Managing Climate Risk in
Hon. Kim Chance,
Minister for Agriculture, Forestry and Fisheries, Western Australia
I am delighted to be here today to
officially open the managing climate risk in agriculture workshop. I would
like to thank Dr Greg Hurtzler of the university of western Australia and
the organisers of today’s event for their hard work in putting together
the program. I believe this workshop will provide a valuable insight into
climate risk and the exciting new methods that are emerging for managing
those risks. I would also like to welcome to western Australia our
national and international delegates and speakers.
As we all know, many farmers and rural
communities are hurting because of adverse seasonal conditions. The
disastrous 2002 growing season illustrates that climate variability has a
very large influence on crop production and farming systems across
Australia. Agricultural production in the grain belt of western
Australia is primarily limited by the amount of rainfall and its
distribution through the growing season. As a result, western Australian
farming systems have some of the highest yield variability in the world.
Western Australian research has shown that
to farm successfully, climate risks need to be appreciated and managed
well. With farm sizes increasing and farm costs continuing to rise, the
importance of tools to assist farmers in better preparing for climate risk
is now greater than ever. Information is critical for better preparedness
and the themes covered today outline "a positive way for the
The four main themes of today’s workshop
1) Better long-range seasonal forecasts
that can prepare farmers for extreme seasons;
2) Management tools that can convert
seasonal outlooks and soil moisture reserves into crop yield forecasts;
3) New initiatives for crop and weather
4) Farmer adaptation to climate risk.
The state government is committed to
assisting farmers to manage climate risk.
One of the mechanisms by which the commonwealth and state
governments handle seasonal risk is through exceptional circumstances
The exceptional circumstances program
provides welfare assistance and business support through the provision of
interest rate subsidies for affected farmers. The debate about exceptional
circumstances efficiency and effectiveness, and suggestions for
improvement, has been on going. The key issue for the program is to
continue to move towards progress that will enable producers to self
In august 2001, as part of our program of
activities to assist farmers in developing risk management tools, the
state government established a task force to investigate the feasibility
of establishing a commercially viable multi-peril crop insurance product
in western Australia. The
taskforce, made up of industry, government and independent research
personnel, has conducted a thorough investigation of multi-peril crop
Multi-Peril Crop Insurance (MCPI)
The task force was mindful of the realities
of trying to establish a crop insurance scheme here in western Australia,
balancing the needs of farmers with the commercial situation faced by the
insurance industry. The
taskforce has recently provided me with a report, which has a range of
recommendations for government to consider.
I will not be commenting on the
recommendations at this stage because I want the key stakeholders to have
some time to consider the complex range of issues that are involved before
they are able to advise me of their views.
The report indicates that while a
sustainable MCPI scheme may be possible on the actuarial data alone, the
combination of September 11 (2001), the HIH collapse and other factors
leading to the present turmoil in the insurance industry, as well as the
current severe drought nation-wide which is not part of the actuaries we
have, mean that such a scheme cannot be underwritten by the insurance
industry at this time.
I have looked carefully at the potential
for government support (as a subsidy) to improve the viability of the
scheme and this is not beyond reasonable realms of possibility; indeed the
report indicates that the level of subsidy required could be less than is
currently committed to the EC scheme. But even with the matter of subsidy
resolved, the fundamental stumbling block of a complete absence of an
underwriting capacity still remains. This issue, while hopefully a
temporary matter, is so serious that I am informed that insurers had
difficulty obtaining re-insurance for fire and hail insurance last year.
I believe the report provides reason for
hope that in the future, when a level of confidence is restored in the
insurance industry, a form of MCPI may be possible. While it is
disappointing that a MCPI scheme is not possible at present, the work that
the taskforce has done in alternative risk management areas, including
mutual funds and weather derivatives, open some interesting opportunities
that go to the core of today’s seminar.
WA farmers have for generations been
effectively managing climate risk through a variety of strategies such as
diversification in farm and off farm enterprises. Today, with increasing
climate volatility, new and innovative products are being developed to
Farm Management Deposit (FMD) Scheme
The farm management deposit (FMD) scheme is
designed to assist eligible primary producers with their year-to-year cash
flow management. It is delivered commercially through authorised financial
institutions such as banks, credit unions and building societies.
An FMD allows pre-tax income from profitable years to be set aside
to help balance short falls incurred in poorer years. Interest on FMD’s is earned at market rates, and tax is
paid at the rate relating to the year in which the money is withdrawn.
