Farm income insurance, a coverage rarely written years ago, has recently become a standard component of farm insurance accounts.
The trend is one of many indications of how farming operations have consolidated and become more integrated into other commercial activities, and of how farmers are adopting risk management techniques similar to those developed for commercial enterprises.
“Ten to 15 years ago very few people bought business income coverage on a farm operation,” says Chris Leliaert, an expert in agricultural insurance and vice president with Towers Perrin Reinsurance business in Chicago.
“Today, farming is a bigger business,” he says. “It’s really about financial risk. The larger the farm operation is, the more like a commercial business it is, and the greater the need for income insurance.”
“Farming used to be considered an occupation, something you did, like a trade,” says Steve Van Sluys, former farm division supervisor, recently promoted to marketing representative for Wilson Mutual Ins. Co., Sheboygan, Wis. “Today farming is considered more of a business enterprise that needs to make money.”
Years ago, farmers withstood income losses through informal arrangements with neighbors and business partners, or simply absorbed them.
No more, according to Van Sluys.
“The days are gone when a farmer would lose his barn and go to a neighbor’s to milk his cows,” he says. “When a dairy had 25-50 cows, that was no problem. Now you’ve got 100, 200, 500 head. That’s too many animals, and too far to go.”
A similar change has occurred in crop-raising, as farms consolidate into large, “vertically integrated” growing and processing operations with specialized equipment that is not readily available from neighbors.
Another trend driving the growth of farm income insurance, according to Leliaert, is the increasing demand from grocery and restaurant chains for produce and livestock to be delivered in predictable quantities throughout the year.
“It used to be that you only ate the things that were in season” Leliaert says. “Today, the chains don’t concern themselves if produce is in season or not, or if a herd is ready for slaughter or not.
“They want their menu items delivered consistently, and they contract with farmers accordingly.”
This trend toward contract farming, which is increasingly the rule rather than the exception, helps to establish more defined income streams for farms.
Those income streams can be quantified and insured more precisely than was the case when farm income depended almost exclusively upon commodity prices at harvest time.
Farm income still tends to be subject to more fluctuation and variables than commercial enterprises of comparable size
and scope, however, and the diverse exposures facing modern farms makes it uniquely challenging to write income coverage for them.
AAIS provides an endorsement option for writing farm income coverage under its Farmowners Program.
The endorsement can be used to provide coverage for loss of income and extra expenses incurred when specified farm operations are interrupted by a covered loss to covered property. Coverage can also be provided for loss of rent that occurs when a covered farm building rented to others is damaged by a covered peril.
The farm income coverage offered under the endorsement differs from standard business income coverage in that it applies only to specified farm operations described on a schedule that accompanies the endorsement.
Moreover, the coverage can only be triggered by a covered loss to one of three types of property:
- A farm building insured under Coverage E - Barns, Buildings, and Structures of form FO-6 - Farm Coverage;
- Farm personal property insured under Coverage F - Scheduled Farm Personal Property or Coverage G - Unscheduled Farm Personal Property of FO-6.; or
- Farm personal property covered under the open perils provisions of endorsement FO-360 - Farm Machinery (or a company variation thereof).
In this way, a farm insurer avoids taking on an open-ended exposure for the diverse activities that can take place on a contemporary farm. Income coverage is targeted for specific activities triggered by losses to described property supporting those activities.
Beyond that, the calculation of a farm income loss is largely the same as that for a business income loss. One takes the estimated lost revenue plus continuing expenses (e.g., mortgage payments), subtracts any reduction in expenses (e.g., wages), and adds on any reasonable extra expenses needed to resume the operation.
That said, it is no simple matter to write farm income coverage, especially during the current soft market for farm coverage
“There is quite an art to doing this,” says Deborah Summerlin, AAIS vice president of insurance lines and the principal developer of its agricultural insurance programs. “You have to establish the operation’s annual income, then estimate how long it would take to get up and running after a loss.
“Is the exposure year-round or seasonal? Would you be able to move an operation, or be forced to shut it down?
“There is a lot of knowledge-based decision-making that goes into this.”
According to Summerlin, underwriters find it especially challenging to establish limits and select coinsurance factors for the coverage.
Farm income insurance is relatively costly, she notes. Under AAIS manual rules, the base rate for loss of income and extra expense coverage is more than double the rate for physical damage coverage for the corresponding farm property.
Given that cost, and given the intense competition for farm P/C accounts, agents and underwriters have to determine a limit and apply a coinsurance factor that keep them competitive on an account while avoiding a damaging coverage gap in the event of a loss.
When determining the coinsurance factor, Summerlin says it helps to consider the factor as a number reflecting the amount of time you believe it will take an operation to resume following a loss.
For example, a coinsurance factor of 0.5 is roughly equivalent to a six months’ loss of revenue. That’s because the coinsurance factor is multiplied by 12 months of farm earnings to arrive at the minimum limit to meet the coinsurance requirement.
In setting the limit and estimating the time needed
to restore operations, there is no substitute for detailed knowledge of the risk.
“It comes down to the producer having a good understanding of the operation from an income standpoint and an expense standpoint,” says Van Sluys at Wilson Mutual.
“A good working knowledge of farming and an ability to research all kinds of agricultural operations is essential,” says Kelli Kukulka, a vice president and agriculture expert in the Chicago office of Munich Re America.
“Ideally, underwriters should look for an historical income profile of the operation to assist in establishing the income limit,” she adds. “Then, they need to determine the cause and amounts of prior losses.
“Finally, knowledge of the farm’s risk management plan is essential.
“Underwriting of the farm’s risk management is the most critical to the underwriting of loss of income coverage.”
