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Updated LRP-Swine could bolster ability to weather black swan events

Tumultuous market conditions and repeated ad-hoc disaster payments highlight need for improved longer-term, market-based support for livestock producers.

The term "unprecedented" has been overused throughout the COVID-19 pandemic, but it truly is the only way to describe the environment hog farmers have had to navigate over the past several months. Record production, coupled with supply chain disruptions and a sudden change in consumption patterns, created a perfect storm that has resulted in significantly negative margins throughout most of the year.

As of July 27, pork producers have received $416 million from the federal government's Coronavirus Food Assistance Program. These payments, while welcomed by the industry, pale in comparison to the economic harm faced by the sector. According to a study commissioned by the National Pork Producers Council, hog farmer losses will approach $5 billion by year-end due to a decline in market prices, euthanasia and carcass disposal.

While Congress is currently considering further aid for the industry to subsidize producers for losses incurred, there also should be consideration into longer-term support for the industry to better weather similar black swan events that are inevitable in future crises. Fortunately, the structure of one such program already exists and, with slight modifications, could serve as a sustainable, long-term program to avoid or reduce the need for ad-hoc livestock disaster payments in the future.

The USDA Risk Management Agency offers single-peril price risk coverage for future livestock sales under the Livestock Risk Protection Insurance program. In other words, LRP protects farmers from unexpected price declines. Although the program has existed for years, its uptake has been lackluster due to several shortcomings initially put in place during its pilot project period. Policyholders of LRP-Swine choose a variety of coverage levels (from 70% to 100% of the expected price) and insurance periods (13, 17, 21 or 26 weeks) to match the timeframe during which their pigs would normally be marketed. There is a limit of 20,000 head per endorsement and an annual limit of 75,000 hogs for each crop year, which runs from July 1 to June 30.

A subsidy makes these programs more attractive when market volatility is elevated – reflecting a time when producers need risk protection but may find it prohibitively expensive. Active risk management decisions can continue to be made throughout the production period by incorporating insurance with other tools, such as futures and options. Unfortunately, this subsidy has been below levels needed to make the product attractive to producers.

Additionally, the size limitations reduce the number of head eligible for participation and the short duration of LRP-Swine reduces the efficacy of the program for a sector where active risk management decisions are routinely being made up to 52 weeks ahead of time. Despite widespread use of futures and options by market participants, total LRP participation has only covered more than 100,000 head annually once in the past 15 years.

Futures contracts can fluctuate daily and often post highs and lows prior to expiration, sometimes many months before expiration. Looking at seasonal charts for the February and December lean hog contracts over the past five years, it is clear the highs for some contracts tend to occur well before the 6-month window for which the program is currently available. In other words, by the time the LRP window of opportunity was available for hogs ready to be marketed in February, the contract high would have already passed because, on average, it would have occurred in early June. Likewise, a seasonal tendency to post contract highs in mid-April for the December lean hog contract represents lost opportunity for producers to utilize LRP for hogs coming to market late in the year.

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Chart 1. February Lean Hog 5-Year Seasonal Chart.

 

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Chart 2. December Lean Hog 5-Year Seasonal Chart.

Recent changes to LRP have been a step in the right direction, but unfortunately fall short of fully transforming it into a reliable and worthwhile tool for hog farmers. USDA RMA announced on June 8 changes that include moving premium due dates to the end of the endorsement period (to better align with cash flows) and increasing premium subsidies to assist producers. The previous subsidy level near the market for LRP products was 20-25%. Subsidy levels farther from the market were 30-35%. After RMA's recent action, these were slightly increased to a subsidy range of 25%-30% near the market and remain capped at 35% farther from the market.

Success in federal crop insurance and the newer Dairy Revenue Protection program demonstrate there is an appetite for these types of tools in the countryside if the program is designed effectively. After recognizing the inadequacy of existing government-sponsored tools for dairy farmers to manage a volatile environment, DRP was established to provide insurance for the difference between the revenue guarantee and actual milk revenue. It was first made available for purchase nationwide in October 2018 and has quickly become a critical component for many producers' margin management policies. Unlike LRP, there is no coverage quantity limit for DRP, subsidy levels are much higher, and coverage periods extend five quarters out in time.

Total current DRP purchases represent over 25% of the milk likely to be produced in the United States in 2020. DRP is not viewed as a standalone program for many dairy farmers; rather, it serves as a foundation for a comprehensive risk management program in conjunction with other tools, such as forward contracts, swaps, or futures and options. With further modifications, LRP could similarly provide a baseline against which hog farmers build out their overall risk management plan.

The Federal Crop Insurance Corporation meets in August and has the authority to approve changes to improve LRP. Chief among the changes that should be considered is bringing subsidy levels across all coverage ranges more in line with insurance programs offered to dairy and crop producers. This can be done by basing the subsidies on their proximity to the market. Stated simply, the LRP pricing is market driven so it allows a producer to put a floor on price, similar to a put option at expiration, at a highly subsidized cost. Furthermore, the current total annual and per head endorsement cap should be reexamined to ensure the program can be utilized by any producer who shows interest. If the caps cannot be completely removed, they should be doubled for the near term with a long-term plan of continued expansion. This would allow a larger number of farmers and a greater share of production to participate in the program if they so choose.

The process of evaluating the advantages and disadvantages of changes to programs is known as the 508(h) submission process. The method relies on support from practitioners, producers, industry groups and others to convince the FCIC to approve such modifications. Specifically, letters of support to the FCIC can be very useful to implement any proposed changes. Voice your support for these changes to the program with your state and/or national producer association or directly to the FCIC.

The above modifications would increase usage of LRP across the livestock sector and bolster the ability of hog producers to proactively weather black swan events in the future. The 508(h) process can be cumbersome, but it is past time for the livestock sectors to have access to viable tools that have been offered to crop and dairy producers for years. LRP-Swine has the potential to be a practical addition to the toolbox to help farmers take a proactive approach to their margin management strategy, no matter how unprecedented the market environment may be.

Source: Dustin Baker, who is solely responsible for the information provided, and wholly owns the information. Informa Business Media and all its subsidiaries are not responsible for any of the content contained in this information asset. The opinions of this writer are not necessarily those of Farm Progress/Informa.
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