Course Title: Risk Management and Insurance in Agribusiness

Course code: ABVM 441

Academic year: 2024

Target groups: ABVM 4th Year Student

Instructor :Etabez A(MSc)
Chapter One: General Overview

At the end of this chapter, you will be able to;

Understand the concept of risk.

Identify sources of Agricultural risk and their effects.

Understand farmers attitude towards risk

Quantifying Risk
 1. INTRODUCTION

 Agriculture production and farm incomes are frequently affected by natural

disasters such as droughts, floods, cyclones, storms, landslides and earth
quick.
 Susceptibility of agriculture to these disasters is compounded by the outbreak
of epidemics and man-made disasters such as fire, sale of spurious seeds,
fertilizers and pesticides, etc.
 All these events severely affect farmers through loss in production and farm
income, and they are beyond the control of the farmers.
 With the growing commercialization of agriculture, the magnitude of loss due
to unfavorable eventualities is increasing.
 The question is how to protect farmers by minimizing such losses.
 Apart from production the risk is also involved in marketing of produces,
because of high variation in prices.
1.1. Meaning and Scope of Risk and Risk Management
The Concept and definitions of Risk
There is no single definition of risk.
Risk is defined as uncertainty concerning the occurrence of a loss.
oFor example, the risk of being killed in an auto accident is present because
uncertainty is present. The risk of lung cancer for smokers is present because
uncertainty is present
“Risk is a condition in which there is a possibility of an adverse deviation from a
desired outcome that is expected or hoped for”.
 Risk is the chance of loss - Chance of loss is defined as the probability that an
event will occur.
 Risk is the possibility of loss
 Risk is uncertainty
 Risk is the probability of any outcome different from the one expected.
 Risk is doubt
 Risk is worry
 It is the exposure of adverse consequence
 It is undesirable events
Therefore, “risk management” can be defined as an organized approach to
identify possible or probable financial harm and take steps to minimize the
financial impact to acceptable levels.
 Farmers must try to manage risk effectively.
 Profit is the reward for bearing risk.
 The task is rather to manage risk effectively, within the capacity of
the individual, business or group to withstand adverse
outcomes.
 In running their farms, farmers in the world over have always
understood the existence of risk and have adjusted to it in their own
ways.
 Risk is an integral part of agriculture.
 Each day, farmers confront different types of risk but changes in the
risk environment and available tools used to manage the risk make it
a compelling reason to engage in risk management education.
 Meaning of Risk Management

 Risk management is defined as a systematic process for the

identification and evaluation of pure loss exposures faced by an
organization and individuals, and for the selection and implementation of
more appropriate techniques for treating such exposures.
 It refers to the identification, measurement, and treatment of exposure to
potential accidental losses almost always in situations where the only
possible outcomes are losses or no change in the status.
 It is a process that identifies loss exposures faced by an organization and
selects the most appropriate techniques for treating such exposures.
 A loss exposure is any situation or circumstance in which a loss is
possible, regardless of whether a loss actually occurs.
 Examples of loss exposures include manufacturing plants that may be
damaged by an earthquake or flood, defective products that may result in
lawsuits against the manufacturer.
 Risk management is the discipline that clearly shows the management of
the risks and returns of every major strategic decision at both the
institutional level and the transaction level.
 Risk management is defined as the systematic application of management policies,
procedures and practices to the tasks of identifying, analyzing, assessing, treating
and monitoring risk.

 It is an integral part of good management of a farm, being a way to avoid losses

and exploit opportunities.

 Insurance and buying on futures and options markets to lock in input or output
prices are good examples of tools used in risk management.

 Risk management starts with decisions on the farm and at the household level:
which outputs to produce, how to allocate land, which inputs and techniques to use
etc.
 Risk management strategies
1. Enterprise diversification: assumes incomes from different crops and livestock
activities. So that low income from some activities would likely be offset by higher
income from others

Growing several different crops or keeping livestock with the expectation that prices
and market demand for all enterprises will not fail together.

2.Selecting low risk enterprises: Be aware of differences in the yield variability of

crops associated with soils, management, and other factors on their own farm.

3. Crop and livestock insurance: For phenomena, which can be insured, possible
magnitude of loss is lessened through converting the chance of large loss into certain
cost through insurance arrangement
4. Flexibility: allows for changing plans as time passes, additional
information is obtained and ability to predict the future improves.

5. Spreading sales: Instead of selling the entire crop output at one time,
farmers prefer to sell part of the output at several times during the year.
Spreading sales avoids selling all the crop output at the lowest price of
the year but also prevents selling at the highest price.
Making several sales of a product during a year is commonly used by
farmers as a risk reduction strategy
6. Changing Production Practices: The use of inputs and materials that
control crop diseases and pests.

7.Obtaining Market Information: The more knowledge a farmer has

about price changes and the past profitability of enterprises, the better
position they are likely to be in predicting the future.

8.Liquidity: refers to the farmer's ability to generate cash quickly and

efficiently in order to meet financial obligations or assets can be
converted to cash on short notice without incurring a major loss.
 Risk and Uncertainty

◦Risk is the possibility that an outcome or event will not meet planned expectations.
◦This is measurable through probability concepts. Ex: Occurrence of pest and disease,
fluctuation in market prices etc.
Uncertainty: This situation prevails when all the possible outcomes of events are unknown.

It is lack of sureness about someone or something

It may comes from lack of knowledge or information about the present event

For example, no one can assign probability to how many times he will fall sick within
a year
◦It is not measurable. Example: Occurrence of flood, drought etc.
 Differences Between Risk and Uncertainty
 “Risk is measurable uncertainty while uncertainty is immeasurable risk”.