Tax benefits associated with the FMD scheme
require that an FMD be held for a minimum of twelve months in order for it
to be eligible. It is worth
noting that in response to the 2002 drought, the federal government has
announced the introduction of amendments to tax legislation to allow
farmers in exceptional circumstances areas to access FMD’s that are less
than 12 months old and keep the tax benefits. The partial withdrawal of
FMD monies will also be permitted without affecting the benefits that
accrue to the remaining money.
Farmers in western Australia are taking
advantage of the risk management opportunity offered by FMD’s with
$212.3 million held in FMD’s in western Australia as at the 30th June
2002, of which around $150
million was held by grain or grain / livestock enterprises. The FMD works
effectively when farmers have had good years to make substantial deposits
to see them through the poorer seasons.
Without those good seasons to make deposits or with an extended run
of bad seasons the FMD no longer acts as a buffer.
Weather derivatives are products based on
indexes that closely monitor the incidence of ‘normal’ weather
patterns over a period of time. Once
long-term data has been studied, a payment schedule is set, based on the
purchaser’s anticipated revenues during the option period.
Payments are triggered if there is a
sufficient diversion from the norm that exceeds an agreed trigger.
For example, farmers could take out protection against a weather
event occurring at a designated recording station, such as receiving less
that 300 mm of growing season rainfall.
They would receive a payout for each millimetre of rainfall below
this, usually up to a capped amount.
The idea is that in the event of a drought, a farmer could receive
a payment to at least partially compensate for loss in yield.
One of the key advantages of weather
derivatives is that they can be used to cover low-risk, high probability
events as opposed to most insurance products which cover high-risk, low
probability events such a floods or fire. Weather derivative markets have
grown rapidly, particularly in the United States, since their introduction
in 1997. The energy generation industry has been the main user.
Weather derivatives in agriculture offer
the farmer the chance to hedge against the major factors influencing crop
yields - rainfall,
particularly growing season rainfall, and temperature, to hedge against
frost. The demand for weather derivatives will depend on the correlation
between climatic events such as rainfall or temperature and yield and
A number of companies such as Macquarie
Bank, AXA and SG are offering weather derivatives or are looking to
investigate this market. The
potential problem with weather derivatives is that at times there can be a
poor correlation between rainfall and yield. To circumvent this problem,
researchers and the insurance industry are investigating index-based
contracts and the development of models that link rainfall to yield. Such
models would offer farmers greater surety as they would know the effect of
a weather event and would be able to insure effectively.
coverage index based contracts are largely free of adverse selection and
moral hazard problems, and have relatively low start-up and administration
costs. For the risks facing cropping, two simple index contracts are
area-yield and rainfall contracts.
problem with existing index contracts is that an individual can experience
a loss in crop yield, but the index contract is not triggered hence a
payment is not made. This is
known as basis risk. It may
be possible to narrow this basis risk through the use of technology and
western Australian government could have a key role in the future in the
development of a suitable index model for farmers, sufficient
infrastructure to accurately measure the data needed for the index, and
monitoring the information to add to its credibility.
An alternative to the finance industry
providing risk management products is the concept of farmer mutual funds.
Mutual funds usually operate within specific industries.
Claims are usually limited by some ceiling or maximum distribution
of the available pool.
To insure against an event requires broad
participation, either voluntarily through levies or some other rating
basis to pool income to protect those included in the mutual fund. Mutual
funds work similarly to insurance but generally without reinsurance for
disastrous events or catastrophes. The
mutual funds usually do not cover events other than along specifically
targeted defined circumstances.
Some of you will remember the banana
growers in Carnarvon (WA) had such a scheme in place up until three years
ago to assist the re-establishment of banana plantations following cyclone
There are a couple of drawbacks in mutual
funds: firstly, the need for the fund to cross subsidise high-risk areas.
Unless a weighted pooling levy arrangement, similar to that which would be
established in the general insurance market prevailed, it would be
difficult to attract the broad cross section of primary producers to
ensure a viable and stable fund.
Furthermore, systemic risk is also an
issue. If all the growers in the same area were subject to the same
catastrophic event the pooled income would be drawn on in one major event.
Reinsurance, if available, could help overcome this problem. These
drawbacks aside, farmer mutual funds could offer growers the opportunity
to develop a suite of risk management options.
In conclusion, there is a clear need for
further, more detailed, studies on the management of climate risk. I see
this workshop as a good forum to enable us to think about other useful
I wish to congratulate all of those working
in this field for the advances they have made and for sharing this work
with us in this workshop.