June 12, 2023
Livestock Risk Protection
Livestock Insurance Policies
Livestock producers face tremendous uncertainty in managing their operation. Disease, extreme weather, securing labor, geopolitics, and shifting consumer preferences have a significant impact on their bottom line. While exchange-traded tools have existed in agriculture for more than a century and crop insurance has been around for decades, federal government-subsidized insurance programs for livestock producers have largely been lacking. Due to a round of improvements made since 2020, livestock producers have quickly added a key asset to their risk management strategies.
Livestock Risk Protection (LRP Insurance) is a livestock insurance policy developed as a price risk management tool against price decreases for eligible livestock through the U.S. Department of Agriculture’s Risk Management Agency (RMA). The program is available in all 50 states for feeder cattle (young cattle up to 1,000 pounds), fed cattle, and swine. LRP is not designed to cover mortality, physical damage, disease, losses from individual marketing decisions, or local price irregularities. The LRP crop year runs from July 1 through June 30. The purpose of the program is to offer tailored coverage over an insurance period wherein the producer elects the coverage period (a specified end date of your coverage ranging from 13 to 52 weeks), the class of livestock, the coverage level, and number of insured livestock. The subsidy provided by the federal government depends on the coverage level (percent of the expected end value) selected by the producer at the time of endorsement purchase but is uniform across the three commodities and is summarized below:
A producer is paid an indemnity if the actual ending value of the livestock is below the coverage price selected at inception. Maximum head limits for each commodity are outlined in the policy descriptions below. Premium rates, coverage prices, and actual ending values are generally available daily on the RMA’s website and endorsements may be purchased through an RMA-approved livestock insurance agent. Program costs are uniform across all agencies. The value the agent brings is their expertise, tools, and analysis.
LRP-Feeder Cattle insures against declining market prices. Specific coverage endorsements may be purchased throughout the crop year for up to 12,000 head of feeder cattle per endorsement expected to weight up to 1,000 pounds at the end of the insurance period. The LRP-Feeder Cattle annual head limit per crop is 25,000 head. The producer selects the length of insurance coverage, which can be 13, 17, 21, 26, 30, 24, 29, 43, 47, or 52 weeks. Coverage is available for a variety of animal types and two weight ranges: 100 to 599 pounds or 600 to 1,000 pounds. The base animal is a 6 to 10 hundredweight steer, with a slide for other feeder cattle types, summarized below. As you can see, LRP-Feeder Cattle allows for the protection of unborn animals so long as ownership interest is established and documented with the RMA and crop insurance agency.
The price adjustment factors (PAF) above account for the difference in prices between steers and the other types and weights. These are applied to expected ending values, coverage prices, and actual ending values. The coverage price is based on the expected ending value and the PAF, wherein an indemnity is due if the actual ending value is below the coverage price. Settlement of LRP-Feeder Cattle is based on the Chicago Mercantile Exchange Group (CME) Feeder Cattle Index. This index is based upon a weighted-average of transactions in a 12-state region of two weight/frame score categories (700 to 899 pound medium and large frame #1 feeder steers, 700 to 899 pound medium and large frame #1-2 feeder steers) reported by AMS. Because the end dates are generally offered throughout the month, feeder cattle producers can better align coverage with their marketing dates.
LRP-Fed Cattle is also designed to insure against declining market prices. The program protects the value of heifers and steers weighing between 1,000 and 1,600 pounds to be marketed near the end of the insurance period. The available insurance coverage lengths as well as endorsement and annual limits are the same as those available under LRP-Feeder Cattle. Unlike the feeder cattle product, LRP-Cattle has only one available grouping of animals and therefore does not use a slide based on animal type. The coverage price is based on the expected ending value, reported by RMA and based on current futures board prices at the CME. The settlement price, or the actual end value, is based on the 5 Area Weekly Weighted Average Direct Slaughter Cattle (LM_CT150) report. If the value of the price of 80 percent plus Choice live basis steers on this weekly report is below the expected ending value, an indemnity is due to the producer. The shift to the 80 percent bucket rather than the 35 to 65 percent category is a change set to begin in the 2024 crop year (starting July 1, 2023).
