1 LRP For Livestock April 2008 by Duane Griffith, Montana State University Gary Brester, Montana State University Risk Management Agency

2 Livestock Risk Protection Feeder Cattle Fed Cattle Swine Lamb All these types of livestock are covered by LRP in all Montana and Wyoming counties.

33 Examples are Using Livestock Risk Protection for Feeder Cattle

4 Feeder Cattle Coverage Can cover small number of head Not lumpy like Options Contracts Settles to daily CME index price

5 Livestock Risk Protection- Feeder Cattle Highlights LRP for feeder cattle offers single-peril price protection LRP does not eliminate other risks. Does not cover sickness or death of the cattle. Does not insure against possible rising feed costs Producers remain subject to basis price risk: (Actual cash market price minus the cash-settled CME index value)

6 Basics of LRP for Feeder Cattle LRP insurance does protect against decline in prices below the established coverage price. Insurance period: Insurance is offered for 13, 17, 21, 26, 30, 34, 39, 43, 47, or 52-week periods. The producer selects a time closest to When the cattle will be marketed or When cattle will reach the desired weight.

7 Basics of Livestock Risk Protection— Feeder Cattle, cont. Application: An application is required to purchase insurance coverage. It establishes producer eligibility. Must file a form indicating beneficial interest with the application Specific Coverage Endorsement: A producer must file a Specific Coverage Endorsement for each group of feeder cattle to be insured. Several endorsements may be filed under one application as long as beneficial interests are the same.

88 Basics of Livestock Risk Protection— Feeder Cattle, cont. Insurable TypeTarget Weight Steers Weight 1less than 6.0 hundredweight Steers Weight 26.0 to 9.0 hundredweight Heifers Weight 1less than 6.0 hundredweight Heifers Weight 26.0 to 9.0 hundredweight Brahman Weight 1less than 6.0 hundredweight Brahman Weight 26.0 to 9.0 hundredweight Dairy Weight 1less than 6.0 hundredweight Dairy Weight 26.0 to 9.0 hundredweight Feeder Cattle Types and Weights Eligible for LRP Feeder Cattle Coverage

9 Basics of Livestock Risk Protection— Feeder Cattle, cont. Endorsement Limits: Limit of 1,000 head of feeder cattle may be insured under any one Specific Coverage Endorsement. Annual Policy Limits: Total number of head of feeder cattle that may be covered during a crop year is 2,000 head. Coverage Prices: Prices that may be insured by the producer change daily and are obtained from the RMA website:

10 Basics of Livestock Risk Protection— Feeder Cattle, cont. Coverage levels: Calculated based on the chosen coverage price. Coverage levels will range from 70 to 100%. Price Adjustment Factors: Adjustment Factors applied to values listed on RMA website Price Adjustment Factors Weight RangeSteersHeifers Predom. Brahman Predom. Dairy < 6.0 cwt110%100% 85% 6.0 – 9.0 cwt100%90% 80%

11 Basics of Livestock Risk Protection— Feeder Cattle, cont. Off-setting Transaction: A producer must not enter into any transaction that would have the effect of converting any portion of the premium subsidy provided by the FCIC into funds available for the producer’s use. Therefore, no offsetting position may be taken in the commodity futures and options market. Expected End Value: This is the expected prices at the end of an insurance record for each specific type and weight of feeder cattle announced daily on the RMA website:

12 Basics of Livestock Risk Protection— Feeder Cattle, cont. Actual End Value: This is the value of CME feeder cattle index on the end date of the insurance period, Adjusted by RMA for feeder cattle type and weight Subsidy Level: 13% subsidy on LRP feeder cattle contract insurance premiums

13 LRP—Feeder Cattle Example Contract DataValueCalculation Number of Steers1,000 hdProducer Expected Weight800 lbProducer Current DateApril 29, 2008Producer Marketing DateJuly 29Producer Insurance Period13 weeksProducer Expected Ending Value$ cwtRMA Coverage Level92.38%Producer Coverage Price$99.73 cwtRMA

