Livestock Revenue Insurance: Livestock risk management using an insurance tool

1
Livestock Revenue Insurance Livestock risk
management using an insurance tool

• Research and Commodity Services
• Iowa Farm Bureau Federation

2
Presentation Objectives

• Review Risk Management Factors
• Livestock Revenue Insurance Programs for Hogs
• Livestock Gross Margin (LGM) Insurance
• Livestock Risk Protection (LRP) Insurance
• Livestock Revenue Insurance Programs Fed
  Feeder Cattle
• Livestock Risk Protection (LRP) Insurance
• This presentation reviews hog insurance first,
• Then gives information on fed and feeder cattle
  insurance

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Important !

• This presentation is from a general risk
  management perspective it is not intended to be
  specific insurance advice.
• Examples used are to teach concepts Check with
  an agent or insurance company on all details ! !
  !
• Education resources used include
  
  Center for Agricultural and Rural Development,
  ISU Extension, USDA Risk
  Management Agency and National Crop Insurance
  Services

4
Risk Management is not predicting prices!!

• No one can know the future!
• UNKNOWN factors move the market and that
  is the risk !

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Revenue Insurance

• Approach/Attitude toward risk management tools is
  important !
• Crop/Livestock insurance is not an
  investment.
• Other forms of insurance are not viewed
  as investments!
• Revenue Insurance is risk management, and should
  not be expected to pay.

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Risk Management Tools

• Futures options
• Constant hedge, targeted hedges
• Forward Contracts
• Fixed price
• Formula pricing arrangements
• Plus many others
• Livestock Revenue Insurance

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Any risk management tool

• Is intended to minimize negative
  outcomes
• by taking some action.

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February Lean Hog futures
Market prices are always a risk!
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Swine Production One Litter
Cost are large in hog production and so is the
risk !
Output price is important and remember that feed
cost is 54 of total costs !
10
Risk Management Tools

• Each tool has advantages disadvantages.
• Livestock Revenue Insurance is simply another
  tool in the risk management toolbox.
• The products have distinct advantages to point
  out

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Livestock Revenue Insurance

• Convenience
• Saves the producer management time and effort
  over using options strategies.
• Customization
• Products are flexible and fit any operation.
  Coverage can be purchased for any number of hogs
  or cattle.
• Futures contracts have specific size (40,000 lbs.
  216 head)
• New products fit well with small to medium size
  operations.

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Livestock Revenue Insurance

• May have lower cost
• Premiums vary, but some examples show that
  coverage can be cheaper.
• Producer subsidy may make coverage cheaper than
  ag options.
• Other Advantages . ? . ?

13
Livestock Revenue Insurance

• Hog Revenue insurance started in Iowa in 2002
• Livestock Gross Margin (LGM)
• Livestock Risk Protection (LRP)
• Suspended in Dec. 2003 (BSE) and reintroduced in
  2004
• Allowed as result of ARPA, Agriculture Risk
  Protection Act of 2000.
• LRP has since expanded to many other states and
  fed feeder cattle.

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Livestock Revenue Insurance

• Futures based revenue calculations are meant to
  mirror the farmers cash based situation.
• Uses futures based values to help producers
  manage price risk even though the products may
  settle to cash type markets, these are not equal
  to your cash market.

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Livestock Revenue Insurance

• Livestock Gross Margin (LGM)
• Protects against a negative change in gross
  margin (hog less feed cost).
• Livestock Risk Protection (LRP)
• Protects against a negative change in hog price.

Lets look at LGM first ? ? ? ? ?
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Livestock Gross Margin (LGM)

• Guarantees MINIMUM gross margin
• hog value per head less feed costs
• Locks in a floor gross margin.
• Gross margin is based on
• Price of lean hog futures contracts.
• Price of corn futures.
• Price of soybean meal futures.

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LGM Hog Insurance Policy

• Hogs are assumed to be marketed at 260 lb.
• Feed prices are lagged to represent the middle of
  the feeding period.
• Cost of feed depends upon type of operation
• Farrow-to-finish
• Feeder-to-finish
• SEW-to-finish (Segregated Early Weaned)
• (Feed costs based on ISU estimates)

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Determining the Guarantee

• Classify the operation (farrow-to-finish,
  feeder-to-finish, or SEW-to-finish).
• 12 insurance periods each year, each is 6 months
  in length, no hogs insured for 1st month of
  period
• Project the number of hogs to be insured in
  months 2 through 6 (5 months of coverage)

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Determining the Guarantee

• Insuring floor gross margins of total number of
  hogs insured during the 5 months (months 2 -
  6).
• Maximum is 15,000 head in each period (30,000
  head in insurance year).

