For decades, livestock price risk management meant buying a position in the futures or options markets. Problem is, too few cow-calf producers and feeders — especially those with smaller operations — understood or were able to use those risk management tools.
Today, though, producers are being introduced to a new generation of risk management strategies — livestock price insurance.
USDA's Risk Management Agency (RMA) was mandated under the Agricultural Risk Protection Act of 2000 to initiate pilot programs offering insurance guaranteeing a minimum price for feeder and fed cattle.
Meanwhile, a conceptually different private industry alternative has been patented in Texas to insure fed cattle prices. Risk Reduction Resources, Inc. (RRR), Victoria, TX, has a blueprint for price insurance based on expected breakeven selling prices.
The proponents of each price insurance system say their schemes will be useful to operations of all sizes. In some cases, smaller cow-calf operators and feeding operations are the target, which is often not the case with futures and options contracts, they say.
The Subsidized Program
RMA's Livestock Risk Protection (LRP) offers coverage based on expected cash prices at the policy end date. Coverage levels range from 70-95% of the expected ending value. The Federal Crop Insurance Corporation subsidizes 13% of the producer's gross feeder and fed cattle premiums.
“RMA has a mandate to make price protection affordable so smaller swine and cattle producers can be profitable in the livestock business,” says Randy Rhodes, Glenwood, IA. He's an insurance producer for Farmers National Company.
The calendar year for the LRP programs will be from July 1 to June 30. Early signup ran June 9-30 for the 2003 coverage year. After July 1, applications taken will be for the 2004 coverage year.
Tip Of The Iceberg?
Many analysts see LRP's “base products” as the tip of the insurance iceberg, paving the way for expansion into other livestock “revenue products” and other commodities. It's even been mentioned that USDA's Animal and Plant Health Inspection Service is exploring livestock price risk insurance in addressing foreign animal diseases and managing quarantine and depopulation policies.
Livestock price insurance doesn't come cheap though. And, like other insurance, it's intended to protect against unforeseen events or a catastrophic collapse in market prices.
Jim Robb, an economist with the Livestock Marketing Information Center in Englewood, CO, says price insurance is certainly a concept that's gaining attention — and credibility.
“What level of insurance an individual producer can afford is only going to be determined as the programs advance,” Robb says. “The costs and benefits will vary for everyone, but price insurance gives livestock producers another tool to use in risk management.”
The Selling Points
Robb says it's important to keep in mind that LRP insurance has nothing to do with what price the cattle sell for. It's merely an insurance policy that provides a minimum guarantee of income for insured cattle.
“Another important feature of this product is that it could be used as collateral with a lender,” Rhodes says.
Producers can choose the length of a policy's term, but must sell the cattle or move them to the next phase of production within 30 days of the endorsement date.
“You are locking in a price, but without making margin calls,” Rhodes explains. “And, when it comes to feeder cattle, the cattle don't necessarily have to be sold, which helps people who want to retain ownership.”
To date, more than half of the 17 insurance companies certified to sell under Federal Crop Insurance have signed up to represent the LRP products.
Even though the program is only available in the pilot states (see sidebar), producers living in other states may choose to take advantage of the insurance.
“The program covers cattle where they reside when the papers are signed,” Rhodes adds. “You can live in another state and qualify for the coverage.”
Rhodes admits that this program is new and there are a lot of wrinkles yet to be ironed out.
“But, cattle producers are wanting more tools to protect prices,” he says. “There's a lot of interest in this program.”
A Private Industry Alternative
Jim Hartman, Victoria, TX, a former ag banker, came up with a different form of risk management for feedlots. A former banker, Hartman and his partners own a patented product to insure fed cattle based on an estimated future breakeven price.
While the insurance is still 6-12 months from fruition, RRR plans to have a pilot program for cattle feeders and cow-calf producers retaining ownership through the finishing period. Policies will be issued by a domestic insurance company but a portion of the risk will likely be backed by reinsurance behemoth Lloyd's of London.
“The concept with this insurance is that you supply the company with a projected breakeven price. For a percent of that breakeven, the company covers the market risk equaling 15% of that breakeven,” Hartman says. “The producer isn't locking in a sale price under this program, but simply buying market risk insurance.”
Hartman admits his insurance is costly risk management compared to a put, a call or selling the board. But, in return, the producer is getting a solid insurance policy where he or she knows exactly the cost of coverage and the level of protection.
“Also, in talking with the bankers, the producer can use this insurance in lieu of their normal feeding equity cash requirements,” Hartman says. “This can be a very important factor for some producers.”
Breakevens Are The Key
Ernie Davis, a Texas A&M University economist, has been working with RRR. He says this insurance product makes sense because it deals with production costs.
“The feeding industry can do a good job of predicting a breakeven selling price,” Davis says. Insurance prices will be based on USDA's posted weighted average Choice price.
“It's so simple that a lot of people wonder why it hasn't been thought of before,” Davis adds. “But, in general, people have been satisfied with the futures market or haven't bothered with risk management strategies at all.”
He says this type of price insurance will be useful to cow-calf and stocker producers retaining ownership.
“The company might not insure every pen of cattle, though,” Davis explains. “If you bring a sorry-doing set of cattle in with a far-out breakeven price, they probably won't be accepted.”
The premiums will have to be competitive and outperform what RMA is offering, he adds.
“Cattlemen haven't thought too much about risk management until now, but it's becoming the smart thing to do,” Davis concludes. “It's a whole new world today, and this insurance is a tool that's easy to understand and can be used by virtually anyone who needs it.”
For details on RRR's insurance offerings, contact Jim Hartman at 361/550-0163 or e-mail [email protected].
Government-Backed Price Insurance
USDA's Livestock Risk Protection (LRP) program for fed cattle is available in Illinois, Iowa and Nebraska. It covers steers expected to grade Select or better with a Yield Grade of 1-3 when slaughtered at the end of the insurance period.
Fed cattle policies will be offered in 30-day increments from 13-52 weeks. A maximum of 4,000 fed cattle may be insured in any one year.
USDA's Agricultural Marketing Service calculates the prices used for the fed cattle program using the Five Area Weekly Weighted Average Direct Slaughter Cattle Price.
The LRP feeder cattle insurance program will be available in Colorado, Iowa, Kansas, Nebraska, Nevada, Oklahoma, South Dakota, Texas, Utah and Wyoming.
Feeder cattle refers to steers that will weigh 650-900 lbs. at the end of the insurance period. Heifers, and dairy or Brahman steers, are not eligible.
The insurance period will be in 30-day increments from 22 to 52 weeks. A maximum of 2,000 feeder cattle can be insured in any one year.
The prices, rates and coverage levels are available on the RMA/LRP Web site at http://www3.rma.usda.gov/apps/livestock_reports/main_menu.cfm on a daily basis. Coverage levels range from 70-95% of posted prices. Prices used for feeder cattle are taken from the Chicago Mercantile Exchange Feeder Cattle Reported Index.
How LRP Insurance Works
Let's say a producer has 100 head of feeder cattle expected to weigh 750 lbs. and ready to market in 21 weeks. The expected ending live value as posted on the RMA Web site at the end of the 21-week period is $78.95/cwt.
The producer opts for a coverage level of 95% of this price, which would be $75/cwt. The coverage equals $56,250 with a premium of $685. This $6.85/head cost guarantees the producer will receive no less than a value of $75/head when the cattle are ready to market.
Producers can find a local agent by contacting the RMA website at http://www3.rma.usda.gov/apps/agentslpi/.