How many bushels can you contract prior to harvest? The current high prices are attractive, but can you take advantage of it. This is a question that you probably ask yourself every production year, and in particular, during a period of high market prices. If you have crop insurance with revenue protection, you already pay for a risk management tool that can help provide an answer.
First, let’s think about some reasons why you might hesitate to take out a contract prior to harvest. Production and price risk are certainly a few reasons. In fact, they are probably why you have insurance in the first place. You want protection in case yields are low. You also want protection in case harvest prices go down.
So how can an insurance policy that protects against yield loss and low prices help? More precisely, how can it tell you how many bushels to comfortably contract prior to harvest or even prior to planting?
The answer lies in understanding how the revenue protection policies work. The default of the revenue policy contains the “harvest price option.” This option kicks in if the harvest price is higher than the initial base price. The revenue you are guaranteed increases, but so does the value of your harvested production. This feature protects you if you have pre-harvest marketed your grain.
There are a number of advantages that revenue-based insurance can provide to help you make a marketing decision. Let’s consider a few scenarios:
Scenario 1: It’s March and cold out. Do you forward price 40% of next fall’s crop now? What if you do not get it planted?
The answer: Yes, you can forward contract 40%. Revenue Protection includes a prevented planting coverage factor at 60% of your guarantee coverage level. This 60% factor is based on pre-planting costs a producer would typically incur right until planting. For example, if you have 75% coverage level, you have 45% coverage if you don’t get the crop planted (0.75 x 0.60 = 45%).
Scenario 2: You have revenue protection and decided to forward contract up to the 75% insurance coverage level on your soybeans. Your actual production history (APH) is 40 bushels per acre and you are planning to plant 600 acres. How many soybean bushels are protected?
Multiplying your APH by your acres and the insurance coverage level provides the answer: 600 x 75% x 40 = 18,000 bushels protected that you can feel comfortable contracting. However, August turns dry and prices have jumped up. You now don’t have the bushels to deliver on your contracts. Does the insurance cover any of this?
The answer: Yes, you are covered. The final revenue guarantee with revenue protection is recalculated using the harvest price, if it is higher than the initial base price. The insurance increase will offset the cost of buying the higher priced grain to fill your contracts. Let’s look at this scenario a bit closer:
Table 1. Revenue Protection with Low Yields and High Prices
|Marketed 18,000 bushels at $10.00 per bushel||$180,000|
|Only produce 13,200 bushels and have to buy back 4,800 bushels at $11.40 per bushel||-$54,720|
|Crop Insurance indemnity based off of Futures Prices at $11.73 per bushel||+$56,304|
|Gross Return (after purchasing 4,800 bushels)||$181,584|
In Table 1, the farm forward contracted 18,000 bushels for a gross revenue of $180,000. But it only produced 13,200 bushels. That means it needed to purchase 4,800 bushels at the higher market price of $11.40 per bushel.
However, the crop insurance final revenue guarantee is re-calculated using the higher harvest price based on the Chicago Board of Trade futures price of $11.73 per bushel. This means that after purchasing the bushels to fill the contract, the farm’s gross revenue for soybeans is $181,584.
It’s important to remember that this example is based on a poor crop yield year. Crop insurance isn’t purchased to make money, but to manage price and production risk. Managing risk is what keeps your farm in business and moving forward into the next year. The intent of the insurance tools is to allow you to reach your potential revenues by pre-harvest marketing your grain (up to the coverage level).
In times of higher market prices, using the revenue protection insurance can help you lock in favorable prices, while offsetting the concern of poor production.