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LRP For LivestockLRP For Livestock

April 2008by Duane Griffith, Montana State

University Gary Brester, Montana State University

Risk Management Agency

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Livestock Risk Protection

Feeder Cattle Fed Cattle Swine Lamb All these types of livestock are covered

by LRP in all Montana and Wyoming counties.

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Examples are Using Livestock Risk Protection for Feeder Cattle

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Feeder Cattle Coverage

Can cover small number of head Not lumpy like Options Contracts

Settles to daily CME index price

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Livestock Risk Protection-Feeder Cattle Highlights

LRP for feeder cattle offers single-peril price protection

LRP does not eliminate other risks. Does not cover sickness or death of the

cattle. Does not insure against possible rising feed

costs Producers remain subject to basis price risk:

(Actual cash market price minus the cash-settled CME index value)

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Basics of LRP for Feeder Cattle

LRP insurance does protect against decline in prices below the established coverage price.

Insurance period: Insurance is offered for 13, 17, 21, 26, 30, 34, 39, 43, 47, or 52-week periods.

The producer selects a time closest to When the cattle will be marketed or When cattle will reach the desired weight.

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Basics of Livestock Risk Protection—Feeder Cattle, cont.

Application: An application is required to purchase insurance coverage. It establishes producer eligibility. Must file a form indicating beneficial interest with

the application Specific Coverage Endorsement:

A producer must file a Specific Coverage Endorsement for each group of feeder cattle to be insured.

Several endorsements may be filed under one application as long as beneficial interests are the same.

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Basics of Livestock Risk Protection—Feeder Cattle, cont.

Insurable Type Target Weight

Steers Weight 1 less than 6.0 hundredweight

Steers Weight 2 6.0 to 9.0 hundredweight

Heifers Weight 1 less than 6.0 hundredweight

Heifers Weight 2 6.0 to 9.0 hundredweight

Brahman Weight 1 less than 6.0 hundredweight

Brahman Weight 2 6.0 to 9.0 hundredweight

Dairy Weight 1 less than 6.0 hundredweight

Dairy Weight 2 6.0 to 9.0 hundredweight

Feeder Cattle Types and Weights Eligible for LRP Feeder Cattle Coverage

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Basics of Livestock Risk Protection—Feeder Cattle, cont.

Endorsement Limits: Limit of 1,000 head of feeder cattle may be

insured under any one Specific Coverage Endorsement.

Annual Policy Limits: Total number of head of feeder cattle that may be

covered during a crop year is 2,000 head. Coverage Prices:

Prices that may be insured by the producer change daily and are obtained from the RMA website:http://www.rma.usda.gov/tools/livestock.html

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Basics of Livestock Risk Protection—Feeder Cattle, cont.

Coverage levels: Calculated based on the chosen coverage

price. Coverage levels will range from 70 to 100%.

Price Adjustment Factors:

Adjustment Factors applied to values listed on RMA website

Price Adjustment Factors

Weight Range Steers HeifersPredom. Brahman

Predom. Dairy

< 6.0 cwt 110% 100% 100% 85%

6.0 – 9.0 cwt 100% 90% 90% 80%

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Basics of Livestock Risk Protection—Feeder Cattle, cont.

Off-setting Transaction: A producer must not enter into any transaction

that would have the effect of converting any portion of the premium subsidy provided by the FCIC into funds available for the producer’s use.

Therefore, no offsetting position may be taken in the commodity futures and options market.

Expected End Value: This is the expected prices at the end of an

insurance record for each specific type and weight of feeder cattle announced daily on the RMA website:

http://www.rma.usda.gov/tools/livestock.html

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Basics of Livestock Risk Protection—Feeder Cattle, cont.

Actual End Value: This is the value of CME feeder cattle index

on the end date of the insurance period, Adjusted by RMA for feeder cattle type and

weight

Subsidy Level: 13% subsidy on LRP feeder cattle contract

insurance premiums

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LRP—Feeder Cattle Example

Contract Data Value CalculationNumber of Steers 1,000 hd Producer

Expected Weight 800 lb Producer

Current Date April 29, 2008 Producer

Marketing Date July 29 Producer

Insurance Period 13 weeks Producer

Expected Ending Value $107.96 cwt RMA

Coverage Level 92.38% Producer

Coverage Price $99.73 cwt RMA

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LRP—Feeder Cattle Example

Feeders, Feb. 4, 2008

Contract Data Value Source

Insured Value $797,840 1,000 hd x 8 cwt/hd x $99.73/cwt

Premium Rate 0.013 RMA

Total Premium $10,488 $797,840 x 0.013

Subsidy Rate 13% RMA

Subsidy Amount $1,363 $10,488 x 0.13

Producer Premium $9,124 $10,488 – $1,363

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LRP Example

Suppose a producer actually sells 1,000 of 800 pound steers on May 7, 2008. Sold the steers for $100.00/cwt

The CME-reported actual ending value is $97.50/cwt.

