In years like 1998-99, when farmers grow less grain because of the vagaries of weather and world commodity markets, grain companies grit their teeth and prepare for lower earnings.
Less grain means lower volumes and less business.
But United Grain Growers has found a way to protect itself from this business risk.
In January, it plans to implement a new kind of insurance program that will include protection against revenue losses from low volumes.
The company is a pioneer in the field of integrated risk financing, said Robert Nusslein, a director with Swiss Re New Markets, the insurance company that will underwrite the deal.
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UGG is the first company in the world to announce it will embrace the new concept.
Swiss Re is working with four other companies on similar volume-based packages.
“Quite frankly, it’s not inspiration, it’s good business,” said Mike McAndless, UGG’s corporate risk manager.
Brian Hayward, UGG’s chief executive officer, said the company will have more stability and be protected against a broader swath of risks for the same costs. He called it a “shock absorber” for extreme years.
“It’s similar to the way a mixed farm can have greater income stability compared to a specialized operation,” he told delegates at the company’s annual meeting in Winnipeg last week.
Chief financial officer Peter Cox compared the program to a floor for reductions in grain handling revenue.
When volumes decline significantly, the company will recover some of its lost revenue through insurance, Cox explained.
For competitive reasons, Hayward would not reveal how much the insurance will cost, nor the point at which it would kick in.
But he admitted it would have been nice to have the new program in place for the 1998-99 crop year, when the company’s net profits plummeted to $3.78 million from $16.33 million the previous year.
The new risk management program is a culmination of three years of work with risk management specialists from the international consultancy Willis Group Limited.
UGG first developed a “huge laundry list” of risks it faces, said Hayward, from traditional hazards like fire to business risks like weather.
Next, the company had to quantify its risks.
John Bugalla of Willis Group gathered 50 years of precipitation and temperature data from the parts of the Prairies where UGG does business.
Bugalla correlated the data with Canadian Grain Commission production data and UGG’s overall revenues, creating an index for volume risk.
Technology is making possible the complex financial models needed for this kind of risk management, Bugalla explained.
Swiss Re combined protection for volume risk with insurance for more traditional hazards into one risk management package.
The risk of pioneering this strategy is on the shoulders of Swiss Re rather than UGG, Nusslein said.
