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What is risk management?

Jane Marsick, New Zealand Tree Grower May 2012.

All farms face risks which can potentially affect the assets or income. In terms of a small forest, many of the risks are fairly obvious such as fire or storm damage. Risk management is the identification, measurement and control of the risks which threaten assets and earnings. The main aim of risk management is to avoid loss from accidental risk. The secondary objective is to minimise loss or their effects.

The risks that businesses face can be many and varied. For example, a forest fire is a very different risk from a biosecurity problem. For the best risk management a systematic approach should be applied. The Australian and New Zealand standard is AS/NZS 4360:2004. The standard establishes a systematic seven-step process which you can apply to any risk.

The seven steps

The first step is to define the basic parameters where the risks must be managed and sets the standard for the rest of the process. The context includes the external and internal business environment and the purpose of the risk management activity.

The next three steps form the basis of the risk assessment process − identifying, analysing and evaluating risks. As there are many possible risks, a business needs to be able to assess the potential for those to cause loss. The consequence of a fire for example, could be total physical or financial loss of the forest. The likelihood of a fire makes it a common risk.

Likelihood scale
Level Exposure
Very rare Once every 100 years or more
Rare Once every 10 years
Likely Annually
Probable Monthly
Almost certain Daily
Consequence scale
Level Financial effect on business
Very serious $3,000,000 plus
Major $1,500,000
Moderate $1,000,000
Minor $500,000
Insignificant $100,000
Risk matrix
Likelihood Consequences
Insignificant Minor Moderate Major Very serious
Almost certain Medium High High Very high Very high
Probable Medium Medium High High Very high
Likely Low Medium High High High
Rare Low Low Medium Medium High
Very rare Low Low Medium Medium High

A risk matrix is a simple tool used to help in assessing risk. It is made up of a likelihood and a consequence scale.

Likelihood and consequence are then plotted against each other on the risk matrix. This allows a business to compare different risks and identify those that require action.

Having assessed and evaluated the risks that have been identified, a business can then make decisions about those it must treat. Priority should be given to the risks with the highest correlation between likelihood and consequence.

The final two steps are communication and monitoring.

Where does insurance fit in?

Insurance is not risk management if the main aim is to avoid loss as insuring for a risk does not prevent a loss. However, in transferring the financial costs of the loss to an insurer, insurance meets the secondary goal of risk management in minimising the effect of the loss. Therefore insurance is an important risk management tool for any farm forester.

The most important thing is to identify which risks you wish to insure for and to ensure that the insurance covers the risks. You should have a clear understanding of what is included in the cover.

Fire is a risk that most foresters often look to insure. However there are other risks that can damage a forest, such as wind-throw. But as these have a lower likelihood and consequence, only some forest owners will wish to insure for them. This decision would be based upon each owner’s appetite for the risks they face. The more risk adverse, the greater insurance cover the owner is likely to purchase.

You need to understand what the policy does not cover and if any of your own actions might invalidate the cover. For example, some policies require any planned burn-off to be pre-declared to the insurer so that control measures may be checked. Failure to do this may invalidate a claim.

Most farmers will be aware of public and statutory liability cover and they may also consider taking out this cover as forest owners. Those who own smaller tracts of trees should check with their general insurer because they may find that this cover can be included in their farm public liability policy. Those who own larger forests may find that they are required to take out separate cover for this.

Some forest insurance companies have cover for carbon credits. Forest owners should check with their individual insurer to see if this cover is offered. Not every forest owner will need this as not all have joined the ETS. In addition, of those forest owners who have joined, not all have sold the credits issued to them.

To make sure that you are getting good value for your premium, start by looking at the excess. This is the first part of any claim that you would pay, although another description might be the amount of the forest you can afford to lose. The higher the excess, the greater the discount given. Forestry excesses can be anywhere between $1,000 and $150,000 and the savings made can be up to 25 per cent of the premium.

In addition you need to look at what you are being encouraged to purchase. If you are not trading carbon credits, do you need carbon insurance? If the forest is at low risk from wind-throw loss, is this cover necessary? Spend insurance dollars wisely to gain the best cover possible.

Jane Marsick is the Rural Underwriting Manager for NZI Commercial Risk Services

One post

Post from Piers MacLaren on August 16, 2012 at 9:48PM

Jane Marsick said that fire has a higher likelihood and consequence than that of other damaging forestry risks such as windthrow.

My understanding is that in New Zealand wind is ten times more likely to devastate a stand than fire, and indeed it would be almost impossible to burn down some forests that have been planted on pasture in wetter parts of the country. As for the consequences, I recently witnessed fire-blackened logs being milled at an Otago forest at a loss of only one dollar a cubic metre.

By way of contrast, it can be horrendously expensive and dangerous to salvage wind-damaged forests, and the logs can be severely downgraded because of hidden checks that become apparent only after milling. And then there is disease (which none of the contributors discussed). This has frequently obliterated stands of eucalypt and other species. Insurance against disease is unobtainable because hard data is rare and possibly irrelevant in the case of new biological threats.

It is a shame that professionals from areas other than forestry, such as insurance, often do not seem to be aware of the huge body of expertise and experience that has accumulated among New Zealand foresters and do not consult more widely before making public statements.


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