Livestock Insurance Alternatives For Risk Management February 15 to March 6, 2007 Dr. Darrell R. Mark Price Change ($/cwt) 5.

Transcription

1 February 15 to March 6, Livestock Insurance Alternatives For Risk Management 1 Sponsors 2 February 15-March 6, Darrell R. Mark, Ph.D Ext. Livestock Marketing Specialist Dept. of University of Nebraska Lincoln dmark2@unl.edu agecon.unl.edu/mark Today s s Topics 1. Brief review of futures & options 2. Livestock Risk Protection Insurance (LRP) LRP is single-peril price insurance 3. Livestock Gross Margin Insurance for Cattle (LGM) LGM is cattle feeding profit margin insurance (doesn t insure production losses) 4. Comparing LRP & LGM in today s market 6 Why Do Producers Need Price Insurance? Price Change Source: University of Nebraska Nebraska Fed Steer Weekly Price Changes, Jan Dec Average = $0.05/cwt Min = -$3.47/cwt Max = $4.11/cwt Standard Dev. = $1.23/cwt 1/16/1998 5/16/1998 9/16/1998 1/16/1999 5/16/1999 9/16/1999 1/16/2000 5/16/2000 9/16/2000 1/16/2001 5/16/2001 9/16/2001 1/16/2002 5/16/2002 9/16/2002 1/16/2003 5/16/2003 9/16/2003 1/16/2004 5/16/2004 9/16/2004 1/16/2005 5/16/2005 9/16/2005 1/16/2006 5/16/2006 9/16/ Average = $0./cwt Min = -$12.81/cwt Max = $14.30/cwt Standard Dev. = $2.80/cwt 7 Why Do Producers Need Price Insurance? Price Nebraska Combined Weighted Average lb. Feeder Steer Price Weekly Price Changes, Average = -$0.08/cwt -10 Min = -$6.09/cwt Max = $5.61/cwt Standard Dev. = $2.04/cwt -15 6/4/99 6/4/00 6/4/01 6/4/02 6/4/03 6/4/04 6/4/05 6/4/06 Source: University of Nebraska Average = $0.02/cwt Min = -$12.16/cwt Max = $9.33/cwt Standard Dev. = $2.83/cwt 8 Why Do Producers Need Price Insurance? Corn Price ($/bu) Omaha Nebraska Corn Prices, Average = $1.94/bu Min = $1.40/bu Max = $2.71/bu Standard Dev. = $0.25/bu Source: University of Nebraska 1/7/2000 5/7/2000 9/7/2000 1/7/2001 5/7/2001 9/7/2001 1/7/2002 5/7/2002 9/7/2002 1/7/2003 5/7/2003 9/7/2003 1/7/2004 5/7/2004 9/7/2004 1/7/2005 5/7/2005 9/7/2005 1/7/2006 5/7/2006 9/7/ Average = $2.17/bu Min = $1.47/bu Max = $3.56/bu Standard Dev. = $0.43/bu 9 1

2 February 15 to March 6, Cattle Price What s s Happened Since Sept 1? Nebraska Fed Steer, Feeder Steer, & Omaha Corn Prices, 2006 Fed Cattle Down $4.25/cwt Feeders Down $24.97/cwt Feeders Down $19.87/cwt Corn Up $1.75/bu Fed Steer Nebraska FC (Steer) Nebraska FC (Steer) Nebraska Corn Omaha Source: University of Nebraska 1/6/2006 1/20/2006 2/3/2006 2/17/2006 3/3/2006 3/17/2006 3/31/2006 4/14/2006 4/28/2006 5/12/2006 5/26/2006 6/9/2006 6/23/2006 7/7/2006 7/21/2006 8/4/2006 8/18/2006 9/1/2006 9/15/2006 9/29/ /13/ /27/ /10/ /24/ /8/ /22/2006 1/5/ 1/19/ Corn Price ($/bu) 10 $ Per Head The Result? Record Feeding Losses In 2006 AVERAGE RETURNS TO CATTLE FEEDERS Feeding 725 Lb. Steers, S. Plains, Monthly Returns To Cow-Calf Calf Better But Will Decline As Herd Expands ESTIMATED AVERAGE COW CALF RETURNS Returns Over Cash Cost (Includes Pasture Rent), Annual 12 Futures & Options: A Review 13 $ Per Cow Hedging Use of the derivatives market or other contract (insurance) as a temporary substitute for an intended transaction in the cash market which will occur at a later date Why would this be necessary? Cash prices change over time 14 Evaluating a Futures Hedge Hedging locks in futures price, but not basis Before hedging want to know expected cash price Exp. Cash Price = Exp. Basis + Futures Price Must determine expected basis 15 2

3 February 15 to March 6, Short vs. Long Hedging 16 Short vs. Long Hedging 17 Short Using futures market as a temporary substitute for a cash market SALE that will take place at a later date Start by selling a futures contract and, after cash market SALE, offset futures by buying it back Long Using futures market as a temporary substitute for a cash market PURCHASE that will take place at a later date Start by buying a futures contract and, after cash market PURCHASE, offset futures by selling it back Fed Cattle Futures Hedge On February 7,, producer hedges 100 head of steers he plans to sell in August at 1200 lbs August CME Live Cattle futures on Feb 7, is $88.18/cwt Expect basis in August to be Commission = $100/contract ESP = Futures Price + Basis - Commission ESP = $88.18/cwt $0.52/cwt - $0.25/cwt ESP = $87.41/cwt 18 Cash price received = $79.48/cwt Futures Hedge ESP = Fut + Basis Comm = $ $ $0.25 = $87.41 Cash Futures Market Fut. Basis action Sell 100 head of 1200 lb. $79.48/cwt Sell 3 Aug LC $88.18 Buy 3 Aug LC $80.00 Net on Futures = $8.18/cwt ASP = $ $ $0.25/cwt = $87.41 Exp basis to be Actual 8-08 basis is Diff. b/w Act. & Exp. = $0.00/cwt 19 ESP = Fut + Basis Comm = $ $ $0.25 = $87.41 Cash Futures Market Fut. Basis action Sell 100 head of 1200 lb. $89.48/cwt Cash price received = $89.48/cwt Futures Hedge Sell 3 Aug LC $88.18 Buy 3 Aug LC $90.00 Net on Futures = -$1.82/cwt ASP = $ $ $0.25/cwt = $87.41 Exp basis to be Actual 8-08 basis is Diff. b/w Act. & Exp. = $0.00/cwt 20 Long Futures Hedge On February 7,, cattle feeder plans to purchase 10,000 bu corn in May Wants to protect against price increases Hedge by buying May CBOT corn futures at $4.12/bu Expect basis in May to be -$0.20/bu Commission = $100/contract EPP = Futures + Basis + Commission EPP = $4.12/bu + -$0.20/bu + $0.02/bu EPP = $3.94/bu 21 3

