Disclaimer: This web page is designed to aid farmers with their marketing and risk management decisions. The risk of loss in trading futures, options, forward contracts, and hedge-to-arrive can be substantial and no warranty is given or implied by the author or any other party. Each farmer must consider whether such marketing strategies are appropriate for his or her situation. This web page does not represent the views of Kansas State University. 
Disclosure:  Dr. Barnaby’s research was the basis for the privately developed Crop Revenue Coverage.

Different Harvest Prices give Different RA, IP, and CRC Payments[1]

Are you still recommending purchase of the least expensive replacement-revenue insurance product given that the indemnity payments were not the same on 2002 winter wheat?

The simple answer is, YES! 

There was not a “large” difference in the size of the indemnity payments among the alternative Kansas wheat crop insurance contracts (figure 1).  While the results were unusual in 2002, the long-term expected indemnity payments for Crop Revenue Coverage (CRC) and Revenue Assurance with the harvest price option (RA-HPO) are approximately equal.  However, in any particular year one of these contracts will pay more than the other and that occurred in 2002.

The RA contract without the harvest price option on average will pay less than either RA-HPO or CRC and in some cases less than MPCI-APH.  Income Protection (IP) will normally pay less than RA-HPO, CRC, and RA in Kansas because IP is based on the Chicago Board of Trade (CBOT) wheat price that is normally lower than the Kansas City Board of Trade (KCBOT) wheat price and IP offers enterprise units only. 

The major surprise in 2002 was the CRC and IP contracts paid based on a revenue indemnity payment because the price declined 25 cents a bushel or 7.5 percent lower than the fall planting price as measured by KCBOT July wheat.  The CBOT price declined from $3.04 to $2.89 or a 4.9% decline that applied to IP in the Southern Great Plains and CRC in the Southern soft wheat states.  During the same crop year the RA harvest price for hard red winter wheat increased by 6 cents or 1.8 percent above the fall planting price. 

Why Two Prices?  Both RA and CRC planting price is based on the Kansas City July “new crop” wheat price that is set on September 15.  The planting price election for both 2002 contracts was $3.34 that set the minimum revenue guarantee for CRC and RA but their harvest prices were different.

The reason there were two different harvest prices was caused by the harvest price being measured during different time periods.  The CRC harvest price measurement is the June average of KCBOT July wheat, while RA’s harvest price is the July 1-July 14, average price of KCBOT July wheat.  In 2002, the June average price was $3.09, while the July 1-July 14 average was $3.40. 

This price change generated the unusual result of prices being lower for CRC and triggering the revenue guarantee, while being higher for RA-HPO and triggering the replacement coverage guarantee.  This was the first time in 30 years when one price was lower and the other price was higher thus triggering revenue insurance on one contract, while triggering replacement coverage on the other contract (Table 1).

The higher prices measured from July 1-14 lowered the RA (without the harvest price option) indemnity payments because it is a revenue guarantee only and does not provide the replacement coverage when prices are higher.  The IP contract is also a revenue guarantee only but the harvest price was measured as the June average price of the CBOT July wheat contract for Kansas and other hard red winter wheat states.  Because the IP harvest price was lower than the IP base price the result was higher IP payments than RA or RA-HPO under some conditions.  Because the IP wheat price election was $3.09 based on the CBOT versus $3.34 for RA (hard red winter wheat states), RA insured growers with “large” yield losses would be paid more than IP insured growers.  However, with “small” yield losses, IP insured growers may be paid more than RA insured growers.  Payment differences will also depend on the unit structure selected for RA versus IP.

So which contracts paid the most on the 2002 wheat losses?

To show the different possibilities that generate indemnity payments an example hard red winter wheat farm was assumed with a 40 bushel average yield (actual production history) and a 75 percent guarantee.  The MPCI-APH contract would have had the lowest coverage (except for IP) because of a $3.15 price election versus $3.34 on the revenue products.  Those growers that are in the soft wheat states would have had a price election of $3.04 and under those conditions, depending on yields; MPCI-APH could have actually paid more. 

The IP contract uses the Chicago Board of Trade contract even in the hard red winter wheat states and the result would have been lower coverage than the MPCI-APH contract.  Therefore, with “low” yields, MPCI-APH would have paid more than IP in states where prices were measured by the CBOT wheat contract.  This would also be true for both RA and CRC in Southern soft wheat states.  However, that would not be true for RA-HPO because the price increased to $3.17.

For this farm with a 40 bushel APH in Kansas and other Southern hard red winter wheat states, the insurance coverages were: IP, $91.20; MPCI-APH, $94.50; RA, $100.20; CRC, $100.20 and RA-HPO, $102.00.  With a 5 bushel yield, the indemnity payments were: IP, $76.75; MPCI-APH, $78.75; RA, $83.20; CRC, $84.75 and RA-HPO, $85.00 (Table 2).

In the case of Kansas and other Southern hard red winter wheat states, the preferred contract would depend on the amount of yield produced.  If the grower produced an average yield then no insurance was the preferred alternative.  But with claims there was no contract that was best under all conditions.

Because there are many different yields that could have occurred on this farm, the indemnity payments for each of the contracts were plotted in figure 1 for yields ranging from 0 bushels to 33 bushels.  For yields above 6 bushels, on this particular farm, the CRC contract paid the highest indemnity payments among all of the contracts as represented by the green line labeled CRC.  This was caused by the revenue indemnity payment being triggered by the lower CRC harvest price measurement (figure 1). 

The RA (red line and labeled RA) contract, without the harvest price option, paid the lowest indemnity payments compared to RA-HPO or CRC when yields were below 6 bushels.  RA would have paid less than RA-HPO or CRC, unless the yield was equal to zero and then RA and CRC would have paid exactly the same.  The RA-HPO contract paid more than CRC if yields were below 6 bushels but less than CRC if yields were above 6 bushels as represented by the blue line and labeled RA-HPO.  This was caused by the RA harvest price being higher than the fall planting price. The MPCI-APH contract paid less than CRC or RA-HPO, which is represented by the black line and labeled MPCI-APH (figure 1).

In order to get a closer look, figure 2 shows the indemnity payments for yields ranging from 0 to 6 bushels.  Notice with these very “low” yields the RA-HPO payout was higher than all of the contracts compared.  The CRC paid more than RA without the harvest price option for these very “low” yields.  MPCI-APH paid less than RA-HPO, CRC or RA.  The insurance contract that would have paid the least in Kansas was the IP contract (purple line and labeled IP), primarily because it was measured by the Chicago Board of Trade wheat price.  IP had a lower price election than MPCI-APH ($3.04 versus $3.15) and the harvest price measurement was lower at $2.89.  With smaller yield losses, at some point, IP would have paid more than MPCI-APH but still less than the CRC contract (figure 2).  There was very few IP wheat contracts sold in Kansas . 

Figure 3 shows the payouts for yields of 29 bushels to 33 bushels.  Because the CRC contract was triggered by the revenue loss the indemnity payments triggered at about 32.5 bushels rather than 30 bushels as required by MPCI-APH and RA-HPO because of the price increase.  With a small yield loss the IP contract paid more than the RA-HPO, RA, or MPCI-APH but the unit structure may have offset this advantage.  The RA contract required the largest yield loss to trigger payments. 

With “small” yield losses the CRC contract would have been the preferred coverage.  With severe yields losses the RA-HPO would have been the preferred contract.  The least preferred insurance product would have been RA without the harvest price option and “small” yield losses while IP would have been the least preferred with “large” yield losses (Figures 2 and 3).