Over the past couple of months, we have been reading about an investment bank that has been dealing with massive losses (over $2 billion) as a result of their risk management program. What was intended to be risk management became speculative and instead of protecting earnings, has become a threat to the business. This investment bank’s risk management did not perform as expected and is causing severe economic and damage to their public reputation. What are some risk management lessons in this experience?
Jim Gunther of Harvard Aimes Group compiled 101 Rules of Risk Management. This article will discuss a few of those and those recognized by other risk management experts.
- Risk management does not have to be complicated.
- Understand your risk management program.
- It is difficult to protect the business and still achieve superior rates of return. Some balancing of those goals must be your goal – with a nod toward safety when cash and equity are low.
Risk management strategies are intended to preserve the life of the business. Something as simple as deciding to market crop production into four marketing segments (above your farm’s cost of production), spread throughout the year, including some forward contracting is risk management.
Setting the goal of hitting the top of the market and selling 100 percent of the crop in one sale is not risk management. A number of well known professional commodity marketers believe they are successful when their average sales price is in the top third of the sales prices for the year. When you know you are selling at a profit, you are doing the right thing toward staying in business.
Risk management is preserving your potential when weather or markets move against you. A business that has significant leverage may have a much more conservative risk management plan than one that has been in existence for many years. A farm that is debt free and can self insure may require fewer risk management strategies and tools than one that is relatively highly leveraged. Adequate and current fire and extended coverage insurance and an operating entity that reduces personal liability are risk management tools.