There are four general ways to mitigate risk, and one or more can be important if you own a farm in New Jersey or Pennsylvania. Understanding your risks and developing a plan to reduce them can be critical for guarding your investment and your livelihood. Consider these four options as you think about protecting your farm and the business you love so much.
The four major ways to deal with risk are avoidance, reduction, assumption or retention, and transfer. Read on to determine if any of these would work for your business.
Avoidance refers to the process you undertake to structure your business to eliminate certain kinds of risks. For example, diversification is a risk management technique traditionally used by farmers. If one enterprise did not do well, the farm had other enterprises on which to rely. Returns were generally not as high as with specialization, but year to year variability was reduced.
Economics and agronomics lead many cornbelt farmers to a corn/soybean rotation. Costs are reduced and yields improved relative to continuous corn. In addition, because corn and soybean yields do not vary exactly together, there are risk reduction benefits from diversification. Diversification may also result in greater timeliness of operations and in increased returns. For most farmers, combining corn and soybeans is not risk management–it is good management! Risk management begins after these production efficiencies are gained.
Reductio refers to lowering risks that are generally associated with your business. If you are involved in grain production, you might use crop scouts to determine early signs of disease or pest control problems. The risk might not be eliminated completely, but putting such a system into place could help reduce risks.
Assumption or retention relates to accepting the risks with the underlying thought that these higher risks are necessary either for being profitable or for maintaining control. Even though you recognize that this risk might be part of doing business, you do need to understand the risk and catalogue it internally.
The final way to deal with risk is known as transfer. This happens when one party determines that he or she can lower their individual risk by shifting it to somebody else. This is usually done for a fee, though. Insurance and futures and options contracts are all examples of transferring risk. In order to successfully transfer risk, a farm owner must be aware of the risk factor to begin with and determine that the costs of transferring that risk are minimized by the potential losses otherwise. For example, damage to equipment without insurance could be devastating, and sudden damage or loss of a piece of equipment is much more catastrophic than the premiums paid into an insurance policy. Transferring this risk to someone else means that you have acknowledged the potential for loss or damage and guarded yourself against it.
While you certainly hope that you’ll never need the safeguards, they can be critical in times of need. Failing to have this protection in place could put your farm’s future in jeopardy.