LRP-Swine similarly insures against declining market prices. Like the other two commodity insurance programs, the producer selects coverage prices and the length of insurance coverage. LRP-Swine policies are subject to a 70,000 head limitation per specific coverage endorsement on hogs that are expected to reach market weight near the end of the insurance period. Producers are also subject to a 750,000 head limitation per producer per crop year. More recently, modifications have been added to allow for unborn swine to be protected under LRP, subject to proof of ownership interest. Actual ending values are based on the same series used to settle the CME’s lean hog futures contract, commonly referred to as the lean hog index (LHI). The LHI is simply a two-day weighted average of producer sold data in the National Daily Direct Hog Prior Day Report – Slaughter Swine (LM_HG201) report. Specifically, the LHI considers the negotiated, swine or pork market formula, and negotiated formula categories to arrive at a weighted average price. Like the other commodities, actual ending values are published on the AMS website.
LRP Insurance can be particularly helpful in price risk management because it is customizable, offered nearly every day, and subsidized by the federal government. The following examples are common applications of the program but are not exhaustive of the scenarios in which LRP can help livestock producers take control of their bottom line and manage risk:
The most straightforward use of LRP Insurance is as a cost-effective price risk management tool. As described above, LRP provides protection against declining market prices but allows for participation in market movements higher. From a risk and opportunity perspective, this is similar to an exchange-traded put option, although several key differences exist. In particular, LRP is less flexible than an exchange-traded option in that it cannot be lifted or sold after the specific coverage endorsement is purchased. Regardless, the subsidies provided by LRP make the program particularly attractive to livestock producers who may be looking for cost-effective protection. There exists a degree of seasonality in which the cost advantage of using an LRP policy compared to a similar put option is greater than others. Additionally, LRP offers cash flow advantages over exchange-traded options. Premiums for LRP are due at the end of the endorsement period whereas options require premium paid upfront. For these reasons, many producers find utility in using LRP as part of their margin management approach. In a highly-connected world in which export channels play a pivotal role in producer profitability and the threat of foreign animal disease entering our country is ever present, many producers have also found value in using the program to provide relatively inexpensive catastrophic event coverage below the current market price.
Tailored Risk Management
As outlined above, the producer elects the length of coverage, percent of expected end value insured against, the number of head, weight, and in the case of LRP-Feeder Cattle, the type of animals insured in each specific coverage endorsement. As such, the customizability of the program allows for producers to tailor this risk management tool to align more closely with their own production practices than an equivalent exchange-traded instrument would allow. For example, there may be a situation in which a feeder cattle producer is looking to protect the value of a mix of animal types expected to be marketable later in the year. Whereas the feeder cattle future contract would reflect the value of specific weight/frame scores of steers the feed into the CME Feeder Cattle Index, LRP would allow for the producer to use the PAF to adjust coverage based on the type of feeder cattle grouping. The producers could purchase the mix of specific coverage endorsements that most closely aligns with his or her expected marketings.
A primary use case for LRP Insurance has been reducing basis risk faced by livestock producers. For example, LRP-Swine settles to the LHI. The CME offers 8 futures contracts per calendar year, 7 of which are primarily used by market participants. As such, there are gaps in the year during which there are approximately 60 days between futures expiration dates (mid-December through mid-February, for example). Since LRP settles against the LHI as opposed to futures prices, this makes LRP particularly beneficial when this gap in futures contracts coincides with seasonally-weak basis levels, such as the end of the year for hog producers. Additionally, depending on the manner in which a particular producer is paid for their animals, LRP could significantly reduce basis risk if the pricing mechanism is identical or very similar to the calculation for actual end value as set forth by RMA.
LRP Insurance Summary
Many producers have also found utility in pairing the LRP Insurance coverage as the root of more advanced futures and options strategies, such as collars and position adjustments. Producers who use LRP also have the opportunity to layer into relatively cheap coverage below where the market is currently trading. This allows for major market disruption insurance at a subsidized price level should a catastrophic event send the markets tumbling lower. LRP could be an excellent tool for someone who is looking to establish cash flow-friendly, cost-effective coverage. The endorsements establish some level of protection while maintaining opportunity to the upside should the market move higher and could help with basis risk along the way.
The sign-up process for LRP Insurance is simple and program costs are uniform across all agencies. The value the agent brings is their knowledge, tools, and approach to implementing the tool to suit the producer’s risk management needs and profitability goals. We have created a suite of price risk tools on our website to help navigate the decision-making process and determine optimal uses from a risk tolerance, marketing, and timing perspective. Contact us with any questions about how LRP may fit into your cattle and swine risk management approach.