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Experts Overstate Crop Insurance Competition with CME


Kansas State University and the Commodity Futures Trading Commission (CFTC) recently held a joint conference on the lack of convergence in grain futures. In addition to hedges, convergence is required for crop insurance claims to work properly. Many in the grain industry still think revenue-based crop insurance tools compete with their grain futures contracts. Making this argument even more confusing is a new report from Harvard and other Law Schools.

Crop Insurance

As a group, there are still a large number of traders who think government-backed crop insurance competes with them for the farmer’s risk management dollar. Many of these misunderstandings originated from academic researchers, and more recently by a group of Law Schools. The FBLE group argue the existing Harvest Price Option (HPO) subsidies encourage over-exposure to the futures markets and farmers should not forward price more than a third of their expected crop. However, Smith, et al., argue that price coverage is available via private futures market exchanges, therefore revenue insurance is unnecessary. As a result, one academic expert suggests farmers should use futures, and another academician says no, farmers are over-exposed to the futures. However, both are wrong. Once farmers plant their crop or hold unpriced inventory they are 100% exposed to the real cash market of potentially falling prices. Following the one-third argument, farmers would still have two-thirds of their crop exposed to downside price risk.

Conclusions

FSA’s PLC and Marketing Loans provide direct competition with CME-traded puts when markets are extremely low. However, currently the “strike” for these program are low enough that the “put” protection is way out-of-the-money for corn and soybeans, but these USDA programs have provided recent “put” protection on wheat.

Revenue insurance and ARC provide limited competition with CME traded puts, but currently these “put” derivatives are out-of-the-money on corn and soybeans. If policy makers want to eliminate any “small overlap” with traded puts or the commodity programs, they would remove the “put” (revenue) from RP and retain the HPO.

The HPO is not competition with calls. HPO turns the revenue insurance product into a yield guarantee only. When HPO triggers, the RP is the same guarantee as YP, but YP indemnifies the lost bushel at a below-market price while RP indemnifies the lost bushel at the current market price. As a result, RP is a complement to futures because it maintains the hedge on forward-priced bushels. Both YP and RP contracts require a yield loss greater than the yield guarantee to trigger any payments.

Read the full report at the Kansas State University website.

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