1. 1 Production Risk Management: Running With The Bulls Gary Brester MSU Department of Agricultural Economics and Economics May 6, 2008 Current Dynamics in Agriculture: Energy Costs, Global Markets, Ag Policy, Price Protection, and Leasing Arrangements Great Falls, MT

2. 2 OUTLINE 1.Production Risk Management a. Insuring Production Costs? b.Insuring Crop Replacement? 2.Multiple Peril Crop Insurance 3.Revenue Insurance a.Revenue Assurance b.Crop Revenue Coverage 4. Questions

3. 3 OUTLINE 1.Production Risk Management a. Insuring Production Costs? b.Insuring Crop Replacement? 2.Multiple Peril Crop Insurance 3.Revenue Insurance a.Revenue Assurance b.Crop Revenue Coverage 4. Questions

4. 4 Production Risk Management 1.How Does A Bull Market Influence Crop Insurance Decisions? 2. Insuring Production Costs? a.Increase In Crop Prices Between Planting And Harvest b. Little Correlation c. Not Really An Issue 3.Crop Replacement Costs a.Expect To Use Corn Crop To Feed Cattle b.Replacing Such A Crop With Higher Priced Corn Is An Issue

5. 5 Wheat Insured Counties for Wheat, 2008 MPCI, RA, CRC Coverage

6. 6 OUTLINE 1.Production Risk Management a. Insuring Production Costs? b.Insuring Crop Replacement? 2.Multiple Peril Crop Insurance 3.Revenue Insurance a.Revenue Assurance b.Crop Revenue Coverage 4. Questions

7. 7 Multiple Peril Crop Insurance 1.Original FCIC, Subsidized Crop Insurance 2.Producer Establishes An APH 3.Producer Chooses A Coverage Level a.50%-75% (Or 85%) Of APH 4.Producer Chooses A Price Election a.55%-100% Of MPCI Price Forecast 5. Premium Equals The Maximum Indemnity Multiplied By The Premium Rate

8. 8 MPCI Spring Wheat Example Contract DataValueCalculation APH Yield50 bu.producer Coverage Level70%producer* Yield Guarantee35 bu.0.70 x 50 bu. MPCI Price Forecast$9.00/bu.RMA Price Election100%producer* Elected Price$9.00/bu.1.0 x $9.00

9. 9 MPCI Spring Wheat Example 1.Suppose You Actually Harvest 33 Bushels Per Acre 2.You Receive An Indemnity Because 33 Bushels Is Less Than Your Yield Guarantee Of 35 Bushels. 3.You Receive The Difference In Bushels a. 35 – 33 = 2 bu/ac 4.Valued At Your Elected Price a.2 bu/ac x $9.00/bu = $18/ac 5. Harvest Price Of $12.00/bu a. 33 bu/ac x $12.00/bu = $396/ac

10. 10 OUTLINE 1.Production Risk Management a. Insuring Production Costs? b.Insuring Crop Replacement? 2.Multiple Peril Crop Insurance 3.Revenue Insurance a.Revenue Assurance b.Crop Revenue Coverage 4. Questions

11. 11 Revenue Assurance (RA) 1.Can Insure Optional, Basic, Or Enterprise Units 2.Producer Establishes An APH 3.Producer Chooses A Coverage Level a.50%-75% 4.RMA Establishes A Projected Harvest Price a.Formula-Based Off Of September MGE Futures Price

12. 12 Revenue Assurance (RA) 5.RA Basic Revenue Guarantee a. APH Yield x Coverage Level x RMA Projected Harvest Price 6.Producers May Choose a Harvest Price Option a.RA Harvest Revenue Guarantee b.APH Yield x Coverage Level x RMA Harvest Price 7. Producers Receive An Indemnity If Crop Value Is Less Than The Basic Revenue Guarantee (Or, The Harvest Revenue Guarantee)

13. 13 RA Example Contract Data ValueCalculation APH Yield 50 bu.producer Coverage Level 70%producer* RMA Price Forecast $11.00/bu.RMA RA Basic Revenue Guarantee $385/ac 50 bu. X 0.70 x $11.00

14. 14 RA Example: Price Increase 1.Suppose You Actually Harvest 33 Bushels Per Acre 2.But, The Actual RMA-Determined Harvest Price Increased To $12.00/bushel a. Rather Than The Projected Harvest Price of $11.00/bu. 3.Your Crop Value Is a. 33 bu/ac x $12.00/bu = $396/ac

