A Risk Analysis of Adjusted Gross Revenue-Lite on Beef Farms Art Barnaby, Jeff Williams, Andrew Saffert, and Michael Langemeier Department of Agricultural Economics Kansas State University Presented at the 2009 National Extension Risk Management Conference Reno, NV March 31 –April 1, 2009

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3 Adjusted Gross Revenue-Lite (AGR-Lite) A Whole Farm Revenue Protection Plan Provides protection against loss of revenue from natural and named disasters and/or market fluctuations

Examine impact of participation in AGR- Lite as a stand-alone program for SE Kansas Beef Farms on farm income variability and risk reduction Objective 4

Motivation 5 76 % of Kansas’ $8.7 billion in agricultural production is without risk protection (NASS, 2008) Beef largely remains without protection

6 Overview of Analysis Generate Net Farm Income (NFI) distributions  With and without AGR-Lite participation Examine change in  Mean  Standard Deviation  Coefficient of Variation (CV)  Minimum

7 Simulation & Econometrics to Analyze Risk (SIMETAR©) is used to perform Stochastic Efficiency with Respect to a Function (SERF) Analysis. This analysis determines the preferred strategy (AGR-Lite or no AGR-Lite) at various levels of risk aversion for each farm. Analysis Methods

How is Coverage Established? 8 Federal Income Tax Records  Usually IRS Schedule F form 1040 Current Year’s Farm Plan  Annual Farm Report

Data (continued) 9 KFMA data  59 SE Kansas Beef Farms – Most diversified area with little irrigation (20 counties)  Schedule F not available but reproduced necessary data  Continuous annual farm level data ( ) Two data sets  15 yrs Need 5 years of previous data excluding the immediate previous year for current insurance year applicant.  9 yrs Used for creating NFI distributions and evaluation.

Farm Category  50% or more of average total income 1993 to 2007 from Beef Data (continued) 10

11 NFI Characteristics Beef Mean $56,100 $51, Standard Deviation Average Coefficient of Variation 1 1 Includes only positive Coefficient of Variations for 54 of 59 farms. Data (continued)

AGR-Lite Critical Values 12 Allowable Farm Income (AFI) - Used for establishing guarantee (liability)  Schedule F items directly related to production  Excludes custom work, insurance indemnities and ag program payments.

AGR-Lite Methodology Overview 13 Allowable Farm Income (AFI)  Calculate 5-year average of AFI - called AGR  Calculate indexed AGR if necessary for growth or contraction  Determine expected income (EI) - annual farm report that projects income  Determine approved AGR - Minimum of AGR or EI

14 AGR-Lite Example Claim 1 From the annual “farm plan” for the upcoming year. Year Tax Return InformationTrend Indexed Revenue Expected Income 1 Historical Year 1265,000 Historical Year 2250, Historical Year 3260, Historical Year 4287, Historical Year 5271, Historical Year 6 a. Income Trend Factor1.033 b. 5-year Average266,666 c. Expected Income for Insurance Year Total290,000 d. 5-year Average Indexed (a  b) 275,478 e. Lesser of Indexed AGR or Expected Income275,478 f. Coverage Level75% g. Payment Rate90% h. AGR-Lite Loss Inception Point (e  f) 206,609 i. AGR-Lite Liability ($ of Coverage) (h  g) 185,948

Adjusted Gross Revenue to Count (AGRC) Used for Establishing Claim  equals AFI generated for current year + insurance payments + accrual adjustments (accounts receivable, crop, and livestock inventory) AGR-Lite Critical Values 15

16 AGR-Lite Example Claim 1 From the annual “farm plan” for the upcoming year. Year Tax Return InformationTrend Indexed Revenue Expected Income 1 Historical Year 1265,000 Historical Year 2250, Historical Year 3260, Historical Year 4287, Historical Year 5271, Historical Year 6 a. Income Trend Factor1.033 b. 5-year Average266,666 c. Expected Income for Insurance Year Total290,000 d. 5-year Average Indexed (a  b) 275,478 e. Lesser of Indexed AGR or Expected Income275,478 f. Coverage Level75% g. Payment Rate90% h. AGR-Lite Loss Inception Point (e  f) 206,609 i. AGR-Lite Liability ($ of Coverage) (h  g) 185,948 j. Adjusted Gross Revenue to Count150,000 k. Insurable Loss (h - j)56,609 l. Indemnity (j  g) 50,948

AGR-Lite Methodology Overview 17 Allowable Expenses (AE)  No direct impact in determining initial AGR- Lite guarantee  However, effective guarantee reduced in claim filing process if expenses significantly less than 5 year average expenses  Schedule F items directly related to production excluding some items such as interest, taxes, and rent.

