Farm Forestry New Zealand

Forestry insurance - the next steps

Keith Hales, New Zealand Tree Grower May 2005.

Objective for insurance

In order to work out your objectives are in taking out insurance, think about and record what you want if a loss happens to your trees.

This will change from time to time because your circumstances will change, as will your trees.

Examples of what you may decide would be that you want enough money so that you can –

• Pay off all debts and walk away.
• Have enough to pay for clearing up and replanting.
• Be put into the same financial position after the loss as before it happened.

This decision will establish the maximum amount of insurance that you will want to buy.

Risks – frequency and severity

The risks that could be considered are – fire, storm and wind throw, flood, drought, lightning, volcanic eruption, disease, other pests and log price fall. There will be others, but this is somewhere to start and you will be able to add to these from your knowledge and experience.

How often are these risks likely to happen? And when and if they do, what will they cost, bearing in mind your objective?

Select the risks that, along with the highest cost to you, have medium to low degree of frequency. Those are the risks that you want to cover. Incidentally do not insure risks that happen regularly – regardless of how much they cost. If you do that you will find that you will simply swap dollars with the insurer, and the insurers will end up charging you more than they pay out.

Controls

Go through the list of risks and consider the ways and means that you have in place to control a loss in size or frequency. You might find, for example, that you would not lose a lot from a particular risk, and that you might delete it from the insurance and bear it from your own resources. In other words you are self-insuring.

You will also be able to tell the prospective insurers about your risk profile compared to others. And if you can show that you are better than others then you will get a cheaper premium.

Loss funding and insurance

At last, I hear you mutter. But you do need to go through the above processes before you get to this stage and consider what you are going to insure, and then find out how much it will cost.

Insurance is only one of the ways that are available to you to pay you for a loss. The others are self insurance, passing the risk to others or borrowing after the event. Unless you have a claim, insurance premiums are dead money – essentially you buy a lotto ticket and you do not win. So do not ignore the other ways of handling the loss.

Contracting out

Contracting out is one way of avoiding a loss. For example, you can try to make sure that anyone who enters a forest that you own signs a piece of paper which says that if they cause a loss then they will indemnify you. They would need to have third party insurance to back that promise up. Your lawyers could give you a simple form for this or you will be able, if you go looking, to get one off the web. Incidentally, if you show the insurers what you are doing with this indemnity business you will get a tick in the ‘better than average’ box and a cheaper premium.

Borrowing

This option is generally out of the reach of most of us. It is really only available to those who have the financial ability to be able to afford to pay off the loss themselves as well as covering all their other commitments. But those who use this system – and you might do it as an excess for the first part of a loss potential – will simply pay less in insurance because they are not actually buying part of it.

Self-insurance

It is likely that you will be forced into some self-insurance, either because the insurer imposes an excess on you, or because you cannot get insurance at all for some of the risks that you have identified. Once you know what self-insurance is being imposed, you should consider whether you might increase the excess imposed, self insure some risk factors or deliberately under insure.

Insurers do not like under-insurance because you are, in effect, stealing the top end of the risk away from them. This is the very area where the premium rate is the same, but the possibility of a claim at this level has reduced substantially.

Insurance techniques

Some of the following techniques will only be available if the insurance requirement is large.

Standard type cover

After you have worked out your objectives you will be able to be quite specific about the risks that you want the insurance to cover, and the sums insured. Be specific and only take out cover for more than you need if you are confident that the extra cover is not increasing the cost.

First loss

This form of insurance gives a sum insured that is selected by the insured as the maximum possible that can take place. Let us say that a 20-hectare forest has a present total net value of $200,000 and that it is very well managed and has well maintained fire breaks. It might be considered that you could not lose it all in any single event, so despite the amount at risk, the insurance is taken for only $100,000. It is like insuring against the risk of burglary in a commercial operation where it is a physical impossibility for a burglar to take it all away at one time. So you insure for that amount and not the whole lot.

Layering

In this process the sum insured is bought from the insurance market in ascending layers of value. So in the first loss example above, the $200,000 sum insured might be bought in three layers –

• From zero up to $50,000
• From $50,000 to $100,000
• Then for $100,000 in excess of the combined layers of $100,000 to give a total of $200,000.

The advantage of this approach is that although the ground up insurer – up to $50,000 – will want a higher rate than the top layer insurer, the average rate will generally be lower. If it is not, then you just go back to buying the $200,000 as a single sum.

Prompt payment or monthly premiums

Insurers earn a lot of their income from investment – the earlier they can get your premium, the better for them. So ask what discount you will get if you pay on due date.

Monthly premiums are the reverse of the prompt payment discount. Although you will have little problem arranging to pay monthly, you will be charged a rate of interest. Therefore you might find that you can do better by getting your bank to lend you the premium, pay it all immediately and then pay it off monthly to the bank.

We will come to using brokers in more detail in a moment. But because it is part of the cost of the insurance I just want to remind you that brokers earn commission from the premium that you pay, plus interest on the premium before they pay it over to the insurer.

Just make sure that what the broker is earning – he must tell you if you ask – is what you think is fair and justifiable compared to the work done. This is particularly true when the insurance rolls over as a renewal.

Careful broker selection

You have two options when buying your insurance. The first is to go through the yellow pages and get a few quotes until you find an insurer who will give you a suitable price. The alternative is to employ an insurance broker to do this for you. For the convenience and the expertise that they bring, I think you are better off using a broker.

There are brokers and brokers. At one end of the spectrum there are those who pretend to be brokers but are life insurance agents in disguise. At the other are those who will know a lot about insuring forests because they have done work in that subject before. It is a special field with its own risks along with the unusual feature of the continual change, over time, in the value of the asset. So be careful about your selection. Ask others who they use and whether they are happy with the service and cost. When you make contact ask some pertinent questions to see if the broker you are about to use really knows the forest insurance business.

Another feature of the broker is the size of the company. The smaller brokers always have difficulty in covering the absence of staff, which could be a problem if you want urgent answers. In addition they are unlikely to have contacts with offshore insurers.

Having selected your broker you will tell them what insurance you want and the broker will then go to the insurance market and getquotations. There are not many insurers who are prepared to insure trees and forests. However the broker should get quotes from all who are prepared to do so – that is what insurance broking is all about.

One method of insurance that forest owners in New Zealand do not seem to have tried is setting up a mutual insurance company. If enough of you got together and set up a mutual company you would be able to get into the cheaper reinsurance market – but that is another story.

Keith Hales of Risk Management & Insurance is a risk management consultant based in Wellington