Yield and Revenue Insurance Considerations

usdalogoBack in 2011 there were some important changes to the crop and revenue insurance programs. A range of products like multi-peril crop insurance (i.e., the old APH yield policy), and the revenue insurance products that applied to cotton (e.g., Crop Revenue Coverage, Revenue Assurance, and Income Protection) were basically re-packaged by USDA-RMA, with a common mechanisms for price discovery and rating.  The repackaged crop insurance program gives cotton growers a wide range of choices within one package. The first set of choices involve whether the grower wants to insure only yield (similar to the old multi-peril, APH yield policy, and is now simply called Yield Protection), or gross revenue (known as Revenue Protection, or RP, and similar to the old CRC product using the higher of planting or harvest time futures prices to value the coverage) or gross revenue without the harvest time price valuation (known as Revenue Protection Harvest Price Exclusion, or RPHPE,and similar to the old RA or IP products. The three new product choices vary in cost as they provide differing levels of protection.

How does this relate to cotton marketing? Well, the yield protection product basically only covers your yield risk (valued at pre-plant futures prices, and only triggering if there is a yield loss). The revenue products protect you from declines in gross revenue caused by lower yields and/or lower prices. Thus the new revenue products are analogous to having yield insurance plus a deep out-of-the-money put and call option (for RP) or just having yield insurance plus a deep out-of-the-money put option (RPHPE). All things being equal, the latter revenue product would cost less than the former, but the latter leaves a grower more exposed to the risk of revenue losses.

Besides having to decide about the insurance product, growers also must decide the coverage level and aggregation level, both of which will influence the premium cost.  One implication of the common pricing and rating procedures for these products is that you can compare the difference in premiums and infer the value of the built-in price insurance.

Details on the official price discovery methods and sales closing dates can be found here. In short, the price  used to value insured cotton is based on the average of futures prices at defined periods of the year. This approach is new for yield insurance, but similar to how CRC coverage was priced in years past. The relevant price discovery windows are determined by a region’s sales closing date (see here for irrigated cotton and here for non-irrigated cotton). For example, for regions with a Feb. 28 sales closing date (including Central Texas), the 2015 price was the average of Dec’15 settlement prices between mid-January and mid-February, which worked out to be 63 cents per pound.  The South Texas region with the earlier January 31 sales closing date had a higher base price of 65 cents, based on the the average of Dec’15 settlement prices between mid-December and mid-January.   The regions with a March 15 sales closing date have a base price using the average of Dec’15 settlements during the month of February.  For 2015, this base price worked out to 64 cents per pound.

Relative to the past several years, these 2015 insurance prices mean that yield and revenue policies will generally provide sub-profitable price and gross revenue protection. Even with supplemental insurance policies like SCO or STAX, growers are insuring a percent of their APH yield times a sub-profitable price.  Choices about supplemental insurance under this scenario involve somewhat complicated questions related to grower cash flow and risk preferences.   One additional possibility is to consider marrying your revenue insurance coverage with additional down-side price protection.  A put spread, for example, could be designed to cover the range of price risk exposure left by your revenue protection coverage.  Click here to see more discussion and examples of put options and put spreads.


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