Making Informed Crop Insurance Decisions… Rochester, NY June 18, 2002

1. Making Informed Crop Insurance Decisions…Rochester, NYJune 18, 2002 Brent Gloy Cornell University

2. Overview of Presentation • NY Field Crop Production • Why buy crop insurance? • Crop Insurance Products • Crop Insurance Decisions • Case-Farm Break-out

3. NY Field Crop Production

4. NY Grain Production Statistics • Corn is # 1 field crop… • In total acres planted and harvested

5. NY Corn Production • Grain vs. Silage • 50% of corn acres are harvested for grain and 50% for silage

6. NY Corn for Grain ProductionTop 10 Corn Acre Counties • Top 10 corn counties are located in central ‘Upstate’ New York #7 #6 #8 #4 #10 #3 #5 #1 #2 #9

7. ‘ • ‘ • ‘ Higher % to grain • ‘ NY Corn ProductionTop 10 Corn Acre Counties • Top 10 NY Corn Counties • Total Corn Acres Planted 39% • Total Corn Acres Harvested for Grain 59% • Total Grain Corn Production 61% • % of Corn Acres Harvested for Grain 78% Compared to State Average of 51%

8. Is there a need/role for crop insurance in NYS? Some facts: • Not all corn in NYS is harvested for silage • In top counties nearly 80% harvested for grain • Value of corn for grain production in top 10 counties approaches $70 million

9. Some Corn Trivia • In 2001, McLean County IL (#1 county in U.S.) produced 50,180,80 bu of corn • IL had the top 6 producing counties in the U.S. • NY state produced 56,700,000 bu of corn in 2001 • NY ranked 20th in corn production in 2001 • The highest yielding county (with at least 20,000,000 bu produced was Phelps County NE, South Central (194 bpa) • The top 10 counties in the U.S. produce 4% of U.S. corn production • There were 115 counties in the U.S. that produced over 20 million bushels of corn. Of these the highest average yeild was 194 bpa and the lowest was 111 bpa Nobles county MN • # of these counties by state IA = 41, IL = 35, IN = 3, KS = 1, MN = 12, ND = 1, NE = 19, TX = 1, WI = 1 • These counties produce 31% of U.S. corn • Top 4 states are IA 1.66 bb, IL 1.65 bb, NE 1.1 bb, IN 884 mb and account for 54% of production

10. Why buy crop insurance?

11. Risk = variability in profits and cash flow • If you are committed to certain cash flows, debt service, family living, etc., how can you manage the risk of failing to achieve cash flow? production uncertainty price uncertainty input price uncertainty Why buy crop insurance? • Profit = Total Revenue – Total Cost grain price * grain produced - input costs * inputs - other costs profit It’s about Profit!

12. Risk Means Something to Everyone • Usually it’s different to everyone • We will view risk as a financial phenomena • Care because it has financial consequences • Ability to pay bills • Ability to maintain lifestyle • Ability to meet business goals and objectives

13. Tools to manage… • hedging • planning/maintenance • insurance/management • practices Tools to manage… • hedging/marketing • timeliness • Insurance • Management practices Crop Insurance tools… Production and/or Revenue Insurance Sources of Risk On the cost side… • input price variability • unplanned input needs • liability On the revenue side… • grain price variability • grain yield variability

14. How prevalent are price and yield risks in NY?

15. Production Uncertainty • Uncertain yields • County average yields ranged from - 84 bu/ac to 132 bu/ac • A 40 bu/ac yield difference was observed in 2001 between Cayuga and Livingston County • Farm or even field yields are much more variable! Sources: Select NY county yields: NASS county yields

16. Production Uncertainty • Uncertain yields • For Lewis County, yields over the past 12 year typically ranged from 75 to 125 bu/acre • 4 out of these 12 years, yields varied out-side of one standard deviation • Farm or even field yields are much more variable! Sources: Cayuga county yield: NASS Cayuga county yield

17. Price Uncertainty • Uncertain prices are another source of risk • National average corn prices have varied around $2.40 (’90-’01) $2.40 avg. Oct. Corn - Dec. Futures Price Source: Harvest futures price: October average daily close price of the December CBOT futures contract

18. High Prices Low Production Principles of Supply and Demand Revenue Balances The Natural Hedge • When production is down; prices go up Right?

