1 Livestock Gross Margin (LGM) Insurance Policies for Cattle James B. Johnson and Vincent Smith MSU Department of Agricultural Economics and Economics Riverton, Wyoming February 23, 2009 Collaborating Partners RMA Billings Regional Office Fort Peck Community College

2 Some Basics First offered in Premiums are subsidized: The Federal government pays 13% of the premium. Any producer who owns cattle intended to be sold at slaughter weight is eligible to purchase the product. Calves or yearlings can be insured.

3 How Does LGM Insurance Work? 1.The product can be purchased in any month of the year. The sales date is the last business day of the month (the only day on which it can be purchased). 2.Producers are insured against loss of gross margin either because of declines in cattle prices or increases in corn (feed) prices. 3.The insurance operates for up to11 months from date of purchase.

4 LGM Product Basics Producer is covered for up to 11 months. –January 31:Coverage Purchased –December 31: Coverage Ends Producer can buy insurance for more than one insurance period. The Coverage can be purchased for no more than 5,000 cattle in one insurance period. The Coverage can be purchased for no more than 10,000 cattle each marketing year (July1 of the current year – June 30 of the following year).

5 LGM Product Basics For each insurance period, to claim an indemnity, a producer must provide sales receipts proving that the insured cattle have been marketed. The LGM product relies on futures prices: producers with LGM cannot use offsetting options positions to simply gain the subsidy (such actions are viewed as fraud and the producer is liable to prosecution). Exact descriptions of the futures prices being used are provided by RMA at the following URL: q&a.pdf

6 LGM Product Details 1.At the time the product is purchased, RMA computes a producer’s expected gross margin on a calf (or yearling) for the month in which the producer plans to sell it (up to 11 months after the insurance is purchased). 2.The producer insures a proportion of the expected gross margin (up to 100% of the margin).

7 LGM Product Details (cont.) 3.RMA computes an estimate of the producer’s actual gross margin in the month of sale. 4.The producer receives a payment for loss (indemnity) if the actual gross margin is smaller than the amount of the expected gross margin insured by the producer. 5.The producer can opt to take a deductible of between $0 and $150 of the gross margin per head. 6.The indemnity is equal to the difference between the insured component of the expected gross margin and the estimated gross margin.

8 A Simple Illustrative Example A producer in Fremont county buys an LGM contract for 20 calves on January 31, 2009 and plans to market the calves in December The expected December gross margin for a calf in Fremont county on January 31 is estimated by RMA to be $310. The producer takes a deductible of $50 per head so the insured component of the expected gross margin is $260.

9 A Simple Illustrative Example (cont.) The actual Fremont county feeder calf gross margin is estimated by RMA at the end of December for December sales to have been $180. For each of the 20 calves the producer receives an indemnity of $80 (the difference between insured component of the Expected Gross Margin and the Actual Gross margin). The total indemnity is $1,600 (20 calves x $80 per calf).

10 Calculating the Expected Gross Margin RMA uses a predetermined formula for yearling feeder cattle.  EGM t =Expected Gross Margin in month cattle are to be marketed  EPLC t =Expected Price of Live Cattle in month cattle are to be marketed  EPF t-5 =Expected price of feeder cattle 5 months before cattle are to be marketed  EPC t-2 =Expected price of corn 2 months before cattle are to be marketed

11 Expected Gross Margin: Yearling Example January 31:Purchase Coverage January 31:EPLC DEC = $90 January 31:EPFC MAY = $94 January 31:EPC OCT = $3.13 EGM = 12.5 EPLC DEC – 7.50 EPFC MAY – 57.5 EPC OCT = $1,125 - $705 - $180 = $240

12 Calculating the Actual Gross Margin For a Jan 31 Contract December 31: AGM = Actual Gross Margin December 31: PLC DEC = Price of Live Cattle in December December 31: PFC MAY = Price of Feeder Cattle in May December 31: PC OCT = Price of Corn in October

13 Actual Gross Margin Yearling Example December 31: PLC DEC = $ 86 December 31:PFC MAY = $100 December 31: PC OCT = $ 3 AGM = 12.5 PLC DEC – 7.5 PFC MAY – 57.5 PC OCT = 12.5 (86) – 7.5 (100) – 57.5 (3) = $152.50

14 WYOMING CATTLE YEARLING ACTUAL AND EXPECTED GROSS MARGINS: 2008 JAN. - NOV. INSURANCE PERIOD JulyAugSeptOctNov Expected Gross Margin Actual Gross Margin

15 Who Decides What the Prices Are? RMA Process is defined in the contract In principle, fed cattle, yearling, calf and corn prices are county specific because RMA makes a county specific basis adjustment from the national prices. In Wyoming, all counties have the same basis adjustment for each commodity and the basis adjustment varies by month.

16 QUESTIONS?