Will ARC Allow Farmers to Cancel Their 2014 Crop Insurance (Updated)? 1

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1 Disclaimer: This web page is designed to aid farmers with their marketing and risk management decisions. The risk of loss in trading futures, options, forward contracts, and hedge-to-arrive can be substantial and no warranty is given or implied by the author or any other party. Each farmer must consider whether such marketing strategies are appropriate for his or her situation. This web page does not represent the views of Kansas State University. Will ARC Allow Farmers to Cancel Their 2014 Crop Insurance (Updated)? 1 Dear Dr. Barnaby, I purchased and listened to your Webinar on the Farm Bill February 21st. Thank you, it was very informative. I have some Producers that we work with on their Crop Insurance who have some really good land in a particular County and don t feel they need to take any crop insurance protection. My question to you is, should they at least take a minimum level of crop insurance coverage so they can benefit from the new Farm Bill? Obviously this is their choice. Thank you, and please advise or call if my question needs clarification. Illinois Crop Agent ====================== 1 Prepared by G. A. (Art) Barnaby, Jr., Professor, Department of Agricultural Economics, K-State Research and Extension, Kansas State University, Manhattan, KS 66506, March 10, 2014, Phone ,

2 Dear Illinois Crop Agent, There is no cross compliance with crop insurance, so farmers don t need to buy crop insurance in order to participate in the Farm Service Agency s new (FSA) Agricultural Risk Coverage (ARC) or the Price Loss Coverage (PLC) commodity programs. Farmers do need to buy crop insurance in order to be eligible to buy the Supplemental Coverage Option (SCO) provided by the Risk Management Agency (RMA) via private insurance companies and agents. Farmers who enroll in ARC are not eligible for SCO, but all other farmers meeting conservation compliance are eligible to purchase SCO. The SCO is unavailable until 2015, while ARC and PLC will cover the 2014 crop and for next 4 years, but signup will likely not happen before June. The selection of the preferred FSA program does not appear to be a risk management decision by most farmers. Farmers pay no premium, so the question from most farmers is which program is likely to pay or which program will make the largest payment? As a result, it appears the ARC-PLC decision is a separate decision from crop insurance for most corn-soybean farmers in the Corn Belt and irrigated corn farmers in the Great Plains. When farmers buy crop insurance, in most years farmers write premium checks. Even if farmers do have claims, over time some of those farmers will have paid more in premiums than they have collected in claims, i.e. they have netted none of the crop insurance subsidy. It should be obvious those farmers are making a risk management decision to pay premiums to avoid a major financial loss, as is the case with any other line of insurance. As a result, individual farmers decide how large of a deductible to select, is the revenue coverage worth the extra premium, and do they need to pay for the harvest price? Because of the premium cost, farmers in most cases do not select the lowest deductible, especially in the higher rate areas in the Great Plains. If the government is going to provide a free revenue insurance contract via ARC, how low does a farmer want the deductible? Often, crop insurance is a part of a bigger risk management program that includes marketing of the crop and financing the operating line of credit. All farmer grain marketing plans, including just cash grain selling across the scales at harvest time, assume production, and only crop insurance will replace lost production or else a government-provided free disaster program. Effectively, FSA is offering a free, near-zero deductible revenue insurance contract that has a minimum strike price or the alternative offer is a free put. Renaming the revenue insurance coverage to ARC, renaming a put to PLC, and renaming strike prices to reference prices does not fundamentally change the economics. Farmers will receive either a free revenue guarantee or a free put. The answer is relatively simple: corn farmers who expect the Marketing Year Average (MYA) corn price to stay

3 above $3.50, will likely select ARC, and those who expect a $3.00 MYA corn price will select PLC. The answer is different for wheat because the strike prices in the ARC and PLC are close together. If ARC did not have the 10% stop-loss, then your farmer is right, there is likely no reason, especially in the Corn Belt to buy crop insurance. If policy makers were to remove the 10% stop-loss in ARC that also has a minimum strike price, then all farmers would select ARC over PLC and it would be the end of farmer-paid premium crop insurance. The ARC without the 10% stop-loss is the free crop insurance policy that was advocated by an endowed-chaired professor at one of the largest land-grant universities in the recent public policy debates on the Farm Bill. The Agricultural Risk Coverage (ARC) only covers about 7% of the expected revenue, assuming the farm has a full corn base, because ARC only pays on 85% of the base acres and has a 10% stop-loss. If farmers are planting corn beyond their base, then they will have even more acres not covered by ARC, and their coverage is less than 7% of their expected revenue. For that reason, your customer may want to rethink his decision to go uninsured on the 2014 crop. The ARC coverage will likely be selected for corn at the county level too, otherwise it is whole farm coverage and only pays on 65% of the base acres, vs. 85% of the base acres with ARC coverage at the crop by county level. In addition, ARC has a $110,000 payment limit that is over and above the 10% stop-loss. Revenue Protection (RP) has no stop-loss or payment limit. Below in Tables 1 and 2 are two examples. If there is a big 2014 crop (or any of the crops for the next 5 years) and it drives the Marketing Year Average (MYA) price to $3.00 (average price for the entire year as determined by USDA), then the PLC would generate a larger payment than ARC. The Revenue Protection (RP) indemnity payment is larger than either of the Farm Service Agency s (FSA) programs under this scenario (Table 1). The alternative scenario of a short crop combined with a higher corn price is presented in Table 2. The RP coverage will increase due to higher harvest prices and the PLC will not pay because the MYA price is above the reference price. Unlike RP, higher harvest prices will not increase the ARC coverage and the 10% stop-loss will limit the payment. Under this scenario, crop insurance is going to provide most of the payment to cover the loss. This is the scenario farmers are facing who cancel their 2014 crop insurance thinking they are covered with ARC, when that will not be the result. ARC and PLC payments are subject to sequestration, while crop insurance is a contract with an insurance company. If ARC should pay a large number of Corn Belt Farmers about $80 an acre, then the new FSA programs will generate large taxpayer costs, so

