To grain producers, crop insurance is an operational cost, simply a part of conducting business. For many producers, the Midwestern floods of 2019 have made it clear that traditional forms of crop insurance do not provide perfect safety nets.
Fortunately, there’s another way of protecting a harvest from the unknown: grain futures. Whether you’re raising corn, wheat, or soybeans, standardized futures contracts can provide a degree of security that most insurance policies can’t.
The USDA, RMA, and FCIC
When you hear the word “insurance,” visions of financial reimbursement and lump-sum payouts come to mind. If you drive a car or have a mortgage, then you’re familiar with the basic concept ― pay a little today for safety tomorrow.
In the case of traditional crop insurance, producers typically purchase coverage with the help of official programs. At the federal level, the Risk Management Agency (RMA) administers government-subsidized policies. Part of the U.S. Department of Agriculture, its official mission is “to promote, support, and regulate sound risk management solutions to preserve the economic stability of America’s agricultural producers.”
To accomplish this goal, the RMA operates the Federal Crop Insurance Corporation (FCIC). To secure coverage, ag producers buy policies from FCIC-approved providers, with the terms, premiums, and oversight furnished by the RMA. The FCIC enjoys permanent government funding, providing upwards of $100 billion in annual coverage to the agricultural industry. Associated premiums used to service the liability are split roughly 60/40 between the FCIC and producers.
Crop Insurance Isn’t Infallible
Featuring $100 billion in emergency resources, it appears as though the FCIC gives U.S. producers rock-solid crop insurance. The reality is quite the contrary, with coverage often being inadequate for dealing with true environmental outliers.
The Midwestern floods of 2019 created a black swan economic event. Various grain and oilseed producing regions fell victim to the impact of a 500-year flood and its improbable 0.2% chance of wielding devastation. Accordingly, traditional crop insurance policies that pay out when planting is impossible, crops are lost in the field, or yields come in lower than expected proved inadequate because much of the destruction involved crops already harvested and in the silo. FCIC subsidized insurance typically does not cover these assets.
Using Futures to Limit Losses
Fallout from the 2019 “bomb cyclone” that hit the American Midwest was staggering. In addition to severely delaying the planting season, ag experts identified 832 storage bins holding between 5 and 10 million bushels of corn and soybeans that the flood damaged. Unfortunately for producers, buying separate flood or property insurance policies was the only conventional means of protecting siloed crops. These items are expensive and largely unwarranted due to the infrequency of such extreme flooding.
By contrast, the purchase of related futures products can help limit the assumed risks associated with these types of rare agricultural events. By buying or taking a long position in a forthcoming contract, increases in commodity pricing stemming from catastrophe can be used to offset the losses of a destroyed harvest.
Hindsight is 20/20, but a corn producer presented with the challenges of 2019’s springtime flooding could have reduced risk through buying post-harvest December corn futures contracts (ZCZ2019). Had the position been opened during the early stages of the disaster (March/April), the May gains of 16.5% in December 2019 corn could have reduced financial liabilities substantially.
One of the great things about futures is their inherent flexibility. Ag industry insiders predict that the effects of 2019’s floods will be felt more during the marketing years of 2020 and 2021, which means that futures can help producers profit from the projected scarcity. In the case of Midwestern corn farmers, taking long positions in March 2020/2021 and December 2020/2021 corn futures can potentially increase future revenues, making up for the losses suffered in 2019.
Getting Started With Risk Management
Hedging strategies via futures offer unique functionality over traditional crop insurance. For more information on how to protect your harvest through a futures-oriented marketing plan, consult the team at DanielsAg today.