4 February 15 to March 6, EPP = Futures + Basis Comm= $ $ $0.02 = $3.94 Cash Futures Fut. Basis action Buy 10,000 bu $4.20/bu Cash price paid = $4.20/bu Buy 2 May CBOT Corn $4.12/bu Sell 2 May CBOT Corn $4.40/bu Net = $0.28 APP = $ $ $0.02 = $3.94 Exp basis to be -$0.20/bu Actual 5-08 basis is -$0.20/bu Diff. b/w Act. & Exp. = $0.00/bu EPP = Futures + Basis Comm= $ $ $0.02 = $3.94 Cash Futures Fut. Basis action Buy 10,000 bu $3.60/bu Cash price paid = $3.60/bu Buy 2 May CBOT Corn $4.12/bu Sell 2 May CBOT Corn $3.80/bu Net = -$0.32 APP = $ $ $0.02 = $3.94 Exp basis to be -$0.20/bu Actual 5-08 basis is -$0.20/bu Diff. b/w Act. & Exp. = $0.00/bu Put Option 24 Call Option 25 The BUYER has the RIGHT, but not the obligation, to SELL the underlying futures contract at a specified strike price at any time during the life of the option The BUYER has the RIGHT, but not the obligation, to BUY the underlying futures contract at a specified strike price at any time during the life of the option Option Premium 26 Option Premium 27 Option Premium is the price the buyer pays the seller for an option Premium is negotiated It is the price that is negotiated for the option in the open outcry market Components of a premium: 1. Intrinsic value (IV) is the value of an option if it were to expire immediately 2. Time value (TV) is the amount by which the premium exceeds the option s intrinsic value Total Option Premium (TOP) = IV + TV 4

5 February 15 to March 6, Intrinsic Value (IV) Calculation Put Example 28 Determinants of Option Premiums 29 Prices on February 7, $100/cwt March CME FC put premium = $2.63/cwt March CME FC futures = $98.88/cwt IV = $100/cwt - $98.88/cwt = $1.12/cwt TV = $2.63/cwt - $1.12/cwt = $1.51/cwt 1. Changes in underlying futures price level IV changes Options are a secondary market in that the options market reacts to changes in the futures market Determinants of Option Premiums 30 Determinants of Option Premiums Time remaining until option expiration Probability option will expire in-the-money increases as time remaining until expiration increases TV changes Option premiums decrease as time remaining until expiration decreases (AKA Time Decay ) Time Value 3. Price volatility Volatility measures how much underlying futures price varies Increased volatility increases option premiums Decreased volatility decreases option premiums Time To Expiration Determinants of Option Premiums 32 Fed Cattle Options Hedge Interest Rates Option purchases/sales are viewed as an investment Increases in interest rates lead to small decline in option premiums Interest rate impacts are usually small On February 7,, producer hedges 100 head of steers he plans to sell in August at 1200 lbs August CME Live Cattle futures on Feb 7, is $88.18/cwt Buys $84/cwt Aug CME LC put for $1.85/cwt Expect basis in August to be Commission = $100/contract MESP = Strike Price Premium + Basis - Commission MESP = $84.00/cwt $1.85/cwt + - $0.25/cwt MESP = $81.38/cwt 5

