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Taking Charge of

Yield & Revenue Risk Management on Your Farm

Elliot AlfredsonSpartan Crop Insurance

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Objective for Today’s WorkshopObjective for Today’s Workshop “Frame” approaches to managing risk

What’s new in 2002?

Review types of crop insurance

Discuss how crop insurance can be used to:

o Limit financial risk exposure

o Substitute for balance sheet liquidly

o Facilitate pre-harvest pricing

Develop a crop insurance plan

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What’s New In 2002?What’s New In 2002?

Subsidy level and structure has changed:

– Subsidy increased

– More favorable to higher coverage's than previously

– Revenue products treated more favorably compared to MPCI than previously.

Authority to facilitate livestock insurance (e.g., facilitate options on futures “equivalent” across all months; subsidize)

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Alternative Approaches to Alternative Approaches to Managing RiskManaging Risk

Manage sources of risk you face to reduce risk exposure

Retain risk using your equity / net worth

Choose farm plans which avoid risk

Shift risk to someone else

o Insurance

o Options on futures contracts

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What lessons do we take from the What lessons do we take from the financial risk management module?financial risk management module? How much equity are you willing to risk?

Balance management of financial risk through: Maintenance of equity

Plans and action that avoid risk

Tools such as insurance and options that shift risk.

How much revenue do you have to generate to cover alternative “cost of production” targets?

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Revenue Required / AcreRevenue Required / Acre

Revenue per acre needed:

High debt farm

Corn Soybeans

To cover economic cost $361.01 $290.32

To meet Cash flow requirements $309.47 $238.78

To maintain equity $299.19 $228.50

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Revenue Required / AcreRevenue Required / Acre

Revenue per acre needed:

Medium debt farm

Corn Soybeans

To cover economic cost $352.86 $282.17

To meet Cash flow requirements $312.45 $241.76

To maintain equity $284.59 213.90

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Managing Revenue Risk ExposureManaging Revenue Risk Exposure

Farm plans to avoid risk

o Spread sales across year

o Agronomic practices

Plans to shift risk

o Options and minimum price contracts

o LDP’s

o Crop insurance

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But, Some Approaches to Reducing But, Some Approaches to Reducing Risk Create New RisksRisk Create New Risks

Suppose I cash forward price corn in late spring / early summer

My objective is to spread sales and take advantage of a risk premium in late-spring / early summer new crop markets

But, I also have created a delivery risk if I have a short crop

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Some Types of Crop InsuranceSome Types of Crop Insurance Yield

– Named Peril– Multiple-Perils

• Trigger on farm / sub-farm parcel yield• Trigger on county yield index

Revenue index

– Trigger on farm / sub-farm parcel revenue index– Trigger on farm / sub-farm parcel revenue index

with replacement price coverage

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Insurance to Protect Against Insurance to Protect Against Production Shortfall ExposureProduction Shortfall Exposure

0%

2%

4%

6%

8%

10%

12%

14%

16%

18%

20%

10 28 46 64 82 100 118 136 154 172

Yield/planted acre

Ch

an

ce

s in

100

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Crop InsuranceCrop Insurance

To directly protect against revenue risk exposure

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Crop InsuranceCrop Insurance

Tailored to protect against revenue risk exposure and reduce delivery risk associated with pre-harvest

pricing

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Think in Terms of Revenue Risk Think in Terms of Revenue Risk

Management Management PortfoliosPortfolios “CAT” MPCI yield coverage and LDP’s

“Pure” revenue insurance and LDP’s

Yield insurance, pre-harvest price if price moves significantly above loan and into pricing targets, and LDP’s

Revenue insurance with “replacement price coverage”, pre-harvest price if price moves significantly above loan and into pricing targets, and LDP’s

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Let’s Review Some Specific Let’s Review Some Specific PoliciesPolicies

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Multiple-Peril Multiple-Peril (MPCI)(MPCI)

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Losses Are Paid As A Result of Shortfalls Due to Acts Of God, Not

Management

• Hail/fire• Drought• Disease• Excess moisture• Animals• Insects

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How is Protection Determined?How is Protection Determined?

Insurance yield (APH) is based on the farmer’s own yield history

Producer chooses level of coverage: from 50% to 85% of APH yield

Losses are paid at a pre-determined price set by the RMA/USDA

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How is MPCI Coverage How is MPCI Coverage Determined?Determined?

Case farm’s APH yield on corn is 128.5 bu / planted acre

Consider coverage @ 70% of APH yield

Yield guarantee = 128.5 x .70 = 90 bu

If yield falls below 90 bu, a loss is triggered

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How are losses paid on MPCI?How are losses paid on MPCI?

Loss is triggered when actual yield goes below guarantee.

Example:

o 60 bu. realized yield

o (90 bu guarantee – 60 ) = 30 bu. Loss

o 30 bu loss x $2.05 = $61.50

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Units: What Farm Breakout is Units to

Calculate Protection, Coverage and Losses?

