The agriculture and farming industries both require a significant amount of risk-taking and with the commercial market unable to cover certain risks, captive interest is on the rise
The agriculture sector plays a major role in the world’s economy as 60 percent of the world’s population depends on agriculture for survival. However, in recent years, many challenges are facing this sector resulting in higher costs for business owners.
With trade wars, new technology and climate change, the agriculture sector is facing a challenging time.
The US has over two million farms within the country that employs just under one million people. The sector has a value total of over $130 billion in exports. However, it’s widely reported that US President Trump’s trade war with China and the EU is actually damaging American farmers. Adding to the damage are the increase in droughts and forest fires in California over recent years, risks are increasing as are the costs. The agriculture and farming industries both require a significant amount of risk-taking, and with the commercial market unable to cover certain risks, captive insurance companies seem to be on the rise to cover specific risks that commercial insurers cannot compete.
Commercial vs captive insurance
Dustin Partlow, senior vice president, Caitlin Morgan Captive Management Group, said that the firm is getting an increase in the number of inquiries and a rise in the amount of interest in the agribusiness and farming sector.
Partlow adds: “We have received a number of inquiries for large scale produce farmers in the California area in addition to a number of inquiries from large scale agribusinesses in the Midwest.”
Pinnacle Actuarial Resources have also seen an increase of captive insurance in those sectors, with Aaron Hillebrandt, director and consulting actuary, stating that there had also been an uptick in “emerging areas such as hemp and cannabis farming operations have expressed a lot of interest in captives since they can have even greater insurance coverage gaps than traditional farms”.
Hillebrandt adds: “There has also been an industry-wide trend of consolidation in the agriculture industry. Consolidation and growth of cooperatives make captives increasingly viable and more attractive to agribusiness.”
He explains that there has been a “tremendous amount of change in the agricultural industry” including a broader understanding of the environmental risk of herbicides and pesticides; overspraying into adjacent organic farms and fields which may result in significant losses to organic crops; genetic modification of crops; increasing threat of avian and porcine influenza; and, the increasing integration of a variety of drones and robotic equipment in farming production.
Hillebrandt notes: “All of these issues make captives a potentially powerful option to consider for agribusiness and farming.”
Partlow explains that the biggest risks that generally drive the formation of a captive for the agribusiness and farming industry are product recall and crop insurance.
Hillebrandt also looks at crop insurance, stating that a natural place to start is gaps in federal crop insurance coverage.
The US federal government offers multiple-peril crop insurance but that coverage has several shortcomings. Farmers are left with large self-insured retentions, some crops are not covered by the programme, and many combinations of specific crops and geography (state-county) have known subsidies.
That makes deductible reimbursement and differences in conditions coverage for crop insurance natural fits for captives.
He adds: “There are other potential coverage gaps, however, depending on the operation’s commercial insurance policies that may include examples such as pollution coverage related to overspray, those instances when chemicals intentionally sprayed onto a field are carried by wind onto a neighbouring field that the farmer doesn’t own.”
“That example represents a typical material liability risk, particularly when the neighbouring field is organically farmed.”
Outlining product recall, Partlow explains that generally for produce farmers, anytime produce they grow gets recalled due to contamination if it’s from a farm in their general geographic area all of the produce grown in that area is recalled for safety reasons. These recalls are becoming more and more common.
He says: “These farmers are then faced with the lost revenue from that produce in addition to the costs of pulling their produce from the shelves.”
On crop insurance, Partlow suggests that although there is federal crop insurance available to some farmers, “it is only available to those growing certain crops and even those who can obtain federal crop insurance coverage is limited and there is still retained risk. For those in which the federal crop insurance is unavailable, the cost of commercial coverage is generally prohibitive and can be difficult to obtain”.
Hillebrandt believes that many larger farms are engaged or have expanded food processing capabilities. He states: “Issues with food-borne illnesses, product liability and product recall are all foreseeable risks.”
He adds: “Reputational risk or brand rehabilitation risk can be a material issue, causing serious damage to a company when a recall is large and makes national news.”
Partlow explains that traditional risks such as workers’ compensation, general liability, and auto liability can be covered in addition to medical stop loss.
He continues: “Generally agribusiness and farming entities have a great deal of expensive machinery as such coverages such as machinery breakdown are of interest to those in the industry considering a captive.”
Hillebrandt suggests that there are several types of captives that can be used in the market, however, a vital component of any farming-related captive programme should be geographic diversification of risk.
He believes that insuring some of the catastrophe risks through a captive can be helpful to a farming operation, but the captive is still taking catastrophe risk which may ultimately lead to solvency concerns.
