Lunch and Learn February 10, 2004 Crop Insurance Update George Patrick

Crop Insurance Update Topics 1. Review of crop insurance 2. Risk management crop insurance and pre-harvest pricing 3. Crop insurance for hogs

Crop Insurance Alternatives Multiple Peril (Yield Insurance) –Actual Production History (APH) –Group Risk Plan (GRP) Multiple Peril and Price (Revenue Ins.) –Crop Revenue Coverage (CRC) –Revenue Assurance (RA) –Income Protection Plan (IPP) –Group Risk Income Protection (GRIP)

Multi-Peril APH Insurance Insurance against losses from almost any cause except poor farming practices Large deductible - protection against major losses only 50 to 85% of historical production level (15 to 50% deductible) Prevented planting/replant protection

Multi-Peril APH Insurance Level of yield coverage may vary from 50 to 85% of APH yield (85% in most IN counties) Maximum price is set based on Feb. futures for Dec. corn and Nov. beans Producer can choose between 55% and 100% of max. price (100% is most common) CAT is 50% yield, 55% price

Multi-Peril Crop Insurance Indemnity is based on average yield of the unit relative to APH yield guarantee Actual yields for at least 4 years (up to 10 years if available) to establish the APH yields -Severe yield guarantee penalties w/o historical yields

Multi-Peril Crop Insurance Indemnity is calculated: (Guaranteed Yield - Actual Yield) X Price Example: 120 bu. APH yield, 75% level, $2.50 Producer harvests 80 bushels 90 bu. (120 X 75%) - 80 bu. yield = 10 bu. 10 bu. X $2.50 = $25.00/acre indemnity

APH Premiums Historical yields have little effect on premiums per acre. Cost/bu. is lower with higher yields Premiums are subsidized by Uncle Sam Additional subsidies from Agricultural Risk Protection Act ‘00 - increased subsidies on higher levels

Revenue Insurances Crop Revenue Coverage (CRC) Revenue Assurance (RA) no harvest price option harvest price option Income Protection Plan (IP or IPP) Group Risk Income Protection (GRIP)

Crop Revenue Coverage (CRC) Provides both yield and price protection Yield protection is based on APH crop insurance coverage If prices change from spring to harvest, use higher price for insurance Revenue guarantee is based on the futures price, not the price received

CRC Indemnities Revenue guarantee level - “Production to count” (Lower of actual yield or APH guarantee level) X Price (higher of spring or harvest) = Indemnity

Crop Revenue Coverage Indemnities are triggered by shortfalls in revenue due to: 1. Low yields 2. Low prices 3. Combination of low prices and yields Premiums (both yield and price) are subsidized

Revenue Assurance (RA) Generally similar to CRC No harvest price option - uses spring price Harvest price option - uses higher price like CRC Some differences in units from CRC Generally larger units or combinations of enterprises Check with insurance agent

Income Protection Plan (IPP) Similar to CRC - income coverage If income falls below insured level, pays an indemnity Low yield/high price may result in no indemnity if income level is above insured level Builds on the “natural hedge” Low yields generally have higher prices Premiums generally lower than APH

Group Risk Plan (GRP) Coverage is based on expected county yields and actual county yields Individual’s yield is not relevant “Trigger level” - based on % of expected county yield Ranges from 70 to 90% of exp. yield Can insure up to 150% of county yield

GRP Indemnity Indemnity is paid if county yield is below the trigger yield of the insurance (140 bu. X 90%)=126 bu. Indemnity is % shortfall X coverage level (( )/126)= 28.6%* $300 = $86

GRP Crop Insurance Indemnity is paid only if county yield is below trigger yield Producer could have a disaster and county be near normal Producer could do well and get an indemnity if county is low

Group Risk Income Protection (GRIP) Based off the GRP concept Pays if actual county revenue drops below trigger revenue Expected prices are based on futures prices in mid-March “Harvest” price is Nov. soybeans futures in Oct and Dec. corn in Nov.

2004 Corn Premiums/Acre Carroll County – 155 bu. APH

2004 Soybean Premiums/Acre Carroll County 51 bu. APH

Crop Insurance, Indiana Type of Insurance CAT APH CRC IP RA GRP GRIP TOTAL ACRES (1,000) Corn % of insured acres ,623.0 Soybeans % of insured acres ,259.6

General Crop Insurance Information Purdue Ag. Econ. Report Sept “Crop and Revenue Insurance Alternatives” extension/pubs/paer/archives.asp

County Specific Information 1. Premium Calculator Specify county, crop and yield 2. Insurance Evaluator Specify county and crop Analyzes performance

Research Results Carroll County farm Excludes ’89,’92,’94 and ’96 - years following “short” crop have different price patterns Benchmark - Cash sale at harvest with no insurance Average returns after risk management costs are subtracted

Value at Risk (VaR) Concept 5% VaR “Value at Risk” concept Measure of downside risk 95% of the time revenue will be greater than this amount (worst year in 20) Strategy with higher VaR is preferred if average revenue is the same

Marketing Strategies Using marketing strategies will keep average revenue high, but involves more downside risk than cash sale at harvest. Marketing earlier in year generates a higher average revenue than later sales, but presents more downside risk. Does not work well in drought years.

Insurance Strategies Insurance can reduce downside risk, but generally has a lower average return due to insurance premium Individual insurances (i.e., APH and CRC) has greater downside protection than group plans but reduce avg. returns Higher coverage levels -greater downside protection but reduce avg. returns

Combination Strategies Combination strategies, especially yield insurance and marketing tools, (synthetic revenue insurance) tend to have high revenue and 5% VaR Synthetic revenue insurance requires more management than revenue insurance

Concluding Remarks Trade-offs exist among all of risk management alternatives BUT producers can increase average revenue and reduce downside risk relative to cash sales at harvest Differences are relatively small No ONE “best” strategy for all producers

Reference Material “Protecting Farm Revenues with Pre- Harvest Pricing and Insurance” Purdue Ag. Econ. Report Dec p extension/pubs/paer/archives.asp

Crop Insurance for Hogs Livestock Risk Protection (LPR) Price protection only Can insure 70% to 95% of expected cash price over a 13 to 27 week production period

Crop Insurance for Hogs Very similar to an option – provides downside protection and does not limit upside potential 1 hog to 32,000 hogs annually

Advantages of LRP Coverage 1.More flexible than options or futures (quantity) 2.No margin calls 3.Premiums are subsidized 4.Simple to understand 5.Provides some basis protection

Disadvantages of LRP 1.Offers only price protection 2.Some basis risk 3.Specified settlement date whether hogs are ready 4.Use of futures/options restricted 5.Based on price outlook