Risk management extra important in down economy

My colleagues and I have been crisscrossing the country the last few months. This is a busy time of year given the crop insurance sales closing date for spring crops is March 15 and just 10 days after the staff at National Sorghum Producers and its subsidiary, Sustainable Crop Insurance Services, returns from Commodity Classic. This year we’re even busier as it’s time to write a new farm bill.

The common thread in our roadshow conversations this year has been the importance of taking an active approach to risk management. It’s no secret this farm economy has many producers worried, and in some cases the best risk manager in the world can’t prevent a hit to equity. However, with the correct strategies, serious financial strain can be mitigated. As usual, pencils will need to be sharpened.

I wrote a few months ago about a new private crop insurance product called Production Cost Insurance, or PCI. We’ve had an incredible amount of interest from
producers looking to cover risk more effectively, and our producer discussions, as well as extensive modeling of the product and how it can interact with multi-peril crop insurance (MPCI), have convinced us PCI (and the MPCI companion PCI Select) could revolutionize risk management for the American farmer.

One of our most interesting takeaways from the last few months has been the lack of attention to detail with regard to MPCI. No single party is to blame for this, as the financial climate we’re now in is unlike any other. Think about it: Before the 2008 run-up in commodity prices, input costs were low enough for $2 corn to cash-flow. Producers didn’t get rich, and periods like the 1980s saw a lot of farm sales, but for the most part production agriculture in the U.S. didn’t need the risk management strategies employed by Corporate America.

Then, from 2008-2014, commodity prices were high enough to forgive rising input costs and little risk management. And, MPCI guaranteed a profit in many cases, so years like 2012 didn’t hurt too badly. Three years later, we are in the midst of a nearly unprecedented farm financial crunch, and active risk management will be the only way out for many producers.

MPCI is an incredible tool when used correctly. I have written in the past about revenue protection policies guaranteeing producers will have something to market, and I think this is worth repeating. For example, a producer with a guaranteed soybean yield of 50 bushels and an 85% RP policy is assured at least 42.5 bushels per acre will be available to market for at least the crop insurance base price. Selling this entire amount forward might not always be wise, particularly if 42.5 bushels per acre is well below breakeven, but producers must remember MPCI lends some certainty to the decision of whether or not to aggressively sell forward or hedge.

This logic applies at lower coverage levels as well, so producers who simply can’t afford 85% will still benefit. Sixty percent is much more common for my clients, but I always urge them to be very strategic in their choice of coverage level. The highest level possible is expensive, but will it cover production costs? If it will cover costs and guarantee a profit, why worry about the premium? Conversely (and much more likely for most producers), why buy 85% if it will never trigger an indemnity? In our modeling for PCI, we’ve found many areas where even 60% won’t trigger more than one year out of 10.

Reducing the coverage level and banking the premium savings for either PCI Select or put options is a much more effective strategy. It is a significant departure from the old way of approaching MPCI, but we think it is necessary for surviving the next few years of tough times on the farm.

Chris's columns appear in Kansas Farmer magazine monthly. You can view this column published in the online edition here.