Original publication: December 2014
Authors: UMR SMART-LERECO, Agrocampus Ouest INRA: Jean Cordier
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The 2014 Farm Bill includes risk management tools as an integral component of national agricultural policy whereas the CAP 2014-2020 seems to include them as an afterthought. While EU principles are sound, policies remain in limbo. They suffer from a double dichotomy:
two CAP pillars and two administrative levels for implementation. Ten recommendations are proposed for transforming the current state of limbo for EU agricultural risk management policy into a coherent CAP linked to world markets. They cover (1) EU coordination between public
safety nets and private risk management tools, (2) flexible funding with improved reserve funds and precautionary savings, and (3) field tests to take full advantage of the creativity of private-public partnerships and to create an experience curve.
Farm Bill 2014 and CAP 2014-2020
Both the 2014 Farm Bill and the CAP 2014-2020 saw their genesis at nearly the same time. Public Law n° 113-79, referred commonly as the “2014 Farm Bill” was signed by President Obama in February 2014 after a long process of negotiation between the House of Representatives and the Senate. The 2008 Farm Bill was to have lasted up to 2012. The 2014 Farm Bill is set to run for the period 2014-2018. In the European Union, a political agreement on the reform of the CAP was reached between the Parliament, the Commission and the Council in June 2013. Four Basic Regulations (N° 1305, 1306, 1307 and 1308/2013) were then published in December 2013 (which have subsequently been completed by delegated and implementing acts in 2014) dealing with direct payments, common organization of agricultural markets and rural development.
The US and EU Agricultural laws both deal with farm income level and variability with different tools and methods reflecting their respective agricultural sectors, history of agricultural policy and differentiated political vision of farm risk management.
Risk Management Tools and Safety Nets
Risk management is crucial at the micro-level (farms) and at the macro-level (national). It is a fundamental issue for farmers as, apart from bankruptcy which is the ultimate consequence of catastrophic events, variability of income and risks of income loss lead first to sub-optimal production decisions every year and second to sub-optimal investment decisions. The result is a reduction of farm competitiveness through short-term loss of productivity and long-term loss of innovation. At the macro-level, errors in collective risk management have adverse effects on value creation in the agricultural sector and may even affect the adequate regional food supply.
The US has historically supported farm income through deficiency payment type instruments that tend to stabilize farm income while leaving markets to their “natural” variability. Farmers were responsible for managing price risks on futures and OTC markets along with safety nets. In a completely different way, the initial CAP supported instruments to stabilize market prices, with “high” intervention price, variable levies, export refunds or production quotas. The result is that farm income support and risk management have often been confused as being one in the same. This confusion continues with direct payments which are sometimes, wrongly, considered as a risk management tool.
As a result of the 1994 WTO Agreement, world agricultural markets have become more competitive, leading to increased EU price volatility and farm income variability. Exogenous shocks are expected to increase due to climate change and international spread of diseases. It is also said that endogenous volatility, due to market participants behaviours, is exacerbating exogenous volatility as agricultural products are now considered as financial assets by portfolio investors.
Public agricultural policy will therefore maintain safety nets for dealing with natural disasters and other major market disturbances from the supply or the demand side. But private risk management instruments should be the core of the scheme for handling a large layer of risk ranging from “normal” to “catastrophic”. Developing the private risk market is crucial, with or without the support of public policies, and crowding out private market instruments by safety nets should be carefully avoided.
Private instruments include financial contracts, insurance policies, horizontal as well as vertical coordination for risk spreading. Futures markets and derivatives are key elements for intra-annual price risk management. Public support for these instruments remains indirect through education, training and reducing information asymmetry (development of costly information systems). Direct support for private tools is directed more to production risks, and more specifically to risks with a systemic component such as most climatic and sanitary risks.
Apples and Oranges
Risk management policies in the US and the EU are like apples and oranges. They deal with farm income variability but they are orthogonally different in the instruments they support. It is estimated that the respective “weight” of instruments in the US and the
EU policies are the following:
US: 60% insurance, 40% safety nets, 0% income support with direct payments
EU: 1% insurance, 39% safety nets, 60% income support with direct payments
The proportions of the three types of instruments contributing to farmer risk management strategies, including credit management, lead to a vision of dynamic-integrated US policies versus static-segmented EU policies.
