Statistical_Research

Businesses are faced with uncertain decisions on a regular basis. Dilemmas businesses can face range from salary amount for employees to potential layoffs. Farmers are faced with the uncertain decision to invest or not invest in crop insurance policy. Purchasing a crop insurance policy is a risk management tool enabling “farm families to meet their financial obligations, both business and personal, and helps ensure the survival of the farm business in times of low production and damaging weather” (White, n.d., para. 2). To determine if purchase crop insurance farmers need to compare the expected benefits from the insurance to the annual premium costs and the effects of the long-run average profit. One of the most common forms of crop insurance is Multiple Peril Crop Insurance (MPCI) which “guarantees a minimum average yield per acre for the insured crop” (Johnson, 1988, p. 2). MPCI covers most crops with unavoidable productions losses caused by but not limited to drought, hail, wind, frost, flood, insect infestation, plant disease, and fire. Farmers can use inductive reasoning to acknowledge the benefits of MPCI by saying crops grow outside, Mother Nature constantly changes, thus crops outside can be affected by Mother Nature. Especially with the large range of variables that can ruin a crop. In the long-run, weather, fire, or insets will skew a farmer’s yield per acre. The farmer will evaluate the risk versus reward of MPCI by analyzing historical yields. The first step is for the famer to evaluate their long-run average yield by calculating Olympic average by removing the highest and lowest yields in a 10 year period, and then calculate the average. After establishing an expected range in possible yields the farmer may expect, a cash flow analysis will provide estimated figures showing the profit margins with or without MPCI. To limit uncertainty, viewing the estimated projections in a cash analysis, farmers will be able to view net cash flow with and without MPCI in both a disaster year and a typical year. A negative net cash flow in a disaster year can affect the demise of a business. For example, a farmer “has an operating loan, low receipts may make it impossible to repay all or a portion of that loan and the unpaid debt gets rolled over into intermediate debt. Liabilities on the balance sheet are now higher than they were at the end of the season the year before, and debt payments are increased” (White, n.d., p. 3). The balance sheet will show the value of asset and liabilities and the impact of cash flow variations. The question the farmer needs “to answer is how much you can allow these reserves to be drawn down and still maintain solvency or how much you are willing to let them be reduced” (Johnson, 1988, p. 12). Providing most farmers have high debt to finance the cost of production, harvesting expenses, land set aside, property taxes, land payment, equipment debt, family living and labor, MPCI protects long term viability by increasing “long-run average net profit per year as well as reducing the downside risk” (Johnson, 1988, p. 2). In Maryland, farmers who purchased MPCI between 1981 and 1986 saw an average cost/benefit ratio of 1.45. Meaning out of every dollar in premium paid by famers during that period they received $1.45 in return (Johnson, 1988, p. 3). From 1988 to 2007, “Pennsylvania farmers who purchased crop insurance averaged more than a $1 back for every $1 they paid in premiums in 19 of the past 20 years” (Crop Insurance Education Web Site, 2008, para. 1). Purchasing crop insurance provides an average return of over a dollar to dollar return proving to be worth the investment. Keeping the farm running “through tough times is the idea behind purchasing crop insurance. To find out if it makes sense to insure” (White, n.d., para. 10) the crop and potentially lowering the profit margins in a given year, farmers need to first analyze historical yields. With the expected average yield, the famer should review the balance sheet evaluate if the farm does not have MPCI, can they sustain a disaster year' The farmer can review the statistical data, which indicates that in the long run, the insurance will more than pay for itself and help stabilize the farm’s cash flow through the good and the bad. References Crop Insurance Education Web Site. (2008). http://cropins.aers.psu.edu/ Johnson, D. M. (1988). Multiple peril crop insurance: What is it' Should you buy it'. Retrieved from http://extension.umd.edu/publications/PDFs/EB321.pdf White, J. (n.d.). Why buy crop insurance'. Retrieved from http://www.agrisk.cornell.edu/DOWNLOAD/Why_buy_crop_insurance.pdf