Transcript Taking Charge of Yield & Revenue Risk Management on Your Farm Elliot Alfredson Spartan Crop Insurance $

Taking Charge
of
Yield & Revenue Risk Management
on Your Farm
Elliot Alfredson
Spartan Crop Insurance
$
Objective 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?

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
Managing 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
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 / Acre
High debt farm
Revenue per acre
needed:
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
$
Revenue Required / Acre
Medium debt farm
Revenue per acre
needed:
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
$
Managing 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
Risk 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 latespring / 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 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
Production Shortfall Exposure
20%
18%
Chances in 100
16%
14%
12%
10%
8%
6%
4%
2%
0%
10
28
46
64
82
100
118
136
154
172
Yield/planted acre
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Crop Insurance
To directly protect against revenue
risk exposure
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Crop 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
Management Portfolios

“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
Policies
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Multiple-Peril
(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?
 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 predetermined price set by the
RMA/USDA
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How is MPCI Coverage
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
$
How are losses paid on MPCI?

Loss is triggered when actual yield
goes below guarantee.

Example:
o
o
o
60 bu. realized yield
(90 bu guarantee – 60 ) = 30 bu.
Loss
30 bu loss x $2.05 = $61.50
$
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
$
MPCI 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 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 Insurances

“Pure” Revenue Insurance
o

RA
Revenue Insurance With Replacement
Price Coverage
o
CRC
o
RA w/ RPC option
$
CROP REVENUE COVERAGE

CRC is a Revenue index contract
with replacement price coverage

CRC is Designed to facilitate preharvest pricing

CRC is an index contract because
the futures price is used to
calculate “farm revenue” , not the
local cash price
$
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
$
Replacement Price Coverage:
Case Examples of How Price is Chosen
Year
Price used
Harvest Futures Price
to
calculate
the
Pre-sales
revenue
closing
Harvest guarantee
1999
$2.40
$1.96
$2.40
1995
$2.57
$3.28
$3.28
$
Calculating Replacement Price
Coverage Insurance Revenue
Guarantee:
70% 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
$
Replacement Price Coverage:Loss Examples
Revenue
Guarantee 70%
Using
Using
Dec.
Dec.
Futures Futures
in April in Oct
Year Base
Hvst
1995 $231.17 $295.04
1999 $215.88 $176.30
Realized revenue
Hvst
fut.
price
Act.
@
Yield hvst.
Rev
Loss =
Guan.
Minus
realized
60
$3.28 =
$196.80
$98.24
100
$3.28 =
$328.00
$0.00
60
$1.96 =
$117.60
$98.28
100
$1.96 =
$196.00
$19.88
$
How is RA Protection Under the No
Replacement Price Option Determined?

RA guarantees revenue based on farm
unit’s APH yield x CBOT harvest futures
price prior to sales closing.
$
Calculating the RA Insurance Revenue
Guarantee: 70% Coverage Example
Year
APH
yield
(bu)
Presales
closing
futures
price
’95
128.5
$2.57
= $330.25 x 70% = $231.17
’99
128.5
$2.40
= $308.40 x 70% = $215.88
Cov
Rev.
guar.
$
Compare Revenue Insurance Indemnities With
and Without Replacement Price Coverage
Harvest Futures
Price
Presales
Year closing Harvest
‘95 $2.57
‘99 $2.40
$3.28
$1.96
Loss
Yield
With Rep.
Price Cov.
Pure revenue
60
$98.24
$34.37
100
$0.00
$0.00
60
$98.28
$98.28
100
$19.88
$19.88
$
CRC and RA with RPC are “HYBRID”
Policies

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
$
CRC 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
$
RA 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
$
Revenue Insurances:
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 preharvest pricing.

If the farm uses pre-harvest pricing,
Revenue insurance with replacement price
coverage typically outperforms MPCI and preharvest pricing … particularly, if farm yield and
market price are correlated.
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STOP!
• Fill out Crop Insurance Decision
Worksheets!
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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.
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