6 February 15 to March 6, Options Hedge 34 Options Hedge 35 MESP = Strike - Prem + Basis Comm = $84 - $ $ $0.25 = $81.38 MESP = Strike - Prem + Basis Comm = $84 - $ $ $0.25 = $81.38 Cash Futures Market Put Option Fut. Basis Cash Futures Market Put Option Fut. Basis 2-- action N/A. Aug LC $88.18 Buy 3 $84 Aug LC $1.85 Exp basis to be 2-- action N/A. Aug LC $88.18 Buy 3 $84 Aug LC $1.85 Exp basis to be Sell 100 head of 1200 lb. $79.48/cwt N/A. Aug LC $80.00 Sell 3 $84 Aug LC $4.00 Actual 8-08 basis is Sell 100 head of 1200 lb. $89.48/cwt N/A. Aug LC $90.00 Let 3 $84 Aug LC Puts expire Actual 8-08 basis is Cash price received = $79.48/cwt Net on Put = $2.15 ASP = $ $ $0.25/cwt = $81.38 Diff. b/w Act. & Exp. = $0.00/cwt Cash price received = $89.48/cwt Net on Put = -$1.85 ASP = $ $ $0.13/cwt = $87.50 Diff. b/w Act. & Exp. = $0.00/cwt Long Options Hedge On February 7,, cattle feeder plans to purchase 10,000 bu corn in May Wants to protect against price increases May CBOT corn futures at $4.12/bu Buys $4.20/bu May CBOT corn call at $0.19/bu Expect basis in May to be -$0.20/bu Commission = $100/contract MEPP = Strike Price + Premium + Basis + Commission MEPP = $4.20/bu + $0.19/bu + -$0.20/bu + $0.02/bu MEPP = $4.21/bu 36 MEPP = Strike + Premium + Basis + Comm= $ $ $ $0.02 = $ Cash action Buy 10,000 bu $4.20/bu Cash price paid = $4.20/bu Futures N/A. May CBOT Corn $4.12/bu N/A. May CBOT Corn $4.40/bu Call Option Buy 2 $4.20/bu May CBOT Corn $0.19/bu Sell 2 $4.20/bu May CBOT Corn $0.20/bu Net = $0.01/bu APP = $ $ $0.02 = $4.21 Fut. Basis Exp basis to be -$0.20/bu Actual 5-08 basis is -$0.20/bu Diff. b/w Act. & Exp. = $0.00/bu 37 MEPP = Strike + Premium + Basis + Comm= $ $ $ $0.02 = $ Cash action Buy 10,000 bu $3.60/bu Cash price paid = $3.60/bu Futures N/A. May CBOT Corn $4.12/bu N/A. May CBOT Corn $3.80/bu Call Option Buy 2 $4.20/bu May CBOT Corn $0.19/bu Let 2 $4.20/bu May CBOT Corn Calls expire Net = -$0.19/bu APP = $ $ $0.01 = $3.80 Fut. Basis Exp basis to be -$0.20/bu Actual 5-08 basis is -$0.20/bu Diff. b/w Act. & Exp. = $0.00/bu 38 Livestock Insurance 39 6

7 February 15 to March 6, LRP & LGM Related to futures & options market But protection is based on cash market prices (or equivalents) Involve no trading of futures or options Do not need broker or margin account May protect smaller groups of livestock Available through crop insurance agent system 40 LRP is Price Risk Protection Creates A Price Floor Pays Producers If A Regional/National Cash Price Index Falls Below A Set Price Does t Guarantee A Cash Price Received Covers Feeder Cattle, Fed Cattle, & Swine 41 Encourage Producers To Enroll 42 LRP States 43 Once Enrolled, Producers Have The Right But t The Obligation To Purchase Coverage Coverage Obtained With A Specific Coverage Endorsement (SCE) Livestock Has To Be In Eligible State Owners Can Be In Other States NV UT WY CO ND MN WI SD NE IA IL KS MO OK TX IN MI OH WV LRP Policy, Provisions, & Forms Basic Policy Application Forms Substantial Beneficial Interest (SBI) Must Have At Least 10% SBI In The Insured Livestock Specific Coverage Endorsement (SCE) Claim Form Producer Agent Application SBI Endorsements Endorsements Endorsements Endorsements RMA E-DAS 44 Substantial Beneficial Interest (SBI) Must Have At Least 10% Interest A Spouse Of An Applicant/Insured Will Have Substantial Beneficial Interest In The Applicant/Insured Unless Spouse Proves: The Insured Class Is In A Totally Separate Farming Operation Spouse Derives Benefit From The Farming Operation Of The Applicant/Insured 45 7

8 February 15 to March 6, Coverage Coverage Available About 5pm To 9am CST Available Sat Mornings Until 9am, But t Sun, Mon, & Holidays Coverage Initiated With Specific Coverage Endorsement (SCE) Limit On Number Of SCEs Producers Have Flexibility On The: Timing Of Purchase Time Length Of The SCE Number Of Head Covered 46 Eligible Livestock Feeder Cattle Feeder Steers, Bulls, & Heifers < 600 lbs Feeder Steers & Heifers From lbs Includes Dairy & Brahman Breeds Fed Cattle Steers & Heifers Select Or Higher, Yield Grade 1-3 Weight: 1,000-1,400 lbs Swine Market Hogs Weight: lbs (Carcass), lbs (Live) 47 Per SCE Per Crop Year July 1-June 30 Limitations On Number Of Head Insured Swine 10,000 32,000 Fed Cattle 2,000 4,000 Feeder Cattle 1,000 2, Endorsement Lengths LRP Endorsement Lengths LRP Fed Cattle LRP Feeder Cattle LRP Swine Months Weeks Actual Days Weeks Actual Days Weeks Actual Days LRP Terminology Expected Ending Value (EEV) The Expected National/Regional Cash Index Depends On Futures Prices & Endorsement End Coverage Prices Range From 70% To 95% Of EEV Cost Per CWT Cost Per CWT = Coverage Price X Rate Actual Ending Value (AEV) Indemnity If AEV Less Than Coverage Price 50 LRP EEV, AEV, & Premium Web Page LRP EEV, AEV, & Premium Web Page

9 February 15 to March 6, Actual Ending Value (AEV) Fed Cattle 5-Area Weekly Weighted Average Direct Slaughter Steer Price TX/OK, KS, NE, CO, IA/MN 35-65% Choice Steers, Live Weight Basis FOB Feedyard AMS-USDA Report LM_CT150.txt Represents National Average Cash Price If Insuring Heifers, LRP Insurance Contract Still Indemnified On 5-Area Steer Price Price Weekly 5-Area Weighted Average 35-65% Choice Steer Price (Live Weight), /5/2001 4/5/2001 7/5/2001 Source: AMS-USDA 10/5/2001 1/5/2002 4/5/2002 7/5/ /5/2002 1/5/2003 4/5/2003 7/5/ /5/2003 1/5/2004 4/5/2004 7/5/ /5/2004 1/5/2005 4/5/2005 7/5/ /5/2005 1/5/2006 4/5/2006 7/5/ /5/2006 1/5/ 54 Actual Ending Value (AEV) Feeder Cattle CME Feeder Cattle Cash Index Price National Average Cash Market Price lb. Steers Reported Index Is 7-Day Average ed_commodity_prices.html If Insuring Heifers Or Different Weight Range, LRP Insurance Contract Still Indemnified On CME Index ( lb. Steer Price) But An Adjustment Factor Is Used 55 CME Feeder Cattle Index 56 CME Feeder Cattle Cash Price Index, CME Index /5/01 1/5/02 1/5/03 1/5/04 1/5/05 1/5/06 1/5/ Source: University of Nebraska 9

