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An Overview of Canada’s Business Risk Management Programming - presentation at the conference in Madrid, November 2006

Author: Danny Foster, Agriculture and Agri-Food Canada
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Source: www.mapa.es

The purpose of the presentation is to provide an overview of the core Business Risk Management (BRM) programs in Canada.

The facts on Canada’s agriculture industry…

Canada’s agriculture industry contributes over 8 percent of the Canadian Gross Domestic Product (GDP) of which 2.2% is derived from primary production. As the fourth largest exporter of agri-food products in the world, the value of Canada’s exports have doubled since 1990 to $26.5 billion in 2004. Major markets include the US, the European Union, Japan, Mexico and China.

There are five major commodity sectors in Canada produced for both export and domestic markets. As a percentage of farm cash receipts, these are Grains and Oilseeds (34%), Red Meats (27%), Dairy (12%), Horticulture (9%), Poultry and Eggs (8%).In 2005, the total farm cash receipts for Canadian farmers was $36 billion.

The global economy – increased competition, lower commodity prices…

The global economy has radically transformed the sector:

–             Technology and productivity improvements have led to sustained, long-term price declines;

–             Fuelled by liberalized trade and intense competition from low-cost producing countries.

In this environment, farmers need to focus on profitability. They should develop the capacity to produce innovative high-value food and non­-food products that stand above the competition.

Canada has adopted a policy vision for the 21st century. The policies and programs support growth, diversification and value-added activity and encourage risk mitigation.

The Canadian approach to programming has evolved over time.

Safety Net Programs

Mid-1980’s

Policy Transition

BRM Programs

Current

Commodity Focus

Whole Farm

Price Based

Income/Margin Based

Provincial/Regional

National Framework

Trade Distorting

Trade Neutral/Decoupled

With a number of factors driving the need for change…

From a policy perspective, the commodity-specific and price support programs of the past were expensive, production distorting and did not focus on producer profitability.

Internationally, the WTO was a significant event. Canada had to introduce key changes to ensure programming was in compliance with WTO rules. On the domestic front, Canada faced considerable deficits during this period – solving it required a reduction in expenditures of which agriculture had to share.

Canada shifted to BRM programming: nationally-available, decoupled whole-farm programs.

BRM programming is an approach that focuses on enhancing farm profitability through risk mitigation, adaptation and considering a farm’s future potential. Under BRM there are two main programs:

– Canadian Agricultural Income Stabilization Program (CAIS). This program combines stabilization and disaster assistance into a single permanent program;

– Production Insurance (PI). This program provides a range of new products beyond traditional Crop Insurance.

The CAIS Program

CAIS program helps producers protect their farm operations from income declines beyond their control. It provides stabilization and disaster assistance under one permanent program. The program offers more broad and effective income protection for both newly established farms and those experiencing back to back disasters. CAIS continues to provide assistance based on “whole farm” income, rather than commodity-specific support.

How it works……

Income is defined as “production margin”. Production margin = allowable farm revenues minus allowable expenses in a given year. Payments are made to producers when their production margin in the current year income falls below their historical production margin.

Reference margin = “Olympic” average of last five years’ production margins i.e., the highest and lowest years are dropped. The program is targeted to needs of the producers, the amount of assistance available under the program depends on the magnitude of a producer’s loss. Under CAIS, smaller losses are shared equally between governments and producers. For larger losses, governments cover a greater share of the producer’s loss – up to four times the amount absorbed by the producer.

Example

A producer’s production margins for the last five years were:

2000                – $50,000 (lowest year)

2001                – $90,000

2002                – $150,000 (highest year)

2003                – $110,000

2004                – $100,000

Dropping the high and low years and averaging the remaining 3 years gives the producer a reference margin of $ 100,000. This is, in effect, the producer’s level of support going into the 2005 program (tax) year.

If the producer’s 2005 production margin:

declined by $15,000, a government payment of $7,500 (i.e., 50% of the loss) would be triggered;

declined by $30,000, a government payment of $18,000 (i.e., 60% of the loss) would be triggered;

declined by $100,000, a government payment of $70,000 (i.e., 70% of the loss) would be triggered;

Annual CAIS Participation Process

Producer receives an Options Notice in January. The option notice outlines each producer’s reference margin allowing them to indicate a level of protection. The farmers select a protection level and pay a corresponding fee by April 30.