Insurance policies in the US are largely subsidized. As a result, the acres and the capital insured have increased by a factor 6 over the past twenty years. Some economic studies have demonstrated that the subsidy level may be excessive. Babcock (2013b) has even called the Revenue Protection with an 80% coverage level, the most widely purchased by US farmers, the “Cadillac” policy. But insurance is a dynamic sector based on a partnership between the public and the private sectors, developing data-bases for risk assessment, risk valuation, individual loss expertise as well as index-based loss estimates and even fraud reduction. Consequently, the Risk Management Agency (RMA) has been able to, by taking advantage of an experience curve, build a Common Crop Insurance Policy, incorporating several types of partially redundant historical policies. A new program to cover shallow losses is proposed in the 2014 Farm Bill based on countylevel index used in the group policies for intermediate losses (20% to 50% production loss). In addition, the agricultural products that can be insured are continuously being expanded. The 2014 Farm Bill mandates research on policies for organic products, bioenergy crops, and specialty crops. Risk management also benefits from new or improved insurance policies (livestock diseases, specific production practices, business interruption).
Safety nets in the US have many common parameters with crop insurances. The catastrophic coverage (CAT policy) that covers a 50% production loss “for free” is used as a basis, with the same parameters, for deductible buy-up, allowing farmers to choose between a set of deductibles and related premiums. The new counter-cyclical program on adaptive (agricultural) revenue coverage (ARC), individual or county-based, uses parameters similar to those in insurance programs.
Inversely, the direct payments that support EU farm income, the majority of CAP spending, look static and totally disconnected from safety nets and risk management tools. Most of the provisions to manage direct payments in Regulation (EU) n° 1307/2013 (67 articles) are related to administrative repartition within and among MS. Their goals are unclear even though they do play a role in farmer risk management strategies by modifying not income standard deviation but its coefficient of variation (standard deviation divided by an augmented income mean). In addition, the direct payments should have a positive effect on farm liquidity inducing an increased credit capacity. However, the direct payments do not improve any farm risk assessment or capacity to manage specific agricultural risks. They may even induce more highrisk behaviour as fixed income is provided to farmers.
The safety net measures are also totally independent from the risk management tools in place in EU Member States, such as private insurance and reference markets. The “old” measures like price intervention and storage aid have no link with any insurance program (or mutual fund). The evident inefficiencies in managing the effects of the Russian embargo in 2014 with the new emergency measures and new reserve funds have proven the need to improve data on farm loss due to either production or market factors.
Finally, risk management tools proposed in Articles 36 to 39 of the Regulation (EU) n°1305/2013 (rural development policy) are more suggestions (optional for MS) rather than effective programs. After ten years of “options”, numerous studies and regulation adjustments, the new regulation presents risk management as an afterthought, “priority 3, sub-title b” of article 5. It represents one to two percent of the text, far behind local development issues (quality schemes, short supply chains, business diversification). Dedicated research on risk management, advisory services to farmers and training are not mentioned in related articles of the regulation. The three instruments that may benefit from public subsidies are first mentioned in Article 36 and then detailed in three subsequent articles. The first support to enhance crop insurance (art. 37) has already been implemented, though by few European countries. It is known that high systemic risks, high loss expertise costs (that could be reduced by the use of indexes authorized in the 2013 regulation) and demand of public or subsidized reinsurance limit the development of such instrument. Effective EU spending to support crop insurance is very limited. Support for mutual funds to compensate production loss (art. 38) was already proposed in the 2009 regulation, and it is clear that this Commission proposition did not create a deep movement within MS as only countries with existing mutual funds acted to simply improve their practices. The third instrument, the Income Stabilisation Tool proposed in article 39, introduces for the first time the price dimension of farm outputs and inputs. The instrument, based on a mutual fund scheme, looks like a copy-paste of the mutual funds for compensation production losses (art. 38), which is a bit short considering that it deals with such a fundamental issue as farm risk management (90% of the US insurance program). The Measure Fiche provided to MS by the Commission includes no more details for practical design and implementation. For example, it is important to know if accounting documents or farm income proxies should be used.
As a consequence of very vague guidelines for designing risk management toolkit (particularly mutual funds and the IST), principles and constraints imposed and the two-level administrative process of accreditation and control, it is doubtful that risk management tools in the EU will be developed in the seven years to come .
The dynamic nature of risk management policies in the US is demonstrated by the implementation of ten new insurance policies and safety net programs in six months as opposed to the EU which has embarked in long administrative procedures between MS and the Commission to validate projects to be co-funded by the EAFRD (European Agricultural Fund for Rural Development). The dynamic nature of such programs in the US is possible thanks to a flexible budget which can be modulated easily in stark contrast with the EU’s preference for seeking flexibility within a fixed budget by using contingent financial reserves.
