Risk Management Education for Michigans Beginning Producers Custom Ag Solutions United States Department of Agriculture Risk Management Agency (RMA)

Risk Management Education for Michigan’s Beginning Producers

Custom Ag Solutions

United States Department of Agriculture

Risk Management Agency (RMA)

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Program Sponsorship, Coordination, and Delivery

•USDA / Risk Management Agency (RMA)– Oversees $62B Federal Crop Insurance Program– Springfield, IL, Regional Office– Around 500 Employees – Main Offices in Washington, DC, and Kansas City, MO

•Custom Ag Solutions– Crop Insurance Education Programs– Risk Management Tools– Rural Appraisals– Technology Development

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What is Risk?

Think “Chance” Think “Bad”

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Chance

Bad

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Chance

Bad

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Chance

Bad

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Are You a Risk Taker?

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Chance

Bad

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Chance

Bad

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Are You a Risk Taker?

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Are You Risk Averse?

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Risk Taker?

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Risk Averse?

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Not All Risks Are Equal

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Some Risks Can Be Managed

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Some Risks Can’t

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Some Risks Bring Rewards

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Some Risks Bring Losses

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1. Market Risk

2. Production Risk

3. Financial Risk

4. Human Risk

5. Legal Risk

Five Categories of Agricultural Risk

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Risk ManagementChoosing Among Alternatives to

Balance Risk and Reward

A B C

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How Can We BalanceRisk and Reward in Agriculture?

• Management Practices

• Diversification / Flexibility

• Transfer Risk to Someone Else (e.g., Crop Insurance)

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• You now own the RULazy2 farm/ranch, and you will operate it for six years.

• Your profitability could vary dramatically depending on uncontrollable chance and the risks you choose to take.

The RULazy2 Farm/Ranch

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• Goal: earn $100,000 or more;

• Goal: earn $33,000 to $100,000;

• If your cash balance falls below -$10,000 at any time during the six years, the bank forecloses on you and you are out of the game.

RULazy2 – Risk vs. Reward

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RULazy2 - Year 1

• You have just inherited 100 acres and 100 cows. Your farm/ranch is adequate to run the cows for the entire year.

• Because of volatile production and market situations, hay production is more risky and rewarding than cattle production.

• In the long run, cattle will make you less money than hay, but you will also be less likely to go bankrupt during the six years.

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RULazy2 - Year 1

Expected Net Income from Cows and/or Hay:

PRODUCTION PRICE EXPENSES PROFIT/100 HDHigh 600 Lbs $1.20/lb $37,000 $35,000Average 450 Lbs $1.00/lb $37,000 $8,000Low 300 Lbs $0.80/lb $37,000 ($13,000)

PRODUCTION PRICE EXPENSES PROFIT/100 ACHigh 9 Tons $108/Ton $35,000 $62,000Average 5 Tons $90/Ton $35,000 $10,000Low 1 Tons $72/Ton $35,000 ($28,000)

HAY

COWS

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RULazy2 - Year 1

• You could sell half of your cows and raise 50 acres of hay, for a cost of $5,000.

• If you raise both cows and hay you are 25% less likely to go bankrupt than if you raise only cows.

• Because it will cost $5,000 to make the change, you are less likely to reach the magic numbers of $75,000 or $25,000 in earnings if you diversify.

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RULazy2 - Year 1

• You could also sell all of your cows and drill two wells to turn your entire farm into hay.

• Your drilling/irrigation vendors will give you a discount, and you can make this change for no money out of pocket.

• If you raise only hay you are more likely to reach $25,000 in five years, but you are four times as likely to go bankrupt as if you just raise cows.

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RULazy2 - Year 1

Expected net income from 100 cows,OR 100 acres of hay, OR from 50 cows and 50 acres of hay:

Minimum Average Maximum

Cows -$13,000 $ 8,000 $35,000

Both -$18,000 $ 9,000 $44,000

Hay -$28,000 $10,000 $62,000

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Your Year 1 Choices:

1. Stick with cows only

2. Diversify to raise both cows and hay

3. Convert your entire operation to hay

RULazy2 - Year 1

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Transfer Risk to Someone Else

• Contracting– Production

– Pricing

• Hedging– Futures– Options

• Crop Insurance

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• It’s May, and a buyer has offered to buy your hay/cows/both this fall.

• He is offering $1.00/lb. for calves, and $90/ton for hay, which are the long-term average prices.

• Assuming average production, this means you are almost certain to make your expected average net income.

RULazy2 - Year 2

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• Prices vary by as much as 20% from spring to fall, and your net income could be over $5,000 ($9,000) higher if you wait until fall to establish a price.

• On the other hand, prices can just as easily drop, and your net income could be more than $5,000 ($9,000) lower if you price in the fall instead of taking the buyer’s offer today.

RULazy2 - Year 2

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1. Take the buyer’s offer, and establish your prices today

2. Wait until fall to establish your prices

RULazy2 - Year 2Your Year 2 Choices:

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• A neighboring farm is for sale, and you are considering buying it.

• It has better soil and is generally more profitable for both cattle and hay production.

• However, the new farm has a water problem, and the wells sometimes dry up in the middle of the summer, reducing calf weights and hay yields.

RULazy2 - Year 3

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RULazy2 - Year 3Profitability Comparison between the two farms:

RULazy2 Minimum Average Maximum

Cows -$13,000 $8,000 $35,000

50/50 Mix -$18,000 $9,000 $44,000

Hay -$28,000 $10,000 $62,000

New Minimum Average Maximum

Cows -$16,000 $9,000 $42,000

50/50 Mix -$24,000 $10,000 $56,000

Hay -$42,000 $11,000 $107,000

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• The new farm is under pivot irrigation, so you can run cows, raise hay, or both.

