This article first appeared in the April 25 Pro Farmer weekly newsletter.
Cattle futures have been subject to volatility due to outside markets and headlines over the past several months, with concerns over affordability and anxiety over a
potential southern border reopening among the most recent drivers. With prices near record high, producers should consider how the Livestock Revenue Protection program (LRP) can help protect their bottom line.
LRP functions as a price floor on expected revenue by guaranteeing a minimum price per hundredweight (cwt) for the insured livestock. LRP is a subsidized insurance policy that can be purchased on various types of livestock to protect against drops in price. The quantity, livestock type (feeders, fats, unborn, dairy, swine), target weight, coverage price and ownership share can all be adjusted based on needs. The subsidy depends on coverage level. Subsidies are as high as 55% and coverage levels can go up to 100% of the projected value.
Available coverage options
LRP is typically used for feeder cattle, fed cattle and swine. Producers must have an insurable share in the livestock to be eligible. Various target weights are available depending on the insured’s goal and type of the animal insured. Insurance periods range from 13 to 52 weeks, and coverage levels range from 75% up to 100% of the expected ending value, which is published daily by RMA and determined by CME futures contracts and adjusted by actuarial documents depending on the livestock type. A single endorsement can cover from one to 12,000 head, with an annual cap of 25,000 head.
How indemnities are determined
At the end of the insurance period, RMA publishes the actual ending value based on a specific national/regional index. For feeders, that is determined by the CME Feeder Cattle Index, while fats are determined by the 5-Area Weekly Weighted Average. Swine use the appropriate national or regional cash price index for that specific policy.
LRP vs. hedging at the board
LRP is effectively a federally subsidized put option, as it protects against only drops in price (not death or any other type of loss). It provides the option of hedging a specific number of head, rather than being constricted to contract sizes at the board. That allows scaling of positions, without risk of being under- or over-hedged. LRP is about 25% to 30% cheaper than buying put options outright. While providing similar levels of coverage, LRP is cheaper and has no upfront cost. LRP does lack the flexibility of options, though, as once a policy is purchased, it cannot be sold to recapture any premium. LRP is especially attractive in periods of high volatility, as option premiums rise due to the bigger swings in futures prices.
Why considering LRP is key
LRP offers a payment date advantage over hedging at the board. While insurance premiums are known upfront, they aren’t due until the insurance policy expires. If an indemnity is due, premiums are deducted from that amount, so no payment is actually paid out of pocket for that policy.
Margins remain tight across the agricultural complex, and the past year has been a testament to how headlines can move markets. LRP can help to mitigate the downside at a cheaper rate than buying put options at the Chicago Mercantile Exchange, protecting margins while still allowing for upside potential. Contact your local agent for more information and see if LRP would be a worthwhile addition to your risk management plan.