4 one cannot rule out sequestration of FSA payments. ARC and PLC only pay on 85% of the base acres and farmers cannot build base; only reallocate base acres. Crop insurance covers all planted acres. I expect most Corn Belt and irrigated corn farmers will select ARC because it covers 5 years and farmers only give up 4 years of the Supplement Crop Option (SCO) added crop insurance coverage sold by crop insurance agents. In addition, farmers in low-risk counties can afford to buy 85% RP coverage, especially as an enterprise unit, that is less aggregated than the county level SCO coverage and have almost the same coverage. SCO only covers 85% RP insured farmers from 86% to 85% or 1% of their coverage and if their APH is greater than the county, it is less than 1%. Also an 80% enterprise unit has a subsidy rate of 68% vs. 65% for SCO. So SCO in this case would cover 6% of the liability. RP will pay claims immediately, but both ARC and PLC will only pay losses after USDA publishes the MYA price. As a result, the farmers will need to wait a year or more to receive payments for any ARC and PLC claims. In the Great Plains, many counties don t have any crop insurance offers above 75%, so SCO would provide coverage from 86% down to 75%. Because wheat only has an 11 cent spread on the effective reference (strike) prices between ARC and PLC, I expect most wheat growers will select PLC. This also gives greater flexibility on the insurance side between farm coverage and area coverage, because farmers who select ARC are not eligible to purchase SCO crop insurance. I expect most Corn Belt farmers to select ARC because the reference price is $5.28 generated from the prior 5 years of high prices. Even after the adjustment for the 14% deductible, the effective reference price is $4.54; that is 84 cents higher than the reference price of $3.70 for PLC. However, farmers who cancel their 2014 crop insurance thinking that ARC will cover their risk, will soon discover they only have coverage on about 93% of their crop s value. If the crop is a total loss, ARC will provide only enough dollars to cover about 7% of the loss, and that assumes farmers have not planted beyond their base acres! FYI, soybean premiums are really discounted this year because of record low volatility. The 13% implied volatility will make the soybean premiums about 25% lower in the Corn Belt than when the volatility is at a more normal level of about 20%. The discount is less in the Great Plains, but still saves on premium. Unlike lower base prices that lower coverage, lower implied volatility has no impact on coverage; it only lowers the premium. The recording of the Farm Bill Webinar from February 27 that covers the new FSA commodity programs is still available on AgManager.info for a $25 fee. After you register, you will be sent the link for the recording and the slides from the presentation.

5 The web page with explanation: The link for the registration page is: Art Table 1. Illinois Corn Farm Electing ARC and 85% Revenue Protection on 2014 crop and a bumper crop combined with a market price drop. Assume 200 bu. APH X Price $5.62* $1, % Revenue Protection (RP) Coverage $ Corn Calculations for ARC and PLC ARC PLC RP ins. 5 Yr. Olympic Avg. County/Prog. yield/aph Yr. Olympic Avg. MYA $5.28 N/A N/A Reference Revenue/Price/Crop Ins. Price $ $3.70 $ %/100% Coverage $4.54 $ % Revenue/Price Guarantee $ $3.70 $ Current County Yield/Farm Yield 216 N/A 228 Assume MYA 2014/15 Price/Harvest Price** $3.00 $3.00 $3.10 $ to Count/Price Difference $ $0.70 $ Payment Rate/Acre $ $ $ Max Payment Rate*** $95.04 Payment Acres 85% X Base Ac 85% 85% 100% Total Payment per Base Acre $80.78 $ $ *Percent of Farm Level Expected Revenue Covered by County ARC % **Crop insurance prices are based on Futures; while likely they will move with the MYA price it is unlikely they will be equal. ***A 10% stop loss times the Reference Revenue, PLC stop loss at the Loan Rate and no stop loss for RP crop insurance

6 Table 2. Illinois Corn Farm Electing ARC and 85% Revenue Protection on 2014 crop and a short crop combined with a market price increase. Assume 200 bu. APH X Price $5.62* $1, % Revenue Protection (RP) Coverage $ Corn Calculations for ARC and PLC ARC PLC RP ins. 5 Yr. Olympic Avg. County/Prog. yield/aph Yr. Olympic Avg. MYA $5.28 N/A N/A Reference Revenue/Price/Crop Ins. Price $ $3.70 $ %/100% Coverage $4.54 $ % Revenue/Price Guarantee $ $3.70 $ Current County Yield/Farm Yield 90 N/A 95 Assume MYA 2014/15 Price/Harvest Price** $6.00 $6.00 $6.10 $ to Count/Price Difference $ $0.00 $ Payment Rate/Acre $ $0.00 $ Max Payment Rate*** $95.04 Payment Acres 85% X Base Ac 85% 85% 100% Total Payment per Base Acre $80.78 $0.00 $ *Percent of Farm Level Expected Revenue Covered by County ARC % **Crop insurance prices are based on Futures; while likely they will move with the MYA price it is unlikely they will be equal. ***A 10% stop loss times the Reference Revenue, PLC stop loss at the Loan Rate and no stop loss for RP crop insurance

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