18 Assumptions for Analysis Every farm insured every year 75% Coverage Level and 90% Payment Rate Expected Income from "farm report" for insurance year (EI) equals 5-year Average AFI Examine AGR-Lite as stand-alone Actuarially fair premiums by farm category

Actuarially Fair Average % Rate = Total $ indemnities for farms with claims / total $ liability for farms with claims Applied to all farms 19 Premium Calculation

Premiums Summary 20 All Farms With Claims Without Claims Premium rate % Average Premium$5,009$5,214$4,749 Minimum Premium$353$496$353 Maximum Premium$26,584 $21,544 1 Percent of liability

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Results –Indemnities and Liabilities 22 Farms with Claims 1 33 Average Indemnity 1 $22,702 Average Liability 1 $137,796 1 Farms with at least one claim.

23 NFI Characteristics With Claims (33) Without Claims (26) Mean54,53858,083 Standard Deviation47,28956,347 Coefficient of Variation1.57 (31) 1.23 (23) Average Minimum-14,835-15,659 Average Maximum127,948159,627

24 NFI Results All Farms With Claims Without Claims (59) (33)(26) Average Without$56,100$54,538$58,083 Average With$54,008$54,538$53,334 Average Percent-3.73%0.00%-8.14% Standard Deviation Average Without51,28147,28956,342 Average With50,65546,21356,294 Percent Change-1.22%-2.28%-0.09% Coefficient of Variation Average Without Average With Percent Change-7.38%-28.21%28.51%

25 NFI Results (continued) All Farms With Claims Without Claims (59) (33)(26) Minimum Average Without-15,214-14,835-15,695 Average With-12,630-6,533-20,368 Percent Change16.99%55.96%-29.77% Maximum Average Without141,908127,948159,627 Average With141,872131,712154,768 Percent Change-0.03%2.94%-3.04%

26 SERF Risk Premium Results AGR-Lite not preferred on 37 farms at all levels of risk aversion. They would need increased returns or a payment to use AGR-Lite. 26 had 0 indemnities. 7 had 1 indemnity. 3 had 2 indemnities. 1 had 3 indemnities.

27 SERF Risk Premium Results (continued) AGR-Lite preferred on 10 farms at all levels of risk aversion. They would pay an additional amount for AGR-Lite. 1 had 1 indemnity. 1 had 2 indemnities. 2 had 3 indemnities. 4 had 4 indemnities. 1 had 5 indemnities. 1 had 7 indemnities.

28 SERF Risk Premium Results (continued) AGR-Lite not preferred by 7 risk neutral managers became preferred on 7 farms as risk aversion increased. All 7 had 1 indemnity.

29 SERF Risk Premium Results (continued) AGR-Lite preferred by 5 risk neutral managers but became not preferred on 5 farms as risk aversion increased. AGR-Lite actually increased risk because indemnities paid in higher NFI years but not lower NFI years. In these cases AGRC and NFI did not correlate well. 2 had 1 indemnity. 3 had 2 indemnities.

30 Correlation – All Farms AGRC to NFI Average0.65 Minimum-0.30 Maximum0.99 Negative Correlations2 Average correlations were slightly lower for farms with claims This leads to indemnities based on AGRC in years when NFI is higher than average or the opposite for some farms.

Summary & Conclusions 31 NFI Results – 33 Farms with claims  Reduced standard deviations  Reduced CV  Increased minimums SERF Results  10 farms preferred AGR-Lite at all levels of risk aversion  7 farms preferred at higher levels of risk aversion

Summary & Conclusions (continued) 32 First attempt to evaluate whole-farm product Future research  Provisions of the contract  Actual premiums  Analysis by size of farm

Issues with AGR-Lite 33 AGRC and NFI not highly correlated for all farms  Could have high cost year when AGRC is not low enough to generate a claim

34 Issues with AGR-Lite (continued) AGR-Lite does not adjust for feed purchased.  If in a drought, and producers purchase hay to replace lost forage, this loss will not be covered. The loss will lower net income, but not gross income.  If producers normally sell excess hay, then it is covered because there will be reduced hay sales.

Issues with AGR-Lite (continued) 35 AGR-Lite does not include indemnity payments when calculating 5-year average gross income that will set future guarantees.  This has no impact on current year’s indemnity payment but it lowers future guarantees reducing the effectiveness of AGR-Lite as a risk management tool for multiple year droughts.

36 Questions ?