AMERICA’S FOOD CHAIN IS TOO IMPORTANT TO BE LEFT OPEN TO UNNECESSARY RISk
Raising livestock is a unique business – the end product has a small sales window, and a price that is more or less fixed by markets. If prices drop, ranchers are usually stuck taking the hit. Farmers have crop insurance to protect against market fluctuations, and since 2003 RMA has also provided Livestock Revenue Protection (LRP).
What is Livestock Revenue Protection?
LRP is a group of insurance products designed to protect livestock producers’ bottom lines against falling markets. By letting producers buy an insurance policy against commodity prices falling below a certain price threshold, they are able to ensure a certain level of revenue for their animal crop, similar to futures and options based hedging. However, there are a few differences that may make LRP a better option for some producers.
There are currently policies available for producers of Feeder Cattle, Fed Beef Cattle, Swine, and Dairy Cattle. RMA offered lamb protection in the past but the program was put on hold in 2021. The Risk Management Agency has three distinct livestock insurance programs – Livestock Risk Protection, Livestock Gross Margin Protection, and Dairy Revenue Protection.
Livestock Risk Protection
In simple terms, Livestock Risk Protection allows Feeder Cattle, Fed Cattle, and Swine producers to pay a premium to guarantee in a market price for their livestock months ahead of time. To get coverage, a producer would fill out an application for the exact head count they would like covered, the target weight, and the expected market date. The RMA calculates expected values for endorsement periods (market dates) based on futures prices, and producers can set a price at any percentage of that expected value.
For example, if the expected value for fed cattle in March were $137/CWT, a producer would pay a different premium for insuring 99% of expected value, effectively locking in a $135.63 price; and insuring 90% of expected value, locking in a price of $123.30.
At market time, “actual value” is also calculated by RMA – rather than using the actual cash price the producer receives for the livestock. The price is based on averages of accepted industry metrics like the CME Feeder cattle index over the endorsement period.
Livestock Gross Margin Protection
Just getting a good sale price may not always be enough to ensure a profit for producers – rising feed prices can erode away margins even when you’re selling livestock for top dollar.
Livestock Gross Margin Protection operates very similarly to Livestock Risk Protection, except that rather than lock in a final sale price, farmers lock in an expected final Margin, calculated as Final Market Value minus Feed Costs (and Feeder Cattle Costs for fed cattle). This is useful for livestock and dairy producers because it takes input prices into account.
If, for example, Fat Hog Prices stayed at projected levels over the term of the policy, but corn prices increased over projected levels, gross margin would likely be less than the insured amount, and the policyholder would be entitled to a payment.
Dairy Revenue Protection
Dairy revenue protection operates essentially the same as Livestock Risk Protection – producers insure expected yield for an expected final market value. However, dairy risk protection will also provide protection for loss of revenue due to reduced yield due to certain factors as determined by the Dairy Revenue Protection Commodity Exchange Endorsement.
Why Use LRP vs. Commodity Hedging?
Livestock producers have long had commodity futures markets available as a risk management option, so LRP policies may not seem necessary, but they offer a few advantages, especially to smaller operations.
For one, there are no minimum head counts required for Livestock Revenue Protections – producers can take out insurance on one head if they need to, compared to clunky futures contracts that often leave producers under- or over-hedged. Futures contracts also aren’t available for every commodity in every month, whereas LRP policies can mature over any 30 day period.
Short-selling futures contracts can lead to expensive margin calls in order to maintain a position, and can wipe out any potential upside if you don’t catch the market just right. LRP programs have no margin calls, and don’t limit upside potential. And unlike trading Put options, with LRP there is no risk of not being able to exercise an option because of an inactive market.
Wether or not Livestock Revenue Protection is right for you is a discussion you should have with an insurance agent licensed to sell these products. Like many government programs, livestock revenue insurance has a lot of moving – and changing – parts. Plummer Insurance has an experienced team of dedicated Livestock Insurance experts that know the ins and outs of making sure every head is protected.