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Determining the Guarantee

• Coverage, indemnity and premium are based on the
  marketing plan submitted by producer
• The expected insured hogs to sell in the period,
  not the hogs the producer actually sells.
• Marketing plans and price levels are adjusted for
  each sales period.

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Determining the Guarantee

• Uses hog, corn and bean meal futures prices
  during the last 3 business days of the month.
• Each month uses the price for the contract that
  expires in that month, or an average of the
  contracts that expire in the surrounding months.

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Determining the Guarantee

• Feed prices are lagged
• 3 months for farrow-finish
• Example
  August marketings use feed
  priced in May
• 2 months for feeder finish and SEW pigs
• Example
  August marketings use feed priced in
  June

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LGM details

• Projected gross margin 260 lb. x 74 x hog
  price - feed cost.
• Projected gross margin per pig in each month
  x number of head to sell monthly
  gross margin.
• Add together all 5 months total gross margin.
• Guarantee can be from 80 to 100 of
  projected total gross margin.

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Example

• Purchased last business day of December
• Based on prices last 3 business days Dec. 28
  30.
• Coverage for Feb. through June.
• Farrow-to-finish operation example

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Farrow-to-Finish Example

• Expected Gross Margin
• Hog Value less feed costs
• 0.74 (lean conversion) 2.6 (weight in cwt.)
  X Expected Hog Price
• MINUS 12.95 (bu. per head)
  X Expected Corn Price
• MINUS (184.89/2000 (change per ton to per lb.)
  X Expected Soybean Meal Price

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Gross Margin Per Hog (Feb.)

• 2.6 x 0.74 x Lean Hog Pricet
• 12.95 x Corn Pricet-3
• (184.89 / 2000) x SoyMeal Pricet-3
• 2.6 x 0.74 x 75.17
• 12.95 x 2.01
• (184.89/2000) x 158.10
• Gross Margin per Hog 103.98

For Feb. Marketings
Top of page 4
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Projected Gross Margin (GM)
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Coverage and Guarantee
Coverage
Guarantee
Lets insure the example at 90
Selected
100
51,755
95
49,167
90
46,580
85
43,992
80
41,404
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Example

• 46,580 floor insured amount (90 of total
  expected gross margin)
• Estimated premium 2.22 per head or 1,108 for
  500 head.

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Example
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Internet site for Premium Estimates

• www.card.iastate.edu/ag_risk_tools/lgm
• Interactive tool that includes estimated
  premiums, gross margins and the prices used to
  calculate gross margins

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Actual GM Per Hog

• Actual Gross Margin is not your farm Gross
  Margin
• Calculated using the average of the last three
  days of trading of the appropriate futures
  contract, includes
• Price of lean hog futures contracts.
• Price of corn futures.
• Price of soybean meal futures.

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Actual GM Per Hog

• 2.6 x 0.74 x Lean Hog Pricet
• 12.95 x Corn Pricet-3
• (184.89 / 2000) x SoyMeal Pricet-3

Example
Lean hog price goes 4.00 lower,
corn 25 cents higher
soymeal 25/ton higher! That would narrow
margins. What is the result?
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Gross Margin narrows

• Example Lean hog price down 4.00 lower, corn up
  25 cents soymeal up 25/ton!
• Narrower margins

Hog Price
Gross
Margin
Feed Cost
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Projected Gross Margin was
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Projected Gross Margin was
Insured 90 or 46,580
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Actual Gross Margin (GM)
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Example

• 46,580 floor insured amount (90 of
  total expected gross margin for 5 month period)
• Actual Gross Margin 40,619
• Indemnity to farmer 5,961

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Internet Table
Risk Management Agency - USDA
www3.rma.usda.gov/apps/livestock_reports/main_menu
.cfm
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Premiums

• Premiums are dependent on a number of variables
• Amount of coverage selected
• Producers marketing plan
• Level of futures prices
• Amount of price volatility

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Premiums

• Higher guarantees will have higher premiums
• Also, if more hogs will be marketed early in the
  period, premiums should be lower (prices in
  nearby months should change less than for later
  months)

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Example Effect of LGM Coverage Level on Per-Hog
Premium

• Per hog premium is directly related to the
  coverage level.
• There is no producer premium subsidy in this
  program.

