E-335
03-05
Livestock Risk Protection
William Thompson, Blake Bennett and DeDe Jones*
Livestock Risk Protection (LRP) is a single-peril price risk insurance program
offered by the Risk Management Agency (RMA) of USDA through commercial
crop insurance vendors. An LRP policy protects producers from adverse price
changes in the underlying livestock market. The policy does not cover any other
peril, such as death or disease. RMA has launched a pilot program for LRP insurance in several states. Fed cattle policies (LRP–Fed Cattle) are available to producers in Illinois, Iowa and Nebraska. Feeder cattle policies (LRP–Feeder Cattle) are
available to producers in Colorado, Iowa, Kansas, Nebraska, Nevada, Oklahoma,
South Dakota, Texas, Utah and Wyoming.
How LRP Works
A producer must submit an LRP policy application through an authorized crop
insurance vendor. Insurance vendors must have completed an RMA training program to become authorized. The application process establishes producer eligibility by documenting a substantial beneficial interest in the cattle. A producer with
a partial interest in a group or pen of cattle may independently insure his or her
portion. After completing the policy application, producers select a coverage
price and endorsement length that meets their risk management objectives.
This information may change daily and is posted on the RMA Web site. Table 1
lists key RMA Web sites.
Table 1. Key LRP Web sites.
The coverage price is a percentage of the expected ending value.
These values and the associated rates are based on the current day’s
closing futures prices and correspond to separate endorsement lengths.
The difference between the expected ending value and the coverage
price is similar to the deductible on an auto insurance policy. A larger
deductible (a lower coverage price relative to the estimated ending
value) corresponds to a lower premium.
* Assistant Professor and Extension Economist, Assistant Professor and Extension
Economist, and Extension Program Specialist – Risk Management, The Texas A&M
University System.
Endorsement lengths are in increments of
about 30 days from 13 to 52 weeks. Both feeder
cattle and fed cattle producers will want to purchase price risk insurance with an ending date
of coverage that meets their risk management
objectives. Feeder cattle producers may want the
end date of coverage to match the expected date
the cattle will be sold or moved to a feedlot. Fed
cattle producers, on the other hand, will want to
match the ending date of coverage with the
anticipated date the cattle will be ready for
slaughter. Both policies, however, can be purchased with shorter endorsement lengths.
LRP coverage does not begin until a Specific
Coverage Endorsement (SCE) is submitted and
accepted by RMA. The submission of the SCE to
the RMA is done online after the application has
been completed and accepted. The SCE specifies
the elected coverage price, the specific number
of head covered, and the length of coverage.
New provisions for crop year 2004 LRP policies
require that sales be allowed from the time rates
are set and validated (based on the current day’s
CME prices) to 9:00 a.m. Central time the following day. Once the SCE is accepted, coverage
is in place and a premium is due. If, at the ending date of coverage, the Actual End Value has
dropped below the selected coverage price, the
producer must file an indemnity claim within 60
days. The indemnity will be paid whether or not
the cattle were sold by the ending date of coverage. However, selling the cattle more than 30
days before the end of coverage will terminate
the policy unless the insurance provider has
specifically approved the sale. Cattle seized,
quarantined, destroyed, or not salable because
of death or disease will still be covered by the
SCE if written notice of the circumstances is
provided within 72 hours.
900 pounds. It allows insurance for heifers and
for Brahma and dairy breeds. A fixed percentage
price adjustment factor (PAF) is used to adjust
the expected ending values and coverage price
from standard-weight, beef breed feeder cattle
for various combinations of light-weight heifers
or non-beef breeds. Table 2 shows the LRP feeder cattle price adjustment factor percentages.
The PAF is also applied to the actual end values
at a contract’s end date.
Table 2. Price adjustment factors for
LRP–Feeder Cattle contracts.
LRP–Fed Cattle policies provide coverage on
fed cattle that will weigh 1,000 to 1,400 pounds
at slaughter. Table 3 lists the contract specifics
for both the feeder and fed cattle contracts.
Table 3. Contract specifics for LRP–Fed
Cattle and LRP–Feeder Cattle policies.
It is crucial for producers to understand that
the ending value of the LRP contract is not the
cash price received or a closing futures price as
of the end date of the policy. The LRP–Feeder
Cattle policy uses the Chicago Mercantile
Exchange (CME) feeder cattle price index as the
actual end value. This cash-settled commodity
index is a mathematical calculation that averages
the head counts, weights and prices from several
livestock sales across the nation to determine its
settlement price. The LRP–Fed Cattle policy
uses a weekly weighted average of the slaughter
cattle prices in five areas as reported by the
Agricultural Marketing Service (AMS).
Contract Specifics
Feeder cattle policies for crop year 2004 (July
1 through June 30) have an expanded coverage
level that insures all feeder cattle weighing up to
Let’s work through an example to calculate the
insured value, the producer’s premium and the
indemnity.
Example 1: LRP–Feeder Cattle for a West
Texas cow-calf producer.
In mid-October, the owner of a 340-head
cow/calf operation is buying an LPR–Feeder
Cattle policy for his current calf crop. The
calves are typically weaned (88 percent calf
crop) about September 15 each year and carried
over to the middle of January before the producer decides whether to market them, retain ownership for additional winter grazing, or move
them to a feedlot. It is estimated that by midJanuary the steer calves will average 700 pounds
and the heifers will average 650 pounds.
Coverage will be purchased on all of the heifer
calves, including those that will be retained as
replacements. This producer has no partners
and owns 100 percent of the calves. This producer will use actuarial data from the RMA on
October 15, 2004, which is shown in Table 4.
Table 4. LRP expected end values, coverage prices, levels, rates and contract end dates for October 15, 2004.
