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April 12, 2012

Graphical Illustrations of Proposed Farm Revenue Programs and Crop Insurance

The Revenue Loss Assistance Program (RLAP) is a proposal put forward by Senators Conrad, Baucas, and Hoeven as a 2012 Farm Bill alternative for making counter-cyclical revenue payments. This alternative differs from others in that crop insurance payments are included in its calculation, often leading to reduced RLAP payments when crop insurance payments occur. Inclusion of RLAP will reduce incentives for farmers to buy higher levels of crop insurance. Impacts on crop insurance purchases are examined in this post for corn given prices in 2012. A more typical price scenario also is examined.

RLAP's guarantee

RLAP makes payments in a band between 75% and 88% of RLAP's benchmark revenue. RLAP's guarantee equals:

.88 x farm historical yield x national price

The farm historical yield is the higher of 1) the historical Actual Production History (APH) yield from the farm, 2) the most recent five-year Olympic average of farm yields, or 3) the counter-cyclical program yield for the farm. The national price will be the higher of the target price or the five-year Olympic average of National season average prices (SAPs). SAPs are reported by the National Agricultural Statistical Service. For corn and soybeans, the SAP is the average price from September of the year of harvest till August of the following year. The national price also cannot exceed the full costs of production. For corn and soybeans, the national price almost always will be the Olympic average of the previous five prices.
The guarantee is compared to the actual revenue which equals the yield from the farm times the average of the first four National monthly prices of the marketing year plus net crop insurance indemnity payments, where net insurance payments equal insurance payments minus farmer-paid premiums. Revenue equals:

Farm yield x four-month average national monthly price + net insurance payments

When revenue is below the guarantee, a payment will be made equal to the difference times .65:

.65 x (guarantee - actual revenue)

The payment given above cannot exceed a maximum equal to the equivalent of payment on a band from 88% down to 75% of benchmark revenue. Hence, the maximum RLAP payment is:

.65 x (.88 - .75) x farm historical yield x national price

From a crop insurance perspective, a key issue is that crop insurance payments are included in revenue calculation. Thus, crop insurance payments have the potential to reduce RLAP payments when the RLAP payment is not at its maximum. In these cases, each dollar of crop insurance payment will reduce RLAP payments by $.65, up to the point where an RLAP payment no longer exists because RLAP revenue exceeds the guarantee. These impacts will be evaluated by calculating adjusted gross revenues with and without RLAP payments for corn in Illinois using 2012 prices and more typical prices.

Adjusted Gross Revenues With and Without RLAP

Adjusted gross revenue with and without RLAP payments are generated for differing harvest prices and coverage levels of crop insurance. Adjusted gross revenue without RLAP equals

Crop revenue + insurance payment - insurance premium

where crop revenue will equal yield times the average of the first four months of national prices. Adjusted gross revenue with RLAP payments includes RLAP payments. As prices are lowered, crop insurance and RLAP payments will increase. These increases will offset crop revenue losses, leading to minimum adjusted gross revenues for different crop insurance coverage levels. Minimum adjusted gross revenues will become less across coverage levels with inclusion of RLAP, thereby reducing incentives to purchase higher levels of crop insurance.

RLAP payments are generated using a Microsoft Excel spreadsheet available for download here (http://www.farmdoc.illinois.edu/downloads/FDD120412.asp). The insurance plan used in generating insurance premiums is Revenue Protection (RP), the most prevalent insurance policy for corn. Yields are based on county yields for McLean County. Yields and insurance premium used in calculations are:



  • A Revenue Protection (RP) is used with a Trend Adjusted Actual Production History yield of 187 bushels per acre.

  • The farm historical yield for RLAP is 182 bushels.

  • Insurance premiums are for a Mclean County, Illinois farm with a 176 bushel APH yield and a 187 bushel TA-APH yield. Enterprise units of 400 acres are used to generate premiums of $.54per acre for a 50% coverage level, $.78 per acre for a 55% coverage level, $1.22 per acre for a 60% coverage level, $1.77 per acre for a 65% coverage level, $2.74 per acre for a 70% coverage level, $5.17 per acre for a 75% coverage level, $10.57 per acre for an 80% coverage level, and $21.50 per acre for an 85% coverage level.

