Risk Management Education for Michigans Beginning Producers Custom Ag Solutions United States Department of Agriculture Risk Management Agency (RMA)

2 Program Sponsorship, Coordination, and Delivery USDA / Risk Management Agency (RMA) –Oversees $62B Federal Crop Insurance Program –Springfield, IL, Regional Office –Around 500 Employees –Main Offices in Washington, DC, and Kansas City, MO Custom Ag Solutions –Crop Insurance Education Programs –Risk Management Tools –Rural Appraisals –Technology Development

3 What is Risk? Think ChanceThink Bad

4 Chance Bad

5 Chance Bad

6 Chance Bad

7 Are You a Risk Taker?

8 Chance Bad

9 Chance Bad

10 Are You a Risk Taker?

11 Are You Risk Averse?

12 Risk Taker?

13 Risk Averse?

14 Not All Risks Are Equal

15 Some Risks Can Be Managed

16 Some Risks Cant

17 Some Risks Bring Rewards

18 Some Risks Bring Losses

19 1.Market Risk 2.Production Risk 3. Financial Risk 4.Human Risk 5.Legal Risk Five Categories of Agricultural Risk

20 Risk Management Choosing Among Alternatives to Balance Risk and Reward AB C

21 How Can We Balance Risk and Reward in Agriculture? Management Practices Diversification / Flexibility Transfer Risk to Someone Else (e.g., Crop Insurance)

22 You now own the RULazy2 farm/ranch, and you will operate it for six years. Your profitability could vary dramatically depending on uncontrollable chance and the risks you choose to take. The RULazy2 Farm/Ranch

23 Goal: earn $100,000 or more; Goal: earn $33,000 to $100,000; If your cash balance falls below -$10,000 at any time during the six years, the bank forecloses on you and you are out of the game. RULazy2 – Risk vs. Reward

24 RULazy2 - Year 1 You have just inherited 100 acres and 100 cows. Your farm/ranch is adequate to run the cows for the entire year. Because of volatile production and market situations, hay production is more risky and rewarding than cattle production. In the long run, cattle will make you less money than hay, but you will also be less likely to go bankrupt during the six years.

25 RULazy2 - Year 1 Expected Net Income from Cows and/or Hay:

26 RULazy2 - Year 1 You could sell half of your cows and raise 50 acres of hay, for a cost of $5,000. If you raise both cows and hay you are 25% less likely to go bankrupt than if you raise only cows. Because it will cost $5,000 to make the change, you are less likely to reach the magic numbers of $75,000 or $25,000 in earnings if you diversify.

27 RULazy2 - Year 1 You could also sell all of your cows and drill two wells to turn your entire farm into hay. Your drilling/irrigation vendors will give you a discount, and you can make this change for no money out of pocket. If you raise only hay you are more likely to reach $25,000 in five years, but you are four times as likely to go bankrupt as if you just raise cows.

28 RULazy2 - Year 1 Expected net income from 100 cows, OR 100 acres of hay, OR from 50 cows and 50 acres of hay: MinimumAverageMaximum Cows-$13,000$ 8,000$35,000 Both-$18,000$ 9,000$44,000 Hay-$28,000$10,000$62,000

29 Your Year 1 Choices : 1.Stick with cows only 2.Diversify to raise both cows and hay 3.Convert your entire operation to hay RULazy2 - Year 1

30 Transfer Risk to Someone Else Contracting –Production –Pricing Hedging –Futures –Options Crop Insurance

31 Its May, and a buyer has offered to buy your hay/cows/both this fall. He is offering $1.00/lb. for calves, and $90/ton for hay, which are the long- term average prices. Assuming average production, this means you are almost certain to make your expected average net income. RULazy2 - Year 2

32 Prices vary by as much as 20% from spring to fall, and your net income could be over $5,000 ($9,000) higher if you wait until fall to establish a price. On the other hand, prices can just as easily drop, and your net income could be more than $5,000 ($9,000) lower if you price in the fall instead of taking the buyers offer today. RULazy2 - Year 2

33 1.Take the buyers offer, and establish your prices today 2.Wait until fall to establish your prices RULazy2 - Year 2 Your Year 2 Choices:

34 A neighboring farm is for sale, and you are considering buying it. It has better soil and is generally more profitable for both cattle and hay production. However, the new farm has a water problem, and the wells sometimes dry up in the middle of the summer, reducing calf weights and hay yields. RULazy2 - Year 3

35 RULazy2 - Year 3 Profitability Comparison between the two farms: RULazy2MinimumAverageMaximum Cows-$13,000$8,000$35,000 50/50 Mix-$18,000$9,000$44,000 Hay-$28,000$10,000$62,000 NewMinimumAverageMaximum Cows-$16,000$9,000$42,000 50/50 Mix-$24,000$10,000$56,000 Hay-$42,000$11,000$107,000

36 The new farm is under pivot irrigation, so you can run cows, raise hay, or both. If you buy it, you will produce the same commodities you currently produce. You have a buyer for your farm for exactly the same amount as you can buy the new farm. RULazy2 - Year 3

37 RULazy2 - Year 3 Your Year 3 Choices: RULazy2MinimumAverageMaximum Cows-$13,000$8,000$35,000 50/50 Mix-$18,000$9,000$44,000 Hay-$28,000$10,000$62,000 NewMinimumAverageMaximum Cows-$16,000$9,000$42,000 50/50 Mix-$24,000$10,000$56,000 Hay-$42,000$11,000$107,000

38 Crop Insurance 101 What is Insurance? Insurance is purchased protection against a specific loss over a defined period of time. What is Crop Insurance? Crop Insurance is purchased protection against specific crop losses over a defined period of time.