 This indicates is that risk is a subset of uncertainty.

 Risk can be considered as a subset of uncertainty that is quantifiable or

measurable, whereas uncertainty refers to ignorance about potential outcomes or

their respective likelihood of occurrences.

 When the chance or probability of an outcome is known in advance this is called risk,

where as the chance of an outcome is not known in advance this is called

uncertainty.
Basis for Comparison Risk Uncertainty

Meaning The probability of winning or Uncertainty implies a

losing something worthy is situation where the future
known as risk. events are not known.
Ascertainment It can be measured It cannot be measured.

Outcome Chances of outcomes are The outcome is unknown.

known.
Control Controllable Uncontrollable

Minimization Yes No

Probabilities Assigned Not assigned

 Dimensions of Agricultural Risks

Farmers face a number of risks which are often interconnected.

Five types of risk are generally considered in agriculture, according to their sources:

1. Production risks, concerning variations in crop yields and livestock

production, affected by a range of factors: weather conditions/climate change,
pests, diseases, technological change as well as management of natural resources
such as water. These factors affect both the quantity and quality of commodities
produced.
2. Market risks, associated with variability in output price (mostly), also input price
variability and integration in the food supply chain (with respect to quality, safety, new
products, etc.)
3. Regulatory risks : is the risk that a change in rule and regulations will materially
impact on business, sector or r market.

It connected with the impact of changes in agricultural policies (e.g. subsidies,
regulations for food safety and environmental regulations) or trade policies: a
change in government action, which is at odds with what farmers expected, may
have a negative impact on their income.

4. Technological risks associated with the adoption of new technologies

5. Financial risks :a risk incurred when money is borrowed to finance the
operation of the business. That is, any time money is borrowed there is some
chance that future income will not be sufficient to repay the debt without using
equity capital

6. Human/personal risks, associated with unavailability of personnel.

It refers to factors such as problems with human health or personal

relationships that can affect the farm business. Accidents, illness, death, and
divorce are examples of personal crises that can threaten a farm business
 Production risk, market risk and financial risks are usually considered the
most important in agriculture.
 1.2. Sources and Effects of Risk on Agriculture

Sources of risk
 Risk affects production such as changes in the weather and the incidence of
pests and diseases.
 Equipment breakdown can be a risk as can market price fluctuations.
 Borrowing money can also be risky with sudden changes in interest rates.
 Risk also occurs as a result of changes in government policies.
 Such risks often have a major impact on farm income.
 Finally, there are risks related to the health and well-being of the farmer and his
family and the supply of labour for the farm.
The risks that farmers face result from numerous sources of change or
uncertainty.
Some of these are related directly to the farm business and would not exist were it
not for the farm.
Others are related to our involvement in a farm business as individuals.
These risks, such as the risk of a heart attack, may exist even if we don’t farm, but
may have particularly important implications for risk management relative to the
farm business.
Others are related to the environments (natural, social, institutional) in which
our farm business and we as human beings operate.
 1.3. Farmers’/Producers’ Attitude towards Risk
 Farmers differ in the degree to which they accept risk.
 Some farmers are willing to accept more risk than others.
 Often farmers’ attitudes regarding risk are based on their
personal feelings rather than information presented to them to
help them make more rational decisions.
 Attitudes to risk are often related to the financial ability of the
farmer to accept a small gain or loss.
Farmers’ attitudes may be classified as:
1. Risk-averse :those who try to avoid taking risks; . They tend to be more cautious
individuals with preferences for less risky sources of income. In general, they will
sacrifice some amount of income to reduce the chance of low income and losses.

2. Risk-takers: those who are open to more risky business options; and they choose
the alternative that gives some chance of a higher outcome, even though they
may have to accept a lower outcome. When faced with the choice, risk-taking
farmers tend to prefer to take the chance to make gains rather than protecting
themselves from potential losses. The risk-takers prefer to take a chance to make
more profit.

3. Risk-neutral farmers: who lie between the risk-averse and risk-taking position
The following are some of the factors that may influence a farmer’s attitudes
toward risk.
1. Farmers who operate under subsistence conditions tend to be the most risk-
averse.
The provision of food for their dependants is an overriding priority for many of them
Activities with a monetary reward are frequently sacrificed in favor of meeting the
objective of producing their own food.
2. Market-oriented farmers who are not willing or able to withstand the possible
financial losses associated with a risk also tend to be more risk-averse.
In market-oriented farming the farm is run as a business buying inputs, using them
to produce agricultural products, marketing those products and selling them for cash.
This is often true for smallholder farmers
 In effect the relationship between the input costs and the value of output from the
farm influences the farmer’s attitude toward risk.
3. Family commitments and responsibilities can also play a role in attitudes
toward risk. A person without family commitments may be more willing to take
risks. Similarly, older people are likely to take less risks.

4. Past experience may also influence a farmer’s decisions. The effects of

particularly good or bad years in the past influence decisions to be made today.

Again, this may be related to age; a younger person may not yet have many
experiences on which to base decisions.
 1.4. Quantifying Risk

 Risk quantification refers to the forecasting of loss frequency and severity to make risk
financing decisions.

 It's about measuring risk and risk response in monetary terms so you can
understand your company's loss exposure, communicate it clearly, and make
better-informed risk decisions.

 It is the process of defining a risk's impact on the business in terms of a specific

value, often in terms of dollars

 It helps you to optimize your decision-making to be worth conducting.

 Risk must be quantified in order to evaluate whether various risk management tools and
strategies are effective in achieving producers’ risk reduction goals.