Outlining one example, Hillebrandt says: “A captive programme that writes a multitude of independent farming operations in the same general geographic area may be exposed to significant solvency risk if that area is hit by one storm. But catastrophe and solvency risks are certainly mitigated when a captive programme’s multitude of insured farms are scattered in diverse locations across the country. A fairly obvious, alternative way to mitigate catastrophe risk is by securing catastrophe reinsurance from the commercial market.”
Although there are some agribusiness and farming companies that are large enough to warrant their own single parent captive, Partlow believes that generally, these entities are of a size where a group captive structure is more of interest.
There are a number of associations throughout the country that represent growers, farmers in this industry, Partlow suggests that after hearing from their members in regards to hardships around some of these key risks, the associations look into pulling together a group captive solution to benefit its members.
Hillebrandt adds: “Captives, in many ways, mirror the benefits of agricultural cooperatives. Farming co-ops, as they are called, are structures in which farmers pool their resources to save costs from inputs (seeds) to marketing. Like a captive, the co-op helps to distribute risk and is naturally and successfully aligned to the structure and benefits of captives.”
Agribusiness trends
Looking at the trends, Partlow suggests that with the market starting to harden, carriers are starting to pull out of markets making it harder to obtain coverage.
Partlow explains: “In the farming and agribusiness sector, there has been an uptick in the number of product recalls due to contamination. It seems like there is a new event almost weekly that you see on the news whether its eggs, lettuce, meat, there is a large-scale recall.”
He adds that these recalls are very expensive and due to these recent events product recall and contamination coverage is becoming harder to obtain in the commercial market.
In addition to general upward trends in interest from this sector, Hillebrandt says: “We’re seeing more and more coverages tailored to very specific farming operations.”
Hillebrandt explains that these are things like genetically modified crops, horse shows, livestock market payments, animal mortality, hull coverage for crop dusters, spoilage, and even porcine or avian influenza.
He continues: “The industry is always reckoning with weather catastrophes, but there is anecdotal evidence of the increasing intensity of storms and in some states where farms are impacted, increasing intensity of wildfires. It will be worthwhile to monitor how the industry continues to evaluate and price that risk.”
Partlow adds that severe weather events have also caused similar issues in terms of obtaining crop insurance. He also looks at commercial auto coverage as another market that has really started to harden and it is an industry that significantly affects the farming and agribusiness sector.
Is a captive the right option?
With the advantages of a new route for businesses to take, there can be disadvantages. Hillebrandt states that “any business owner, farmer or not, needs to go through a captive feasibility study with a reputable captive manager to fully weigh the pros and cons of starting a captive.”
As with any business, running a captive takes time, effort and resources, and there are no guarantees.
Hillebrandt explained that captives can lose money just like any other business, especially when they’re writing catastrophe risk.
He says: “This is why it’s so important to engage with service providers, including actuaries, who understand and have expertise with agricultural exposures.”
Partlow believes that captives are a long-term risk management and risk financing vehicle that require an upfront capital expenditure to see an overall reduction in the cost of risk in the long term.
Partlow states: “For farmers, cash flow is generally an issue, so making this upfront cash expenditure to capitalise a captive can be an issue.”
Risks such as crop insurance and product recall by nature are low frequency and high severity type coverages. Partlow adds: “If a significant event occurs in the early years of the captive it can be difficult for the captive to withstand.”
The future
In any sector, can be difficult to predict the future, however, with agriculture, science plays a big and important role.
Climate change is a huge issue affecting the world and the agriculture sector will face the biggest consequences of this issue.
With weather forecasting becoming harder to predict as climate change continues to reshape the planet, will captive insurance expand for the agriculture sector?
Partlow believes that with global warming causing the weather to be more volatile and harder to predict, it will continue to cause the commercial carriers to withdraw from the market or increase the premiums for coverage to compensate for that unpredictability.
He says: “This inherently will lead more entities to explore alternative risk financing solutions such as captives.”
However, at the same time, “a captive makes sense only for insuring those risks that are predictable in nature, as such this unpredictability can also create issues from a captive standpoint,” Partlow adds.
“Entities in this sector need a solution to ensure that their businesses can withstand an extreme weather event and survive for another year, as such formalising the funding of these risks through a captive is a likely solution many will be forced to explore.”
Hillebrandt explains that the expansion or contraction of captive insurance for this sector may be more driven, domestically, by coverage offered and the rates charged by the US federal crop insurance programme.
He believes that reinsurers may see increasing uncertainty in their estimates due to climate change and other economic, social or political influences.
He concludes: “As a result, reinsurers may build in increased conservatism in their estimates, meaning higher reinsurance rates.”
"This could lead to captive programmes leaning toward using captive pooling mechanisms as opposed to commercial reinsurance options.”
