Economics: August 2003 Other Economics Articles

The USDA's Risk Management Agency (RMA) has announced a pilot program that will extend insurance protection to cow-calf and stocker cattle producers in Texas and Oklahoma. The effective date was June 9, 2003. This program provides producers a new risk management tool designed to protect against a decline in prices below an established coverage price. The Livestock Risk Protection (LRP)- Feeder Cattle Insurance Program is designed to insure feeder cattle inventory against decreases in price. "Feeder cattle" refers to steers that will weigh 650 to 900 pounds at the end of the insurance period. Feeder cattle that are predominantly dairy or Brahman breeds are not eligible for the insurance. Also, note that heifers are not eligible for the insurance.

The LRP-Feeder Cattle program offers producers a price risk management tool that is very much like the protection available with feeder cattle put options traded at the Chicago Mercantile Exchange (CME).

The LRP-Feeder Cattle insurance program, however, may have advantages, particularly for smaller producers.
These advantages include:
  1. A producer can choose the number of head to insure as opposed to the 50,000-pound lots mandated by the CME options contracts. There is no minimum number of head specified in the Federal Crop Insurance Corporation (FCIC) rules. This will provide producers the capability to match the coverage purchased with expected production.
  2. The LRP-Feeder Cattle program provides the producer the opportunity to adjust coverage levels between 70 percent and 95 percent of the quoted coverage price. This allows producers to protect projected cash flow in relation to their individual cost structure and their ability to bear risk. If one can bear risk, then a larger deductible will reduce the cost of the insurance.
  3. The cost of LRP-Feeder Cattle insurance is partially (13 percent) subsidized by FCIC.
  4. The LRP-Feeder Cattle insurance periods will be in approximately 30-day increments from 22 to 52 weeks.

The distant periods may offer more viable risk protection than the lightly traded distant CME option contracts. An application for coverage must be made through a crop insurance agent authorized to sell livestock insurance. The RMA will publish a list of agents authorized to write LRP insurance on its Web site at www2.rma.usda.gov/tools/. The "crop year" for LRP-Feeder Cattle Insurance is July 1 to June 30. During the crop year, any one producer is limited to insuring 2,000 head.

The two main components of the LRP premiums are the coverage price and the premium rate. This information and the coverage levels are available daily on the RMA Web site for the LRP program (www2.rma.usda.gov/tools/). The table on page 4 is an example of the choices available for July 7, 2003, for Oklahoma producers.

An example of calculating premium and insured value:
1. A producer has 20 steers that are expected to weigh 700 lbs. on or about December 1, 2003.
2. From the table below, or the RMA web site mentioned above, determine an insurance period (endorsement length) that fits the sale date or end date for the cattle. An end date of December 1, 2003, has an endorsement length of 21 weeks for policies with an effective date of July 7, 2003.
3. For endorsement lengths of 21 weeks, there are six coverage price options. (Note: several coverage price options have been deleted for space) The expected end value is $86.177. For a coverage level of 95 percent (.9461), the coverage price is $81.53. Thus the 20 steers with a total weight of 14,000 lbs. would be insured for a total value of $11,414.20.
4. The premium rate for this level of coverage is $0.011836. The coverage price of $81.53 per cwt. times the rate of $0.011836 results in a cost or premium per cwt. of $0.965 or $6.755 per head for 700 lb. steers.
5. The FCIC producer premium subsidy is 13 percent. Thus the final cost to the producer of the insurance program outlined above is $5.877 per head or $117.54 for the 20 head.

If the actual ending value of the insured cattle is less than coverage price, an indemnity is calculated. Note that the ending value is not calculated using the actual sale weight and price of the steers. The actual ending value is the weighted average price of feeder cattle as calculated by the CME for the Cash-Settled Commodity Index Prices. This price is reported as the CME Feeder Cattle Index™ and is available on the Internet at www.cme.com/clearing/clr/list/contract_listings_cl.html?product=FC&foi=OOF.

In the example above, if the actual ending value is $80.00 per cwt., then an indemnity payment of $1.53 per cwt. will be due. The indemnity payment would be $10.71 per head or $214.20 for the 20 steers. The new LRP-Feeder Cattle insurance program should fill a need in the price risk management area for many small- to medium-size cow-calf and stocker cattle producers. It offers the potential to provide greater flexibility to the producer who wants to tailor a price risk management plan to his situation at an affordable cost. To effectively use this new tool, a producer must know how his local cash market relates to the CME Feeder Cattle Index™. The basis relationship will vary widely by location, ending weight of the steers and quality of the calves. Fortunately, Noble Foundation agricultural economists have been collecting data from several regional sales in our work area. If you think the LRP-Feeder Cattle insurance program may be of benefit in your operation, contact one of the agricultural economists for assistance in analyzing your situation.

Thought for the month: "No other human occupation opens so wide a field for the profitable and agreeable combination of labor with cultivated thought, as agriculture. I know of nothing so pleasant to the mind, as the discovery of anything which is at once new and valuable -- nothing which so lightens and sweetens toil, as the hopeful pursuit of such discovery. And how vast, and how varied a field is agriculture, for such discovery." – Abraham Lincoln

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