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Will ACRE work on Kansas wheat? [1]

Good morning Dr. Barnaby

I hope you are doing well.  It was nice to see you a few weeks ago at the Washington crop insurance meeting. 

This morning, Dan Morgan did a piece in the Washington Post raising concerns about ACRE.  I followed up with USDA and understand RMA has concern with the impact ACRE may have on revenue products and buy up. 

Have you had a chance to take a look at the program and if so, do you share this view?  Just curious what the experts think. 

Thanks and hope you have a good day. 

Washington Guy

Dear Friend,

I will use your question and post it on AgManager.info because I am getting hit with this question from a lot of people.  Disclaimer:  My comments are a first cut based on my upstanding of the statute.  USDA will write the implementation rules so some of the economic consequences could change.

There have been 3 major crop losses since 1980 on Kansas wheat; 1989, 1996, and 2007. However ACRE would not have paid on the 2007 Kansas wheat loss!  Also ACRE hit the 25% per acre payment cap on the 1989 Kansas wheat crop failure (see table 1).

Farmers must select ACRE for all of their crops, not just wheat.  Crop insurance allows farmers to select different types of coverage and deductibles for different crops.

The state level revenue loss is the first trigger for ACRE payments.  The second trigger is the farm must have revenue below the farm level benchmark revenue plus crop insurance premiums, so even if the state triggers payments farmers must have below average revenue to collect.

If farmers collect, they only collect on 83.3% of their acres and there are payment limits too.  Crop insurance pays on 100% of the planted acres.

Farmers must give up 20% of their direct payment and accept a 30% cut in the loan rate to select ACRE.  This effectively is the same a paying a premium for ACRE coverage.

The loan is worthless in this new market but a 20% cut in a direct payment is real.  Assuming an average wheat direct payment of $15, ACRE would cause a $3.00 reduction in direct payments.  The 28 year average ACRE payment was $3.07 on Kansas wheat and that assumes farmers also had a farm level loss in all of those ACRE payment years.  So the reduction in direct payments would have paid for ACRE on Kansas wheat.

However, there will be miss-informed farmers who will cancel their crop insurance coverage because they have ACRE unless your insurance agents educate them on ACRE vs. crop insurance that include:

1. Crop insurance does not require a state level revenue loss for payments.
2. Crop insurance does not have a per acre payment cap of 25%.
3. Crop insurance does not have a farmer payment limit.
4. Higher market prices will eliminate the ACRE payment as occurred on 2007 Kansas wheat.  Under crop insurance farmers may buy CRC or the harvest price option so that when prices increase it does not eliminate crop insurance payments but does the opposite by increasing payments.  When farmers have no yield is when they have the greatest need for cash.
5. There is larger negative price-yield correlation at the state level in core growing states, i.e. Iowa corn, Kansas wheat, etc.  It is likely this negative-price yield correlation has increased because there is very little carry over causing very tight stock-to-use ratios.  This means low crop yields in those states often cause prices to increase and eliminate ACRE payments as occurred on the 2007 Kansas wheat crop. 
6. In 2007 Kansas wheat yields were good in NW Kansas but not central Kansas.  Acre would not have paid and those central Kansas wheat farmers would have had major losses without crop insurance payments.

Conclusion:  It does not appear that ACRE will be a major competitor for crop insurance.  However, ACRE may cause some farmers to drop their crop insurance coverage because they believe crop insurance is overrated in their area.  There is evidence to support the argument that in some counties the expected county yield is overstated for GRIP/GRP but in other counties it is understated.  University of Illinois on their WEB site FarmDoc will even identify the counties with overstated county yields, making it easier to adverse select.  The APH programs are more difficult to rate with short run yield problems.  In any case there maybe an argument that the ACRE program will put greater pressure on rating accuracy.  When allowed to work even Washington can not ignore the judgment of the market!

Will ACRE work on Kansas wheat? Yes.

The method for setting expected Kansas wheat yields was changed from the original proposal.  The new method is more favorable to Kansas wheat.

The strike price for ACRE is a two year average of the prior two years so when prices start to fall farmers will have a lower expected price.  Farmers are in effect buying an in-the-money put option on expected state revenue.  However, because of the negative price-yield correlation on Kansas wheat, I would suggest locking in the expected payment with the purchase of a call option. 

So it will depend on the market, if farmers should select ACRE on wheat the first year.  It will also depend on the markets for the other crops.  So one may get a different answer if a farmer’s dominate crop is wheat versus corn.

Conclusion:  ACRE is not a “no brainier” on Kansas wheat.  Over the last 28 years the reduction in direct payments would have equaled the sum of the ACRE payments.  However, once prices start to decline, then farmers will be able to adverse select on ACRE and there is a 10% cup on the guarantee.  The only thing that would have made ACRE better for farmers would have been if farmers could select individual crops for ACRE and not all crops, and if they could switch back to the direct payment in future years.

On must also remember there is a 10% cap, so in some years it is possible the expected market price will be higher than the ACRE strike price.  Therefore, farmers are effectively buying an out-of-the-money put option on state yields.  In those years ACRE will provide little risk protection.