Producers report farming income for tax purposes and complete CAIS forms by June 30th of the following year. Participating producers receive a Calculation of Program Benefits and, if applicable, a payment once the application is processed.

An interim payment option is available to producers in the fall to allow for more timely access to CAIS benefits.

CAIS Payments

Faced with historic declines in farm income over the past few years, the demand-driven design of CAIS has enabled a considerable response from governments. Approximately 150,000 producers participate in the program annually. The total insurance sum (protection sum) is about 11 billion CAD per annum. About 45-55% of producers receive payments annually.

CAIS Payments as of October 23, 2006

2003

2004

2005

CAIS Payments

$1.529 billion

$1.389 billion

$596 million

Number of Producers received payments

74,755

66,532

26,200

Production Insurance

Production Insurance has been available in Canada for 40 years, operating in all provinces for 25 years. The program offers voluntary enrollment for producers. Production Insurance stabilizes a producer’s income by minimizing the economic impacts of production losses caused by adverse weather and other insured perils.

General Overview

The program is cost-shared by producers and the federal and provincial governments. Provincial governments are responsible for program design and delivery. The Federal government contributes a portion of total premiums and administrative costs. The Federal government also provides a reinsurance arrangement to provincial agencies (5 of which participate in the arrangement). There are 10 Provincial Programs in Canada and the other 5 provinces reinsure their program portfolio through international reinsurance companies. These provinces consider to have more developed production insurance programs.

The program covers most commercially-produced crops in all provinces (90% of the value of all crops grown in Canada are insurable). 65% to 70% of crop acres grown are insured. 50% to 55% of Canadian farmers are insured. The average coverage level insured across Canada is 74%.

Production Covered

Currently, insurance plans exist for grains, oilseeds, forage and horticulture. Fresh horticulture and forage are under-represented in some provinces. Livestock is virtually uninsured at present time (a pilot project will be started in Quebec in 2007. Later the program might be introduced in other provinces).  The plans are being investigated based on livestock mortality. Additional benefits are available and paid separately:

– Hail spot loss

– Perennial plant coverage/tree loss

– Reseeding

– Unseeded acreage

Protection Offered includes:

– commodity specific and basket of crops losses;

– asset loss (livestock and perennial plants) replacements costs or business interruption losses;

– compensation at market or replacement values;

– quality losses;

– wildlife compensation.

No protection provided for:

– market failures or price declines;

– perils not identified in contracts;

– financial, intermediary human resource and management risks.

Insurance Plan Types

•             Multi and Single Peril

•             Whole Farm or Basket of Crops Coverage

•             Proxy Crop Coverage (forage)

•             Satellite Imagery (forage)

•             Weather Derivatives: Rainfall

•             Acreage Loss (fruits and vegetables)

•             Quality Coverage

•             Tree and Plants Coverage

How Production Insurance works…

Under PI, premium payments from producers and governments are pooled together into one fund which is used to pay claims. The program allows risk for a small number of producers to be spread over all the producers in the program keeping costs stable and affordable. Production Insurance is available to all Canadian farmers, landlords and sharecroppers who produce an insurable commodity.

Producer selects crops and must insure all acres

The program guarantees a certain level of production based on farmer’s or area’s projected yield per acre, or a provincial or regional production value when yields are not used as the basis of insurance.

Projected yield determined by moving average (5-15 years). It may include adjustments for trend and buffering extreme (high/low) yields.

Farmer’s premium is based on crop/area/individual risk. Farmer selects coverage level – usually 70 – 80% of farmer’s projected yield. (50%, 60%, 70%, 80%, 85% and 90% also available).

For non-yield based programs (i.e., livestock), the farmer insures all production and assumes the first losses based on long term average loss levels for the commodity.