10 February 15 to March 6, Price Adjustment Factors 58 Price Adjustment Factors 59 Weight < 600 lbs Weight lbs Steers Weight 1 110% Steers Weight 2 100% Heifers Weight 1 100% Heifers Weight 2 90% Brahman Weight 1 100% Brahman Weight 2 90% Dairy Weight 1 100% Dairy Weight 2 80% 550 lb. Fdr Str Price 110% X Index Index 90% X Index Actual Ending Value (AEV) Swine 2-Day Volume Weighted Average Of Negotiated & Swine Or Pork Market Formula Average Net Price AMS-USDA Report LM_HG201 Represents National Average Cash Price Same As CME Lean Hog Index CME Lean Hog Cash Index, Price /3/01 8/3/02 8/3/03 8/3/04 8/3/05 8/3/06 Source: University of Nebraska 10

11 February 15 to March 6, The Fed Cattle Hedge With LRP On February 7,, Producer Selects Fed Cattle LRP Policy With: Expected Ending Value = $89./cwt Coverage Price = $84.14/cwt Cost = $2.06/cwt (After 13% Subsidy) End = August 8, MESP = Coverage Price Premium + LRP Basis MESP = $84.14/cwt $2.06/cwt + $0.53/cwt MESP = $82.61/cwt 64 Premium Calculation Head X 12.0 cwt = 1200 cwt cwt X $84.14/cwt = $100,968 Coverage Price 3. $100,968 X = $2, Rate 1 Minus 13% Subsidy 4. $2, X 87% = $2, Insured Weight (Production) Insured Value Total Premium Producer s Premium 65 Indemnity Payment 66 Indemnity Payment 67 If AEV Is Less Than Insured Coverage Price Indemnity = Coverage Price AEV Example: If AEV = $80.00/cwt: 1. $84.14/cwt - $80.00/cwt = $4.14/cwt Coverage Price AEV 2. $4.14/cwt X 1200 cwt = $4, Indemnity If AEV Is Greater Than Insured Coverage Price Indemnity = $0 Example: AEV= $90/cwt Indemnity Paid Insured Production Total Indemnity 68 MESP = CP + LRP Basis Premium = $ $ $2.06 = $82.61 Cash LRP Insurance LRP Basis action Sell 100 head of 1200 lb. $80.53/cwt Cash price received = $80.53/cwt Buy LRP With $84.14/cwt Coverage Price For $2.06/cwt EEV = $89./cwt LRP Indemnity (AEV<CP) = $4.14/cwt AEV = $80.00/cwt Net on LRP= $2.08/cwt Exp basis to be $0.53/cwt Actual 8-08 basis is $0.53/cwt Diff. b/w Act. & Exp. = $0.00/cwt ASP = $ $2.08 = $ MESP = CP + LRP Basis Premium = $ $ $2.06 = $82.61 Cash LRP Insurance LRP Basis action Sell 100 head of 1200 lb. $90.53/cwt Cash price received = $90.53/cwt Buy LRP With $84.14/cwt Coverage Price For $2.06/cwt EEV = $89./cwt LRP Indemnity (AEV>CP) = $0.00/cwt AEV = $90.00/cwt Net on LRP= -$2.06/cwt ASP = $ $2.06 = $88.47 Exp basis to be $0.53/cwt Actual 8-08 basis is $0.53/cwt Diff. b/w Act. & Exp. = $0.00/cwt 11

12 February 15 to March 6, What Were The Alternatives To This LRP Hedge? Futures Hedging 02// Aug LC Futures = $88.88/cwt Adjust For Basis () Higher Protected Price Maximum Price Also Established Options Hedging Buying Puts Adjust For Basis Establishes Minimum Price, Maximum Price 70 Cash price received = $79.48/cwt Futures Hedge ESP = Fut + Basis Comm = $ $ $0.25 = $87.41 Cash Futures Market Fut. Basis action Sell 100 head of 1200 lb. $79.48/cwt Sell 3 Aug LC $88.18 Buy 3 Aug LC $80.00 Net on Futures = $8.18/cwt ASP = $ $ $0.25/cwt = $87.41 Exp basis to be Actual 8-08 basis is Diff. b/w Act. & Exp. = $0.00/cwt 71 ESP = Fut + Basis Comm = $ $ $0.25 = $87.41 Cash Futures Market Fut. Basis action Sell 100 head of 1200 lb. $89.48/cwt Cash price received = $89.48/cwt Futures Hedge Sell 3 Aug LC $88.18 Buy 3 Aug LC $90.00 Net on Futures = -$1.82/cwt ASP = $ $ $0.25/cwt = $87.41 Exp basis to be Actual 8-08 basis is Diff. b/w Act. & Exp. = $0.00/cwt 72 Options Hedge MESP = Strike - Prem + Basis Comm = $84 - $ $ $0.25 = $ Cash action Sell 100 head of 1200 lb. $79.48/cwt Cash price received = $79.48/cwt Futures Market N/A. Aug LC $88.18 N/A. Aug LC $80.00 Put Option Buy 3 $84 Aug LC $1.85 Sell 3 $84 Aug LC $4.00 Net on Put = $2.15 ASP = $ $ $0.25/cwt = $81.38 Fut. Basis Actual 8-08 basis is Diff. b/w Act. & Exp. = $0.00/cwt 73 Exp basis to be Options Hedge MESP = Strike - Prem + Basis Comm = $84 - $ $ $0.25 = $ Cash action Sell 100 head of 1200 lb. $89.48/cwt Cash price received = $89.48/cwt Futures Market N/A. Aug LC $88.18 N/A. Aug LC $90.00 Put Option Buy 3 $84 Aug LC $1.85 Let 3 $84 Aug LC Puts expire Net on Put = -$1.85 ASP = $ $ $0.13/cwt = $87.50 Fut. Basis Actual 8-08 basis is Diff. b/w Act. & Exp. = $0.00/cwt 74 Exp basis to be Put Options vs. LRP 1. Both protect floor selling prices 2. Strike prices are not directly comparable 3. Expiration dates are not exactly the same 4. Puts are American options & LRP is European type option 5. K-State research indicates that, after correcting for these differences, the premiums are about the same 75 12