19. Harvest Price – Harvest Yield Relationship • National yields and harvest futures prices exhibit a relatively weak negative relationship • Beginning stocks and corn demand also factor into the equation • This weak relationship reflects the ‘double whammy’ of low prices and low yields in the same year! Sources: Harvest futures price: October average daily close price of the December CBOT futures contract National yield: NASS US National yield

20. U.S. Corn Production and Harvest Futures Prices

21. Low yields & low prices NY and National Price/Yield Relationships: an Example • Cayuga County yields do not tend to follow to National Yields • NY low yields do not affect national yield averages • This increases the risk of low yields with not price response – ‘double whammy’ of low yields low prices • As a result, Cayuga County yields have a very weak relationship with National Prices • In the past 10 years, 1992, 1999, and 2000 were years of low yields and low prices

22. Basis for Considering Crop Insurance • Grain production is relatively important in many counties • Natural hedge tends to be weak in NYS • Some variability in prices and yields • Individual producer need for insurance is also (highly) dependent upon their financial situation

23. Amount of risk Cost of risk management Risk Management is an Expense High Risk Low Risk (very uncertain profits) (future profits with relative certainty) The trade off: reducing risk vs. the cost of risk reduction

24. Low Yields Low Prices Crop Insurance Expense Provides a Safety Net • Crop Insurance Places a Safety Net Beneath Cash Flow • Various crop insurance products provide a safety net by paying producers when yields or revenue falls. • Protect against the down-side potential of yields and/or prices. Farm Revenue

25. Low Yields Low Prices Farm Revenue Crop Insurance Indemnity Payments Crop Insurance Expense Provides a Safety Net • Crop Insurance Places a Safety Net Beneath Cash Flow • Various crop insurance products provide a safety net by paying producers when yields or revenue falls. • Protect against the down-side potential of yields and/or prices.

26. Crop Insurance Products

27. Cost of risk management Crop Insurance Products and Coverage Levels High Risk Low Risk (very uncertain profits) (future profits with relative certainty) Production Risk… • Yield Insurance Products Price Risk… • Revenue Insurance Products Catastrophic Coverage (CAT) Indexed Income Protection (IIP) Actual Production History (APH) Crop Revenue Coverage (CRC) • Income Insurance Product Adjusted Gross Revenue (AGR) Coverage Levels

28. Sounds Complicated • Identify cash flow needs • Factor in risk tolerance • Establish a cost effective safety net What product & coverage level should grain producers choose?

29. What product and coverage level are NY corn producers choosing? • The minimum – CAT

30. Making Informed Crop Insurance Decisions First: Know the Products

31. Multi-Peril Insurance Products – NY Grain Crops • Corn and Soybeans • Actual Production History (APH) • Includes: Catastrophic Coverage (CAT) • Indexed Income Insurance (IIP) • Crop Revenue Insurance (CRC) • Adjusted Gross Revenue (AGR) • Pilot Program in select NY counties • Small Grains – Wheat, Barley, Oats, & Rye • Actual Production History (APH) • Includes: Catastrophic Coverage (CAT)

32. Farm Insurance Products • Yield Insurance • Catastrophic Coverage (CAT) • Actual Production History (APH) • Revenue Insurance without Guarantee Increase • Indexed Income Protection (IIP) • Crop Revenue Coverage (CRC) • Income Insurance • Adjusted Gross Revenue (AGR)

33. Catastrophic Coverage (CAT) Type of product: • Basic multi-peril crop insurance product Producer choices: • No insured unit choices • No coverage level choices Available for the following Field Crops: • Corn • Soybean • Wheat • Barley • Oats • Rye • Flax Protection provided against: • Low yields Indemnity Trigger = Actual yield < 50% of APH yield NY Sales Closing Date • March 15

34. Actual Production History (APH) Type of product: • Multiple peril crop insurance product at the selected level of coverage Producer choices: • Insured unit • Yield election: % of AHP yield • Price election: % of MPCI price Available for the following Field Crops: • Corn • Soybean • Wheat • Barley • Oats • Rye • Flax Protection provided against: • Low yields Indemnity Trigger = Actual yield < Yield election*APH yield NY Sales Closing Date • March 15

35. Indexed Income Protection (IIP) Type of product: • A multiple peril crop insurance product with a revenue insurance component Producer choices: • No insured unit choice • Coverage level: % of revenue Available for the following Field Crops: • Corn • Soybean Protection provided against: • Low yields • Low prices Indemnity Trigger = Actual yield * Harvest Price < Coverage level * APH yield * Higher of HP/BP NY Sales Closing Date • March 15