4.50
4.00
3.50
3.00
2.50
/hog
2.00
1.50
1.00
0.50
0.00
80
85
90
95
100
Coverage Level
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Who can benefit from LGM?

• Producers who depend on the daily cash market or
  a formula related to it.
• Smaller producers who do not have the volume to
  use futures contracts.
• Producers who dont want to put up margin money.
• Producers who have feed price risk.

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• Livestock
• Risk
• Protection
• (LRP)

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Livestock Risk Protection (LRP)

• Coverage in lots of 1 to 10,000 at any one time,
  but no more than 32,000 head/yr.
• Sold throughout the year.
• Available to insure hogs with end dates at 13,
  17, 21, 26 weeks.
• Select end date closest to market date.

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Livestock Risk Protection (LRP)

• Priced daily throughout year, premiums calculated
  using formula based on hog futures prices.
• Coverage available from 70 to 95
  of hog price (not 5 increments).

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Livestock Risk Protection (LRP)

• Producer chooses target weight (example 250),
• Lean weight conversion (.74) 1.85 cwt.
• Premium rate changes w/ coverage price.
• Premium subsidy is 13.

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Internet Table LRP Swine
www3.rma.usda.gov/apps/livestock_reports/criteria_
flow.cfm
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Internet Table LRP Swine

• LRP Insurance Table includes
• Expected Ending Value,
• Coverage Price,
• Coverage Level ,
• Rates
• and Cost.

www3.rma.usda.gov/apps/livestock_reports/criteria_
flow.cfm
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LRP Internet Table Example
Deduct 13 for producer subsidy from Cost column
1/14/05
Expected
Cost
Endorsement
End
Coverage
Per
Coverage
Rate
Length
Value
Price
Level
Cwt.
0.9359
13 (weeks)
77.562
72.590
0.0353
2.566
13
77.562
70.590
0.0270
1.905
0.9101
13
77.562
68.590
0.0211
1.445
0.8843
0.8585
13
77.562
66.590
0.0161
1.071
There will be different endorsement lengths 13,
17, 21, 26 week coverages.
End date 4/15/05
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LRP Simple Example (Swine)

• Expected ending value (17 weeks) 76.56,
• Choose to insure price protection at 70.59
  (91.01 coverage)
• Example If ending value was 65.00 for insured
  hogs, insured producer paid 5.59/cwt.
• If avg. cash price was gt 70.59 for insured hogs,
  no loss, no indemnity.

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Ending value

• AMS (Agricultural Marketing Service-USDA) price
  series is used to determine the weighted average
  price of lean hogs.
• This is the same series used to settle lean hog
  futures contract at Chicago Mercantile Exchange
  (CME).
• Weighted average price is calculated using two
  Producer Sold data series in report
• Negotiated category and
• Swine or Pork Market Formula (SPMF) category.

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LRP Simple Example (Swine)

• Gross premium from table is 1.905/cwt.
• Premium subsidy is 13.
• Farmer premium 1.66/cwt. or 3.07/head (if Lean
  weight selected by farmer is 1.85 cwt.)
• For floor price of 70.59.

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LRP availability
The Expected Ending Value, Coverage Price,
Coverage Level , Rates and Cost are changed
daily. Coverage available from price and rate
posting on RMA website (about 500 p.m) and
ending the following day at 900 a.m. Central
Time
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Livestock Revenue Insurance

• Key policy provisions allow for the suspension of
  sales of the insurance under certain conditions,
  including, but not limited to
• Limit moves in the livestock futures market.
• Also, offsetting futures or options transactions
  are not allowed (farmer can still hedge).

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Livestock Revenue Insurance for Hogs

• Livestock Gross Margin (LGM)
• Protects against a negative change in gross
  margin (hog less feed cost).
• Livestock Risk Protection (LRP)
• Protects against a negative change in hog price.

