November 20, 2014
Livestock Risk Protection (LRP) insurance isn't a new product but doesn't seem to get due usage by beef producers, considering its low price and simplicity in comparison with futures options.
In theory, LRP insurance is similar to buying futures put options as a "floor price," but it is an insurance product more like crop insurance. Pricing is based on futures markets, and payout is based on the CME feeder cattle index, which is an index of cash prices.
It is available for a wide weight range of calves from under 600 pounds to 900 pounds, so it can be used by cow-calf producers or stocker operators and backgrounders.
It is a federally subsidized insurance program in which beef producers basically buy an insurance premium which guarantees them a percentage of a future CME feeder cattle index price. Then, if the CME index price on the expiration date of the contract is below the price level at which a producer "insured" his cattle, he will receive a settlement for the difference.
This use of the CME feeder index can be an important advantage for LRP insurance over options, says Scott Bulling of Farm Data Services in Oklahoma. Bulling is a beef producer and licensed seller of LRP insurance. Options settle by the board price and often rectify with cash prices only on the date the feeder contract closes. Most LRP contracts don't expire on those dates, Bulling adds. That means the LRP contracts should be more in line with cash pricing and should minimize basis as much as possible, depending on where you live.
Deciding which product to purchase is the most complex part.
Comparing LRP and puts.
Here is an example comparing LRP insurance with a put option for a similar timeframe in May 2015.
On one day in early November you could buy an LRP contract for May 8, 2015, at a "coverage price" of $206.11 per hundred on a final CME index price that day of $229.81 for a cost of $2.66 per hundredweight. That represented an 89% coverage level.
If you planned to sell two potloads in May of 725-pound cattle, or 150 head, that would be 108,750 pounds or 1,087 hundredweight. At that cost of $2.66 per hundred, your LRP would cost you $2,891. Keep in mind your "insured" price on this contract would be $206.11. If the feeder index closes below that level on the close of your contract you will get a payment.
To do roughly the same thing by buying a put option on that date would have cost about $5.40 per hundredweight, or something like $5,870. This would give you a "floor price" of $220 per hundredweight, which was the "strike price" of the May put option. To use the put option you would need a brokerage firm of some sort and could incur a brokerage fee. You would get a payment if the feeder cattle futures contract for May closed below your $220 strike price.
Not accounting for basis variations between the two methods, the LRP insurance would set your floor price at $206 per hundred while the option would set it at $220. A person could argue the difference of up to $14 per hundredweight in the insured level would be $15,218 and therefore the LRP would not be such a bargain in this case.
However, the values and pricing change daily for both products, so the cost-benefit relationship will change a great deal as well.
One big advantage of LRP insurance is you can buy it for any amount of livestock, says Clay Burtrum, another Oklahoma beef producer, LRP seller and a partner in Farm Data Services. By comparison, feeder cattle futures are for lots of 50,000 pounds.
Bankers and producers both like the LRP insurance because it's easy to use, says Burtrum.
"From the producer's standpoint, it's simple. I write a check and I'm done," he says. "I don't need a broker. There are no margin calls. And my banker's happy."
Although the process of purchasing LRP insurance is pretty simple, here are 10 helps to understand the system.
1. Forget about basis as a part of this equation. It may matter to your actual price and profitability but has nothing to do with pricing and purchasing LRP.
2. You can sell your cattle within the last 30 days of when your LRP contract expires, or you can keep them beyond that point. Both these actions keep your contract valid.
3. To purchase it you need to contact an LRP agent who is licensed in the state where you will have cattle. You can find a list of them on the Risk Management Agency (RMA) website by using its Agent locator tool.
4. High market volatility can really cut the number of LRP insurance contracts available. Sometimes you can shop the market a few days or wait for volatility to die down. You may want to phase in coverage on cattle.
5. LRP insurance is independent of and unaffected by other contracts, such as futures contracts, options or forward contracted cattle which you may have arranged.
6. You can insure a price on a set of cattle more than once, but not at the same time. In other words you could insure a price on wheat-pasture calves until the usual end of wheat pasture grazing in March. Then if you decide to keep them you could insure them again with LRP to another date further out.
7. The largest weight for which you can insure feeder cattle price and receive payment is 900 pounds. There are two categories: calves under 600 and those between 600 and 900 pounds. You'll put this information on your contract.
9. The LRP feeder cattle contracts also factor in variations for steers or heifers and for Brahman or dairy cattle.
8. If payment is due you, the LRP insurance system will pay you whether you sold the cattle in the 30 days prior to their insurance date or kept them.
10. LRP contracts are only available after the close of CME business until it begins the next day, or about 5 p.m. to 9 a.m. Central time.
To explore the current pricing of LRP insurance go to "LRP Coverage Prices, Rates and Actual Ending Values." To get correct pricing from this page, you'll need to multiply the rate listed near the right side in the "Cost Per CWT" column by .87 to include the 13% federal subsidy.
You can reach Burtrum at (405) 747-9865 or Bulling at (405) 205-0061.
You can read a good overview of the LRP program on K-State's AgManager site.
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