36. Crop Revenue Coverage (CRC) Type of product: • A multiple peril crop insurance product with a revenue insurance component Producer choices: • Insured unit • Coverage level: % of revenue Available for the following Field Crops: • Corn • Soybean Protection provided against: • Low yields • Low prices Indemnity Trigger = Actual yield * Harvest Price < Coverage level * APH yield * Higher of HP/BP NY Sales Closing Date • March 15

37. Adjusted Gross Revenue (AGR) – Pilot Program Type of product: • Whole farm revenue insurance • Multiple commodities under one insurance product Producer choices: • % of Coverage • % of Payment Producer eligibility: • If more than 50% of expected income will be derived from a crop or combination of crops • No more than 35% of expected allowable income can be from animals or animal products Protection provided against: • Low yields • Low prices NY Sales Closing Date • January 31

38. Practical Approaches to Making Crop Insurance Decisions

39. Making the Crop Insurance Decision • Could dedicate the rest of your life to this one decision • Let’s balance costs and returns • What do you need? • What should be considered? • What is the goal?

40. 55% 60% 65% 70% 75% APH $2.31 $2.81 $3.96 $5.18 $7.71 IIP $2.07 $2.61 $3.71 $4.66 $6.50 CRC $3.28 $4.04 $5.73 $7.51 $11.13 Cost of Coverage ($/acre)– Premiums Only* Cayuga County - Corn • APH Yield = 100 bu/acre • 2002 MPCI Price = $2.00 • CRC Yield = 100 bu/acre • 2002 CRC Base Price = $2.32 IIP Yield & Base Price = CRC Base Price & Yield CAT 50% Yield 55% Price $0 * Premium only, does not include the administrative fee

41. Costs versus Returns • Although not trivial the cost of these products are not overwhelming • Likely means the returns won’t be either • Should dedicate an amount of time to this decision that is appropriate • The major amount of time lost to these decisions involves trying to find the “profit maximizing” product and coverage level • The real benefit to crop insurance is not in profit maximization • The benefit is that the products can help avoid financial stress

42. Avoiding Financial Stress • If the benefit is in risk reduction let’s evaluate these products ability to reduce risk • Let’s answer these questions, “To what extent do crop insurance products… • help maintain liquidity? • help maintain solvency? • help keep future plans on track? • Then consider how much this protection costs • Let’s not waste time on whether they increase expected profitability – maybe they do but we’re not going to get rich

43. Costs of Products • Increases substantially with coverage level • Increases with the types of risk they guard against • Are difficult to evaluate from a profit standpoint without solid data • One way to examine is to look at the marginal costs of additional protection

44. Marginal Cost of Additional Coverage Levels • Marginal cost of coverage generally increases as coverage level increases • Marginal costs have fallen due to higher subsidy rates CRC APH IIP

45. Our Approach to Crop Insurance Decisions We seek to answer these fundamental questions: • What are the consequences if the operation experiences a revenue shortfall? • How likely is it that a shortfall will occur? • How willing is the producer to accept these risks? • Including their costs, how do various crop insurance products alter the likelihood of such a shortfall?

46. A Three Step Process to Answer these Questions • Assess cash flow and financial situation • Perform a sensitivity analysis on cash flow and financial situation • Evaluate the types of risk and protection provided by the crop insurance products

47. Information Needs • Coordinated financial statements • Crop budgets • Yield and price history and projections • Insurance product information including mechanics and premium information • Ideally in spreadsheet format – we’ll help with that

48. Uses of Cash… • Debt service • Operating needs • Family living • Special needs • Health Insurance • Others Practical Approach to Making Crop Insurance Decisions • Assess Cash Flow Needs Goal: To determine your operation’s level of critical cash flow… Sources of Cash… • Additional borrowing • Savings • From business earnings • Others

49. Assessing Critical Cash Flow • Develop a crop budget • Cost and return information are critical • So is financial information • Where to get information • Historical records • CBOT • USDA • RMA • Once a budget and pro-forma finanicals are developed can begin to assess critical cash flow

50. Build the Budget • What costs must be paid what could be put off • How much borrowing capacity is available • How willing are they to use it – retirement, expansion, etc. • Come up with a bottom line # • How likely is it that the number will be hit? • What can be done to avoid hitting the number