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Market Strategy: Crop Insurance 101

January 29, 2014
By: Jerry Gulke, Top Producer Market Strategy Columnist
 
 
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I grew up in the Dakotas where my dad could count on a crop failure every four years. His insurance plan was to summer-fallow 25% of cropland to control weeds, let the land regenerate and preserve rainfall.

In an adverse year, he counted on 25% of our land to produce a crop, likely at drought-induced higher prices. We didn’t leverage ourselves with debt, which meant that one bad year wouldn’t ruin us. Having experienced the Great Depression, my dad stayed relatively debt-free. I do not recall that he purchased crop insurance. I also don’t recall making payments very often. If we did, we mostly went without until the loan was paid. Faith was such that if one worked hard while being thrifty, things would work out.

But that was then, and this is now. These are not my father’s times, or are they? Crop insurance has evolved from the basic catastrophic coverage to a complicated revenue insurance vehicle, backed by USDA’s Risk Management Agency, to save the farmer from himself and his banker. With the help of his colorful spreadsheet, Gulke Group’s insurance expert Jamie Wasemiller reduces the decision-making comp-lexities to a red (loss) and green (profit) scenario. However, I prefer to simplify it even more.


"The market isn’t interested if I drive a new pickup or use high-priced seeds. The only green I’m interested in is what’s in my pocket."


I try to justify being 85% covered. Lenders might be happy with 70% coverage, but that only covers their interests. If that’s all you can afford, you might as well throw money in a river and run downstream to catch what you can.

My view of crop insurance is less conventional than most. I expect 85% of my average production history (APH) to be covered at the February average or by an optional coverage available in some states. Per Jamie’s advice, I chose the July average for December 2014 at $5.26, which leaves 15% of production unprotected. Each year, I expect to grow 5% more than my APH, which means 20% of my crop is at price risk.

Using conventional insurance, if the February average for December 2014 corn is $4.60, that means 85% of my 172 bu. APH will guarantee $672 per acre. But with basis at -45¢, that changes to $605 actual gross per acre. Of my "planned" 180 bu. yield, 34 bu. are at risk. Should I do nothing from a marketing standpoint, I might get $3.60 minus a 45¢ basis, or about $107 per acre. Adding this to my crop insurance guarantee grosses $712 per acre.

Low Price Seller. My bare-bones variable cost per acre could be less than $400 this year, as the market pays to be the lowest price seller, not the most productive. The market isn’t interested if I drive a new pickup or use high-priced seeds. The only green I’m interested in is what’s in my pocket.

The $312 net profit before land expenses should not be a challenge for those subscribing to anything close to my father’s philosophy. But for the highly leveraged who have after-tax cash demands, it will be a challenge. Regardless of one’s debt-to-equity ratio, it’s all about after-tax cash flow that counts.

During the 1980s farming crisis, my father said: "President Reagan can’t get the price of grain low enough to hurt me any more. I am not bothered by low prices. Government will bail out the least efficient, and I will benefit from their inability to be proactive for the ‘what-if’ when it occurs."

Prices might not get low enough this year to hurt the well-established, low-debt farmer. Cash has been and still is king! Insurance will become what it was intended to be—a stop-loss vehicle acceptable to the most efficient and best managed.

Jerry Gulke farms in Illinois and North Dakota and is president of Gulke Group Inc., a market advisory firm with offices at the Chicago Board of Trade. For information, send an e-mail to info@gulkegroup.com or call (707) 365-0601.

Disclaimer: There is substantial risk of loss in trading futures or options, and each investor and trader must consider whether this is a suitable investment. There is no guarantee that the advice we give will result in profitable trades.

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FEATURED IN: Top Producer - February 2014

 
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