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The 21 Century -- Multi-Media and Multi-Functional -- Approach to Risk Management: Using RFD-TV Television, Internet, Interactive

CD-ROMs, and On-Site Workshops

Brought to you by

AgriLogic, Inc; Farm Credit; New York Farm Bureau; New York Corn Growers Association; Hot Shots Video Productions; ABG, Inc.; The Practical Planner, LLC; USDA-Farm Service Agency; and with

funding provided by the USDA-Risk Management Agency RMA Agreement Number: 06-IE-0833-0114-E

RISK MANAGEMENT EDUCATION WORKSHOP

August 23, 24, & 25, 2007 - New York

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Pre-Quiz

Handout of 10 Questions

Have you seen our Ag Lifestyle TV shows

on RFD-TV?(Channels – Direct TV 379 & Dish Network 231)

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What is Risk?

The possibility that something unpleasant will happen in the future.

Risk Management: – The practice of managing our life and resources, in a

manner that provides an acceptable level of risk. Risk management is everything you do to understand and deal proactively with risks.

Three issues to consider– Frequency of Loss

– Severity of Loss

– Overall Dollar Impact

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Types of Risk

Production Risk - Anything that hinders the quantity and quality of your production. (weather, pests, diseases, etc.)

Market Risk - Market uncertainty for your product, price declines, gov’t actions to limit imports/exports, input costs.

Financial Risk - Having the ability to pay your cash obligations in a timely manner, to obtain capital and financing, and to protect or grow your equity.

Legal Risk - The possibility of being sued, fined, or penalized for violating current or future laws, regulations, or contractual obligations.

People Risk - Managing people and disruptions that come from any of the 3 Ds: death, divorce, or disability, which could limit or even eliminate the farming operation

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Risk Tolerance

Risk Attitude: Your desire to seek risk– Risk-Averse

– Risk-Seeking

– Risk-Neutral

Risk Bearing Ability: Your financial ability to sustain a loss.

Risk Tolerance Assessment

See

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High

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Low Medium High

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Risk Bearing Ability

Risk Tolerance

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Risk Management Techniques

Risk Avoidance

Risk Control– Prevention: Lowers frequency (irrigation)

– Reduction: Lowers severity (spraying for a visible pest)

– Diversification: Lowers both by spreading risk

Risk Financing– Self Insurance/Retention

– Transfer through Insurance & Hedging

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Risk Management Agency

Overview: – U.S.D.A. & Federal Crop Insurance Corporation (FCIC)

– Providing crop insurance since 1938.

– Provides reinsurance to private-sector insurance companies that sell and service the insurance policies

Subsidy– Premiums set to break-even on losses paid plus a

reasonable reserve.

Coverage Level CAT 50% 55% 60% 65% 70% 75% 80% 85% 90%

Premium Subsidy 1.00 0.67 0.64 0.64 0.59 0.59 0.55 NA* NA* NA

GRP/GRIP Sub. 1.00 NA NA NA NA 0.64 0.64 0.59 0.59 0.55

* 80% & 85% are available outside New York

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RMA Insurance Products

Actual Production History (APH) Plan & GYC– Covers individual’s yield loss: 50% - 75% Cov. Levels– CAT: 50% Coverage Level & 55% Price Election

Crop Revenue Coverage (CRC)– Covers individual's yield and price losses

Indexed Income Protection (IIP)– Covers individual’ lost revenue; uses county yields to

index your production history to determine your Approved Yield

Dollar Plan– Specialty Crops– Covers individual’s lost revenue

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RMA Insurance Products

Group Risk Plan (GRP)– Covers county’s yield loss: 70% - 90% Coverage Levels– CAT: 65% Cov. Level & 45% of Max Protection/Acre

Group Risk Income Protection (GRIP)– Covers county’s yield and price loss

Adjusted Gross Revenue (AGR)– Cover’s individual’s lost revenue from multiple

commodities– Coverage based off Schedule F tax form

Adjusted Gross Revenue - Lite (AGR-Lite)– Like AGR, but liability limited to $1 million in revenue

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RMA Insurance Products - Review

