Livestock Risk Protection insurance contracts emerged in the early part of this century as a tool to help cattle, swine and lamb producers protect against downward movements in national live animal market prices. They are single-peril policies on price tied directly to national markets in the form of an index. After remaining relatively unchanged since inception, several enhancements and improvements have taken effect in the LRP insurance program the past couple of years.
One of the most significant changes involves increases in the premium subsidy rates. LRP premiums were subsidized by USDA at 13% up until mid-2019. Each of the past two summers have brought increases in the subsidy rates, with the latest increase effective July 1 resulting in the current subsidy rates displayed in Table 1 for cattle and swine.
New and beginning producers receive an additional 10% premium subsidy. These subsidy changes will make LRP insurance coverage more affordable for livestock producers to acquire.
Another important change that took effect July 1 is a change to when the premium cost is due. Previously, the premium cost was due at the time the specific coverage endorsement was put in place. Now, the premium is not due and payable until the end of the endorsement period.
LRP is purchased in a two-step process. The first step is to submit an application to purchase LRP insurance through a livestock insurance agent. The second step is to submit a SCE for each group of cattle to be insured. Multiple specific coverage endorsements can be done under one application. However, a SCE can only be put into effect when the Chicago Mercantile Exchange is not trading, effectively between the afternoon close of trade and when it opens up for trading the following morning.
Previously, the premium payment needed to accompany the SCE on the day of purchase for the insurance to attach. Besides tying up valuable cash for the duration of the coverage period, producers had to plan carefully with their insurance agents to arrange payment on the day of purchase. This new change in premium due date is a positive development for livestock producers and should make the process of purchasing LRP more convenient and less of a strain on cash flow.
Summary of LRP-feeder cattle use in Nebraska
About 93% of the LRP policies sold in Nebraska since July 1, 2010, are for feeder cattle weighing less than 900 pounds. Fed cattle policies make up about 5%, and lamb policies the other 2%. Only seven LRP-swine policies have been purchased in the past 10 years.
Table 2 summarizes the use of LRP-feeder cattle insurance in Nebraska over the past 10 years. Overall, 38% of the policies earning a premium during this period have paid out an indemnity with an overall loss ratio of 0.70. The loss ratio is calculated by dividing the indemnities by the total premiums.
This has varied greatly each year depending upon whether cattle prices are moving up or down. The premium subsidy on LRP was 13% up through and including the 2019 insurance year. When that is taken into account, the effective producer loss ratio is 0.81 as producers paid about $5 million in premiums and collected about $4 million in indemnities.
Overlaying a minimum subsidy level of 25% now in effect, these same policies would have resulted in a producer loss ratio of 0.94. It is worth noting the average premium subsidy for 2020 was 22%. This implies most of the policies in effect for the most recent crop year were for coverage levels above 90%. With the most recent changes, we can expect the average premium subsidy to increase by 5 percentage points in 2021.
Example for LRP-feeder cattle: Retained calves
LRP insurance is purchased to protect value. It is not desirable to “collect” on it, as that happens as a result of a downturn in markets. It is probably best to look at an example to see how LRP insurance can affect your bottom line.
Table 3 shows how LRP-feeder cattle insurance contracts would have performed for a cow-calf producer retaining steers until the end of January. A 13-week LRP contract for Steers Weight 2 (600-900 pound ending weight) entered into at the end of October from 2015-19 providing coverage for prices at the end of January would have added an average of $3.65 per cwt to the bottom line under the LRP premium subsidy policies in place at the time they were purchased. With the new premium subsidy rates in effect, this net LRP effect would have increased to $4.25 per cwt.
More important is how LRP controls the downside risk while allowing the producer to participate in upward price movements. For example, the 2016 calf crop represents the only year over this span where the January feeder cattle contract prices moved up between the end of October and the end of January. The net effective price of $126.85 from the national market with this LRP contract captures 77% of the upward price movement from a $115.54 expected ending value to a $130.29 actual ending value that year.
Meanwhile, for the other four years, the average expected ending value was $159.23 compared to an actual ending value average of $148.26. The average net effective price of $154.43 for those years mitigates 56% of the downside price risk that occurred.
Of course, the effect of LRP insurance is most pronounced in years where the price moves down considerably like it did for the 2015 calf crop. That year it moved from a relatively high expected ending price of $183.08 to an actual ending value of $160.58. The $15.64 net effect of LRP mitigated 70% of the downside price risk that occurred in the national market that year.
LRP insurance is another tool in the toolbox for Nebraska livestock producers to use in managing national market price risk. Producers using LRP still market their calves in their local or regional markets. The net effects of LRP insurance contracts will add to and complement an effective local marketing plan. The most recent changes to LRP continue the trend of making it more affordable and more accessible for producers to use.
This material is based upon work supported by USDA-NIFA under Award Number 2018-70027-28586.
Parsons is a farm and ranch management specialist in the Department of Agricultural Economics at the University of Nebraska-Lincoln.
Source: Jay Parsons, Nebraska Farmer
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