• If you buy it, you will produce the same commodities you currently produce.

• You have a buyer for your farm for exactly the same amount as you can buy the new farm.

RULazy2 - Year 3

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RULazy2 - Year 3Your Year 3 Choices:

RULazy2 Minimum Average Maximum

Cows -$13,000 $8,000 $35,000

50/50 Mix -$18,000 $9,000 $44,000

Hay -$28,000 $10,000 $62,000

New Minimum Average Maximum

Cows -$16,000 $9,000 $42,000

50/50 Mix -$24,000 $10,000 $56,000

Hay -$42,000 $11,000 $107,000

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Crop Insurance 101

What is Insurance?Insurance is purchased protection against a specific loss over a defined period of time.

What is Crop Insurance?Crop Insurance is purchased protection against specific crop losses over a defined period of time.

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How Does Crop Insurance Work?

Risk Transference (pooling):Risk is Transferred from Many Individuals to the Federal Crop Insurance Corporation and Participating Insurance Companies.

Law of Large Numbers: The Larger the Pool, the More Predictable the Losses.

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Federal Crop Insurance Programs

• Multiple Peril Crop Insurance (MPCI)

• Catastrophic (CAT)

• Crop Revenue Coverage (CRC)

• Income Protection (IP)

• Group Risk Plan (GRP)

• Revenue Assurance (RA)

• Adjusted Gross Revenue (AGR)

• Livestock Risk Protection (LRP)

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• Insurable Interest

• Levels of Coverage

• Deductible

• Underwriting

Crop Insurance 101 - Terms

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• Rating

• Premium

• Loss Event

• Indemnity

Crop Insurance 101 - Terms

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Year Revenues Premium Indemnity Net Revenues

1 $ 100

2 $ 50

3 $ 150

4 $ 25

5 $ 175

Avg. $ 100

Basic Crop Insurance Example

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1 $ 100 - $ 25

2 $ 50 - $ 25

3 $ 150 - $ 25

4 $ 25 - $ 25

5 $ 175 - $ 25

Avg. $ 100


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1 $ 100 - $ 25 $ 0

2 $ 50 - $ 25 $ 50

3 $ 150 - $ 25 $ 0

4 $ 25 - $ 25 $ 75

5 $ 175 - $ 25 $ 0

Avg. $ 100


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1 $ 100 - $ 25 $ 0 $ 75

2 $ 50 - $ 25 $ 50 $ 75

3 $ 150 - $ 25 $ 0 $ 125

4 $ 25 - $ 25 $ 75 $ 75

5 $ 175 - $ 25 $ 0 $ 150

Avg. $ 100 $ 100


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UNITED STATESIn 2007, RMA insured over $62 billion in crop value across 1 million policies, 250 million acres, and 100 commodities.

MichiganIn 2007, RMA insured nearly $1 billion in crop value across 3,600 policies, 3.6 million acres, and 20 commodities.

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Michigan Commodities Covered by Federal Crop Insurance Programs

•Apples•Barley•Blueberries•Cabbage•Cherries•Corn•Dry Beans•Grapes•Green Peas•Hybrid Seed Corn

•Oats•Onions•Peaches•Popcorn•Potatoes•Processed Beans•Soybeans•Sugar Beets•Tomatoes•Wheat

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Livestock Risk Protection (LRP) Program– Provides Price Protection to Michigan

Livestock Producers– Covers Swine, Fed Cattle, and Feeder Cattle– Similar to a (Futures) Put Option– Premium Subsidized (13%)

Federal Risk Management(Crop Insurance) Programs

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• For $1,000 you can buy RMA’s LRP to protect against price downturns, which can cost you more than $5,000.

• Assuming average production, buying LRP assures that you will make at least $4,000.

• On the other hand, every dollar counts in this game.

RULazy2 - Year 4

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1. Buy LRP

2. Take your Chances in the Market

RULazy2 - Year 4


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Multi-Peril Crop Insurance–Based on a Producer’s Average Historical

Production–Causes of Loss Include Weather Events,

Drought, Insects, and Disease. –Premiums are Subsidized up to 56 Percent.


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• Hay yields must be consistent to make money.

• About one year out of eight, yields fall to less than 40% of average, which equates to a net loss of over $8,000 given normal prices.

• For $3,000, you can purchase forage crop insurance that will guarantee you a yield of at least 75% of normal, and which limits your possible loss to less than $2,000 at normal price levels.

RULazy2 - Year 5

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1. Buy Forage Crop Insurance

2. Take your Chances with Mother Nature

RULazy2 - Year 5


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Whole Farm Revenue Programs: Adjusted Gross Revenue (AGR) and

Adjusted Gross Revenue-Lite (AGR-Lite) Based on a producer’s average historical

adjusted gross revenue. Protects against many causes of loss. Premiums are subsidized up to 56 percent.


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Your Year 6 Choices:1. Buy an AGR-Lite Policy

2. Take your chances with the market and Mother Nature

RULazy2 - Year 6

For $2,000, you can purchase an AGR-Lite policy that guarantees you an adjusted gross revenue of at least 80% of your average revenues.

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Summary

•Risk is the “Chance” of a “Bad” Outcome.

•Some Risks Can be Managed; Some Can’t.

•Risk Management Involves the Concept of “Balancing Risk and Reward.”

•We can Sometimes Transfer Risk to Others Using Tools such as (Crop) Insurance.

•Federal Crop Insurance Programs are Subsidized to Promote Grower Participation

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Thank You

Documents

Risk Management Education for Michigans Beginning Producers Custom Ag Solutions United States Department of Agriculture Risk Management Agency (RMA)