LRP Changes with Sales Expected to Follow[1]

RMA has announced changes to the Livestock Risk Protection (LRP) contract. With these changes, LRP may still be a good risk management tool but one will no longer be able to buy fire insurance �when the house is on fire�. Just one of those government cows that can no longer be milked!

The agency went a little further than I suggested on the available LRP selling time period. The major change is that livestock producers will no longer be able to purchase LRP when the Futures Market is open. RMA will set the LRP rates at market close and then producers can buy at that premium rate until the next morning. The LRP contract will be available for sale from about 3:00-5:00 p.m. to 9:00 a.m. Central Standard Time (CST) the next day. The start time is still being negotiated, but the closing time is 9:00 a.m. CST on the next day. I am not sure how this will work over the weekend. I am guessing it means 9:00 a.m. CST on Monday when rates are set at the market close on Friday.

The RMA Board also set a limit on daily sales. This will force sales to be spread over time. Currently, about half of the LRP sales were on 12/23/03. This concentration of sales on a single day eliminated risk pooling provided by time spread. Also, LRP sales will be shut off if the Chicago Mercantile Exchange (CME) futures prices lock limit down.

Sales will also be suspended if the implied volatility exceeds a Board set level. This would require a very volatile market caused by a similar event as occurred on 12/23/03.

The question of when LRP feeder cattle and fat cattle sales will resume has not been settled. The best guess is July but that is just a guess.

Other Changes. Once LRP sales resume, feeder cattle producers will be able to insure heifers in addition to steers. Producers will also be able to insure calves weighing less than 600 pounds.

RMA has not changed the rules on combining futures and LRP. For example, producers can not buy LRP and then sell/write put options. Because LRP will no longer have a price advantage over options as was the case with the one day delay in LRP rates similar to Loan Deficiency Payments (LDP) on grain, the RMA imposed limits on futures and options may limit LRP sales.

LRP Feeder Cattle Results. The LRP was available for hogs but most of the Kansas LRP sales were on feeder cattle. About 90% of the Kansas LRP feeder cattle sales occurred on 12/23/03, the day USDA announced the �mad cow� case. Most of the producers buying LRP on that day were clearly concerned about the downside price risk. On that day none of the buyers thought LRP was too expensive and the insurance companies thought they would be writing checks for �all livestock producers�.

Those feeder cattle LRP contracts sold on 12/23/03 will start to expire in a few weeks. Based on the current market it does not appear there will be any insurance claims. After all of the concern by USDA-RMA, it appears these feeder cattle LRP contracts will generate a 100% underwriting gain!

So why were these insurance underwriting changes necessary? The short answer is that RMA got lucky on the LRP. If they had continued without those underwriting rule changes, RMA and the insurance industry would have suffered major underwriting loses over time.

Adverse Selection. These underwriting rules will eliminate the adverse selection. Insurance companies will likely be more willing to sell the LRP. LRP will continue to have the advantage of providing coverage for smaller cow-calf producers, 13% premium subsidy, guaranteed order fill, and no commissions paid by the producer.

Some of these underwriting rules may look suspiciously similar to the underwriting rules suggested by me at the Kansas State�s Risk & Profit Conference in August, 2003 and later posted on AgManger.info. Clearly producers had a better deal under the old LRP and probably would have preferred that I not point out the �holes� in the underwriting rules. However, as was demonstrated producers can either have an actuarially sound LRP program or none. It was not possible to support the original LRP. These underwriting rules are absolutely necessary to have a viable LRP program.

It was also pointed out there were a number of underwriting rules that made no sense. RMA has eliminated the underwriting rule on heifers so that they too can be insured. They still have underwriting rules on LRP insured producers� use of futures and options that make no sense. Clearly RMA did not adopt all of the author�s suggested changes but some livestock producers may still wish to hold KSU responsible.

Private Reinsurance. These changes to LRP eliminate the adverse selection. Also LRP does not guarantee the basis so there is no moral hazard in the contract. Individual managers will have no effect on claims. There is still the risk of systemic loses but the new daily sales limit will reduce this risk. These changes should make the LRP more attractive to reinsurers in Europe and the United States. The lack of private reinsurance was going to be a real constraint on LRP sales.

RMA has released several press releases and Manager�s statements on LRP. The board also made changes to the Livestock Gross Margin (LGM) contract. The expectation is that LRP and LGM will be released at the same time. LGM was available on Iowa hogs only. Kansas producers were not offered LGM. LRP on hogs and feeder cattle were the only RMA livestock insurance contracts available to Kansas livestock producers.

RMA has posted several livestock insurance items on their WEB site:

http://www.rma.usda.gov/news/2004/04/414lrplgm.html

http://www.rma.usda.gov/aboutrma/fcic/2004/406lrp.pdf

[1]Prepared by G. A. (Art) Barnaby, Jr., Professor, Department of Agricultural Economics, K-State Research and Extension, Kansas State University, Manhattan, KS 66506, April 15, 2004, Phone 785-532-1515, e-mail � abarnaby@agecon.ksu.edu.