13 February 15 to March 6, More LRP Rules 76 Coverage Limitations 77 Policy Provides Coverage To Protect Against Price Declines During Insurance Period Policy Does t Cover Any Other Peril, Including Mortality, Condemnations, Physical Damage, Disease, Individual Marketing Decisions, Local Price Aberrations, Or Any Other Cause Of Loss Other Than Stated Offsetting Transactions 78 Verification of Ownership 79 The Use Of Futures Or Options To Negate The Benefits Of The LRP Coverage Producers Must Certify That They Have t Entered Into Offsetting Transaction Producers Can Still Use Futures & Options Examples Of Offsetting Transaction: Upon Company Request Or Request Of Any USDA Employee, Insured Must Provide Documents Verifying Ownership Of Insured s Share Of Livestock Identified In SCE Writing A Put On Covered Livestock Buying A Futures (Going Long) On Covered Livestock Verification of Ownership 80 Indemnity Payments for Losses 81 Documents Proving Ownership Bills Of Sale From Prior Owners Or Others Financing Documents Covering Insured Livestock Written 3rd Party Statements Feed Suppliers Or Veterinarians Must Have Visited The Farm Or Ranch, Visually Identified The Livestock & Can Attest To Insured s Ownership To Receive Indemnity (Loss Payment) You Must Submit Claim Form Within 60 Days Following End Indemnity Payment Shall Be Made Within 60 Days Following Company Receipt Of Properly Executed Claim Form 13

14 February 15 to March 6, Availability Sales Will Be Suspended When: At Least 4 Of The Underlying CME Live Cattle Futures Contracts Trade To The Daily Price Limit For Two Consecutive Days Events Occur That May Change Market Conditions That Were Used To Rate LRP Sales Will Be Resumed When: There Have Been At Least 2 Consecutive Days Without There Being 4 Or More Of The Underlying CME Live Cattle Futures Contracts Trading To The Daily Price Limit 82 Expiration of Coverage Coverage Under SCE Continues Until The End If You: Dispose Of Any Part Of Your Insured Share During Last 30 Days Of Coverage; And, Provide Written tice Within 72 Hours Of Occurrence, Of: Livestock Seized, Quarantined Or Destroyed By Order Of Any Government Agency Livestock t Deliverable Due To Death Or Disease 83 Termination Of Coverage If Any Portion Of Insured Livestock Is Disposed Of Prior To Last 30 Days Of Coverage, Then That Portion Of The Coverage Will Terminate Indemnity Will Be Paid For That Portion Premium For That Portion Will Be Refunded An Exception Is Allowed For Transfer Of Coverage 84 End vs. Actual Sales The Risk Indemnity Paid On End Protection Coverage Price Level Planned Protection Cash Market Value Actual Sale 30 Days End Actual Sale 30 Days Before End Of SCE After End 85 Change In AEV Relative To 30 Days Ago ( ) 2006) Swine AEV (CME Index) Fed Cattle AEV (5-Area Price) Feeder Cattle AEV (CME Index) Average Largest Decrease Largest Increase Basis To Consider For LRP Futures Basis = Local Cash Price Futures Price LRP Basis = Local Cash Price AEV Difference Between Local Selling Price & Actual Ending Value Of LRP Insurance Contract AEV Feeder Cattle CME Feeder Cattle Cash Index Fed Cattle 5 Area Weighted Avg Weekly Steer Price Swine CME Lean Hog Cash Index (2-Day Volume Weighted Avg Of Negotiated & Swine/Pork Market Formula Price) 87 14

15 February 15 to March 6, Price Fed Cattle Nearby Futures Prices, 5-Area Steer Price, and Nebraska Direct Steer Price /5/2001 4/5/2001 7/5/2001 Source: University of Nebraska Nearby Fed Futures Wkly Avg AEV (5-Area Cash Price) Nebraska Direct Steer Price 10/5/2001 1/5/2002 4/5/2002 7/5/ /5/2002 1/5/2003 4/5/2003 7/5/ /5/2003 1/5/2004 4/5/2004 7/5/ /5/2004 1/5/2005 4/5/2005 7/5/ /5/2005 1/5/2006 4/5/2006 7/5/ /5/2006 1/5/ 88 Price Nebraska Choice Steer Nearby Futures Basis (Live Weight), Avg Min Max -10 1/7 2/7 3/7 4/7 5/7 6/7 7/7 8/7 9/7 10/7 11/7 12/7 Source: University of Nebraska Nebraska Steer LRP Basis, (Difference Between Nebraska Steer Price & 5-Area Weekly Steer Price) 90 Average Standard Deviation Of Weekly Futures & LRP Basis (2002 ( ) 06) 91 Price Avg Min Max Nebraska Direct Steer Price Nebraska Direct Heifer Price Futures Basis LRP Basis /3 2/3 3/3 4/3 5/3 6/3 7/3 8/3 9/3 10/3 11/3 12/3 Source: University of Nebraska Nebraska Direct Steer & Heifer LRP & Futures Basis, Mean Minimum Maximum Std. Dev. LRP Basis Steers Futures Basis LRP Basis Heifers Futures Basis Basis Risk Conclusion LRP-Fed Cattle Users Can Reduce Some Exposure To Basis Risk It Reduces The Basis Risk By Changes Between Futures & The 5-Area Price But Retains Risk Of Changes Between Your Selling Price & The 5-Area Price (AEV) Still Exposed To LRP Basis Risk Weekly Variation In LRP Basis Less Than Weekly Variation In Futures Basis Over Time, Nebraska Steer & Heifer LRP Basis Appears Less Variable 93 15