  Individual Plan Group Plan

Yield Insurance APH, GYC GRP

RevenueInsurance

CRC, Dollar, IIP, AGR, AGR-

LiteGRIP

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Actual Production History Plan (APH)

Assume you average 110 bu./acre, select the 75% coverage level, plant 100 acres, and the RMA price is $3.50. Your insurance coverage is…• 110 bu./acre x 75% x 100 acres x $3.50 = $28,875

Loss Trigger:• Harvested Yield < APH x Coverage Level

You experience a drought and only harvest 6,900 bushels. Your indemnity payment is…• (82.5 bu./acre x 100 acres – 6,900 bu.) x $3.50 = $4,725

All Examples Assume 100% Share and 100% Price Election

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Crop Revenue Coverage (CRC)

Assume you average 110 bu./acre, select the 75% coverage level, plant 100 acres, and the CRC Base price is $4.06. Your guaranteed revenue is…• 110 bu./acre x 75% x 100 acres x $4.06 = $33,495

Loss Trigger:• Harv Yield x Harv Price < APH Yield x Coverage Level

x Higher of (Harvest Price or Base Price)

You harvest 6,900 bu. Harvest Prices @ $4.06, $3.50, & $4.50. Your indemnity…• (82.5 bu. x $4.06 x 100) – (6,900 bu. x $4.06) = $5,481

• (82.5 bu. x $4.06 x 100) – (6,900 bu. x $3.50) = $9,435

• (82.5 bu. x $4.50 x 100) – (6,900 bu. x $4.50) = $6,075

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Indexed Income Protection (IIP)

Assume you average 1 bu./acre above the county, and the county expected yield is 109 bu./acre, select the 75% coverage level, plant 100 acres, and IIP Projected price is $4.06. Your coverage is...• 110 bu./acre x 75% x 100 acres x $4.06 = $33,495

Loss Trigger:• Harv Yield x Harv Price < APH Yield x Coverage Level

x Projected Price)

You harvest 6,900 bu. Harvest Prices @ $4.06, $3.50, & $4.50. Your indemnity…• (82.5 bu. x $4.06 x 100) – (6,900 bu. x $4.06) = $5,481• (82.5 bu. x $4.06 x 100) – (6,900 bu. x $3.50) = $9,345• (82.5 bu. x $4.06 x 100) – (6,900 bu. x $4.50) = $2,445

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Group Risk Plan (GRP)

Assume the county expected yield is 110 bu./acre, select the 75% coverage level and 100% of Max Protection/Acre, plant 100 acres, and Max Protection/Acre = $488. Your insurance coverage is...• $488 Max Protection/Acre x 100% x 100 Acres = $48,800

Loss Trigger:• Payment Yield < County Expected Yield x Cov. Level

You harvest 10 bu., but it depends on the county

Payment Yield is 69 bu/acre. Your indemnity payment is…• (82.5 bu – 69 bu)/82.5 bu x $488 x100% x 100 acres) =

$7,985

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Comparison – 2007 Madison Corn

APH CRC IIP GRP GRPAPH/ GRP County 110.0 110.0 110.0 110.3 110.3 Coverage Level 75% 75% 75% 75% 90%Yield Guarantee 82.5 82.5 82.5 82.7 99.3 Price Elect/Base/Max $3.50 $4.06 $4.06 $488.08 $488.08Acres 100 100 100 100 100 Prod to Count 6,900 6,900 6,900 6,900 6,900 Payment Yield NA NA NA 69 69 Grower Harvest Price $3.30 $3.30 $3.30 $3.30 $3.30Ins. Harvest Price $3.50 $3.50 $3.50 NA NACrop Revenue $22,770 $22,770 $22,770 $22,770 $22,770Indemnity $4,725 $9,345 $9,345 $8,085 $14,893Premium $1,267 $2,163 $1,296 $134 $551Net Revenue $26,228 $29,952 $30,819 $30,721 $37,112

2007 Corn Madison County Grain-NI

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Madison County 2007 GRP vs. CAT