Will the producer receive an indemnity

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LRP Example Answer

Yes. Indemnity calculation

1,000 head x 8 cwt/head x ($99.73 - $97.50) = $17,840

Revenue from calves 1,000 x 8 cwt/head x $100.00 = $800,000 Plus indemnity of: +

17,840 Less net premium paid: - 9,124 Net revenue: = $808,716

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LRP Example Answer

Recall that the producers was expecting $107.96/cwt 1,000 x 8 cwt/head x $107.96/cwt =

$863,680 Without LRP, the producer receives

$800,000 With LRP, the producer receives

$808,716

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Questions ??

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Adjustment factors account for differences between heifer prices and prices of other types and weight of cattle.

Price adjustments are applied to expected ending values, coverage prices and actual ending values prior to entry on the RMA website.

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Livestock Gross Margin

First offered in late January of 2006 Covers finishing margin on yearlings

and calves fed in major cattle states Uses set (fixed) basis levels for

insurance period Producer chooses deductible level May be cost-effective for small feeders

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South Dakota 2000-2004 Monthly Average Cattle Feedlot Activity

0

20

40

60

80

J F M A M J J A S O N D

Source: USDA-NASS

1,0

00

he

ad

Marketed Placed

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State-Level Basis Tables ($/cwt. or bu.)

MT J F M A M J J A S O N DFed -0.26 -1.08 -0.59 -2.23 -9.20 -

10.90

-9.02 -0.58 0.69 2.06 0.17 -2.44

Yrlg 1.48 1.64 2.44 1.94 0 -0.99 -2.64 -4.25 -4.06 0.25 1.05 1.38

Calf 13.20

14.77

16.18

14.34

12.29

9.57 8.05 10.32

8.31 6.94 7.42 10.52

Corn -0.25 -0.24 -0.22 -0.22 -0.32 -0.14 -0.12 -0.11 -0.10 -0.19 -0.21 -0.18

WY J F M A M J J A S O N DFed 0.54 0.40 0.64 1.29 0.46 3.28 6.86 9.01 6.94 1.98 -2.90 -2.18

Yrlg 0.66 0.42 1.40 0.70 -0.29 1.20 0.79 -1.23 -0.85 1.22 2.22 2.54

Calf 15.63

19.09

19.18

17.42

15.45

14.83

15.50

14.56

14.55

12.48

12.19

15.87

Corn 0.04 0.02 0 -0.01 0 0.13 0.26 0.17 0.21 0.08 0.08 0.09

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Margin Example – May South Dakota Yearling, Covered Jan-06

October Fed ($87.00 + $3.68)$1,133.50Value * 12.5 cwt.

- -May Yearling ($114.00 – $3.77)$ 826.73Cost * 7.5 cwt.

- -August Corn ($2.36 - $0.32) $ 117.30Cost * 57.5 bu.

= =Expected Margin (per head) $ 189.47

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Typical Marketing Plan

Backgrounder with 150 head of steers to sell on March 15, 2006

Buy 2 March FC puts (130 head), 100 strike, for $2.60 per cwt. or better

Buy LRP-Feeder coverage on 20 head, 90 percent level, for $3.00 per cwt. or better

Sell 1 March futures if $110 or better

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LRP Versus Options, cont.

LRP & Put options both protect price risk. For LRP, the selected “coverage price” is the

producer’s price floor. For options, the selected “strike price” is the

producer’s price floor. Both LRP & Options require the payment of

a premium. LRP—an insurance premium is paid to an

insurance agent. Options—an option premium is paid to a

broker.

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LRP Versus Options, cont.

Payouts are received when prices decline below an insured level. LRP- receive an indemnity Options- option premium increases in

value and is reflected in the producer’s brokerage account

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LRP Versus Options, cont.

No payouts are received if market prices remain above the insured level. LRP – No indemnity Options – Option premium declines to zero

and there is no increase in the producer’s brokerage account.

Both LRP and options are subject to basis risk. Both products protect the producer from a

decline in the CME feeder cattle price index

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LRP Versus Options, cont.

Neither product protects the producer from a decline in the producer’s sale price.

Disadvantages of options relative to LRP: Need a brokerage account – hence

brokerage fees Subsidies are not available for option

premiums. No price adjustments for varying weights.

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LRP Versus Options, cont.

Advantages of Options relative to LRP: A producer may buy higher price coverage

levels than LRP. LRP coverage levels always “out of the

money” More timing flexibility because the producer

may sell an option prior to expiration. Can re-purchase an option at any time

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Livestock Risk Protection

Feeder cattle coverage was first offered June 9, 2003.

Feeder cattle endorsement suspended December 24, 2003 after BSE case of previous day.

Feeder cattle endorsement resumed September 30, 2004.