Five questions to ask About a Farm Bill Decision Aid

We have been modeling crop insurance and farm policy for years.  Tremendous advances have been made in quantifying agricultural risk. As farmers face decisions regarding their participation in federal farm programs and crop insurance various decision aides have been developed to evaluate alternatives.  Based on our experience, here are five questions to ask anyone who tells you they have a decision aide for evaluating the ARC/PLC choice.

  • How does the decision aide account for uncertain prices and yields over the life of the bill?

Most spreadsheet aides are simply calculators, meaning they are ‘deterministic’ in that they calculate a payment based on the exact yields and prices provided. The problem, of course, is that one can’t possibly know with certainty what yields and prices will occur. How does the decision aid account for the likelihood of various prices and yields over the next 5 years when estimating payments?

  • If the decision aid accounts for risk, what risks are modeled?

There are five major unknown variables that must be accounted for in any  crop insurance, ARC, and/or PLC decision aide.  These are: three prices – cash prices, futures market prices, market year average prices, and two yields – farm and county yield.  Does the decision aid account for the likelihood of different outcomes for all of these unknown variables?

  • If the decision aide accounts for risk, then how is the correlation of random variables handled?

These five unknown variables are not necessarily independent, meaning there is a relationship (or correlation) between them.  In fact, there is good reason to believe that many of them are related.  For example, farm and county yield are most likely positively correlated.  In the Midwest, yield and price for corn likely have a negative relationship (as yield declines, corn price would increase).  Cash, futures, and MYA price are likely positively correlated.  Prices and yields across years are also often positively correlated (trends develop over time).  There are more relationships, for example: a farm considering individual ARC with three crops potentially needs to account for 120 correlations.  Modelling correlation is difficult, but very important and shouldn’t be avoided to accurately assess the farm program and crop insurance options.

  • Does the model ask you for a lot of farm yield data?

Nobel Prize winner Daniel Kahneman points out the problem of using only a few years of data to form expectations often provides faulty outcomes.  Our research suggests that evaluations of farm-level crop insurance and farm program outcomes with less than ten years of farm yield data will be highly inaccurate.

  • Does the decision aid help you understand risk protections as well as expected returns?

The new programs offered from the 2014 farm bill are intended to help farms reduce exposure to the risks of low price, low yield, or low revenue.  Simply reporting the ‘deterministic’ expected payments – payments that come from one price and one yield – from the programs ignores the question of whether the payments help mitigate risk exposure. In other words, how does the farm program and crop insurance decision fit into the entire operation’s business portfolio?

In summary, predicting the future is extremely difficult. However, methods to provide guidance with respect to the uncertainty and correlation amongst the multitude of possible outcomes do exist but are often difficult to apply. Some of these are built into the current offering of decision aids provided by Texas A&M and Illinois, but few are available in simple spreadsheets built by others. For example, the two spreadsheets we have provided (CLICK HERE) only give the base reallocation calculation and the calculation of how generic acres will be distributed based on a given number of planted acres, both of which are simple calculators. While these types of “decision aids” can be very useful, keep the questions we pose here in mind as you evaluate the results generated from them.

Five things you need to know about County-triggered Shallow Loss Programs

 

The Supplemental Coverage Option (SCO), Stacked Income Protection Program (STAX) insurance and county Agricultural Risk Coverage (ARC) programs in the new farm bill are novel risk protection products.  All three cover a band of shallow losses and leave the producer exposed to more severe losses unless otherwise protected by crop insurance or by some other means.  Shallow loss programs are new, but most people understand the concept of layering risk protection.  What is less clear is how well people can evaluate county- versus farm-triggered programs. County-triggered programs are not new.  They have been around for decades in the form of area coverage insurance. This type of insurance is currently known as Area Risk Protection Insurance (ARPI) and was formerly called the Group Risk Plan (GRP) and Group Risk Income Protection (GRIP).  ARPI is a county-triggered alternative to farm-triggered insurance whereas STAX, SCO, and ARC are supplements to farm-triggered insurance (e.g., Yield Protection and Revenue Protection).  Over the years we have probably studied and evaluated area risk protection products as much as anybody.  So here are a few pointers.

 

