Knowledge is Power

September 24, 2016 02:12 AM
iStock Crops and Clouds

When coupling crop insurance with marketing, keep it simple. It takes an understanding of your yield potential, available risk management tools and possible strategies to safeguard your revenue.

Most farmers select Revenue Protection as their multiple peril crop insurance (MPCI) option, which creates a revenue guarantee in the spring. This uses an actual production history (APH) and a government set spring price. Although the spring prices are standardized, the APH is individualized thus creating different crop revenue guarantees. The insurance revenue guarantee will only change if the October harvest price ends up higher than the spring price. 

To determine if an insurance indemnity will be paid out, the October harvest price and the actual yields are combined to create the crop’s gross revenue and an indemnity occurs only if the gross revenue is below the revenue guarantee. If the harvest price happens to be higher than the spring price, an indemnity is paid out when the actual yield is below the farmers APH and selected deductible.  

For crop insurance to be most effective it should be combined with marketing to counter price and yield volatility. 

First, walk your fields frequently right up to harvest and use your expertise to estimate yields. Calculate a preharvest gross revenue by taking the estimated yield multiplied by the futures prices of that day. Voila! Keep in mind: This estimated preharvest gross revenue figure is a fluid number as both futures prices and yield estimates will change. 

Before the combines roll, changes in estimated yields and futures prices will help determine what marketing tools and strategies to use. If the estimated gross revenue is higher than the revenue guarantee set by insurance, there’s still downside price risk because insurance has not been triggered. Conversely, if the estimated revenue is at or below the revenue guarantee, insurance will act like a price floor and protect further downside price risk.

Although the gross revenue estimates are just that, when compared with revenue guarantees and coupled with crop marketing plans, they create a much better picture of what you need to address in your marketing. 

This is where the futures market is effective. As mentioned before, revenue estimates will change and so might your strategy. This is why we need fluid marketing tools. 

For this insurance influenced situation, change does not mean the strategy put in place was wrong—it might just mean the gross revenue versus revenue guarantee comparison has changed the best strategy. Buying options are difficult to use in a situation that might involve evolving strategies. Selling options has validity, but few farmers are willing to do so. Spreads, straddles or strangles are likely too complex for what we’re trying to accomplish. Futures contracts provide the flexibility and simplicity to keep this plan in motion.

An advantage in 2016 is harvest seems to be ahead of normal. This means we have a better handle on actual yields well in advance of the harvest price being set. 

Trade gossip for disciplined marketing. Let USDA-National Agricultural Statistics Service, crop tours, analysts, social media and coffee shops struggle and argue over national yields all they want. But remember, it will undoubtedly affect futures prices.

Just keep it simple. Use your farms’ estimated yields and futures prices. Compare them to your insurance revenue guarantee. Then, go short futures to protect downside risk, go long futures to protect an insurance indemnity or do nothing. 

Either way, you’re making educated business decisions. Doesn’t that make more sense than risking college tuition, your land and your livelihood because of something Bill, with his Twitter account and zero acres, said while ordering pie? I think so, too.  

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