Max Protection/Acre = $488.08 & 100 acres

Expected County Yield = 110.3 bu/acre

NASS County Yields• ‘02 = 99 bu/ac; ‘04 = 92 bu/ac; ‘06 = 69 bu/ac

CATAPH / Expected Yield 110 110.3 110.3 110.3 110.3 110.3Coverage Level 50% 70% 75% 80% 85% 90%Loss Trigger 55 77.2 82.7 88.2 93.8 99.3Actual / County Yield > 55 69 69 69 69 69Indemnity $0 $5,183 $8,087 $10,626 $12,905 $14,891Producer Premium $0 $118 $134 $184 $300 $551Fee $100 $30 $30 $30 $30 $30Producer Cost $100 $148 $164 $214 $330 $581Net Payment -$100 $5,035 $7,923 $10,412 $12,575 $14,310

GRP

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Adjusted Gross Revenue (AGR)

Assume you average $800,000 in gross revenue, have 3 commodities, and select the 75% coverage level at the 90% payment rate. Your insurance coverage is…• $800,000 x 75% x 90% = $540,000

Loss Trigger:• Annual Gross Revenue < AGR x Coverage Level

You experience loss and only have $200,000 adjusted gross farm revenue. Your indemnity payment is…• ($800,000 x 75% - $200,000) x 90% = $360,000

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AGR & AGR-Lite Issues

Provides revenue protection from yield & price declinesAGR Requirements– Insurance coverage based on Schedule F tax forms (5 Years)– Amount of Insurance cannot exceed $6.5 million– Purchase traditional Federal crop insurance when more than 50% of

expected income is from insurable commodities (with a reduced AGR premium).

– No more than 50% of your allowable income comes from agricultural commodities purchased for resale.

– No more than 35% of the expected allowable income comes from animals and animal byproducts.

AGR-Lite Exceptions– Amount of Insurance cannot exceed $1 million– 35% income limit from livestock is no longer required

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AGR & AGR-Lite Issues

Coverage Level

Payment Rate

Min. # of Commodities

AGR Max. Annual Income

AGR-Lite Max. Annual Income

65 75 1 $13,333,333 $2,051,282

65 90 1 $11,111,111 $1,709,401

75 75 1 $11,555,555 $1,777,777

75 90 1 $9,629,629 $1,481,481

80 75 3 $10,833,333 $1,666,666

80 90 3 $9,027,777 $1,388,888

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Pasture, Rangeland and ForageRainfall Index and Vegetation Index

COMING SOON*???

*Depending on Government Funding

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Rainfall & Vegetative Indices

Rainfall/Vegetative Index background– Index – based on precipitation (Rainfall) or greenness

(Vegetation)• Not measuring actual rainfall/greenness or individual production

The deviation from long-term normal precipitation or greenness is used to establish the index

• SINGLE PERIL COVERAGE

– Precipitation/Greenness has a high degree of correlation to forage production

– WHY?• Lack of actual producer/industry production data

• No consistent and practical methodology for measuring production of the crop

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Rainfall Index

Area of insurance = 0.25o grids (~ 12 x 12 miles)

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Vegetation Index

Area of insurance = 8 x 8 km (~ 4.8 x 4.8 miles)

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Rainfall & Vegetation Index

Rainfall Index Intervals– Multiple Intervals offered – 6

– Crop Year divided into 6, 2-month Intervals for each grid

– Producers must select at least 2 Intervals

Vegetation Index Intervals– Multiple Intervals offered – 4

– Crop Year divided into 4, 3-month Intervals for each grid

– Producers may select more than 1 Interval

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Rainfall & Vegetation Index

Ability for producers to manage their individual risk periods– Correlate to individual growth patterns and production seasons

– The Intervals provide for greater reaction to forage reduction events vs. a yearly average

Not required to insure 100% of acreage

Internet based

Coverage Levels: 90, 85, 80, 75, and 70

Sales Closing Date & Acreage Reporting Date: November 30th

Rating: Each grid, Index Interval, and coverage level is individually rated

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Risk Tolerance: Coverage Levels?

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Low Medium High

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Risk Bearing Ability

Coverage Level

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APH & GRP: County Yield Correlate?

