Production Risk Management: Running With The Bulls

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

2. OUTLINE • . Production Risk Management • . Insuring Production Costs? • . Insuring Crop Replacement? • . Multiple Peril Crop Insurance • . Revenue Insurance • . Revenue Assurance • . Crop Revenue Coverage • . Questions

3. OUTLINE • . Production Risk Management • . Insuring Production Costs? • . Insuring Crop Replacement? • . Multiple Peril Crop Insurance • . Revenue Insurance • . Revenue Assurance • . Crop Revenue Coverage • . Questions

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

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

6. OUTLINE • . Production Risk Management • . Insuring Production Costs? • . Insuring Crop Replacement? • . Multiple Peril Crop Insurance • . Revenue Insurance • . Revenue Assurance • . Crop Revenue Coverage • . Questions

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

8. MPCI Spring Wheat Example

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

10. OUTLINE • . Production Risk Management • . Insuring Production Costs? • . Insuring Crop Replacement? • . Multiple Peril Crop Insurance • . Revenue Insurance • . Revenue Assurance • . Crop Revenue Coverage • . Questions

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

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

13. RA Example

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

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

16. OUTLINE • . Production Risk Management • . Insuring Production Costs? • . Insuring Crop Replacement? • . Multiple Peril Crop Insurance • . Revenue Insurance • . Revenue Assurance • . Crop Revenue Coverage • . Questions

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

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

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

20. CRC Wheat Example

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

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

23. Summary Results

24. Summary Results

25. Summary Results

26. Summary Results

27. Summary Results

28. 10 Bushel Yield & $8.00 Price

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

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

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

32. QUESTIONS?