  • Farm yield will equal the TA-APH yield of 187 bushels per acre.

Adjusted gross revenues will be generated for two price scenarios: 1) 2012 price conditions and 2) more typical prices. The 2012 price scenario is:

  • Projected price for corn = $5.68
  • National price for RLAP = $4.53. This is not certain because the 2011 marketing year is not complete. However, it is likely that the 2011 price period will be the highest price of the last five years, therefore it will be eliminated in the calculation of the five-year Olympic average.

The 2012 prices are somewhat unusual in that the national price for RLAP is much further below the projected price than average. Between 1980 and 2005, the national price averaged $.30 below the projected price. Therefore to more closely match usual price conditions, adjusted gross revenues are generated under the following prices:

  • Projected price = $5.68
  • National price for RLAP= $5.38

RLAP and adjusted gross revenues are generated for differing harvest price. The 4-month average of monthly prices is assumed to be $.25 per bushel lower than the harvest price.

2012 Prices

For 2012 prices, RLAP payments given differing harvest prices are shown in Panel A of Table 1. RLAP payments will not occur when RP is purchased at 75%, 80%, and 85% coverage levels, as net crop insurance payments always cause RLAP revenue to exceed the benchmark. The maximum RLAP payment is $20 per acre at a 70% RP coverage level, $54 for a 65% coverage level, and $70 per acre for coverage levels at or below 60%.

tab1b.jpg


Adjusted gross revenues without RLAP payments are shown in Panel B. Adjusted gross revenues with RLAP payments are shown in Panel C. Gross revenues in Panel C are higher than those in Panel B by the amount of the RLAP payment in Panel A. RLAP payments cause the minimum adjusted gross revenue to increase for coverage levels below 70%. For example, the minimum adjusted gross revenue without RLAP is $694 per acre at a 70% coverage level. This $694 per acre minimum revenue increases to $714 per acre with RLAP.
RLAP payments draws minimum adjusted gross revenues together for some coverage levels. For example, the minimum adjusted revenue with and without RLAP is $51 per acre different between the 70% and 75% coverage levels ($745 for the 75% coverage level - $694 for the 70% coverage level. With RLAP, the increase is only $30 per acre ($745 for a 75% coverage level - $714 for a 70% coverage level). This reduces the value of increasing coverage level from 70% to 75% and may cause some farmers to purchase a 70% coverage level rather than a 75% coverage level.

More Typical Price Relationships

When the RLAP benchmark price is closer to the projected price, the narrowing of minimum gross revenues becomes more pronounced, as illustrated in Table 2. Table 2 shows payments and revenues for the same prices and yields in Table 1, except that the national benchmark price is $5.38. The $5.38 benchmark price causes the projected price and benchmark price to differ by $.30, the more typical historical relationship.

tab2b.jpg


Under these prices, minimum adjusted gross revenue with RLAP have the following increases:

  • At a 70% coverage level, from $694 without RLAP to $777 with RLAP,
  • At a 75% coverage level, from $745 without RLAP to $821 with RLAP,
  • At an 80% coverage level, from without RLAP $792 to $837 with RLAP, and
  • At an 85% coverage level, from without RLAP $835 to 852 with RLAP.

These increases draw the minimum coverage levels together. For example, the difference between minimum adjusted gross revenue without RLAP increases by $90 per acre from the 75% coverage level to the 85% coverage level ($835 at 85% - $745 at 75%). This difference is reduced to $31 per acre with RLAP ($852 with RLPA to $821 without RLAP). These narrowing minimum adjusted gross revenues reduce the incentives to purchase higher levels of crop insurance.

Summary

RLAP includes net crop insurance payments in its guarantee calculation. This provision likely was included to reduce overlapping payments between RLAP and crop insurance. It also will reduce the costs of the program. However, this provision also reduces incentives for purchasing higher coverage levels of crop insurance.

Issued by Gary Schnitkey
Department of Agricultural and Consumer Economics
University of Illinois



Posted by Gary Schnitkey  Permalink

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