16 February 15 to March 6, 94 Nebraska Combined Weighted Average lb. Steer Nearby Futures Basis, Nebraska Combined Weighted Average lb. Steer LRP Basis, Avg Min Max Avg Min Max Basis 8 4 Basis /5 2/5 3/5 4/5 5/5 6/5 7/5 8/5 9/5 10/5 11/5 12/5 Source: University of Nebraska -4 1/5 2/5 3/5 4/5 5/5 6/5 7/5 8/5 9/5 10/5 11/5 12/5 Source: University of Nebraska Average Standard Deviation Of Weekly Futures & LRP Basis (2004 ( ) 06) Futures Basis LRP Basis Neb lb. Steer Neb lb. Steer Neb lb. Steer Neb lb. Steer Nebraska Feeder Steer LRP & Futures Basis, lb. LRP Basis Futures Basis lb. LRP Basis Futures Basis lb. LRP Basis Futures Basis lb. LRP Basis Futures Basis Mean Minimum Maximum Std. Dev Basis Risk Conclusion LRP-Feeder Cattle Users Still Exposed To Basis Risk It Reduces The Basis Risk By Changes Between Futures & The CME Index But Retains Risk Of Changes Between Your Selling Price & The CME Index (AEV) Still Exposed To LRP Basis Risk Weekly Variation In LRP Basis Slightly Less Than Weekly Variation In Futures Basis Variation In LRP Basis Over Time About Same As Variation In Futures Basis Over Time Less Variation in LRP Basis For Heavier Weights 98 Price Western Corn Belt Weekly Negotiated Average Hog Price Nearby Futures Basis, Avg Min Max Jan Feb Mar Apr May Jun Jul Aug Sep Oct v Dec Source: USDA-AMS and University of Nebraska 99 16

17 February 15 to March 6, Price Western Corn Belt Weekly Negotiated Average Hog Price CME Cash Index (LRP) Basis, Avg Min Max Jan Feb Mar Apr May Jun Jul Aug Sep Oct v Dec Source: University of Nebraska Average Standard Deviation Of Weekly Futures & LRP Basis (2001 ( ) 04) Futures Basis LRP Basis IA/S. Minn Base IA/S. Minn Net WCB Base WCB Net ECB Base ECB Net National Base National Net Swine LRP & Futures Basis, WCB Base LRP Basis Futures Basis IA/S. Minn Base LRP Basis Futures Basis ECB Base LRP Basis Futures Basis National Base LRP Basis Futures Basis Mean Minimum Maximum Std. Dev Basis Risk Conclusion Swine LRP-Swine Users Can Reduce Exposure To Basis Risk It Reduces The Basis Risk By Changes Between Futures & The Cash Index But Retains Risk Of Changes Between Your Selling Price & The CME Cash Index (AEV) Still Exposed To LRP Basis Risk Weekly Variation In LRP Basis Less Than Weekly Variation In Futures Basis LRP Basis Over Time Is Less Variable To Further Reduce LRP Basis Risk, Utilize WCB, Or ECB Base Price 103 Basis Risk Reduction With LRP Swine and Fed Cattle Get Biggest Reduction In Basis Risk Little Basis Risk Reduction For Feeder Cattle 104 LRP Benefits for Producers Guaranteed Cost & Coverage Set For Day & Bid/Ask Spread After Hours Price Protection Commission Costs, Brokerage Accounts Partial Basis Risk Coverage Indemnifies On A Cash Index Any Number Of Head Can Be Covered Even 1 Head (Up To Program Limits) LRP Is An Insurance Policy & t A Derivative (Preferred By Bankers)

18 February 15 to March 6, LRP Disadvantages 106 Livestock Gross Margin Insurance For Cattle 1 Some Basis Risk Still Exists Policy Settled On Ending Regardless Of When Livestock Ready For Market Options May Be Sold Prior To Expiration If Livestock Sold Or Price Opportunity Exists Offsetting Transactions Restrictions Could Limit Common Marketing Strategies Livestock Gross Margin Insurance For Cattle Offers protection against decline in feeding margin Gross Margin = market value of fed cattle less feeder cattle and corn costs 108 Expected Prices Determined Producer Inputs Target Marketings How LGM for Cattle Works Gross 109 Margin Guarantee Minus Total Actual Gross Margin = Indemnity Total Actual Gross Margin Calculated Gross Margin Guarantee Actual Prices Determined LGM for Cattle Available in 20 States 110 Substantial Beneficial Interest (SBI) 111 NV UT MT For cattle intended for commercial or private slaughter WY CO ND MN WI SD NE IA IL KS MO OK TX IN MI OH WV Owner Must Reside In One Of 48 States Must Have At Least 10% Interest A Spouse Of An Applicant/Insured Will Have Substantial Beneficial Interest In The Applicant/Insured Unless Spouse Proves: The Insured Class Is In A Totally Separate Farming Operation Spouse Derives Benefit From The Farming Operation Of The Applicant/Insured 18