  1. For an area triggered program to exist, county yields must be estimated and reported.  In the past ARPI programs have been based solely on NASS county yield estimates.  A historical series is used to predict expected yield and an actual yield is necessary to determine actual yield (or revenue) shortfalls in the insured year.  NASS does not report county yields for every commodity in every county.  They are unlikely to report in counties where the commodity is grown on relatively few acres and/or where few farms produce the commodity.  To increase the availability of STAX and SCO it is likely that RMA will, at least in some crops/areas, use aggregated yield reports from farm-triggered crop insurance policies to construct county yields.  It is less clear what FSA will use for ARC calculations.  The bottom line is no county yield equals no program.
  2. Risk protection from area products all depends on correlation.  Correlation is a statistical concept that simply means, two variables are related to each other rather than independent.  For area shallow loss programs, this may be translated to, “To what degree does county revenue go up (or down) when my farm revenue goes up (or down).  What we find is that this relationship is driven by the farm-county yield relationship.  Typically county yield and farm yield move up and down together, but not perfectly.  Further we find wide differences across farms in the relationship between farm yield and county yield.  Think of a farm using typical production practices on the predominant soil type in the center of a county versus a farm using an atypical practice on a less common soil type at the edge of the county.  The correlation of farm-county yields will likely be less for the atypical farm and a county triggered program will provide poorer risk protection.  Some have suggested that with the availability of county-triggered shallow loss products, growers should reduce the coverage level on their underlying farm-triggered insurance. Before making this decision growers should think very carefully about how correlated their yields are with the county yield.  Likewise, a number of shallow loss “decision aids” are becoming available and more will likely follow.  Growers should determine whether these decision aids allow for differences across farms in the correlation between farm yield and county yield. Ideally they would also help in measuring that correlation. Unfortunately, this is not that easy to do and many of the decision aids we have seen implicitly assume that farm-yield and county-yield are independent.  Growers should be aware that any decision aid that does not adequately address correlation is likely to provide erroneous guidance on decisions about shallow loss programs.
  3. What is not very important is whether your average yield is higher or lower than the county average.  With both farm-triggered crop insurance products and county-triggered shallow loss programs, payments occur when the realized percentage shortfall exceeds the percentage deductible. The percentage deductible is just 100% minus the coverage level (thus a crop insurance policy with a 75% coverage level has a 25% deductible). The percentage shortfall and percentage deductible are both calculated relative to the expected yield or revenue. For county-triggered programs it doesn’t really matter whether your excepted farm yield is higher or lower than the expected county yield. What matters is how closely the percentage shortfall on your farm matches with the percentage shortfall at the county level. If the county experiences a 25% revenue shortfall and your farm also experiences a 25% revenue shortfall then the county-triggered program should do a nice job of covering your losses.  However, if your revenue falls 25% but the county revenue only falls 15% you will not be fully covered.
  4. County yields are less variable than the average variability of farms in the county. This is the result of the county yield being an average of all the farms in a county.  Past research typically finds the average farm is about 30% riskier than the county in which it resides.  What does this mean for STAX, SCO, and ARC?  It means that, all else equal, a layer of county-triggered coverage will pay less than the same layer of farm-triggered coverage for the typical farm. This is actually the motivation behind the scale option in ARPI and STAX products.
  5. Get ready for differing USDA estimates of county yields.  FSA, RMA, and NASS may each use different data and different procedures for estimating realized county yields.  Thus, it is quite possible that these various USDA agencies will generate different estimates of the realized county yield in a given year and these different estimates will be used to determine payments for different programs.  If that seems strange, know that the 2014 Farm Bill did not define how these county yields would be developed.   Good luck to the USDA officials who have to explain the differences.     

 

 

 

 

 

Analyzing Mississippi Soybean Producers’ Farm Bill Alternatives

With the recent passage of the 2014 Agricultural Act a number of new choices are available for producers, while many of the previous options are no longer available. The analysis here examines these choices for soybean production in Mississippi. The report can be viewed at this LINK (Adobe Reader required to view the report).

Farm Bill Presentations, Support Tools, and Calculators

This page will provide links to presentations and various tools that we create. Please check back frequently as new tools will be added and updates to existing tools will be provided. If you have any questions or find any errors with any of these tools please feel free to contact us or leave a comment below.

Farm Bill Learning Session Presentations (December 2014):

All About the 2014 Farm Bill

Farm Bill Decision Aids (part 1)

Farm Bill Decision Aids (part 2)

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Base Reallocation Calculator v 1.0  [updated April 8, 2014]

:: Previous versions: N/A

Generic Base Distribution Calculator v 1.1 [updated April 14, 2014]

:: Previous versions:

  • v 1.0, April 8, 2014

Summary of the Agricultural Act of 2014

The recent passage of the 2014 Farm Bill (formally known as the Agricultural Act of 2014) brings about some significant changes in agricultural policies, specifically within Titles One and Eleven in the legislation. The following summarizes the key changes that were made, the new programs that are being made available to landowners and producers, and the decisions that these individuals or firms will need to make.

First, from Title One, the new bill eliminates Direct Payments, the Counter-Cyclical program (CCP), the Average Crop Revenue Election program (ACRE), and the supplemental revenue assistance program. Marketing loans are retained and unchanged.

New offerings for 2014 through 2018 are Price Loss Coverage (PLC) and Agricultural Risk Coverage (ARC). PLC and ARC cannot be chosen for the same base acres and committing to either PLC or ARC is locked for the duration of the current Farm Bill (5 years). Also, for 2014 only, transition payments for current cotton base acres and yield will be available.

Two new Title Eleven products are Stacked Income Protection Plan (STAX) for planted cotton acres and Supplemental Coverage Option (SCO) for other covered program crops. Both STAX and SCO are an “insurance styled” revenue protection coverage.

For more detail on these new offerings click HERE and for a breakdown on each individual program click the acronym: ARC, PLC, STAX (including information on 2014 transition payments), and SCO.

With respect to base acres, landowners are provided the opportunity to reallocate the current base acre allotment. This attempts to bring current base allotment more in-line with recent plantings. The reallocation of covered commodities will be in proportion to the 4-year average of the planted acres (actual planted and prevented plantings) from 2009 to 2012 crop years. Also, yields can be updated to reflect 90% of the 5-year average from 2008 to 2012.

Given that cotton is no longer a covered (Title One) commodity, current cotton base can be converted to “generic” base. In any year that generic base is planted to a covered commodity, that base will fall in-line with the program choice for that commodity. For example, if soybeans are allocated to generic base in 2015 then the generic base will be follow the soybean program chosen (ARC or PLC). Then if corn were planted to the generic base in 2016, the generic base would follow the corn program chosen (ARC or PLC).