The three suggestions related to risk management instruments found in Regulation (EU) 1305/2013 are based on sound principles: responsibility of agents (individual and groups of farmers, insurers) and MS authorities, low distortive effects and capacity of cross compliance measures in favor of environment and resilience to climate change. However, the two-stages of “common” technical decisions to implement instruments behind the principles, the Directorates of the Commission and the MS Ministries of Agriculture (or equivalents) have led to an administrative maze that impedes the development of instruments adapted to local needs and constraints. It has become clear that a better public-private partnership must be established to translate EU suggestions into practical instruments for the long-term benefits of the food market and the production-conservation of public goods in rural territories.
Ten recommendations for transforming the current state of limbo for EU agricultural risk management policy into a coherent CAP linked to world markets are provided under four main categories. A summary of recommendations is presented in Table 1.
Title 1: the need for a coordinated scheme of safety nets and support to specific private risk management instruments
Recommendation 1: Safety net measures related to individual financial compensation should be implemented based on transparent parameters to evaluate individual farm income loss due to market, climatic, sanitary or adverse environmental events. Individual parameters as well as income proxy for (heavy) loss valuation should be harmonized with the same ones used for both crop insurers and mutual funds, which will help to price premiums and fees.
Recommendation 2: The EU should support instruments to fill the “hole” between the pure financial and insurance markets. Contracts dealing simultaneously with independent and systemic risks, usually called hybrid contracts, such as Over-The-Counter (OTC) contracts with a quantity guarantee or insurance policies on revenue, product margin and whole farm income should be supported. The new Income Stabilisation tool (IST) provided by mutual funds or insurance could also fill this gap in partnership with organizations (cooperatives, insurers and banks) to benefit from their specific know-how.
Recommendation 3: The EU should support the creation of savings accounts with validated pre-income tax provisions and withdrawal rules that could fill the “hole” of shallow losses. The CAP could recognize some taxes exemptions as “national cofinancing”. The use of Direct Payments for provisions to be used in individual savings accounts should be considered.
Title 2: an openness to move from principles based on constraints to “no-holdsbarred” field tests as real options for the future CAP
Recommendation 4: The EU should encourage the creativity of the private sector to catch the opportunity of the three basic suggestions of the CAP 2014-2020. The EU must support field tests to validate (or not) risk management concepts, articulation of existing methods and additional instruments.
Recommendation 5: Establish targets for field tests to develop a learning process (such as use of indexes, proxy models of farm income, multi-annual farm income risk management)
Recommendation 6: Remove all current constraints on field tests (WTO Green box, national (fiscal) aid that could be adjusted accordingly to ensure fair competition in the common market, budget inflexibility).
Title 3: the development of adapted resources: research and development networks and financial flexibility
Recommendation 7: Create long-term collaborative networks of European Universities with research and transfer expertise. Such networks should support first theoretical analysis of risk management tools and field tests in their design and follow-up. Transfer to extension and advisory services is also required.
Recommendation 8: Create adequate flexible funding of risk management tools using first specific EU reserves. The agricultural-specific reserve could be expanded by increasing the rates of contribution from direct payments to an adequate percentage in relation with public re-insurance requirements. The reserve must be cumulative from year to year. Flexibility may also be found in individual savings accounts created with (or without) direct payments.
Title 4: an EU organization for risk management oversight
Recommendation 9: Create a “restructured Pillar 1” which will, under a single Agency, coordinate and manage risk management issues at the EU and local levels. The EU authority will be in charge of research coordination, field tests, validation of adapted risk management instruments and budget flexibility requirement.
Recommendation 10: Establish strategic goals for the “restructured Pillar 1”. As developing such a plan runs the risk of becoming a long-term project, short term objectives must be set, such as monitoring field tests, cross-pollination between MS, building an experience curve between MS to decrease set-up and operational costs, and valuating public goods that justify subsidies.
 The Commission delivered in February 2015 information on 2014-2020 approved rural development programs. Allocation of funds on risk management measures appears marginal (1.8% of total spending) and without any funding of mutual funds (production or IST). This information, still incomplete, tend to support the idea of very limited development of risk management tools in the coming years.
Link to the full study: http://bit.ly/540-343
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