Is Now The Time To Cut Down Your Crop Insurance?02/22/2016
Crop insurance is no doubt the cornerstone of any solid marketing plan. At AgYield and EHedger, we don’t even offer crop insurance, but we still recognize its importance to the grower. It’s not just a backstop to prevent financial catastrophe, it provides the confidence to market bushels while the price is favorable, long before the producer knows his actual yield.
With the crop insurance election deadline approaching, we want to discuss something that is a concern to us this year. We’ve heard stories about growers considering to lower or even eliminate crop insurance coverage in order to save money. We think this could be a mistake…
Besides cost cutting, the main reason for the grower to consider this move is due to the lower spring price guarantees. The average price of corn and beans are currently down about 27 and 85 cents respectively from 2015. The prices are already 50% locked for the month of February, which means there is little chance for these levels to improve by a meaningful amount. In many cases, this will leave producers with a guarantee that may be 100’s of dollars below their actual cost of production. While this is a problem that has to be overcome, it’s not going to get fixed by saving the $10 – $15 on crop insurance premiums. In fact that strategy may backfire if weather turns sour this summer. Crop insurance is needed most when prices are rising from falling production. In that case, the spring price would become irrelevant and the higher fall price would used, just as in 2012.
The following is an example of a corn grower’s profitability for this year. Using the Farm Doc’s cost of production estimate, this grower needs $805 per acre in revenue to breakeven. He has an Actual Production History (APH) of 200 bushels per acre and has nothing sold yet for 2016. Using these attributes, we can see his potential profit/loss outcomes at different yield and price scenarios on this matrix:
If the year turns out to be low yielding with low prices, its obvious that this producer would be subjected to large losses. While at high yield and high prices, he would turn a large profit. We don’t know how the year is going to turn out because we can’t predict the weather, nobody can. This is of course the reason that insurance is the backbone of the marketing plan.
In years like 2013, crop insurance guarantees were so high that they could literally wipe out the red portions of the matrix, guaranteeing revenue above costs. Today however, is a different story. Producers will need to rely on other forms of marketing throughout the year. To illustrate how the insurance policy can impact marketing decisions, we will compare two different strategies using a sales only marketing approach to achieve a guaranteed break-even matrix.
The 75% policy holder
Using the same producer credentials, the 75% holder has the ability to sell up to 150 bushels per acre without getting “oversold”. To make sure he is above break-even revenue goal at every yield and price level, this producer would have to sell his guaranteed bushels at $5.37. This would result in a profitable year at every price and yield point on the matrix.
85% policy holder
Meanwhile, the 85% holder would be able to to lock break-even at every yield and price level by selling his guaranteed bushels at $4.74. This is lower than the 75% policy holder because he has an extra 20 bushels guaranteed. He can afford to make that sale at a lower price if needed.
Both scenarios reach the same goal, however the 85% policy holder is much more likely to achieve it in the event of a crop problem this summer. The options delta says that $4.74 has about a 19.5% chance of being reached this year, while the $5.37 level has about a 10.4% chance. Last year, the highest the market could get was $4.54 ¼, and that was it! It is important to have a price goal that is more likely to be achieved.
If futures prices are pushing $4.75 – $5.50, there is a higher probability that your farm will actually NEED that insurance this year. These prices would indicate a large supply problem somewhere and it could very well include your farm.
At the end of the day you have to ask yourself “why do I buy crop insurance? Am I trying to ‘bet’ on an insurance payout or am I trying to lower my risk systematically and improve my chances of turning a profit?” HOW you use that crop insurance policy is part of that answer.
Please note that in the examples above, we only used sales to achieve the break-even scenario. There are other ways to improve farm profitability by using tools such as options. Options can provide a greater degree of flexibility in low margin years like this one.
If you would like to compare your insurance policies please get updated cost estimates from your insurance agent and then call your AgYield representative to go over the policy differences. Here is an example of the matrix showing only the insurance policy to compare the payout levels.