14 LRP—Feeder Cattle Example Feeders, Feb. 4, 2008 Contract DataValueSource Insured Value$797,8401,000 hd x 8 cwt/hd x $99.73/cwt Premium Rate0.013RMA Total Premium$10,488$797,840 x Subsidy Rate13%RMA Subsidy Amount$1,363$10,488 x 0.13 Producer Premium$9,124$10,488 – $1,363

15 LRP Example Suppose a producer actually sells 1,000 of 800 pound steers on May 7, Sold the steers for $100.00/cwt The CME-reported actual ending value is $97.50/cwt. Will the producer receive an indemnity

16 LRP Example Answer Yes. Indemnity calculation 1,000 head x 8 cwt/head x ($ $97.50) = $17,840 Revenue from calves 1,000 x 8 cwt/head x $ = $800,000 Plus indemnity of: + 17,840 Less net premium paid: - 9,124 Net revenue: = $808,716

17 LRP Example Answer Recall that the producers was expecting $107.96/cwt 1,000 x 8 cwt/head x $107.96/cwt = $863,680 Without LRP, the producer receives $800,000 With LRP, the producer receives $808,716

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22 Adjustment factors account for differences between heifer prices and prices of other types and weight of cattle. Price adjustments are applied to expected ending values, coverage prices and actual ending values prior to entry on the RMA website.

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25 Livestock Gross Margin First offered in late January of 2006 Covers finishing margin on yearlings and calves fed in major cattle states Uses set (fixed) basis levels for insurance period Producer chooses deductible level May be cost-effective for small feeders

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28 State-Level Basis Tables ($/cwt. or bu.) MTJFMAMJJASOND Fed Yrlg Calf Corn WYJFMAMJJASOND Fed Yrlg Calf Corn

29 Margin Example – May South Dakota Yearling, Covered Jan-06 October Fed($ $3.68)$1, Value* 12.5 cwt.- May Yearling($ – $3.77)$ Cost* 7.5 cwt.- August Corn($ $0.32)$ Cost* 57.5 bu.= Expected Margin (per head)$

30 Typical Marketing Plan Backgrounder with 150 head of steers to sell on March 15, 2006 Buy 2 March FC puts (130 head), 100 strike, for $2.60 per cwt. or better Buy LRP-Feeder coverage on 20 head, 90 percent level, for $3.00 per cwt. or better Sell 1 March futures if $110 or better

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33 LRP Versus Options, cont. LRP & Put options both protect price risk. For LRP, the selected “coverage price” is the producer’s price floor. For options, the selected “strike price” is the producer’s price floor. Both LRP & Options require the payment of a premium. LRP—an insurance premium is paid to an insurance agent. Options—an option premium is paid to a broker.

34 LRP Versus Options, cont. Payouts are received when prices decline below an insured level. LRP- receive an indemnity Options- option premium increases in value and is reflected in the producer’s brokerage account

35 LRP Versus Options, cont. No payouts are received if market prices remain above the insured level. LRP – No indemnity Options – Option premium declines to zero and there is no increase in the producer’s brokerage account. Both LRP and options are subject to basis risk. Both products protect the producer from a decline in the CME feeder cattle price index

36 LRP Versus Options, cont. Neither product protects the producer from a decline in the producer’s sale price. Disadvantages of options relative to LRP: Need a brokerage account – hence brokerage fees Subsidies are not available for option premiums. No price adjustments for varying weights.

37 LRP Versus Options, cont. Advantages of Options relative to LRP: A producer may buy higher price coverage levels than LRP. LRP coverage levels always “out of the money” More timing flexibility because the producer may sell an option prior to expiration. Can re-purchase an option at any time

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40 Livestock Risk Protection Feeder cattle coverage was first offered June 9, Feeder cattle endorsement suspended December 24, 2003 after BSE case of previous day. Feeder cattle endorsement resumed September 30, 2004.