Source: www3.rma.usda.gov/apps/livestock_reports/main_menu.cfm
Insured value and premium computations
1. The Insured Value = Number of Head multiplied by the Target Weight
(live weight, in cwt) multiplied by the Coverage Price multiplied by
Ownership Share.
2. The Total Premium = Insured Value multiplied by the Rate.
3. The Subsidy = Total Premium multiplied by the Subsidy Rate. The subsidy
percent is 13 percent.
4. The Producer Premium = Total Premium minus the Subsidy
Indemnity calculation
Assume that on the end date of coverage, the CME feeder cattle index has
dropped to $98.00/cwt. Since the actual ending value is less than the coverage
price ($100.12 - $98.00 =$2.12), an indemnity is due the producer on the insured
steers. The PAF for heifers is applied to the actual ending value ($98.00 x 90% =
88.20). Again, an indemnity is due on the heifer calves ($90.11 - $88.20 = $1.91).
The indemnity is equal to the number of head multiplied by the target weight (in
cwt as defined in the specific coverage endorsement), multiplied by the difference
between the coverage price and the actual ending value (in dollars per cwt), and
then multiplied by the ownership share (percentage).
Other LRP applications
Other situations in which LRP may offer producers limited price insurance are presented in
examples 2 and 3. The calculations for insured
value, total premium, producer premium, and
indemnities are similar to those in example 1,
though each producer’s situation is slightly different.
Example 2. An LRP–Feeder Cattle policy for
a south plains wheat pasture/stocker operator.
A Texas producer placing weaned calves on
wheat pasture in mid-November can purchase
coverage at weaning on those calves coming off
the pasture in mid-March, assuming they are
expected to weigh less than 900 pounds.
Example 3. An LRP–Fed Cattle policy for a
fed cattle producer.
A producer who will send yearling cattle from
summer pasture to a feedlot (in a state included
in the LRP pilot) can buy coverage, at the time
of placement into the pasture or feedlot, on cattle to be slaughtered the next spring, assuming
they will weigh between 1,000 and 1,400
pounds.
Comparison to CME Put Options
LRP policies have many similarities to put
options offered on CME futures contracts. As
with a put option, producers are purchasing
downside price protection while retaining
upside potential. Example 1 illustrated how the
LRP functions when prices (i.e., the CME Feeder
Cattle Index) decrease. If prices increase or do
not drop below the coverage price, producers
will realize their local cash market price less the
premium paid for the LRP policy. Purchasers of
LRP policies are still going to bear some local
basis risk in that their local cash price could
decrease relative to the price index on any particular day that an LRP contract could expire.
Advantages of LRP policies
LRP policies are sold at the coverage prices
quoted on the RMA Web site. This is a distinct
advantage over put options. Thin trading in
deferred months can make it difficult to fill a
put option order at the desired price.
LRP–Feeder Cattle policies also allow producers
to insure as few as one head or as many as
2,000 head (4,000 for fed cattle policies), whereas put options are sold in 50,000-pound feeder
contracts (40,000 pounds for fed cattle). With
multiple SCEs and the ability to insure a specific
number of head per SCE, both small and large
producers can have a high level of marketing
flexibility. The RMA also subsidizes 13 percent
of producer premiums and pays the administrative costs and commissions of insurance vendors. When the subsidies, administrative costs
and commissions are taken into consideration,
LRP policies may at times have a cost advantage
over the options market. LRP policies also have
some appeal to leveraged producers and lenders.
Disadvantages of LRP policies
Because LRP is an insurance policy, it cannot
be offset as an option can. Selling cattle more
than 30 days before the coverage end date will
void the policy unless coverage is transferred to
an eligible transferee and is approved by the
insurance company. LRP prohibits a producer
from purchasing a policy and then taking an offsetting position in the futures or option market.
Another LRP policy limitation is that a producer
can purchase price insurance only at levels
below the expected ending value (70 to 95 percent of estimated ending value). Put options
allow producers a wider range of pricing levels,
both above and below the current market.
Response to the 2003 BSE Discovery
The sale of LRP policies was halted in
December 2003 in response to the discovery of
bovine spongiform encephalitis (BSE) in the
state of Washington. Sales were not resumed
until October 2004. Several changes were made
to the actual policies and to their marketing and
availability because of the BSE discovery. These
changes are intended to limit “adverse selection,” which is the purchase of insurance after
the covered catastrophe has occurred. Policies
are no longer offered for sale while the CME is
actively trading. Coverage levels and rates are
based on the current day’s markets rather than
the previous day’s, as was the case before
December 2003. The RMA has also established
a daily premium limit of $1 million. Sales of
policies will cease once the total of premiums
collected on any single day reaches this limit.
Other restrictions on the sale of LRP policies
pertain to periods of major volatility in the
futures market. Policies will be unavailable if
the CME has a 2-day limit move on four or
more contracts. Sales will resume if the CME
does not have a limit move on four or more contracts. Procedures were also implemented to
give the Federal Crop Insurance Corporation
authority to suspend LRP sales in the case of a
catastrophic event.
Marketing Strategies
Livestock producers can use LRP policies to
• establish a minimum average sales price,
or
• get price protection in the event of some
catastrophic event.
To establish a minimum average sales price
for some or all of their cattle, producers will
submit their SCEs at a coverage price and
endorsement length that meets their risk management objectives. For insurance against a catastrophic event, producers may simply buy LRP
policies at a low coverage price to counter
extreme market volatility.
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Issued in furtherance of Cooperative Extension Work in Agriculture and Home Economics, Acts of Congress of May 8, 1914, as amended, and June 30, 1914, in
cooperation with the United States Department of Agriculture. Edward G. Smith, Interim Director, Texas Cooperative Extension, The Texas A&M University System.