19 February 15 to March 6, LGM for Cattle Available For: 1. Yearling Finishing Operation Finished weight = 1250 lbs In-weight = 750 lbs 5 months on feed Corn price = price 2 months prior to cattle finished sales month 2. Calf Finishing Operation Finished weight = 1150 lbs In-weight = 550 lbs 8 months on feed Corn price = price 4 months prior to cattle finished sales month 112 LGM Sales Period Sold on last business day of every month RMA must first validate price data used to calculate Gross Margin Guarantee (GMG) Validation occurs after the futures market closes on last day of price discovery period Sale period ends at 9:00 am CST the next business day 113 LGM for Cattle Insurance Period 114 LGM Limitations on Number of Head Insured monthly insurance periods per calendar year Each runs for 11 months cattle insurable in first month Per Insurance Period 5,000 Jan 31 Feb Mar Apr May Jun Jul Aug Sep Oct v Dec Per Crop Year July 1-June 30 10,000 Sales Closing Coverage Available Producer Specifies Target Marketings for Each Month LGM Premium 116 LGM Deductibles 117 Determined by simulation of losses Calculated using RMA s online calculator Need a user ID and password $0 to $150 per head at the insured s option In $10 per head increments 19

20 February 15 to March 6, LGM Indemnity 118 LGM Example 119 Difference between the Gross Margin Guarantee (GMG) and total Actual Gross Margin (AGM), if positive, at the end of the insurance period LGM for Cattle uses adjusted futures prices to determine expected and actual gross margins Includes state- and month-specific basis levels January 31, sales closing date Yearling finishing operation in Nebraska August target marketing month Determine the indemnity that would be due to producers for that month Total indemnity determined based on sum of target marketings in 11-month insurance period Expected Gross Margin (EGM) Yearling Finishing Operation EGM t = (12.50 cwt X Live Cattle Price t ) - (7.50 cwt X Feeder Cattle Price t-5 ) - (57.5 bu X Corn Price t-2 ) Calf Finishing Operation EGM t = (11.50 cwt X Live Cattle Price t ) - (5.50 cwt X Feeder Cattle Price t-8 ) - (54.5 bu X Corn Price t-4 ) Expected Live Cattle Price Expected August Live Cattle Price as of Jan August CME LC Futures Price: 1-29 $ $ $ day Ave $87.70 Nebraska August LC Basis (LGM) =??

21 February 15 to March 6, Expected Live Cattle Price Expected August Live Cattle Price as of Jan August CME LC Futures Price: 1-29 $ $ $ day Ave $87.70 Nebraska August LC Basis (LGM) = $1.20 Expected August LC Price = $ $1.20 Expected August LC Price = $88.90/cwt 124 Expected Feeder Cattle Price Expected March Feeder Cattle Price March CME FC Futures Price: 1-29 $ $ $ day Ave $95.37 Nebraska March FC Basis (LGM) =?? Expected Feeder Cattle Price Expected March Feeder Cattle Price March CME FC Futures Price: 1-29 $ $ $ day Ave $95.37 Nebraska March FC Basis (LGM) = $4.63 Expected March FC Price = $ $4.63 Expected March FC Price = $100.00/cwt 127 Expected Corn Price 128 Expected Corn Price 129 Expected June Corn Price May CBOT Corn Futures Price: 1-29 $ $ $ day Ave $4.15 July CBOT Corn Futures Price: 1-29 $ $ $ day Ave $4.21 Expected June Corn Price (a weighted average) = (1/2 x Expected May Corn Futures Price) + (1/2 x Expected July Corn Futures Price) = (1/2 x $4.15/bu) + (1/2 x $4.21/bu) = $4.18/bu Nebraska June Corn Basis (LGM) =?? 21

22 February 15 to March 6, 130 Expected Corn Price 131 Expected June corn price (a weighted average) = (1/2 x Expected May Corn Futures Price) + (1/2 x Expected July Corn Futures Price) = (1/2 x $4.15/bu) + (1/2 x $4.21/bu) = $4.18/bu Nebraska June Corn Basis (LGM) = -$0.18 Expected June Corn Price = $ (-$0.18) Expected June Corn Price = $4.00/bu Expected Gross Margin (EGM) Yearling Finishing Operation EGM Aug = (12.50 cwt X Exp Live Cattle Price Aug ) - (7.50 cwt X Exp Feeder Cattle Price Mar ) - (57.5 bu X Exp Corn Price Jun ) EGM Aug = (12.50 cwt X $88.90/cwt) - (7.50 cwt X $100.00/cwt) - (57.5 bu X $4.00/bu) EGM Aug = $ $ $ EGM Aug = $ Gross Margin Guarantee (GMG) for August GMG = EGM Deductible Deductible $0 to $150 per head at the insured s option Let s use a $0/head deductible GMG = $ $0 GMG = $ Gross Margin Guarantee (GMG) Expected Gross Margin, Yearling Finishing Operation, Nebraska January 31, Sales Closing This process is done for each month of the 11-month insurance period The sum of the target marketings times the EGM (less deductible) for each month is the Gross Margin Guarantee (GMG) Deductible is the same for each month Remember, can t have target marketings in the first month GMG is based on 10 months of marketings Expected Gross Margin ($/head) Mar Apr May Jun Jul Aug Sep Oct v Dec Month of 11-Month Insurance Period 22

23 February 15 to March 6, Gross Margin Guarantee (GMG) If you have 1 head of target marketings each month: GMG = $1, ($0 deductible) Premium = $ Gross Margin Guarantee (GMG) 138 Actual Gross Margin (AGM) 139 If you have 1 head of target marketings each month: GMG = $1, ($0 deductible) Premium = $ Yearling Finishing Operation AGM Aug = (12.50 cwt X Act Live Cattle Price Aug ) - (7.50 cwt X Act Feeder Cattle Price Mar ) - (57.5 bu X Act Corn Price Jun ) If total AGM falls below $1,837.50, an indemnity makes up the difference AGM is based on LGM s actual prices (not the actual prices producer receives or pays) Actual Live Cattle Price Actual August Live Cattle Price August CME LC Futures Price: $ $ $ day Ave $85.95 Expected LC Futures = $87.70 Nebraska August LC Basis (LGM) = $1.20 Actual August LC Price = $ $1.20 Actual August LC Price = $87.15/cwt Same 140 Actual Feeder Cattle Price Actual March Feeder Cattle Price March CME FC Futures Price: $ $ $ day Ave $ Expected FC Futures = $95.37 Nebraska March FC Basis (LGM) = $4.63 Actual March FC Price = $ $4.63 Actual March FC Price = $108.18/cwt Same

