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LIVESTOCK RISK PROTECTION
CATTLEFAX TRENDS
Cow-calf producers have several tools to mitigate price risk. While none are perfect for everyone, Livestock Risk Protection (LRP) has gained a lot of popularity from producers over the last couple of years. Just like forward contracting or hedging with futures, it is still particularly important to have an outlook of the market to decide when and at what price level makes sense to incorporate LRP. Knowing breakevens, therefore potential profitability should always be considered when using a risk management tool. LRP is insurance that protects against a drop in price, or essentially creating a floor. At the same time, the upside potential is unlimited. The concept is similar to buying a put option. Although, LRP is a USDA program, and the premium is subsidized. The subsidy increase a couple of years ago made the program a lot more attractive and competitive relative to buying put options. The subsidy rate varies depending on the coverage level. The lower the coverage level, or more risk a producer is willing to accept, the higher the subsidy. One major difference between LRP and options that can be a significant benefit to producers, especially smaller operations, is LRP policies are written on a headcount basis, whereas a feeder cattle options contract is 50,000 pounds. Producers can use LRP for as few as 1 head to as many as 12,000 per endorsement, for a total of 25,000 head per year. The protection levels and costs are listed each day after the futures market closes, since the levels are, to some degree, comparable to futures quotes. Producers can purchase LRP from 4 PM central time until 9 AM the next morning. The endorsement minimum is 13 30
AU G U ST 2022 B R A N G U S J O U R N A L
weeks, or roughly 3 months, and up to 52 weeks if pricing and rating information is available. Typically, there is one coverage option for each month. Because producers can potentially set a floor price up to one year in advance, and unborn calves can be insured with LRP, the next calf crop could be insured before the current one is marketed. Again, it is important to understand the long-term market trends to help with risk management decisions. Arguably the most important thing to understand about LRP is the settlement methodology. Feeder cattle and calf policies are settled against the CME Feeder Cattle Index. In other words, the cash price a producer receives when the cattle are marketed has no effect on the LRP policy. The only price that dictates whether a producer receives an indemnity is the CME Feeder Cattle Index. If the index is below the coverage price, or floor, at the end of the coverage period, the producer receives the difference, after the premium cost is subtracted. It is important to note, the policy premium does not have to be paid until the cattle are sold, and the producer has up to 30 days after the endorsement ends to pay the premium. If the index settles above the coverage price, the producer still must pay the premium. However, the ability to do delayed payment can be beneficial from a cashflow standpoint compared to utilizing options which requires payment up front. In the case of a drought or a change in marketing plans, producers can sell cattle up to 60 days prior to policy expiration. They do not have to be sold when the endorsement expires. Unlike options and futures, producers cannot offset or buy back their position with LRP. Once the policy is written, there are no changes that can be made. However, LRP could be combined with other futures or options positions, such as selling a put or call to cheapen up the strategy. LRP is purchased through licensed insurance agents. Because it is a government backed program, the premium or costs to purchase is the same from all insurance agents. While most of the important details have already been discussed, it is recommended to ask an agent to provide more information regarding
