Beef producers have a limited number of tools to manage price risk associated with marketing cattle. The tools available include futures contracts, options, forward contracting and livestock risk protection insurance (LRP). Each tool brings with it a list of advantages and disadvantages, but each can be used effectively under different circumstances. Futures contracts and options are structured so one feeder cattle contract is 50,000 pounds of feeder cattle (generally 60 to 80 head), while one contract of fed slaughter cattle is 40,000 pounds. The size of the contract fits best for larger producers. However, many cow-calf producers across Tennessee and the nation do not produce a sufficient quantity of uniform calves to manage price risk using futures contracts and/or options. Thus, the focus here will be on LRP, because a producer can insure the price on as few as one head.
LRP has been used successfully as a price risk management tool by a number of cattle producers. However, the majority of cow-calf producers continue to produce cattle without using any type of price risk protection. The purpose of this publication is to:
- Describe what LRP is and how it works for feeder cattle.
- Discuss the timing and availability of LRP.
- Explain specific coverage endorsements, coverage basics, coverage limitations and coverage indemnification.
- Provide an example to demonstrate when an indemnity is paid based on a specific policy.
What is LRP and how does it work?
Livestock risk protection insurance (LRP) is a price insurance policy developed as a price risk management tool for feeder cattle, fed cattle and swine. It is available from the Risk Management Agency (RMA) which is the same agency that provides crop insurance to farmers. LRP provides a method to establish a floor selling price for livestock, and it protects against catastrophic price declines. For feeder cattle, an LRP insurance policy pays producers if a regional/national cash price index falls below a selected coverage price. Historically, large cattle price declines have occurred due to disease outbreaks in cattle (BSE, bovine spongiform encephalopathy) and drought (2012 drought resulting in higher feed prices). The occurrence of a foodborne illness or some other market disruption could also contribute to a catastrophic price decline.
LRP is not designed to enhance livestock producers’ profits nor does it guarantee a cash price for the cattle. LRP strictly protects against declines in a regional/national cash price index. The idea is if prices in the region used to calculate the index rise then prices in other regions should have increased, and the same holds true for price declines. It does not protect against mortality, condemnation, physical damage, disease, individual marketing decisions, local price aberrations, or any other cause of loss.
LRP has a number of benefits such as providing the policyholder with flexibility in the timing of purchase, length of coverage, number of head covered (any number of head is acceptable up to the maximum), target weight of livestock at the end of coverage, and the coverage price level. The benefits of LRP compared to futures and options include no margin calls, up-front premium cost is definite compared to feeder cattle options, and no quantity minimums. A third benefit is that lenders generally understand insurance, and LRP insurance may be viewed more favorable as a price risk management tool than futures and options.
Timing and Availability
Integral components of purchasing LRP insurance include knowing when it is available for purchase, how to purchase insurance, and who to contact to purchase insurance. LRP insurance is available throughout the year for producers to purchase. Sales are typically available for cattle Monday through Friday with each sales period beginning around 5 p.m. eastern time (4 p.m. central time) and ending at 10 a.m. sharp eastern time (9 a.m. central) the following morning. It is also available Saturday morning until 9 a.m. eastern (8 a.m. central). LRP cannot be purchased on Sunday, Monday morning or holidays. The timing/availability of insurance coverage is one of the major drawbacks to the use of LRP as its availability for purchase is largely outside of “normal business” hours.
There are instances when LRP coverage is not attainable and cannot be purchased by anyone. They include:
- Coverage cannot be approved unless accepted by the Federal Crop Insurance Cooperation’s (FCIC) Underwriting Capacity Manager (UCM) website.
- When government funding limits (daily or annual) are reached.
- If the required data for establishing rates or coverage prices are not available.
- If there has been a news report, announcement or other event that occurs during or after trading hours that is believed to result in market conditions significantly different than those used to rate the LRP program.
- If there are two or more consecutive days of price limit moves on the futures contract.
- If the RMA online system is crowded or down.