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Production Risk Management:Running With The Bulls

Gary BresterMSU 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

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OUTLINE1. 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

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OUTLINE1. 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

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Production Risk Management1. How Does A Bull Market Influence

Crop Insurance Decisions?2. Insuring Production Costs?

a. Increase In Crop Prices Between Planting And Harvestb. Little Correlationc. Not Really An Issue

3. Crop Replacement Costsa. Expect To Use Corn Crop To Feed Cattleb. Replacing Such A Crop With Higher Priced Corn Is An Issue

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Wheat

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

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OUTLINE1. 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

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Multiple Peril Crop Insurance1. 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 MPCIPrice Forecast

5. Premium Equals The Maximum Indemnity Multiplied By The Premium Rate

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MPCI Spring Wheat Example

Contract Data Value Calculation

APH Yield 50 bu. producer

Coverage Level 70% producer*

Yield Guarantee 35 bu. 0.70 x 50 bu.

MPCI Price Forecast $9.00/bu. RMA

Price Election 100% producer*

Elected Price $9.00/bu. 1.0 x $9.00

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MPCI Spring Wheat Example1. Suppose You Actually Harvest 33

Bushels Per Acre2. You Receive An Indemnity Because

33 Bushels Is Less Than YourYield Guarantee Of 35 Bushels.

3. You Receive The DifferenceIn Bushelsa. 35 – 33 = 2 bu/ac

4. Valued At Your Elected Pricea. 2 bu/ac x $9.00/bu = $18/ac

5. Harvest Price Of $12.00/bua. 33 bu/ac x $12.00/bu = $396/ac

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OUTLINE1. 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

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Revenue Assurance (RA)

1. Can Insure Optional, Basic, Or Enterprise Units

2. Producer Establishes An APH

3. Producer Chooses ACoverage Level

a. 50%-75%

4. RMA Establishes A “Projected Harvest Price”

a. Formula-Based Off Of September MGE Futures Price

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Revenue Assurance (RA)

5. RA Basic Revenue Guaranteea. APH Yield x Coverage Level x RMA Projected Harvest Price

6. Producers May Choose a “Harvest Price Option”

a. RA Harvest Revenue Guaranteeb. 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)

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RA Example

Contract Data Value Calculation

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

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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

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RA Example: Price Increase

4. You Do Not Receive An Indemnity From Basic Harvest Revenue Guarantee

a. $396/ac > $385/ac5. 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/acc. $24/ac Indemnity

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OUTLINE1. 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

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CRC Insurance

1. Can Insure Optional, Basic, Or Enterprise Units

2. Producer Establishes An APH For Each Unit

3. Producer Chooses ACoverage Level

a. 50%-75% (or 85%)

4. RMA Establishes A “Base Price”

5. Producer Chooses 95% or 100% Price Election

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CRC Insurance

6. Minimum Revenue Guarantee

a. APH Yield x Coverage Level x RMA Base Price x Price

Election

7. Producer Receives AnIndemnity When

a. Actual Yield Multiplied ByThe RMA “Harvest Price”

Is Less Than The Minimum Revenue Guarantee

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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

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CRC Wheat Example

Contract Data Value Calculation

APH Yield 50 bu. producer

Coverage Election 70% producer*

RMA Base Price $11.00/bu RMA

Price Election 100% producer*

Initial Minimum

Revenue Guarantee$385/ac

50 bu. x 0.70 x $11.00 x 1.0

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CRC Example: Price Increase

1. Suppose You Actually Harvest 33

Bushels Per Acre

2. But, The RMA Harvest 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

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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 WasNot Considered

a. Your Indemnity Would Be Zero

b. $396 > $385/ac

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Summary Results

ProductCropValue Indemnity Premium

Net Revenue

None $396 $0 $0 $396/ac

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Summary Results

ProductCropValue Indemnity Premium

Net Revenue

None $396 $0 $0 $396/ac

MPCI $396 $18 $16 $398/ac

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Summary Results

ProductCropValue Indemnity Premium

Net Revenue

None $396 $0 $0 $396/ac

MPCI $396 $18 $16 $394/ac

RA $396 $0 $24 $372/ac

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Summary Results

ProductCropValue Indemnity Premium

Net Revenue

None $396 $0 $0 $396/ac

MPCI $396 $18 $16 $394/ac

RA $396 $0 $24 $372/ac

RA (Harvest

Price Option)

$396 $24 $29 $391/ac

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Summary Results

ProductCropValue Indemnity Premium

Net Revenue

None $396 $0 $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

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10 Bushel Yield & $8.00 Price

ProductCropValue Indemnity Premium

Net Revenue

None $80 $0 $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

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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

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Other Issues2. 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

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What Is The Goal?1. Insure Against Loss OfVariable 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?

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QUESTIONS?