Enterprise Units – Breakout by Crop, County (whole farm within county)

Basic Units - Breakout by County, Crop, Share

Optional Units – Breakout by Crop, Section, Share

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MPCI ReviewMPCI Review Available on most crops

Guarantees can be determined at a sub-farm level (section) which increases “effective” coverage from a whole farm yield perspective

Rates & Prices are established by the RMA/USDA and vary by county and your yield relative to “peers”

Subsidized by the RMA/USDA

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““Catastrophic” Yield CoverageCatastrophic” Yield Coverage

50 % yield coverage

Losses are paid at 55% of MPCI indemnity price

Optional units are not permitted

$100 / crop / county

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Selected Revenue InsurancesSelected Revenue Insurances

“Pure” Revenue Insurance

o RA

Revenue Insurance With Replacement Price Coverage

o CRC

o RA w/ RPC option

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CROP REVENUE COVERAGECROP REVENUE COVERAGE

CRC is a Revenue index contract with replacement price coverage

CRC is Designed to facilitate pre-harvest pricing

CRC is an index contract because the futures price is used to calculate “farm revenue” , not the local cash price

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How is CRC Protection Determined?How is CRC Protection Determined?

CRC guarantees revenue based on the farm unit’s APH yield x CBOT harvest futures price during a base pre-sales closing period.

Price used in setting the guarantee is the higher of CBOT harvest price prior to sales closing and the CBOT harvest price at harvest

CRC gives upside replacement price protection to help mitigate delivery risk for users who pre-harvest price

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Replacement Price Coverage:Replacement Price Coverage:Case Examples of How Price is ChosenCase Examples of How Price is Chosen

Year

Harvest Futures Price

Price used to

calculate the

revenue guarantee

Pre-sales closing Harvest

1999 $2.40 $1.96 $2.40

1995 $2.57 $3.28 $3.28

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Calculating Replacement Price Calculating Replacement Price Coverage Insurance Revenue Coverage Insurance Revenue

Guarantee:Guarantee:70% Coverage Example70% Coverage Example

Year

APH yield

(bu)

Futures price used Cov

Rev. guar.

1999 128.5$2.40 (base) = $308.40 x 70% = $215.88

1995 128.5$3.28 (hvst) = $421.48 x 70% = $295.04

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Replacement Price Coverage:Loss ExamplesReplacement Price Coverage:Loss Examples

Revenue Guarantee 70% Realized revenue

Year

Using Dec.

Futuresin April Base

Using Dec.

Futures in Oct

HvstAct. Yield

Hvst fut.

price @

hvst. Rev

Loss = Guan. Minus

realized

1995 $231.17 $295.04 60 $3.28 = $196.80 $98.24

100 $3.28 = $328.00 $0.00

1999 $215.88 $176.30 60 $1.96 = $117.60 $98.28

100 $1.96 = $196.00 $19.88

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How is RA Protection Under the No How is RA Protection Under the No Replacement Price Option Determined?Replacement Price Option Determined?

RA guarantees revenue based on farm unit’s APH yield x CBOT harvest futures price prior to sales closing.

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Calculating the RA Insurance Revenue Calculating the RA Insurance Revenue Guarantee: 70% Coverage ExampleGuarantee: 70% Coverage Example

Year

APH yield

(bu)

Pre-sales

closing futures price Cov

Rev. guar.

’95 128.5 $2.57 = $330.25 x 70% = $231.17

’99 128.5 $2.40 = $308.40 x 70% = $215.88

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Compare Revenue Insurance Indemnities With Compare Revenue Insurance Indemnities With and Without Replacement Price Coverageand Without Replacement Price Coverage

Harvest Futures Price

Loss

Year

Pre-sales

closing Harvest YieldWith Rep. Price Cov. Pure revenue

‘95 $2.57 $3.28 60 $98.24 $34.37

100 $0.00 $0.00

‘99 $2.40 $1.96 60 $98.28 $98.28

100 $19.88 $19.88

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CRC and RA with RPC are “HYBRID” CRC and RA with RPC are “HYBRID” PoliciesPolicies

If the harvest futures price is less than the pre-sales closing base price, they are pure revenue policies

If the harvest price is greater than the pre-sales closing base price they are a MPCI policy with losses paid at the harvest price

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CRC FeaturesCRC Features Yield procedures are the same as MPCI

including units; enterprise discounts are available

Available on only corn, soybeans and wheat

Rates are based on MPCI rates with an adjustment for the price risk component

Rates vary by historical county experience and farm’s APH yield relative to peers

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RA FeaturesRA Features Yield procedures are ….

Available on only corn, soybeans and wheat

Rates are based on MPCI rates with an adjustment for the price risk component

Rates vary by historical county experience and farm’s APH yield relative to peers

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Revenue Insurances: Revenue Insurances: Where do They Fit?Where do They Fit?

Pure revenue insurance makes sense if farm does little pre-harvest pricing.

Revenue insurance with replacement price coverage fits when farm does significant pre-harvest pricing.

If the farm uses pre-harvest pricing, Revenue insurance with replacement price coverage typically outperforms MPCI and pre-harvest pricing … particularly, if farm yield and market price are correlated.

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STOP!STOP!

• Fill out Crop Insurance Decision Worksheets!

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Tasks:Tasks: Calculate protection for each policy to

help you in your decision of whether or not to purchase and, if so, which coverage (deductible).

Start to lay out your objectives and assess whether crop insurance plays a potential role in meeting those objectives.