Saturday, March 12, 2011

2011 Crop Insurance Plan Changes and Choices

Cory Walters, Extension Economist, University of Kentucky
email: Cory Walters

The Risk Management Agency, who oversees the crop insurance program, released their new Common Crop Insurance Policy (CCIP) or otherwise known as COMBO. COMBO represents a new insurance plan structure designed to simplify choices. In COMBO only individual plans not county level plans like Group Risk Income Plan (GRIP) are affected. The goal of this short article is to educate producers on the differences between COMBO insurance plans.

COMBO offers three insurance plans, Yield Protection (YP), Revenue Protection (RP), and Revenue Protection with the harvest price exclusion (RP-HPE). Table 1, shows the new COMBO insurance plan name and what it replaces.

Table 1, Relationship between COMBO and Previous Insurance Plans
COMBO ProductPrevious Insurance Plan
Yield ProtectionActual Production History (APH)
Revenue Protection Crop Revenue Coverage (CRC), Revenue Assurance with the Harvest Price Option (RA-HPO)
Revenue Protection with the Harvest Price Exclusion Income Protection (IP), Revenue Assurance without the Harvest Price Option (RA)

COMBO products protects against declines in yields or revenue. There are two revenue protection options to select from, RE and RE-HPE. Both protect from declines in price but only revenue protection protects against increases in price, Table 2.

Table 2, Factors Which Can Trigger Crop Insurance Payments
Yield Insurance Revenue Protection Revenue Protection with the Harvest Price Exclusion
Low Yield Yes Yes^ Yes
Low Price No Yes^^ Yes^^
High Price No Yes*(each bushel is then worth more) No

^ Indicates holding price constant (Base = Harvest).
^^Indicates yields are not high enough to offset low price effect.
*Must have a yield loss to collect an indemnity.

The price protection in RP implies both upward and downward protection. For example, if base price is $6.00 and harvest price is $7.00 then the guarantee will use $7.00 instead of the initial $6.00. For a farm with a 150 bushel APH using 80% coverage level the revenue guarantee will go up by $120.00 per acre (initial guarantee using base price = $720.00 guarantee with harvest price = $840.00) because harvest price was greater than base price. RP-HPE product does not allow the producer update their initial guarantee with a higher harvest price. Further, with a yield loss the RP will pay $7.00 per bushel lost starting at 119 bushels (150 APH*.8). The policy holder with RP-HPE will not receive a payment until revenue falls below $720.00 or about 103 bushels per acre (720 revenue guarantee /$7.00). This is because corn price is now worth $7.00 per bushel so 103 bushels gets you $720 dollars per acre, your initial guarantee. Both RP and RP-HPE work the same way when prices fall. For example, using same figures as before but now harvest price is $5.00 and the producer harvests 140 bushels per acre or 93% of their APH yield. Initial revenue guarantee was $720.00 and harvest revenue would be $700.00 (140 bushels per acre * $5.00). Resulting in a $20.00 payment made to the producer ($720.00 - $700.00).
Insurance premiums are subsidized by the government and over time premiums should equal indemnities if the insurance is considered actuarially fair. The implied rate of return with a 55 percent premium subsidy would be 122 percent ((1-.44)/.45). This by no surprise has induced widespread producer crop insurance adoption.

Revenue protection policies are a subsidized form of grain price option contracts. Therefore, option premiums or the insurance premium for the purchase of an option are significantly cheaper than those at futures exchanges. RP-HPE offers the producer the purchase of a put option (lower price protection). RP offers the producer the purchase of both a put and call option (higher price protection).

Which insurance plan does a producer select? The answer depends upon factors such as; marketing ability, premium cost, yield expectations, price expectations, risk tolerance level, forward contracting ability and other personal goals. Producers with a good marketing record may want to save some premium money by selecting YP. However, premium savings obtained by switching to YP to RP may be small relative to the benefit of price protection so it may pay to stay with RP. RP will cost more, especially with optional units (enterprise units will be less due to their high subsidy rate) and you get price protection. If your revenue risk tolerance level is low, meaning you want to transfer as much revenue risk to someone else, then RP with higher coverage levels may be your choice. If you want to forward contract a high percentage of expected production then RP with higher coverage levels may be your choice because of the upward price protection.

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