39 How Does Crop Insurance Work? Risk Transference (pooling): Risk is Transferred from Many Individuals to the Federal Crop Insurance Corporation and Participating Insurance Companies. Law of Large Numbers: The Larger the Pool, the More Predictable the Losses.

40 Federal Crop Insurance Programs Multiple Peril Crop Insurance (MPCI) Catastrophic (CAT) Crop Revenue Coverage (CRC) Income Protection (IP) Group Risk Plan (GRP) Revenue Assurance (RA) Adjusted Gross Revenue (AGR) Livestock Risk Protection (LRP)

41 Insurable Interest Levels of Coverage Deductible Underwriting Crop Insurance Terms

42 Rating Premium Loss Event Indemnity Crop Insurance Terms

43 YearRevenuesPremiumIndemnityNet Revenues 1$ 100 2$ 50 3$ 150 4$ 25 5$ 175 Avg.$ 100 Basic Crop Insurance Example

44 YearRevenuesPremiumIndemnityNet Revenues 1$ 100- $ 25 2$ 50- $ 25 3$ 150- $ 25 4$ 25- $ 25 5$ 175- $ 25 Avg.$ 100 Basic Crop Insurance Example

45 YearRevenuesPremiumIndemnityNet Revenues 1$ 100- $ 25$ 0 2$ 50- $ 25$ 50 3$ 150- $ 25$ 0 4$ 25- $ 25$ 75 5$ 175- $ 25$ 0 Avg.$ 100 Basic Crop Insurance Example

46 YearRevenuesPremiumIndemnityNet Revenues 1$ 100- $ 25$ 0$ 75 2$ 50- $ 25$ 50$ 75 3$ 150- $ 25$ 0$ 125 4$ 25- $ 25$ 75 5$ 175- $ 25$ 0$ 150 Avg.$ 100 Basic Crop Insurance Example

47 Federal Crop Insurance Programs UNITED STATES In 2007, RMA insured over $62 billion in crop value across 1 million policies, 250 million acres, and 100 commodities. Michigan In 2007, RMA insured nearly $1 billion in crop value across 3,600 policies, 3.6 million acres, and 20 commodities.

48 Federal Crop Insurance Programs Michigan Commodities Covered by Federal Crop Insurance Programs Apples Barley Blueberries Cabbage Cherries Corn Dry Beans Grapes Green Peas Hybrid Seed Corn Oats Onions Peaches Popcorn Potatoes Processed Beans Soybeans Sugar Beets Tomatoes Wheat

49 Livestock Risk Protection (LRP) Program –Provides Price Protection to Michigan Livestock Producers –Covers Swine, Fed Cattle, and Feeder Cattle –Similar to a (Futures) Put Option –Premium Subsidized (13%) Federal Risk Management (Crop Insurance) Programs

50 For $1,000 you can buy RMAs LRP to protect against price downturns, which can cost you more than $5,000. Assuming average production, buying LRP assures that you will make at least $4,000. On the other hand, every dollar counts in this game. RULazy2 - Year 4

51 1.Buy LRP 2.Take your Chances in the Market RULazy2 - Year 4 Your Year 4 Choices:

52 Multi-Peril Crop Insurance –Based on a Producers Average Historical Production –Causes of Loss Include Weather Events, Drought, Insects, and Disease. –Premiums are Subsidized up to 56 Percent. Federal Risk Management (Crop Insurance) Programs

53 Hay yields must be consistent to make money. About one year out of eight, yields fall to less than 40% of average, which equates to a net loss of over $8,000 given normal prices. For $3,000, you can purchase forage crop insurance that will guarantee you a yield of at least 75% of normal, and which limits your possible loss to less than $2,000 at normal price levels. RULazy2 - Year 5

54 1.Buy Forage Crop Insurance 2.Take your Chances with Mother Nature RULazy2 - Year 5 Your Year 5 Choices:

55 Whole Farm Revenue Programs: Adjusted Gross Revenue (AGR) and Adjusted Gross Revenue-Lite (AGR-Lite) Based on a producers average historical adjusted gross revenue. Protects against many causes of loss. Premiums are subsidized up to 56 percent. Federal Risk Management (Crop Insurance) Programs

56 Your Year 6 Choices: 1.Buy an AGR-Lite Policy 2.Take your chances with the market and Mother Nature RULazy2 - Year 6 For $2,000, you can purchase an AGR-Lite policy that guarantees you an adjusted gross revenue of at least 80% of your average revenues.

57 Summary Risk is the Chance of a Bad Outcome. Some Risks Can be Managed; Some Cant. Risk Management Involves the Concept of Balancing Risk and Reward. We can Sometimes Transfer Risk to Others Using Tools such as (Crop) Insurance. Federal Crop Insurance Programs are Subsidized to Promote Grower Participation

58 Thank You