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Make the Most of your Revenue Insurance

Jul 11, 2016

Revenue insurance isn’t just about growing a crop, it’s about selling a crop.

If you aren’t taking advantage of the peace of mind Revenue Protection (RP) affords for forward pricing, you may be leaving money on the table. In the current price environment, pennies, nickels and dimes can mean the difference between a financially successful year and one that burns equity.

Most years, prices rally on production uncertainty during the growing season, as illustrated by the corn chart below. On average, the best pricing opportunities (green-shaded area) for corn and soybeans are seen during the growing season.

monthly average price of December corn futures

There are many ways to look at crop pricing opportunities but our purpose here is not to address when to market your crop. We’ll discuss seasonal probabilities just enough to set the stage for a discussion of the possible benefits crop insurance can bring to the marketing table.

The chart above shows the 10-year monthly average price for December corn futures. As you can see, on average, June offers the highest prices, flanked by May and July. The difference between the June average price and December average price is 26 cents. The spring and fall RP insurance guarantees are set in February and October, based on December futures. For corn, the fall guarantee averages 7 cents lower than the spring price.

What the averages hide are the extreme swings in some years. The most extreme, of course, was 2008 when prices reached a record high of $7.99 in June and plunged to $2.90 by December. The average difference between high and low was $2.37 and the smallest difference was last year, at 98 cents.

USDA’s monthly average cash prices follow the same pattern, though at lower prices given they reflect basis.

How Revenue Insurance Helps

The risk of forward pricing before the crop is harvested in order to capture seasonal price strength is failing to grow enough bushels and being forced to buy replacement bushels to fill the contract – possibly at a higher price.

Here’s how to integrate your revenue insurance and your marketing plan. First, calculate your insured bushels and expected uninsured bushels. For instance, if your APH is 170 bu. and you buy 80% coverage, 136 bu. are covered; 34 bu. are not. Perhaps expected yield is higher than your APH, adding to noninsured bushels. On seasonal price strength, you might hedge or forward contract the 136 bu.

To protect the price on the uninsured bushels, you might consider buying put options because options don’t have any delivery risk. If prices rise, the option simply expires worthless. If they fall, you can either sell the option or exercise it and add the profit to your cash price.

Given RP’s fall price adjustment, in a year when a weather event causes a shortfall and prices rise, your indemnity payment helps cover your contract responsibilities. The following example illustrates a 1,000-acre farm that’s three-quarters corn and one-quarter soybeans. Suppose a late-season drought dings corn yield but soybean yields plummet; corn price doesn’t respond but soybean price jumps $5/bu. during the fall price discovery period. The table shows how revenue insurance provides comfort in forward contracting.  Please note that the table is set up by columns, not rows.

Spring base coverage Corn Soybeans Combined RP + marketing
   Acres 750 250  
   APH 170 45  
   Coverage level 80% (136 bu.) 80% (36 bu.)  
   Spring price $3.86 $8.85  
   Guaranteed Revenue $393,720 $79,650 $473,370
Fall coverage/outcome      
   Actual fall price $3.86 $14.00  
   Fall guarantee $393,720 $126,000 $519,720
   Actual yield 150 0  
Forward contract 136 bu. (80% of APH) at $0.50 over spring price $444,720 $84,150 $528,870
Purchase bushels to meet delivery contract 0 ($126,000) ($126,000)
Open bushels sold @ harvest price $40,530 0 $98,430
Indemnity payment     $126,000
   Total sales revenue $485,250 ($41,850) $569,400

In this example, forward pricing the covered bushels (80 percent of the APH or 136 bu. for corn and 36 bu. for beans) at $4.36 and $9.35 locked in $528,870 – or $55,500 higher income than the spring guarantee.

While the corn price remained unchanged in the fall, higher fall prices increased the guarantee for soybeans under the revenue protection plan.

This farm’s corn yield fell 20 bu. short of the APH – not enough of a reduction to prompt an indemnity. In fact, production was still 14 bushels above the guaranteed level. We assume those bushels were sold for $3.86 at harvest.

Soybean production, on the other hand, was zero. This meant the entire contract commitment would need to be bought in the open market to fulfill the contract. The difference between the contract value of $84,150 and the market replacement cost of $126,000 (36 bu. x $14 x 250 acres) is shown as a loss of $41,850 in soybean sales revenue. This is where the role of revenue insurance is important: The indemnity of $126,000 would cover the replacement cost. As shown in the far right column, total sales revenue for both crops is $569,400. Without RP coverage, it would have been $443,400.

This is a simplified example that doesn’t consider basis. It is not meant to portray price outlook, nor does it discuss every possible price outcome. It is just meant to illustrate the connection between crop insurance and advance sales.

In the current economic environment, having the right crop insurance is the first step. Knowing your cost of production and formulating a marketing plan is the second. Understanding how the two to work together is critical.

If you would like more information, call us at 800-884-FARM (3276).


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