Jesús Antón, OECD Trade and Agriculture Annual Workshop of ERCA Research Network on SPAA. Ottawa 25 November 2011 Risk Management in Agriculture: Assessing household level risk, Policy layering and analytical challenges

OECD Trade & Agriculture 2 OECD Workshop on Risk Management in Agriculture (November 2010) 1. OECD Work on Risk Management in Agriculture Thematic Review: country studies Australia, New Zealand, Spain, Canada and Netherlands Farm level data analysis: Risk exposure & Optimal Strategies Aggregate Model Analysis of Exogenous Risk : AGLINK/COSIMO application Synthesis Report (April 2011)

OECD Trade & Agriculture 3Outline Why using Household level data... –...for risk assessment? –...and modelling response? Risk layering and good policy Analytical challenges

Why Using farm household level data for risk analysis?

OECD Trade & Agriculture 5 Aggregate ≠ Individual risk Most farmers are exposed to higher yield risk than the aggregate level Yield risk is higher than price risk… but not in all countries Percentage of farms exposed to higher yield variability than aggregate mean *Wheat for UK, Estonia, Australia and Canada Barley for Italy and Spain Percentage of farms exposed to higher yield variability than price variability

OECD Trade & Agriculture 6 Key role of interactions on Risk Assessment Full attention to the interactions between risks, strategies and policies –Correlations, diversification, government’s programmes

OECD Trade & Agriculture 7 Endogenous pro-active risk management strategies: Interesting results from Stochastic simulation model uncertain output price of crop i uncertain yield of crop i cost adjustment factor for crop i area of land allocated to crop i transfer from government or benefit from risk market strategy level of coverage decided by farmer Representative farmer maximize his expected utility of profits degree of CRRA initial wealth Farmer’s welfare is computed as certainty equivalent of profit uncertain variable cost revenue from livestock operation (applicable for only Australia)

OECD Trade & Agriculture 8 a) Are Minimum Intervention prices effective? Reduce risk rather than Manage risk Only effective for very low Intervention prices Beyond certain level, it increases variability: –Less on-farm diversification –less price-yield correlation => less natural hedging

OECD Trade & Agriculture 9 b) Support to Insurance Start-up support  Information databases and sharing arrangements  Public-private partnership Hard to increase demand Insurance subsidies  Reduce diversification  Differentiate catastrophic and marketable policies  Hard to deter ex post assistance

OECD Trade & Agriculture 10 c) Crowding out of BRM policies Accounting Change in CV of Income (without crowd out) Simulated Change in CV of income (with crowd out) Change in Diversification Change in share of land insured Agri-Insurance-23.5%-0.5%-4%+33% Agri-Stability-33.4%-9.0%-18%-16% Agri-Invest-0.7%-1%0% Agri-Recovery+2.5%-8%-0.2% Lagged Agri- Stability -1.4%-4.9%-18%-16% Impacts of some BRM programs in a sample of Saskatchewan farms

OECD Trade & Agriculture 11 d) AgriStability by tier Certainty equivalent income (change in CAD) CV of income (change in percentage) Change in diversificati on index (Initial = 100) Minimum income (change in CAD) Change in the share of land insured (change in percentage points) Overall change Contributing factors Change in mean Change in variability Total impact Contribution of the coverage of TIER % of reference margin TIER 3 up to 70% of reference margin TIER 4 negative margin

OECD Trade & Agriculture 12 Improving AgriStability Simplify the delivery mechanism: –Eliminate the margin adjustments –Link payment directly to income tax declaration –Declaring tax in accrual basis, like other businesses Make an in-depth evaluation of the effectiveness and targeting –Use available databases –Consider the following changes in policy: Eliminate stabilization tier 2 and tier 4 Refocus on Tier 3, addressing the overlap with insurance Increase participation fee and calculate actuarial premiums

OECD Trade & Agriculture 13 e) Crowding-out effects Government compensation for non-catastrophic risks off-sets pro-active risk management strategies: –Diversification: the main strategy –Market instruments Contracts / integration Futures: farmers benefit Private insurance: asymmetric information Strongest crowding out from policies that address normal business risk: –Price support, income stabilization, CCP Weakest crowding out: Fixed highly decoupled payments

Risk Layering and good policy

OECD Trade & Agriculture 15 Governance of Catastrophic Risk OECD Governments will always be called on to provide disaster assistance –Political pressure –Be prepared with some ex ante framework Procedures Delineation of responsibilities Triggering criteria Types or levels of assistance Examples: –New Zealand Crop insurance as a disaster assistance device +Farmers pay, transparent trigger, stable budget -Refrain from non-catastrophes, deter ex post assistance and efficient administration

OECD Trade & Agriculture 16 Catastrophic Risks Rare, high damage & systemic Marketable Risks Middle range Normal Risks Small damage but frequent On farm strategies Market tools Ex-ante Policies Ex-post Policies Good policy response Probability Higher income loss On-farm strategy - Diversification -Saving On-farm strategy - Diversification -Saving Market tools - Forward contract - Private insurance Market tools - Forward contract - Private insurance Disaster Assistance Policies - Ex-ante/ Ex-post payment - Subsidized insurance Disaster Assistance Policies - Ex-ante/ Ex-post payment - Subsidized insurance More government involvement? Good Governance

OECD Trade & Agriculture 17...to RM Policy Overcrowding in Canada... Catastrophic RisksMarketable RisksNormal Risks On farm strategies Production and income diversification Financial management Market tools Forward contracting Use of cooperatives Ex-ante Policies Ex-post Policies Ad Hoc disaster Aid Tier 1: Saving acc. AgriInvest Wheat Board Public Insurance (AgriInsurance) Public Insurance (AgriInsurance) AgriStability countercyclical payment Tier 4 Tier 3 Tier 2 Negative margin % loss 15-30% loss Tier 4 Tier 3 Tier 2 Negative margin % loss 15-30% loss AgriStability countercyclical payment Tier 4 Tier 3 Tier 2 Negative margin % loss 15-30% loss Tier 4 Tier 3 Tier 2 Negative margin % loss 15-30% loss AgriRecovery

OECD Trade & Agriculture 18...plus supply management... Catastrophic RisksMarketable RisksNormal Risks On farm strategies Production and income diversification Financial management Market tools Forward contracting Use of cooperatives Ex-ante Policies Ex-post Policies Ad Hoc disaster Aid Tier 1: Saving acc. AgriInvest AgriRecovery Supply Management Arrangements (dairy, eggs and poultry) Supply Management Arrangements (dairy, eggs and poultry)

OECD Trade & Agriculture 19 Main Policy Messages for Canada a)Improve the definition of the boundaries between programs and layers of risk: enhance farmer’s pro-active strategies b)Improve the delivery and target of AgriStability: not effective for normal nor catastrophic risk c)Develop an ex ante framework for catastrophic risk covering AgriInsurance, AgriRecovery... and avoiding proliferation of ad hoc

OECD Trade & Agriculture 20 Analytical Challenges and Areas for research on Risk 1.Use of micro panel data: –For farm risk assessment and inform the government and the farmer –For simulation models to better understand the interactions between policies and strategies –For estimating the value of risk for farmers (Why governments tend to overestimate?) and the marginal impact of policies / strategies 2.Economics of governance and institutions –How to make good information prominent? –Risks with externalities and co-funding –Boundaries and how to make most efficient institutions emerge?

OECD Trade & Agriculture 21 Contact OECD Trade and Agriculture THANK YOU!