Comparative analysis of risk management tools
supported by the 2014 Farm Bill and the CAP 2014-2020
UMR SMART-LERECO, Agrocampus Ouest INRA Jean Cordier
For The Committee on Agriculture and Rural Development of the European Parliament
Protection from the devastating effects of agricultural market volatility, dealing with epizootic and weather conditions, and ultimately ensuring a stable and remunerative income: Here are the common objectives of farmers on both sides of the Atlantic. In this regard, risk management has become an integral part of their agricultural policy.
However, the means to achieve this differ; the United States has achieved genuine success with the adoption of the new Farm Bill, whereas the new CAP provides no response to meet the challenges. Therefore, a recent study by the European Parliament drafted by Cordier (extract here1), reviews the risk management policies of the Farm Bill and the CAP. Dynamic and integrated in the United States, the tools offered in Europe are more rigid and largely inadequate, particularly through direct payments. The author of the report even states that that the aid is a disadvantage to farmers more than anything in their management and understanding of risks.
A key objective of the Farm Bill is to guarantee farmers a safety net to ensure them with minimum turnover and sufficient margin levels to secure American agricultural competitiveness at home and abroad. Since 2002, the contra-cyclical and particularly the insurance dimensions of the Farm Bill have expanded, confirmed by the rise of crop/turnover insurance programs to guard against market volatility and climatic hazards. The CAP however is against current trends with regards other global agricultural policies, in a world where agricultural production is a key element for national security, but also a foreign policy weapon.
To remedy this momagri advocates another CAP, still axed on two pillars, but where a significant part of the budget, currently devoted to the BPS and green payments, would be redeployed for agricultural market management tools in a countercyclical logic.
Momagri Editorial Board
Farm Bill 2014 and CAP 2014-2020
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.
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
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.
- EU: 1% insurance, 39% safety nets, 60% income support with direct payments
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 county level 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 high risk 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 40 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).
(…) 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). (…)
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.
1 The entire report is available from