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Who Needs Crop Insurance Most?

December 13, 2013
By: Ed Clark, Top Producer Business and Issues Editor

Farmers on the outer reaches of the Corn Belt if not outside it entirely need crop insurance more because of their propensity for lower yields, right? "Wrong," says Frayne Olson, ag economist at North Dakota State University. "A common misperception is that producers with low average yields have more risk. I adamantly disagree."

When producers evaluate the benefit, cost and appropriate coverage levels, they need to factor in both average yield and yield variability, he says. "Farmers whose average yields are more variable have more risk." However, even if farmers have had yields between 200 and 210 in each of the past 10 years, crop insurance at relatively high levels is worth considering, because one bad year could have devastating financial consequences, Olson says. "The higher the APH, the greater the potential risk in an individual year, even for producers who rarely have a crop failure."   
Olson notes that average corn yields in North Dakota are much different than average corn yields in Iowa. "But that doesn’t mean that a North Dakota farmer has more or less incentive to take crop insurance than a producer in Iowa. The key is how variable yields are."
There are no across-the-board crop insurance answers because risk and premiums are very local, he says. Premiums will be higher not only in some states than others, but some counties than others, based on yield variability. Because of that, Olson says that while it’s important to consider higher levels of coverage this year because of heightened risk, the right answer varies from farmer to farmer. However, crop insurance and at potentially higher levels is worth a look more than in the past because the cost structure has changed: from land to crop inputs, it costs more to produce a crop than it used to, Olson says.  
In Olson’s view, producers need to forget about how crop insurance worked in 2013, which created a veritable windfall, compared to low harvest prices that crashed to $4. "It was an unusual situation," he says. Because of that, the $5.65/bu. corn insurance guarantee for 2013—the average price during February for December futures—was more than $1/bu. higher that the 2014 federal crop insurance revenue guarantee is likely to be. The conundrum moving forward is that the December 2014 futures price at present is about $4.50, and most economists believe that price in February will be somewhere in the $4.25 to $4.50 range, barring unexpected developments.
Because the crop insurance price guarantee is the futures price, "you have to be a really good marketer to price above crop insurance numbers," he says. With higher levels of risk Olson sees for both 2014 and 2015 due to much lower commodity prices than recent years, he suggusts that producers consider increasing price guarantees from 70% if they’re at that level, to 75%, even 80%. Ultimately, it gets down to the cost of individual premiums versus risk, he says.
Here’s why he urges farmers to do the math. Seventy percent of a $4.50 guarantee on corn means that producers are only protected at $3.15 for their entire crop, and that doesn’t include basis. A 30 cent basis would lower the guarantee to $2.85 for the entire corn crop. At 80%, $4.50 becomes a total farm revenue guarantee of $3.60, minus basis. That’s not great, but 45 cents richer that could protect a lot of working capital.

 

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