Payment Calculation – Yield Based

Production Guarantee = Projected Yield x Coverage Level x Insured Acres

Production Shortfall = Actual Production – Production Guarantee

Payment Amount = Production Shortfall x Insured Price

Insured Price is based on a projected or averaged market price for crops, costs of production or replacement values.

Payment Calculation – Non Yield-based

Production Guarantee = Production Value X Insured Units x Coverage Level

Coverage level = (1- Deductible), where the deductible equals the long term average loss level for the commodity

Actual Production Value = Production Value x Units Produced

Payment amount = Production Guarantee – Actual Production Value

Production Insurance by the numbers…

2003

2004

2005

Participating Farms

113,689

100,932

100,540

Acres Insured

71,473,340

59,391,816

64,873,549

Value of Contracts

$8.659 billion

$7.235 billion

$ 6.757 billion

Indemnities

$ 737 million

$ 852 million

$577 million

The CAIS and PI connection…

CAIS and PI address different risks faced by Canadian producers. There is no negative effect – both programs complement each other. By participating in both programs, producers can take full advantage o protection available of risk management programs. As PI indemnities are treated as eligible income in the CAIS production margin, participating in PI provides higher coverage under CAIS.

Two linkages are in place to ensure that producers do not forgot PI. Producers not in PI do not receive CAIS negative margin for insurable losses. Producers disadvantaged under CAIS by participating in PI are eligible to receive a payment up to the amount of their premium.

Cash Advance Programs

In addition to CAIS and PI, Canada has a suite of cash advance programs that are available as risk management tools for Canadian farmers. The two main cash advance programs are:

– The Advance Payments Program (APP). This program facilitates orderly marketing by providing cash advances that allow producers to store the crop and sell it throughout the year to achieve higher returns.

– Spring Credit Advance Program (SCAP). This program provides cash flow to assist producers with input costs

How the Cash Advance programs work..

Under the Advance Payments Program, producers are eligible to receive cash advances of up to $250,000 to assist with orderly marketing. The first $50,000 is interest-free and the interest costs paid by the federal government. Cash advances cannot exceed 50% of the anticipated average farm gate price for each commodity. The advance is repaid as the crop is sold and within a crop year up to 365 days.

Under the Spring Credit Advance Program, producers can receive an interest-free advance of $50,000 to help with input costs. SCAP advances are secured by a production insurance contract. The advance is calculated by multiplying a producer’s insured yield by the advance rate. The advance must be repaid by December 31st of each calendar year or transferred into an APP advance.

Cash Advance Programs by the numbers…

Advance Payments Program

Total Advanced

Interest Costs

2005 Crop Year

$1.031 billion

$15.8 million

Spring Credit Advance Program

Total Advanced

Interest Costs

2006 Crop Year

$1.096 billion

$4.4 million

Adapting the BRM programs to meet challenges…

Although the fundamental design principles of CAIS are sound, industry has raised concerns with some features of the program:

– Complexity and inability of making timely payments relative to need;

– Payments under the program are sometimes not predictable or bankable.

Federal and provincial governments are looking to make significant changes to CAIS in these areas over the coming months, particularly streamlining the administration and making the program more responsive and timely.

…with significant changes targeted for 2007.

Despite key improvements and an expansion of coverage, Production Insurance plans are still not widely available for many horticultural crops and the livestock sector. Governments have partnered with industry to undertake a complete review of Production Insurance programming. Such a review will be completed soon.

To bring the cash advance programs in line with today’s financial needs, the government is making significant improvements by expanding coverage to more commodities, increasing limits and interest-free portion.

Conclusion

The shift to programs that are decoupled has proven to be the most effective method of providing support to farmers. The programs allowed Canada to meet its trade commitments while leaving more money in the farmer’s own pocket.

OECD research shows that price support and input subsidies leak to the supply chain leaving little for farmers. For example, 47 cents/dollar gets to the farmer through decoupled while 17 cents/dollar through coupled.

Canada remains committed to business risk management programs that go beyond crisis management and focus on profitability. Risk management programs have positioned the sector to adapt to global markets. Programs encourage risk mitigation and do not distort market signals.

The document was adopted and prepared for publication by www.agroinsurance.com