Managing Risk on Farms – Insurance, Business Entity, or Both?

Managing the inherent risks of a farm is a top priority for most farm managers.  The challenge for those managers is how best to manage the risks.  We often are encouraged to invest in liability insurance or establish a business entity such as an LLC.  The question becomes: is one better than the other and do we need both?

For most legal questions, the answer is “it depends on the situation.”  However, regarding farm insurance, the answer is a definite “yes, you need good liability insurance.”  Farm liability insurance is the best, most cost-effective liability management strategy for a farming operation. Insurance should always be the primary risk management tool with a business entity being the backup plan. Before spending time and money on setting up a business entity, make sure the farm’s liability insurance policy has adequate coverage limits and protects all the farm’s activities and assets.

There is no precise answer as to how much liability insurance a farm should carry.  For farms with higher risk exposure like customer visitors or trucks and large machinery frequenting roadways, the coverage limit should be higher.  Smaller farms with less liability exposure may need a smaller coverage limit.  Every farm should probably have at least $1 million in liability coverage.  A coverage limit of $3 million to $5 million is probably better for farms with moderate liability exposure.  Farms with high liability exposure for visitors or trucks/equipment may want $5 million or more in coverage.  With liability insurance, more is better although the premium costs must be considered.  Liability insurance is relatively low-cost compared to the protection it provides.  The best solution is to talk to the insurance agent to determine the best coverage limits for the specific farming operation.

When discussing the liability insurance policy with the insurance agent, it is vital to make sure the agent is aware of all activities and assets on the farm.  If the agent does not know about it, the activity or asset might not be covered.  For example, farmers who lease their land for hunting may not be covered by a typical farm policy for injuries to hunters.  To address issues like this, a checklist of unique farm activities and assets has been developed and is available here.  Each activity and asset that applies to the farming operation should be checked and the completed list provided to the insurance agent.  The agent can them make sure that all activities and assets are covered.

For a more thorough discussion on farm insurance, see the Farm Insurance: Covering Your Assets Bulletin available at farmoffice.osu.edu.

After ensuring an adequate liability insurance policy is in place, focus can then turn to a business entity.  Whether a business entity is needed in addition to the insurance depends on the situation.  Generally, a business entity will help provide backup liability protection if the business has any of the following:

• Multiple owners;
• Employees;
• Many visitors;
• External liability exposure such as food safety or product liability.

If none of the above factors apply to a farming operation, a business entity might have limited value for liability protection.  The reason is if a liability issue occurs, the owner of the business will have caused it.  The business owner will likely be personally liable regardless of what type of business entity they may have.

Consider the following examples:

Example 1.  Farmer is a sole proprietor with no employees.  He only occasionally receives help from family members.  If a liability incident happens with machinery on the roadway, Farmer will likely to have caused it.  Farmer will be personally liable.   Even if Farmer had an LLC, Farmer would still be personally liable because they caused the liability incident. Farmer’s best liability protection is liability insurance. 

Example 2. Farmer adds a full-time employee to help on the farming operation and continues to operate as a sole proprietor.  If employee has a liability incident while driving equipment, Farmer will probably be fully liable for employee’s actions.  Under Ohio law, an employer is liable for an employee’s actions during the course of work.  Again, Farmer’s only protection is insurance.

Example 3. Farmer establishes an LLC for his farming operation when they hire the employee.  Now, the LLC is the employer, not Farmer.  When the employee has an incident driving the machinery, the LLC is liable for the employee, not Farmer.  All of Farmer’s assets outside of the LLC are safe because Farmer is not personally liable.  The LLC may be liable and the assets in the LLC are still at risk, but the LLC contains the employee’s liability to only the LLC. 

As these examples show, the utility of a business entity to provide liability protection depends on the situation.  In some cases, the business entity will provide little protection while in other cases, the entity will provide significant protection.  The best course of action is to consult with an attorney to determine the best strategy for a particular situation. 

The type of entity used also affects the protection provided.  A general partnership provides no liability protection and a limited partnership provides some, but not complete, liability protection.  An LLC or corporation are the best entities to use for liability protection.  For a detailed discussion on business entities and liability protection, see the Using Business Entities to Manage Farm Liability Risk Bulletin available at farmoffice.osu.edu.

To summarize, let’s go back to the original question: do you need liability insurance, a business entity or both?  There is no doubt every farm should have liability insurance.  Working closely with the insurance agent to ensure that all activities and assets are covered is a goal that every farm should have.  Business entities can provide a good backup plan but, in some situations, may only provide limited protection.  So, it depends on the situation as to whether a business entity is needed.  Consulting with an attorney is the best way to determine if a business entity is a good choice.