Hig

h GRP (High CL%)

GRP (Medium CL%)

GRP (Low CL%)

Med

ium

APH or GRP (High CL%)

APH or GRP (Medium CL%)

APH or GRP (Low CL%)

Low APH

(High CL%)APH

(Medium CL%)APH

(Low CL%)

Low Medium High

Cou

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Risk Tolerance

APH vs. GRP & Coverage Level

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Commodity Marketing

Forward Price Contracting

Photo Source: USDA/ARS

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Forward Price ContractingForward Price Contracting– Is a tool that agricultural producers of select commodities can use

to mitigate a portion or all of their price risk.

Hedge – The practice of offsetting the price risk inherent in any cash market

position by taking an equal but opposite position in the futures market or with another forward contracting alternative.

– The hedger (i.e. a corn producer) foregoes the opportunity for additional profit as a result of increases in the market price for their commodity (i.e. corn), for the ability shift risk of decreases in the price to another entity (i.e. a feed mill).

Four general categories of hedging mechanisms are:– Forward Cash Contracts– Futures Contracts– Option Contracts– Other privately negotiated forward contracting mechanisms

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Terminology

Forward Cash Contract– Obligates the holder to buy or sell an asset for a certain

price at a certain time in the future.– Non-standardized written agreement

• Terms are open to negotiation (e.g. an agricultural producer and grain elevator manager).

• Privately negotiated

Futures Contract– Obligates the holder to buy or sell an asset for a certain

price at a certain time in the future.– Highly standardized written agreement

• Standard quality, quantity, delivery time, and location• Traded only on an exchange (i.e. Chicago Board of Trade

(CBOT), New York Board of Trade (NYBT), etc.)

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Terminology

Option Contract – A written agreement that gives the buyer of the option the right, but not the obligation to, buy or sell for a limited time a particular good at a specific price.– Call Option - An option to buy.

– Put Option – An option to sell.

Basis – Difference in the local spot (“cash”) and futures markets price for a commodity.

Futures Risk – The risk that fluctuations in the level of price in the futures contract will occur.

Basis Risk – The risk that fluctuations will occur in relationship between the local cash (i.e. New York) and futures markets (i.e. CBOT).

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Forward Cash ContractScenario:

New York Corn Producer– 250 acres of Corn– 100 bushels / ac. expected yield

250 acres × 100 bushel per ac. yield = 25,000 bushels expected production

– Hedges 100% of 25,000 bushels of expected production

Cash Market Futures Market

May: Plans to sell 25,000 bushels of corn

in October

May: Forward Contract 25,000

bushels with local Grain Elevator at

$2.83/bu. (e.g. $2.56 futures price and $0.27

basis)

October: Delivers 25,000 bushels of corn

to buyer. The cash market @ $1.90/bu.

futures price + $0.25/bu. local New York basis in

October

October: Delivers on grain to buyer and

receives the difference in the contracted price

and the revenue received from the cash

market.

Gross Revenue Calculation

Revenue from Cash Market: ($1.90 / bu. + $0.25 / bu.) × 25,000 bu. = $53,750

Revenue from Hedging Strategy:

Futures Price Component: $2.56 - $1.90 = $0.66 / bu.

Basis Price Component: $0.27 - $0.25 = $0.02 / bu.

($0.66 / bu. + $0.02 / bu.) × 25,000 bu. = $17,000

Total Gross Revenue:$53,750 + $17,000 = $70,750

(Approximately 24% From Hedging Strategy)

* NOTE: 100% Hedge is unlikely, but is used for example purposes. Depending on your risk tolerance,

production, etc. you should consider hedging 40% - 80% of your crop.

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Option Contract

Scenario:The same New York Corn Producer– Hedges 100% of 25,000

bushels of expected production

– 1 CBOT Option Contract is for 1 CBOT Futures Contract

Cash Market Futures Market

May: Plans to sell 25,000 bushels of corn

in October

May: Buy 5 CBOT December corn $2.60 Put Option Contracts @ $0.30/bu premium

October: Sells 25,000 bushels of corn in cash

market @ $1.90/bu. futures price + $0.25/bu. local New York basis in

October

October: Exercise the 5 CBOT December Put Option Contracts @ $2.60/bu strike price

Assume round-trip trading cost are approx. $0.01/bu.

