Bradley D. Lubben | Jan 06, 2020
With the new year underway, producers are weeks away from a March 15 deadline to make their 2019-20 farm program election between the Agriculture Risk Coverage program and the Price Loss Coverage program.
After studying program details, reading educational materials, attending meetings and analyzing program choices, producers may feel confident in their ARC vs. PLC decision. But another decision due March 15 on crop insurance is a good reminder that the farm program decision is part of a broader safety net of farm programs, crop insurance and disaster assistance coupled with good marketing and management decisions to manage risk on the farm.
Previous discussions and educational materials on farm programs (available at farmbill.unl.edu) provide the basic details and mechanics of both the ARC and PLC programs. ARC provides a moving average revenue-based safety net, while PLC provides a price-based safety net.
How producers decide between the ARC and PLC programs may largely be a question of which program is expected to provide more protection or more payments but also could be affected by the question of what risk a producer is really trying to cover.
Using corn as an example, if the 2019 crop national marketing year average price finishes at $3.85 per bushel, as projected in the December supply and demand report from USDA, then the 2019 PLC payment rate could be calculated directly at $0 because the $3.85 price would be above the $3.70 reference rate.
By comparison, under ARC, the guarantee is equal to 86% of the benchmark revenue of benchmark yield times benchmark price. A $3.85 price would be about 4% above the $3.70 benchmark price in the ARC guarantee. So, there would be an ARC payment only if the yield dropped at least to a level of about 82% of the benchmark yield.
This analysis can project exact payments given projected prices and yields, but that only gives an answer between ARC and PLC if the projected prices and yields come to fruition.
Given a great deal of uncertainty around those projections, a producer can analyze projected payments by plugging in several possible price and yield scenarios or by running one of the two online farm program decision aids.
The two tools are available as links at farmbill.unl.edu or as links from the USDA Farm Service Agency webpage at fsa.usda.gov.
Either tool will provide estimates of potential program payments by crop based on not just the price and yield projections plugged into the decision aid, but based on a random draw of 500 or 1,000 possible outcomes around those expectations given appropriate assumptions about price and yield distributions.
It is important to recognize, however, that the online decision tools only consider farm program payments. That may be enough if the fundamental goal is to try to maximize expected payments. But, if the goal is to manage price, yield and revenue risk more thoroughly, then considering how the farm programs work and how they match up to other risk management tools also may be important to the decision.
A deeper analysis
The PLC program essentially works like a put option in that it pays if the national marketing year average price drops below the reference rate of $3.70 in the case of corn but doesn’t penalize the producer if prices finish above.
However, as a price hedge, it only protects a portion of expected production. PLC payments are tied to a farm’s payment yield that even if updated, likely reflects only about 75% of expected yield in the case of corn (81% of the 2013-17 average yield, which itself likely trails 2019 and 2020 expected yields) and are paid on only 85% of base acres.
Altogether, PLC provides an automatic $3.70 put option hedge each year, but on only about 64% of the expected bushels from the farm’s corn base acres. Planting more or less acres than in the base obviously would affect the effective amount of protection provided by the PLC program, but regardless, enrollment in the PLC program should have some effect on a producer’s price risk management decisions as PLC and hedging strategies could be duplicative on at least some bushels at price levels near or below the reference price.
In contrast, the ARC program provides revenue protection similar to the higher levels of revenue insurance policies on a band of 86% down to 76% of a benchmark revenue equal to a trend-adjusted benchmark yield and a benchmark price.
ARC-CO (county-level ARC) protection should mimic the protection in the higher band of coverage under the county-based Area Risk Protection policy. ARC-IC (individual coverage or farm-level ARC) provides revenue protection on the farm on the same higher band across program crops in much the same way that a Whole Farm Revenue Protection policy or a combined Corn-Soybean enterprise unit (where available) works.
As ARC only covers a 10% band of revenue losses, it is not designed to replace underlying crop insurance, but may affect the producer’s decision on what levels of coverage to purchase. A major difference between ARC and the revenue policies, however, is that the ARC guarantee is tied to a benchmark price equal to the five-year Olympic average (not to drop below the reference rate), while the revenue insurance policies are tied to the higher of that year’s base price or harvest price (unless the harvest price exclusion is selected).
So, ARC can’t exactly replace higher bands of coverage in the underlying policies, but certainly could affect a producer’s decision on what level of coverage to purchase.
A further complication in the ARC vs. PLC decision is the potential purchase of a Supplemental Coverage Option insurance policy that can provide county-level protection on top of a producer’s underlying crop insurance policy, if a producer is not enrolled in ARC.
The SCO coverage starts at 86% and covers the gap down to the producer’s underlying insurance protection level. Whether SCO is a valuable tool and therefore a reason to lean toward PLC enrollment is partly a function of how high a crop insurance coverage level producers currently purchase, and whether they would willingly want to lower existing farm-level coverage to cover part of the gap with less expensive, but less representative county-based coverage.
Taking the analysis to this deeper level of not just estimating farm program payments but analyzing potential risk management implications is an important consideration. A producer’s overall risk management preferences and strategy may affect the optimal farm program enrollment decision.
At a minimum, the farm program decision should affect the producer’s crop insurance and marketing decisions that follow. Studying these issues will not end with the pending farm program deadline but will be worth considering throughout the rest of the year and the coming years as well.
Lubben is an Extension policy specialist at the University of Nebraska-Lincoln.