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.

TRADING HIGHER CROP INSURANCE COVERAGE FOR AGGREGATE UNITS[1]

            Recently a wheat grower asked; how will the 2004 wheat rates affect his strategy of buying higher levels of Revenue Assurance with no harvest price option (RA-NHPO) and enterprise units?  An enterprise unit combines both rented and owned wheat acres planted in a county in to a single guarantee.  A yield loss is averaged across the entire wheat crop not a single sub-farm level as is the case for basic and optional units.

            How this strategy will work depends on where the fields are located and the number of wheat acres.  Income Protection (IP) offers only enterprise units so all farms qualify for an enterprise unit even if they only have 10 acres.  Crop Revenue Coverage (CRC) discounts premiums as the number of acres increase in the enterprise unit.  Therefore, a 40 acre farm will pay more than a 1,400 acre farm if both elect enterprise units.  RA-NHPO and Revenue Assurance with the harvest price option (RA-HPO) discount premiums for an enterprise unit based on the number of sections planted to wheat.

            An example farm was created assuming 640 acres of wheat, 40 bushel APH, and 2004 Kansas wheat price elections.  IP is based on Chicago wheat prices, while RA and CRC are based on Kansas City wheat prices.  The RA, CRC, and Multiple Peril Crop Insurance based on Actual Production History (MPCI-APH) are offered in all Kansas counties.  IP is only offered in a few counties.  The enterprise analysis was based on the assumption that all 640 acres of wheat was planted in a single section.  An alternative was developed assuming there were eight different 80 acre wheat fields planted in 8 different sections for a total of 640 acres.

            Premiums for the above example farm were calculated for Central Kansas and Western Kansas to compare the alternatives (table 1 and 2).  Growers that are very concerned about yield risk are considering changing from revenue insurance to MPCI-APH with a higher coverage level.  Another option is to consider RA-NHPO.  This gives more dollars of coverage and if the wheat yield is near zero, higher prices will have no effect on the RA-NHPO payment and it will pay more than MPCI-APH.  One could also buy call options next spring if it remains dry and protect against any RA payment losses caused by increasing prices.

            One alternative is to switch from basic or optional units to enterprise units and buy higher coverages.  For example, CRC 80% optional units cost $8.24 and 85% enterprise units cost $7.69 in Central Kansas (table 1).  The key to the CRC enterprise unit is the number of acres.  In this example it was assumed to be 640 acres and it does not matter if the acres are all located in one section (grower must qualify for a minimum of two basic units to be eligible for a CRC enterprise unit discount).

            RA-NHPO provides the same coverage as IP.  IP also does not offer 80% and 85% coverage.  The RA-NHPO premium cost for 640 acres located in one section in Central Kansas is $3.45 and $4.52 in Western Kansas for 75% coverage (tables 1 and 2).  By contrast, 75% coverage IP premiums were $6.62 for Central and $6.76 for Western Kansas .  IP is offered in only a few counties and no condition was found where RA-NHPO premiums were higher.

            RA-HPO provides nearly the same coverage as CRC.  However, RA defines enterprise units based on sections and CRC defines enterprise units based on acres.  In the example, if all 640 acres of wheat is located in one section then CRC is less expensive.  For Central Kansas , CRC 80% coverage premiums were $5.54 versus $6.76 for RA-HPO (table 1).  For Western Kansas CRC 80% coverage premiums were $6.27 versus $8.40 for RA-HPO (table 2).

            However, if the wheat acres are spread over more sections then RA-HPO premiums are less than CRC.  For example, if the grower had eight fields of 80 acres located in 8 different sections he\she would still have 640 acres of wheat.  However, the premium discounts are substantially larger.  At 80% coverage level RA-NHPO is $4.69 per acre and $6.24 per acre for the RA-HPO (table 2).

            An enterprise unit can provide a large premium discount.  For example, 80% RA-NHPO optional units premium is $7.72 in the Western Kansas example.  By electing the enterprise unit the RA-NHPO premium was cut by 39% to $4.69, if spread over 8 sections.  However, the enterprise unit reduces the protection from hail.  Some farmers compensate for reduced protection from hail by increasing coverage.  For example, this Western Kansas farmer could increase RA-NHPO coverage from 65% to 75% by electing the enterprise unit while increasing premium cost by only 25 cents an acre.  The enterprise unit would increase the dollars of coverage by $14 from $88 to $102 (table 2).

            The Central Kansas premium reduction for RA-NHPO was about 37%, or similar to Western Kansas .  However, the dollar premium discounts for Western Kansas are larger.

Summary.  Kansas wheat growers with concerns about drought losses caused by dry planting conditions are considering changing their insurance coverage to MPCI-APH.  However, this may not be the best option.  Growers who have acres that are spread over several sections may find RA-NHPO with enterprise units is a better option.  This will give the maximum number of dollars per acre coverage and would protect the grower from drought even if the other side of the county receives rain.  Giving up the optional units will reduce the protection from spot losses such as hail damage. 

If the acreage is large but concentrated in a few sections, then the CRC enterprise unit may be the preferred option.  No conditions were found where IP that offers only the enterprise unit would be preferred on Kansas wheat.  The premiums were simply higher than RA-NHPO, yet it provides the same coverage as IP.

Greater use of the enterprise unit would be feasible if the subsidy system recognized that enterprise units have less variability than optional units.  Many farmers indicated a 10 to 15 percent increase in coverage under an enterprise unit would provide the same protection as optional units.  For example, these growers are saying a 75 percent optional unit contract provides the same protection as an 85 percent enterprise unit.  However the subsidy on an enterprise unit at 85% coverage is only 38 percent, while the subsidy on an optional unit at 75 percent coverage is 55 percent of the premium.  This subsidy difference currently discourages farmers who would otherwise shift to an enterprise unit. 

Even if the subsidy bias against enterprise units were corrected, policy makers probably would not want to eliminate the optional unit because there is a significant amount of irrigated corn and other crops in the Great Plains covered under optional units. Only the optional unit fits this risk exposure on irrigated crops where hail damage is the primary risk, which is very severe but localized.