Gross Revenue Calculation

Revenue from Cash Market: ($1.90 / bu. + $0.25 / bu.) × 25,000 bu. = $53,750

Revenue from Hedging Strategy:

Futures Price Component: $2.60 - $1.90 - $0.30 - $0.01 = $0.39 / bu.

Basis Price Component: N/A

($0.39 / bu. + N/A.) × 25,000 bu. = $9,750

Total Gross Revenue:$53,750 + $9,750 = $63,500

(Approximately 15% From Hedging Strategy)

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Other Risk Management Strategies

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Other Risk Management Strategies

Production Risk– FSA

• NAP

• Disasters

• Emergency Loans

– Crop-Hail Insurance

– New Technologies (seeds, sprays, precision farming, etc)

Production & Market Risk– Diversification: fields, crops, types, non-farm income

Record Keeping!!!

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Financial Risk

Obtaining Capital & Financing (Interest rates)– Mitigate by lowering debt-to-asset ratio; have collateral,

crop insurance and marketing plan; shop for better borrowing terms and conditions; establish relationships with lenders.

Meeting Cash-Flow Needs (short-term)– Mitigate by having liquidity, reducing expenses, lines of

credit, insurance for crops, machinery, equipment, etc.

Protecting & Growing Equity (long-term)– Mitigate by having insurance for major events: crops,

property, liability, heath, disability, and life – During good years, build-up liquid reserves, invest

(possibly in non-farm assets), pay down debt.

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Legal Risk

Concern: Risk of being sued. Mitigate by…

Structural Entity of Operation– Sole Proprietor (all risk all reward)

– Partnership (shared risk and reward)

– LLC (1 or multiple owners with limited liability)

– Corporations (Sub S or C having 1+ owners with limited liability)

Contractual Agreements– Non-performance: Get it in writing & use trustworthy parties

Tort Liability – Neglect or Harm to Person/Property– Review general liability insurance for coverage and exclusions

Statutory Laws – lots of them for farming– Labor & Environmental: Have insurance and maintain accurate

documentation

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People Risk

Concern: losing key owners/partners/employees– Managing People– Death– Divorce– Disability

Mitigate by having…– Life insurance and disability insurance to offset lost

income, hire new employees, and meet cash-flow needs– Heath insurance and long-term care to offset any new

expenses– Cross-functional training of employees and owners– Written succession and estate plans

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Estate Planning

Is the process of planning for the final disposition of your life's work.

Benefits of Estate Planning – Peace of mind for you and your family.

– The guardianship and care of dependent children.

– A reduction in estate tax liability.

– Distribution of assets according to your wishes.

– An assurance that your business will continue with the least amount of disruption

Mitigate by having…– A Will, use Trusts (Revocable Living Trust, Marital

Trust, Charitable Trusts, etc) and Gifting

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Goals - SMART

S - Specific - Goals need to be clearly defined and written...no room for ambiguity here. For example, 10% return on capital, break-even this year, etc.M - Measurable - Acceptable standards of measurement need to be consistently used for each goal, e.g. bushels, dollars, hours.A - Attainable - It may be exciting to reach for the stars, but accomplishing realistic goals is rewarding. Are you shooting for the highest yield ever or a reasonable average? R - Related - Goals should be written so that they are related to each other and do not compromise your basic values and beliefs. Related goals include moving the operation toward higher returns this year and long-term equity/ownership.T - Tractable - Goals should be established with progressive steps and checked or monitored over time.

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Implementation

Identify and analyze your risks and risk tolerances

Establish your goals

Evaluate the alternatives available

Implement the action plan with your best alternatives

Monitor the progress and results

Update the plan as needed

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Need more information?

Education ManualRFD-TV (Channels – Direct TV 379 & Dish Network 231)

Interactive CD-ROM

Online– www.rma.usda.gov – www.agrilogic.com/education

Contact your local crop insurance agent

RMA Regional OfficesOffice: Raleigh, NC Ballston Spa, NYPhone: (919) 875-4880 (518) 885-6811

Fax: (919) 875-4915 (518) 885-6278 Email: rsonc@rma.usda.gov james.gallons@rma.usda.gov

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Post Quiz

Handout of 10 Questions

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