– Dr. Kenny Burdine, Extension Professor, Livestock Marketing, University of Kentucky
LRP is administered by the RMA with a federally-subsidized premium.
There is probably no single topic that I have discussed more in my recent Extension programming than Livestock Risk Protection (LRP) Insurance. LRP is a good tool to manage price risk and has been made much more attractive over the last several years through increased subsidy levels and other changes in how it operates. As a result, usage has greatly increased, and I think the odds are high that continues. One of the areas that producers tend to find confusing about LRP is how adjustments are made for different cattle types. In this article, I want to focus specifically on the adjustment that is made for heifers as that is one that a large number of producers are likely to encounter.
Livestock Risk Protection (LRP) coverage and indemnities are based on changes in the CME feeder cattle index. The CME feeder cattle index is a 7-day weighted average price for 700-900 lb Medium and Large Frame #1-2 steers in twelve major cattle producing states. A producer covering heavy steers will choose a coverage level when they purchase LRP and if the actual ending value for the CME index is below that coverage level on the ending date of the policy, they will receive compensation in the amount of that difference on each lb they covered.
For the sake of illustration, let’s assume that a producer purchases an LRP policy with an ending date in August and an expected ending value of $250 per cwt. This $250 can be thought of as the expectation for the CME index on that ending date. For simplicity, let’s further assume they purchase 100% coverage, meaning they have a coverage level of exactly $250 per cwt. If the CME Feeder Cattle Index is $240 on the ending date in August, they would receive an indemnity of $10 for every 100 lbs covered. This is the simplest way to think about LRP and generally works if one is covering steers in the higher weight category (600-1000 lbs).
If this producer were instead purchasing coverage on heifers in the same heavy weight category, the relevant index would be adjusted downward by 10%. By this I mean the expected ending value of $250 on the steers is reduced to $225 ($250 x 90%) for the heifers. Let’s again assume 100% coverage – a coverage level of $225 per cwt on the heifers. If the CME index is $240 on the ending date as it was in the previous steer scenario, that is adjusted downward by 10% for the heifers for an actual ending value of $216 ($240 x 90%). With a coverage level of $225 and an ending value of $216, the producer receives an indemnity of $9 for every 100 lbs covered on those heifers.
When I explain this in Extension settings, I like to say that LRP has a “built-in basis” on heavy heifers at 10% below the steer price. This is important because it means that the heifer adjustment moves with the market. If the CME index is $250 per cwt, that heifer discount is $25 per and if the CME index is $150 per cwt, the heifer discount is $15 per cwt. If a cattle producer in the South were utilizing LRP, they would want to ask themselves how the prices of the cattle they plan to sell will differ from the LRP expected ending value. If they are protecting steers, that expected ending value will essentially be the market expectation of the CME index on the ending date. In the case of heifers, the expected ending value will be discounted by 10%.
I think this is important because it means that LRP basis can be very different for steers and heifers because of this heifer adjustment. For example, consider a producer that sells loads of both steers and heifers. Perhaps they expect their steers to sell $5 back of the CME index, which implies an expected LRP basis of -$5. If they typically sell heifers for $15 back of steers at the same weight, this would imply a $20 heifer discount to the actual CME index. But with the 10% heifer adjustment (-$25 per cwt in the previous discussion), the LRP heifer basis could actually be positive. The key point here is that steers and heifers need to be considered separately and the producer needs to fully understand the expected ending value and coverage levels for each.
While I definitely think it is important to understand LRP basis because it paints a picture of the true price floor set by LRP coverage, I also think people can get so focused on the absolute numbers that they miss the impact of price changes. The price an individual producer receives for their cattle is irrelevant to the price floor that is set through LRP and any indemnity that is received. However, this concept works from a risk management perspective because the prices of cattle in a given location should move similar to the prices of cattle in those twelve states. A simple way to look at LRP insurance is just to compare the expected ending value to a selected coverage level. If the expected ending value is $250 per cwt, that means that I have to self-insure the first $8 per cwt drop in the market if I purchase a $242 coverage level. One can think of this as an $8 deductible. And with respect to heifer coverage, one just needs to understand that the movement in the index is slightly truncated by the 90% adjustment factor.