Given the Australian climate – especially in rural areas away from the nation’s coastline – it may seem a little unrealistic to expect insurance providers to offer drought insurance; for some Australians, drought is an almost guaranteed annual threat. With one recent exception, drought insurance has not been available in Australia for this reason, and studies have generally suggested that it is not cost-effective for insurance providers. Instead, farmers have had to adopt a range of other strategies for managing droughts. Insurance Buddy uncovers the facts behind the other option.
The emergence of drought insurance
Going against the grain and offering, for the first time, a legitimate choice for farmers and rural dwellers seeking protection against the rigors of drought, Macquarie has emerged as the exception. The company is the first agribusiness scheme manager to insure against downside risk caused by drought. In an innovative move, Macquarie has struck a deal with Swiss Re to insure investors in Macquarie Almond Investment 2007 for the cost of replanting and lost returns, Investor Daily reports.
Discussing the benefits of this new scheme, Macquarie alternative assets management director Anthony Abraham said, “”We approach this business as an investment bank, not agribusiness managers. We look at an issue and structure our business around the problem. The fact that we’ve done this is big news and it sets us apart from other agribusiness providers.” Abraham insisted that any extra costs incurred in Macquarie providing the cover were borne by the company and not the investor.
Combating drought to facilitate insurance options
Efficient irrigation has allowed the Macquarie managed investment scheme (MIS) to save roughly 750 megalitres of water from 2006, and this will allow the scheme to meet its water requirements for the year ahead. Abraham stresses Macquarie’s tendency to “protect the downside”, which is basically the provision of resources for tougher times simply by thinking ahead and undertaking clear planning.
“Drought is part of the Australian landscape. People going into agribusiness need to understand that there are droughts and there are things that can be done to manage that drought” Abraham said.
Informal drought insurance
Meanwhile, there is the option for businesses to acquire insurance without the help of institutions, creating their own insurance policies. This process is called informal insurance. Two of the most important areas of informal insurance are creating a drought reserve and selecting a stocking rate. Reserves are not used seasonally, but are kept only for use when a drought occurs. Reserves can be hay, silage or grain, or even living reserves of fodder trees. Of course, this form of insurance also has a cost (or premium) because there is expenditure involved in the replacing of reserves after droughts occur, together with annual holding costs (for example interest on capital tied up, plus shelter and insurance). Additionally there penalty costs are incurred from buying in fodder. These penalty costs generally apply when a prolonged drought occurs and insufficient fodder has been kept in reserve.
Reserve insurance and stocking rates
As a common trend, all stocking rates have penalties associated with them. Low rates may have very low penalties in drought years and in return have very high penalties in good years, due to income foregone by low stocking. On the other hand, a high stocking rate may provide the best gross margin in a good year but result in high penalties in drought years due to the cost of fodder bought in.
There are other ways that producers can help themselves, namely:
- choosing a least-cost feed ration
- deciding whether to sell any livestock (and which classes of stock to sell)
- deciding when to sell livestock
- reviewing proposed capital expenditure in the light of reduced income
Drought is a difficult thing to gain financial protection against, but frustratingly its consequences can be devastating, which only makes the situation more desperate. It’s reassuring to know that you can take matters into your own hands with reserves and stocking rates. Whilst this still may require good advice and experienced practice, it is an alternative worth considering. If your insurance provider can’t give you advice (in the event that they can’t offer a drought insurance policy), you will almost certainly be able to find lots of useful specialist advice from dedicated government departments.