1. $ Taking Charge of Yield & Revenue Risk Management on Your Farm Elliot Alfredson Spartan Crop Insurance

2. $ Objective for Today’s Workshop  “Frame” approaches to managing risk  What’s new in 2002?  Review types of crop insurance  Discuss how crop insurance can be used to: o Limit financial risk exposure o Substitute for balance sheet liquidly o Facilitate pre-harvest pricing  Develop a crop insurance plan

3. $ What’s New In 2002?  Subsidy level and structure has changed: –Subsidy increased –More favorable to higher coverage's than previously –Revenue products treated more favorably compared to MPCI than previously.  Authority to facilitate livestock insurance (e.g., facilitate options on futures “equivalent” across all months; subsidize)

4. $ Alternative Approaches to Managing Risk  Manage sources of risk you face to reduce risk exposure  Retain risk using your equity / net worth  Choose farm plans which avoid risk  Shift risk to someone else o Insurance o Options on futures contracts

5. $ What lessons do we take from the financial risk management module?  How much equity are you willing to risk?  Balance management of financial risk through:  Maintenance of equity  Plans and action that avoid risk  Tools such as insurance and options that shift risk.  How much revenue do you have to generate to cover alternative “cost of production” targets?

6. $ Revenue Required / Acre Revenue per acre needed: High debt farm CornSoybeans To cover economic cost$361.01$290.32 To meet Cash flow requirements$309.47$238.78 To maintain equity$299.19$228.50

7. $ Revenue Required / Acre Revenue per acre needed: Medium debt farm CornSoybeans To cover economic cost$352.86$282.17 To meet Cash flow requirements$312.45$241.76 To maintain equity$284.59213.90

8. $ Managing Revenue Risk Exposure  Farm plans to avoid risk o Spread sales across year o Agronomic practices  Plans to shift risk o Options and minimum price contracts o LDP’s o Crop insurance

9. $ But, Some Approaches to Reducing Risk Create New Risks  Suppose I cash forward price corn in late spring / early summer  My objective is to spread sales and take advantage of a risk premium in late- spring / early summer new crop markets  But, I also have created a delivery risk if I have a short crop

10. $ Some Types of Crop Insurance  Yield –Named Peril –Multiple-Perils Trigger on farm / sub-farm parcel yield Trigger on county yield index  Revenue index –Trigger on farm / sub-farm parcel revenue index –Trigger on farm / sub-farm parcel revenue index with replacement price coverage

11. $ Insurance to Protect Against Production Shortfall Exposure

12. $ Crop Insurance To directly protect against revenue risk exposure

13. $ Crop Insurance Tailored to protect against revenue risk exposure and reduce delivery risk associated with pre-harvest pricing

14. $ Think in Terms of Revenue Risk Management Portfolios  “CAT” MPCI yield coverage and LDP’s  “Pure” revenue insurance and LDP’s  Yield insurance, pre-harvest price if price moves significantly above loan and into pricing targets, and LDP’s  Revenue insurance with “replacement price coverage”, pre-harvest price if price moves significantly above loan and into pricing targets, and LDP’s

15. $ Let’s Review Some Specific Policies

16. $ Multiple-Peril (MPCI)

17. $ Losses Are Paid As A Result of Shortfalls Due to Acts Of God, Not Management Hail/fire Drought Disease Excess moisture Animals Insects

18. $ How is Protection Determined?  Insurance yield (APH) is based on the farmer’s own yield history  Producer chooses level of coverage: from 50% to 85% of APH yield  Losses are paid at a pre- determined price set by the RMA/USDA

19. $ How is MPCI Coverage Determined?  Case farm’s APH yield on corn is 128.5 bu / planted acre  Consider coverage @ 70% of APH yield  Yield guarantee = 128.5 x.70 = 90 bu  If yield falls below 90 bu, a loss is triggered

20. $ How are losses paid on MPCI?  Loss is triggered when actual yield goes below guarantee.  Example: o 60 bu. realized yield o (90 bu guarantee – 60 ) = 30 bu. Loss o 30 bu loss x $2.05 = $61.50

21. $ Units: What Farm Breakout is Units to Calculate Protection, Coverage and Losses?  Enterprise Units – Breakout by Crop, County (whole farm within county)  Basic Units - Breakout by County, Crop, Share  Optional Units – Breakout by Crop, Section, Share

