CROP INSURANCE – The Difference Between Yield Protection and Revenue ProtectionFebruary 18, 2013
Part 2 of a multi-part series. Check out Part 1 – Crop Insurance – When, What, How & Why
Primary Protection Plans
For small grains, like wheat and barley, and coarse grains, like corn, soybeans, and grain sorghum, there are two types of Crop Insurance plans that are most popular. Each of them start with the same principles but soon diverge as to how they respectfully respond in providing protection and risk management, for the producer. The two plans are referred to as Yield Protection, YP and Revenue Protection, RP. Each of these products uses an “established price” for the commodity which is set prior to the Sales Closing Date, SCD, the deadline determined by the Risk Management Agency. The price is determined based on an average trading price on the Chicago Board of Trade, CBT, over a time period. At SCD, this is referred to as the “projected price.”
Yield Protection, YP, is the simpler of the two plans. This plan is the basic plan where Crop Insurance originally started. YP is based strictly on the amount of bushels of grain produced on a given acre of the crop. When the policy is purchased or renewed by the Sales Closing Date, SCD, the protection is determined by the “established price” per bushel X the bushel guarantee per acre. (Note: The SCD and the “established price” vary depending on the crop and the region of the country, i.e. state and county.) Let’s look at a simple example to explain the mechanics of the policy.
If a producer has an Actual Production History, (APH) of 100 bushel per acre and he buys a level of protection at 70%, then he is guaranteeing that he will get at least 70 bushels of production per acre. If at the SCD the “established price” per bushel is $6.00 then he will be paid $6.00 for every bushel below the guarantee of 70. So, at harvest time, if his production averages 50 per acre a specific farm, then he will be paid for 20 bushels, 70-50, at $6.00 per bushel for a total of $120.00 per acre. He only has a loss if his production is below the guaranteed number of bushels. It is strictly dependent on the yield.
Revenue Protection, RP, is a more comprehensive plan and provides protection for a revenue loss; a dollar value per acre on the crop produced. Essentially, the producer is guaranteeing that, at the completion of harvest, he will have a pre-established gross revenue in hand per acre. When the policy is purchased by the SCD, his revenue guarantee is determined by the “projected price” per bushel X the bushel “trigger yield.” Again, let’s look at an example for explanation and illustration. We will again use an APH of 100 bushel per acre and a “projected price” per bushel of $6.00 for easy math.
If the producer purchases the 70% protection level, then 70 bushel will be what we call his “trigger yield.” (100 X 70%.) To calculate the revenue guarantee we would multiply the “trigger yield”, 70, times the “established price”, $6.00 per bushel. This guarantees the producer revenue of $420.00 per acre. This is all established by the SCD.
Now let’s look at three different scenarios at harvest time. But first, we must define “harvest price.” This price is in contrast to the “projected price.” As was mentioned before the “projected price” is established at SCD. The “harvest price” is established around harvest time and it varies by the crop being insured. Again the “harvest price” is established based on an average of the CBT over a period of time.
“Projected Price” and “Harvest Price are Equal”
In the first scenario, we have the situation where the “projected price” and the “harvest price” are the same. So if the producer harvests 50 bushel per acre, the value of his crop is 50 X $6.00 or $300.00. His revenue guarantee is $420.00 and he has a deficit of $120.00. So he is paid $120.00 per acre. This is identical to the YP because the price per bushel of the crop did not change from the sales period to harvest. However, it is important to note that this scenario is highly unlikely.
“Harvest Price” is Lower Than the “Projected Price”
The second scenario is the situation where the “harvest price” is lower than the “projected price.” Let’s assume that the “harvest price” is $4.00, $2.00 lower than the “projected price.” If the producer again harvests 50 bushel, then to calculate the value of his crop we multiply 50 X $4.00, the “harvest price.” His harvested crop is worth $200.00. His revenue guarantee was $420.00 and he has a deficit of $220.00.
We mentioned before that his “trigger yield” was 70 bushel; 100 bushel (APH) X 70%, (level of coverage.) What is important to understand is that when the “harvest price” is lower than the “projected price,” the “trigger yield” will go up. The easy way to calculate the “trigger yield” is to think, “How many bushels of $4.00 production do I need to make a value of $420.00?” (Revenue Guarantee). In our example, $420.00 / $4.00 equals 105 bushel. Now the “trigger yield” has increased to 105 bushel, so as soon as the production drops below 105 bushels we have a revenue loss even though our initial trigger yield was 70 bushel.
You do not need to have a production loss to have a revenue loss. Just a note to consider: If you have a poor year with your crop, you are better off if nationally the production is good so that the CBT price is lower at harvest. This will give you a larger indemnity payment, (loss), to buy replacement bushels at a lower cost.
“Harvest Price” is Higher Than the “Projected Price”
Option three is when the “harvest price” is higher than the “projected price.” In this case, the producer’s revenue guarantee increases to reflect the higher “harvest price” at no additional premium. To illustrate, initially our revenue guarantee is $420.00, 70 X $6.00. If the “harvest price” is set at $7.00, then the revenue guarantee will increase to $490.00, 70 X $7.00. If the producer harvests 50 bushel, then the value of the crop will be $350.00, 50 X $7.00. The revenue guarantee increased to $490.00 so there is a deficit of $140.00 per acre. In this scenario, you must have a production loss to have a revenue loss.
The Revenue Protection, RP, is a better risk management tool because it protects the market value of your crop based on the CBT and not just number of bushels produced. In the volatile and unpredictable market we have been experiencing the last few years, RP provides security to be able to execute a marketing plan with greater confidence. It will provide the revenue to buy out a sales contract or purchase replacement bushels to fulfill the contract.
Disclaimer: Information and claims presented in this content are meant for informative, illustrative purposes and should not be considered legally binding.