Insurance and weather derivative products can provide effective and cost-efficient methods for practically eliminating risk for certain events for farmers. In many cases though, where these products are available, they remain underutilised or in market failure, states the Australian Farm Institute (AFI), an agricultural policy research organisation.

In a report entitled “Australian agriculture: an increasingly risky business”, the AFI says that improved financial literacy and understanding of how insurance and derivative products work would raise awareness for farm businesses of the potential utilisation of these products.

However, even with better understanding of the functional specifics of risk mitigation products there is a further need to understand how risk appetite interacts with decisions of cost/ benefit before forecasts of likely uptake can be made. Risk appetite is individual, cultural and differs between subsectors and regions, the report adds.

Furthermore, an issue with the ability to adequately compare and assess weather derivatives and multi-peril insurance products is the different licensing requirements required to sell them. Weather derivatives are classed as financial instruments therefore weather derivative providers require a financial services licence (FSL). Many agricultural insurance providers and brokers do not have FSLs which means that the products are unlikely to be provided by the same organisation allowing for comparative assessment and understanding.

Mr Richard Heath, AFI's executive director, says in the report, “The pursuit of agricultural enterprise in Australia is undoubtedly becoming an increasingly risky business. However, it is also evident that the Australian farm sector has continued to grow despite the absence of significant government support and a limited range of commercial risk mitigation products. While good farm business practice has been effective in driving a strong and resilient agricultural economy, there is no room for complacency as the sector squares up to some significant new challenges and an accelerating pace of changing risk exposure. The impacts of climate change are exacerbating the complexity of risk management both directly and indirectly throughout supply chains, and institutional risk is emerging as a serious concern.”

He adds, “To expedite better uptake of risk management products, a deep and detailed understanding of how risk appetite interacts with the assessment of the value proposition of risk management products—i.e. via the application of behavioural economics filters—would be of great benefit to the industry. A cost/benefit analysis should be performed on the redirection of government funding would also be of value, and —if incentivisation of private market risk mitigation products is deemed appropriate—due consideration must be given to both supply and demand stimulus, rather than demand alone.”