22. $ MPCI Review  Available on most crops  Guarantees can be determined at a sub-farm level (section) which increases “effective” coverage from a whole farm yield perspective  Rates & Prices are established by the RMA/USDA and vary by county and your yield relative to “peers”  Subsidized by the RMA/USDA

23. $ “Catastrophic” Yield Coverage  50 % yield coverage  Losses are paid at 55% of MPCI indemnity price  Optional units are not permitted  $100 / crop / county

24. $ Selected Revenue Insurances  “Pure” Revenue Insurance o RA  Revenue Insurance With Replacement Price Coverage o CRC o RA w/ RPC option

25. $ CROP REVENUE COVERAGE  CRC is a Revenue index contract with replacement price coverage  CRC is Designed to facilitate pre- harvest pricing  CRC is an index contract because the futures price is used to calculate “farm revenue”, not the local cash price

26. $ How is CRC Protection Determined?  CRC guarantees revenue based on the farm unit’s APH yield x CBOT harvest futures price during a base pre-sales closing period.  Price used in setting the guarantee is the higher of CBOT harvest price prior to sales closing and the CBOT harvest price at harvest  CRC gives upside replacement price protection to help mitigate delivery risk for users who pre-harvest price

27. $ Replacement Price Coverage: Case Examples of How Price is Chosen Year Harvest Futures Price Price used to calculate the revenue guarantee Pre-sales closingHarvest 1999$2.40$1.96$2.40 1995$2.57$3.28

28. $ Calculating Replacement Price Coverage Insurance Revenue Guarantee: 70% Coverage Example Year APH yield (bu) Futures price usedCov Rev. guar. 1999128.5 $2.40 (base)=$308.40x70%=$215.88 1995128.5 $3.28 (hvst)=$421.48x70%=$295.04

29. $ Replacement Price Coverage:Loss Examples Revenue Guarantee 70%Realized revenue Year Using Dec. Futures in April Base Using Dec. Futures in Oct Hvst Act. Yield Hvst fut. price @ hvst.Rev Loss = Guan. Minus realized 1995$231.17$295.04 60 $3.28 =$196.80$98.24 100 $3.28 =$328.00$0.00 1999$215.88$176.30 60 $1.96 =$117.60$98.28 100 $1.96 =$196.00$19.88

30. $ How is RA Protection Under the No Replacement Price Option Determined?  RA guarantees revenue based on farm unit’s APH yield x CBOT harvest futures price prior to sales closing.

31. $ Calculating the RA Insurance Revenue Guarantee: 70% Coverage Example Year APH yield (bu) Pre- sales closing futures priceCov Rev. guar. ’95128.5$2.57=$330.25x70%=$231.17 ’99128.5$2.40=$308.40x70%=$215.88

32. $ Compare Revenue Insurance Indemnities With and Without Replacement Price Coverage Harvest Futures Price Loss Year Pre- sales closingHarvest Yield With Rep. Price Cov.Pure revenue ‘95$2.57$3.2860$98.24$34.37 100$0.00 ‘99$2.40$1.9660$98.28 100$19.88

33. $ CRC and RA with RPC are “HYBRID” Policies  If the harvest futures price is less than the pre-sales closing base price, they are pure revenue policies  If the harvest price is greater than the pre-sales closing base price they are a MPCI policy with losses paid at the harvest price

34. $ CRC Features  Yield procedures are the same as MPCI including units; enterprise discounts are available  Available on only corn, soybeans and wheat  Rates are based on MPCI rates with an adjustment for the price risk component  Rates vary by historical county experience and farm’s APH yield relative to peers

35. $ RA Features  Yield procedures are ….  Available on only corn, soybeans and wheat  Rates are based on MPCI rates with an adjustment for the price risk component  Rates vary by historical county experience and farm’s APH yield relative to peers

36. $ Revenue Insurances: Where do They Fit?  Pure revenue insurance makes sense if farm does little pre-harvest pricing.  Revenue insurance with replacement price coverage fits when farm does significant pre- harvest pricing.  If the farm uses pre-harvest pricing, Revenue insurance with replacement price coverage typically outperforms MPCI and pre- harvest pricing … particularly, if farm yield and market price are correlated.

37. $ STOP! Fill out Crop Insurance Decision Worksheets!

38. $ Tasks:  Calculate protection for each policy to help you in your decision of whether or not to purchase and, if so, which coverage (deductible).  Start to lay out your objectives and assess whether crop insurance plays a potential role in meeting those objectives.