LRP For Livestock

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LRP For Livestock

• April 2008
• by Duane Griffith, Montana State University
• Gary Brester, Montana State University

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Livestock Risk Protection

• Feeder Cattle
• Fed Cattle
• Swine
• Lamb
• All these types of livestock are covered by LRP
  in all Montana and Wyoming counties.

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Examples are Using Livestock Risk Protection for
Feeder Cattle
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Feeder Cattle Coverage

• Can cover small number of head
• Not lumpy like Options Contracts
• Settles to daily CME index price

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Livestock Risk Protection-Feeder Cattle
Highlights

• LRP for feeder cattle offers single-peril price
  protection
• LRP does not eliminate other risks.
• Does not cover sickness or death of the cattle.
• Does not insure against possible rising feed
  costs
• Producers remain subject to basis price risk
  (Actual cash market price minus the cash-settled
  CME index value)

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Basics of LRP for Feeder Cattle

• LRP insurance does protect against decline in
  prices below the established coverage price.
• Insurance period Insurance is offered for 13,
  17, 21, 26, 30, 34, 39, 43, 47, or 52-week
  periods.
• The producer selects a time closest to
• When the cattle will be marketed or
• When cattle will reach the desired weight.

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Basics of Livestock Risk ProtectionFeeder
Cattle, cont.

• Application An application is required to
  purchase insurance coverage.
• It establishes producer eligibility.
• Must file a form indicating beneficial interest
  with the application
• Specific Coverage Endorsement
• A producer must file a Specific Coverage
  Endorsement for each group of feeder cattle to be
  insured.
• Several endorsements may be filed under one
  application as long as beneficial interests are
  the same.

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Basics of Livestock Risk ProtectionFeeder
Cattle, cont.
Feeder Cattle Types and Weights Eligible for LRP
Feeder Cattle Coverage
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Basics of Livestock Risk ProtectionFeeder
Cattle, cont.

• Endorsement Limits
• Limit of 1,000 head of feeder cattle may be
  insured under any one Specific Coverage
  Endorsement.
• Annual Policy Limits
• Total number of head of feeder cattle that may be
  covered during a crop year is 2,000 head.
• Coverage Prices
• Prices that may be insured by the producer change
  daily and are obtained from the RMA
  websitehttp//www.rma.usda.gov/tools/livestock.h
  tml

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Basics of Livestock Risk ProtectionFeeder
Cattle, cont.

• Coverage levels
• Calculated based on the chosen coverage price.
• Coverage levels will range from 70 to 100.
• Price Adjustment Factors
• Adjustment Factors applied to values listed on
  RMA website

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Basics of Livestock Risk ProtectionFeeder
Cattle, cont.

• Off-setting Transaction
• A producer must not enter into any transaction
  that would have the effect of converting any
  portion of the premium subsidy provided by the
  FCIC into funds available for the producers use.
  
• Therefore, no offsetting position may be taken in
  the commodity futures and options market.
• Expected End Value
• This is the expected prices at the end of an
  insurance record for each specific type and
  weight of feeder cattle announced daily on the
  RMA website
• http//www.rma.usda.gov/tools/livestock.html

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Basics of Livestock Risk ProtectionFeeder
Cattle, cont.

• Actual End Value
• This is the value of CME feeder cattle index on
  the end date of the insurance period,
• Adjusted by RMA for feeder cattle type and weight
• Subsidy Level
• 13 subsidy on LRP feeder cattle contract
  insurance premiums

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LRPFeeder Cattle Example
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LRPFeeder Cattle Example
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LRP Example

• Suppose a producer actually sells 1,000 of 800
  pound steers on May 7, 2008.
• Sold the steers for 100.00/cwt
• The CME-reported actual ending value is
  97.50/cwt.
• Will the producer receive an indemnity

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LRP Example Answer

• Yes.
• Indemnity calculation
• 1,000 head x 8 cwt/head x (99.73 - 97.50)
  17,840
• Revenue from calves
• 1,000 x 8 cwt/head x 100.00 800,000
• Plus indemnity of 17,840
• Less net premium paid -
  9,124
• Net revenue 808,716

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LRP Example Answer

• Recall that the producers was expecting
  107.96/cwt
• 1,000 x 8 cwt/head x 107.96/cwt 863,680
• Without LRP, the producer receives 800,000
• With LRP, the producer receives 808,716

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• Questions ??

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• Adjustment factors account for differences
  between heifer prices and prices of other types
  and weight of cattle.
• Price adjustments are applied to expected ending
  values, coverage prices and actual ending values
  prior to entry on the RMA website.

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Livestock Gross Margin

• First offered in late January of 2006
• Covers finishing margin on yearlings and calves
  fed in major cattle states
• Uses set (fixed) basis levels for insurance
  period
• Producer chooses deductible level
• May be cost-effective for small feeders

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State-Level Basis Tables (/cwt. or bu.)
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Margin Example May South Dakota Yearling,
Covered Jan-06

• October Fed (87.00 3.68) 1,133.50
• Value 12.5 cwt.
• - -
• May Yearling (114.00 3.77) 826.73
• Cost 7.5 cwt.
• - -
• August Corn (2.36 - 0.32) 117.30
• Cost 57.5 bu.
• Expected Margin (per head) 189.47

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Typical Marketing Plan

• Backgrounder with 150 head of steers to sell on
  March 15, 2006
• Buy 2 March FC puts (130 head), 100 strike, for
  2.60 per cwt. or better
• Buy LRP-Feeder coverage on 20 head, 90 percent
  level, for 3.00 per cwt. or better
• Sell 1 March futures if 110 or better

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LRP Versus Options, cont.

• LRP Put options both protect price risk.
• For LRP, the selected coverage price is the
  producers price floor.
• For options, the selected strike price is the
  producers price floor.
• Both LRP Options require the payment of a
  premium.
• LRPan insurance premium is paid to an insurance
  agent.
• Optionsan option premium is paid to a broker.

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LRP Versus Options, cont.

• Payouts are received when prices decline below an
  insured level.
• LRP- receive an indemnity
• Options- option premium increases in value and is
  reflected in the producers brokerage account

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LRP Versus Options, cont.

• No payouts are received if market prices remain
  above the insured level.
• LRP No indemnity
• Options Option premium declines to zero and
  there is no increase in the producers brokerage
  account.
• Both LRP and options are subject to basis risk.
• Both products protect the producer from a decline
  in the CME feeder cattle price index

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LRP Versus Options, cont.

• Neither product protects the producer from a
  decline in the producers sale price.
• Disadvantages of options relative to LRP
• Need a brokerage account hence brokerage fees
• Subsidies are not available for option premiums.
• No price adjustments for varying weights.

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LRP Versus Options, cont.

• Advantages of Options relative to LRP
• A producer may buy higher price coverage levels
  than LRP.
• LRP coverage levels always out of the money
• More timing flexibility because the producer may
  sell an option prior to expiration.
• Can re-purchase an option at any time

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Livestock Risk Protection

• Feeder cattle coverage was first offered June 9,
  2003.
• Feeder cattle endorsement suspended December 24,
  2003 after BSE case of previous day.
• Feeder cattle endorsement resumed September 30,
  2004.