Two distinct products covering risk differently !
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Livestock Revenue Insurance

• LGM and LRP
• Are year long policies (coverage is in shorter
  time periods).
• Cant have both policies in place at same time
  even if no coverage is selected.
• Can cancel one to use the other if no coverage is
  in place.

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LGM and LRP Similarities

• Market based risk management for producers,
  without locking out chance for better outcome.
• Forward looking, using current market
  opportunities.
• Premium due at purchase.
• Based on target market.

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LGM and LRP Differences

• Gross Margin protection vs. Price Protection.
• Coverage levels.
• Ownership shares
• LGM 100, LRP partial shares
• LGM 260, LRP producer selects weight
• Appeal in different situations to unique pork
  operations.

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• Livestock Risk Protection
• (LRP)
• For fed and feeder cattle have many similarities
  to LRP Hog. Following are some specifics that
  apply to cattle

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• Livestock Risk Protection
• (LRP)
• Fed Cattle

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Livestock Risk Protection (LRP)Fed Cattle

• Can cover lots of 1 to 2,000 head at any one
  time,
• But no more than 4,000 head in one crop year.

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Livestock Risk Protection (LRP)Fed Cattle

• Coverage periods for fed cattle to market in 13,
  17, 21, 26, 30, 34, 39, 43, 47 or 52 weeks.
• The insurance is for fed cattle that are expected
  to grade select or higher with a yield grade of 1
  to 3.
• Cattle targeted for market at 1,000 to 1,400 lbs
  are eligible for coverage.

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Livestock Risk Protection (LRP)Fed Cattle

• The actual ending value is the live basis sales,
  steers, 35 65 choice category on a weekly
  Agricultural Marketing Service-USDA (AMS) report.
  
• If the ending value is below the selected
  coverage price, there would be an indemnity.
• If cash exceeds coverage price, there would be no
  insurance indemnity.

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• Livestock Risk Protection
• (LRP)
• Feeder Cattle

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Livestock Risk Protection (LRP)Feeder Cattle

• Can cover lots of 1 to 1,000 head at any one
  time,
• But no more than 2,000 head in one crop year.

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Livestock Risk Protection (LRP)Feeder Cattle

• Coverage periods are for feeder cattle to market
  in 13, 17, 21, 26, 30, 34, 39, 43, 47 or 52
  weeks.
• For steers or heifers with very specific weights
  and types of cattle.
• Selling weights of cattle depend upon type.

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Livestock Risk Protection (LRP)Feeder Cattle

• The actual ending value is the Chicago Mercantile
  Exchange Feeder Cattle Reported Index (a daily
  average of auction prices).
• If the index is below the selected coverage
  price, there would be an indemnity.
• At prices above the coverage price, no insurance
  indemnity would be paid.

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More information

• Although there is lots of information on the web
  for these products, the coverage must be
  purchased from a qualified livestock insurance
  agent. Check with agent on details.
• LGM information
• (including premium gross margin estimates)
• www.card.iastate.edu/ag_risk_tools/lgm
• LGM LRP information from USDA Risk Management
  Agency
• LGM details www.rma.usda.gov/policies/2005LGM.htm
  l
• LRP details www.rma.usda.gov/policies/2005LRP.htm
  l
• LGM and LRP coverage values, etc.
  www3.rma.usda.gov/apps/livestock_reports/main_menu
  .cfm

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Risk Management is . . . Protecting Financial
Security

• Guarantee cash flow
• Replace working capital
• Protect net worth
• Using insurance doesnt mean the pricing job is
  done -- may need to lock in price using another
  tool (contract, hedge, etc.)

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Who needs to protecting financial security with
livestock revenue insurance ?????

• Operations dependent upon the open market,
• Those with any contract tied to the cash market
  including shackle space contracts that price on
  3 day average,
• In future, those in contracts now !
• Everyone in livestock production
  has risk management needs.

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Points to Ponder for Producers

• Consider the new tools on at least a small
  portion of production to learn concepts for
  future use.
• These products can be stay in
  business insurance (remember hogs in 1998!)
• Check with insurance agent for more information
  and details.

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In Summary

• There is always sufficient reason for producers
  to have a risk management plan in place for
  livestock operations.
• Consider livestock price level and gross margin
  level vs. history
• Producers should consider how the new revenue
  insurance products can help manage risk and check
  with an agent qualified to sell livestock revenue
  insurance .

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Thank you !!!