15. 15 RA Example: Price Increase 4.You Do Not Receive An Indemnity From Basic Harvest Revenue Guarantee a.$396/ac > $385/ac 5.Under The Harvest Price Option, You Would Receive An Indemnity a. Harvest Revenue Guarantee Is 50 bu x.70 x $12.00/bu $420/ac b. $396/ac < $420/ac c. $24/ac Indemnity

16. 16 OUTLINE 1.Production Risk Management a. Insuring Production Costs? b.Insuring Crop Replacement? 2.Multiple Peril Crop Insurance 3.Revenue Insurance a.Revenue Assurance b.Crop Revenue Coverage 4. Questions

17. 17 CRC Insurance 1.Can Insure Optional, Basic, Or Enterprise Units 2.Producer Establishes An APH For Each Unit 3.Producer Chooses A Coverage Level a.50%-75% (or 85%) 4.RMA Establishes A Base Price 5. Producer Chooses 95% or 100% Price Election

18. 18 CRC Insurance 6.Minimum Revenue Guarantee a. APH Yield x Coverage Level x RMA Base Price x Price Election 7.Producer Receives An Indemnity When a.Actual Yield Multiplied By The RMA Harvest Price Is Less Than The Minimum Revenue Guarantee

19. 19 CRC Insurance 8.Producer Minimum Revenue Guarantee Is Adjusted Upward If a.RMA Harvest Price Is Greater Than The RMA Base Price 9. CRC Insurance Results In a.Downward Yield Protection b. Downward Price Protection c. Upward Price Participation

20. 20 CRC Wheat Example Contract Data ValueCalculation APH Yield 50 bu.producer Coverage Election 70%producer* RMA Base Price $11.00/buRMA Price Election 100%producer* Initial Minimum Revenue Guarantee $385/ac 50 bu. x 0.70 x $11.00 x 1.0

21. 21 CRC Example: Price Increase 1.Suppose You Actually Harvest 33 Bushels Per Acre 2.But, The RMAHarvest Price Increased To $12.00/bushel (Rather Than The RMA Base Price of $11.00/bu.) 3.Your New Minimum Revenue Guarantee a.50 x 0.70 x $12.00 x 1.0 = $420/ac

22. 22 CRC Example: Price Increase 4.Your New Crop Value Is a.33 bu/ac x $12.00/bu = $396/ac 5.Your Indemnity Is a.$420 - $396 = $24/ac 6. If The Price Increase Was Not Considered a. Your Indemnity Would Be Zero b. $396 > $385/ac

23. 23 Summary Results Product Crop Value IndemnityPremium Net Revenue None $396 $0 $396/ac

24. 24 Summary Results Product Crop Value IndemnityPremium Net Revenue None $396 $0 $396/ac MPCI $396$18$16$398/ac

25. 25 Summary Results Product Crop Value IndemnityPremium Net Revenue None $396 $0 $396/ac MPCI $396$18$16$394/ac RA $396 $0$24$372/ac

26. 26 Summary Results Product Crop Value IndemnityPremium Net Revenue None $396 $0 $396/ac MPCI $396$18$16$394/ac RA $396 $0$24$372/ac RA (Harvest Price Option) $396$24$29$391/ac

27. 27 Summary Results Product Crop Value IndemnityPremium Net Revenue None $396 $0 $396/ac MPCI $396$18$16$398/ac RA $396 $0$24$372/ac RA (Harvest Price Option) $396$24$29$391/ac CRC $396$24$25$395/ac

28. 28 10 Bushel Yield & $8.00 Price Product Crop Value IndemnityPremium Net Revenue None $80 $0 $80/ac MPCI $80$225$16$289/ac RA $80$305$24$361/ac RA (Harvest Price Option) $80$305$29$356/ac CRC $80$305$25$360/ac

29. 29 Other Issues 1.MPCI Indemnity Price Was Increased To $9.25/bu Prior To Sign Up a. An Administrative Decision b. Huge Potential For Government Liabilities If A Disaster Occurs c. Greatly Increases Potential For Moral Hazard d. It Doubles The Premium, But Greatly Increases Protection

30. 30 Other Issues 2.CRC And RA Price Levels Are Set In February a. They Could Be Below Actual Harvest Prices b. Not A Major Factor Because This Simply Establishes The Revenue Guarantee Floor c. Indemnities Increase With Price d. This Means A Lower Premium e. Upper Bounds On Price Increases

31. 31 What Is The Goal? 1.Insure Against Loss Of Variable Costs? a. Increase Coverage Levels When Input Prices Are High 2.Maximize Indemnities? 3.Capture As Much Of The Government Subsidy As Possible? 4. Minimize Risk? 5.Minimize Premium Costs? 6. Maximize Expected Profits?

32. 32 QUESTIONS?