieved in countries such as the US and Canada, it is more difficult to achieve in Australia's grain industry.
In effect, we are paying $8 per hectare for another business to take on this weather risk for us.
In contrast, data-based insurance products, particularly weather index insurance, rely on third-party datasets that are available publicly, such as Bureau of Meteorology weather stations or a commodity price index.
This type of insurance could be more financially accessible than multi-peril insurance, providing growers with confidence to make major business decisions, particularly around large land purchases and business expansion.
"Weather index insurance is similar to our wheat swaps, providing a hedge against weather events," Dylan says.
With Australian growers facing an extremely high level of risk, not only compared to other industries but also to other farmers around the world, this type of insurance could be incredibly valuable to the industry, he says.
An Australian example
Dylan farms in Western Australia's north-eastern wheatbelt, where dry and drought years are becoming more regular under changing weather patterns.
Making long-term business decisions under these volatile climatic conditions is becoming increasingly difficult.
Following the completion of his Nuffield studies, Dylan considered weather index insurance for his own business.
He says there are only a handful of brokers in the country who offer this type of risk-management option and it is simply "a numbers game" as to whether this type of product can be the right fit for an individual grain business.
"In our case, the gross cost to the business is around $30 per hectare annually," he says.
"But we anticipate that over a 10-year period, we would claim around $22 per hectare back due to the frequency of our drought.
"This then means that the true cost to our business for this type of risk management product is $8 per hectare annually, which we believe we can easily achieve through more confident business decisions, such as strategic land purchases, or more aggressive forward selling - something we may not be comfortable to do without this insurance coverage."
In simple terms, these weather derivatives, or insurance coverage, will pay the businesses according to how much winter (or growing) season rainfall occurs on his property - which is third-party available data.
"In effect, we are paying $8 per hectare for another business to take on this weather risk for us," he says.
Insurance schemes in the US, Canada, the UK and the European Union differ significantly from most insurance options offered here in Australia.
The most obvious of these differences, Dylan says, is the US Farm Safety Net - which is the most extensive and complex insurance system in global agriculture.
This scheme provides growers with revenue protection, with premiums subsidised by the government by 65 per cent, which therefore encourages universal coverage.
Growers can also take out additional hail insurance on crops, which is similar to the fire and hail insurance available to Australian growers.
This part of the insurance is privately funded and managed - and not subsidised by the government.
In Canada, the government also supports several crop insurance programs to the tune of 60 per cent. But, despite this, two private companies are also offering unsubsidised insurance coverage.
"This is an interesting system but is so far working successfully because these private companies are able to conduct their due diligence on farmers using government data, and therefore cherry-pick low-risk clients," Dylan says
He visited a farming business in Alberta, Canada, where the owner uses both levels of insurance and - despite not making a claim in 12 years - still believes both levels of coverage are critical risk-management tools for the business.
"This farmer is able to insure his cost of production, including all business costs, land payments and depreciation, enabling him to take on land purchases and lease opportunities with confidence, with the full support of the bank, to ensure the business can cater for his five sons over the longer term," he says.
"He is quite confident that he would not have farmed in the same way without this insurance and he believes he has made more money by having this cover in place."
In the EU, price index insurance is an over-the-counter product that is similar to a stock option, to manage the risks associated with price instability, particularly for farmers who cannot necessarily lock in long-term prices such as dairy and horticulture.
One agricultural lender was using the product to protect both their own and the farmer's exposure to low milk prices, offsetting the price of the insurance with the reduction in loan rates.
Despite his extensive research, Dylan believes the best form of insurance for Australian grain businesses is self-insurance.
"Obviously this can only occur if the business is financially in a position to take on this risk," he says.
Otherwise, Dylan says, insurance can be an important tool over the longer term to provide business certainty.
"But on its own, with a focus on making claims, I do not think any insurance is worthwhile - premiums are always more than the claims, simply because that is the way insurance companies are able to financially survive," he says.
"One interesting outcome of my travels and research was the evidence of the flow-on effects of greater business confidence throughout the US, Canada, the UK and the EU.
"Farmers are more confident to spend regularly and locally because they do not have years of no - or low - income as a result of droughts or frosts or other climatic shocks, so businesses in local towns are much more supported and can afford to stay in these small communities."
To change the insurance landscape in Australia to one based on third-party data, rather than individual business performance, Dylan believes a range of datasets will need to be more accessible to the commercial sector.
"If we want to encourage more entrants into this sector, they need to have access to long-term datasets," he says.
"Likewise, if growers want to see these risk-management options available in the coming years, we will need to be more open with sharing our data, to reduce the administration burden and shift the focus to these more efficient, data-based insurance products."
GRDC Research Code NUF00010
More information: Dylan Hirsch, email@example.com