24 February 15 to March 6, Actual Corn Price Actual June Corn Price May CBOT Corn Futures Price: 5-9- $ $ $ day Ave $4.22 July CBOT Corn Futures Price: $ $ $ day Ave $ Actual Corn Price Actual June Corn Price (a weighted average) = (1/2 x Actual May Corn Futures Price) + (1/2 x Actual July Corn Futures Price) = (1/2 x $4.22/bu) + (1/2 x $4.35/bu) = $4.29/bu Same Expected Corn Futures = $4.18 Nebraska June Corn Basis (LGM) = -$0.18 Actual June Corn Price = $ (-$0.18) Actual June Corn Price = $4.11/bu 143 Actual Gross Margin (AGM) 144 Indemnity In August 145 Yearling Finishing Operation AGM Aug = (12.50 cwt X Act Live Cattle Price Aug ) - (7.50 cwt X Act Feeder Cattle Price Mar ) - (57.5 bu X Act Corn Price Jun ) AGM Aug = (12.50 cwt X $87.15/cwt) - (7.50 cwt X $108.18/cwt) - (57.5 bu X $4.11/bu) AGM Aug = $ $ $ AGM Aug = $41.70 Indemnity = GMG Aug AGM Aug (if positive) Indemnity = $ $41.70 > 0 Indemnity = $89.55 per head Important te Indemnity is actually figured for whole 11- month insurance period Indemnity = GMG total AGM This averages margins out over entire year 300 Expected & Simulated Actual Gross Margin, Yearling Finishing Operation, Nebraska January 31, Sales Closing 146 Indemnity? 147 Expected Gross Margin ($/head) Again, this example assumes one head of target marketings each month GMG = $1, AGM = $1, Indemnity = $15.81 (total, not per head) Mar Apr May Jun Jul Aug Sep Oct v Dec Month of 11-Month Insurance Period 24

25 February 15 to March 6, What Happens If Cattle Die? If less than 75% of total target marketings for the 11-month insurance period are sold, the indemnity is reduced by the percent actual marketings fall below target marketings If 75%+ are sold in the 11-month period, even in different months than specified under target marketings, indemnity remains the same 148 LGM for Cattle Insurance Period 12 monthly insurance periods per calendar year Can insure target marketings in any/all month (except first) and have multiple sales closing months Jan 31 Feb Mar Apr May Jun Jul Aug Sep Oct v Dec Feb 28 Mar Apr May Jun Jul Aug Sep Oct v Dec Mar 31 Apr May Jun Jul Aug Sep Oct v Dec Jan Jan 149 Feb There Is A Basis Issue 150 $600 LGM Actual Gross Margin and Nebraska Cash Actual Gross Margin, Yearling Operation, LGM indemnities determined based on futures prices and fixed basis Producers will realize a different basis for fed cattle, feeder cattle, and corn than the LGM basis (which is derived from 10-year historical NASS cash prices) Producers realized AGM is different than LGM s AGM LGM s margins don t account for differences in feed amounts and other costs LGM doesn t insure net feeding profits Actual Gross Margin/Head LGM AGM NE Cash AGM $500 $400 $300 $200 $100 $0 Dec-94 Dec-95 Dec-96 Dec-97 Dec-98 Dec-99 Dec-00 Dec-01 Dec-02 Dec-03 Dec-04 Dec-05 Dec-06 Source: University of Nebraska-Lincoln $250 LGM Basis Difference Between LGM Actual Gross Margin and Nebraska Cash Actual Gross Margin, Yearling Operation, $600 LGM Actual Gross Margin and Nebraska Cash Actual Gross Margin, Calf Finishing Operation, LGM AGM 153 NE Cash AGM $200 $500 Actual Gross Margin/Head $150 $100 $50 $0 Actual Gross Margin ($/Head) $400 $300 $200 $100 -$50 -$100 Dec-94 Dec-95 Dec-96 Dec-97 Dec-98 Dec-99 Dec-00 Dec-01 Dec-02 Dec-03 Dec-04 Dec-05 Dec-06 Source: University of Nebraska-Lincoln $0 Dec-94 Dec-95 Dec-96 Dec-97 Dec-98 Dec-99 Dec-00 Dec-01 Dec-02 Dec-03 Dec-04 Dec-05 Dec-06 Source: University of Nebraska-Lincoln 25

26 Actual Gross Margin/Head $200 $150 $100 $50 $0 -$50 -$100 Livestock Insurance Alternatives For Risk Management February 15 to March 6, LGM Basis Difference Between LGM Actual Gross Margin and Nebraska Cash Actual Gross Margin, Calf Finishing Operation, Dec-94 Dec-95 Dec-96 Dec-97 Dec-98 Dec-99 Dec-00 Dec-01 Dec-02 Dec-03 Dec-04 Dec-05 Dec-06 Source: University of Nebraska-Lincoln 154 LGM Benefits for Producers Convenience Producers can sign up 12 times per year and insure all of the cattle they expect to market over a rolling 11- month insurance period Do not have to decide on the mix of options to purchase, the strike price of the options, or the date of entry into various option contracts Customization Can be tailored to any size farm Partial basis risk coverage 155 LGM Disadvantages Does not insure against: Unexpected changes in basis Death loss Other production loss Other costs Energy?? Futures Options LRP LGM Futures Options LRP LGM Protect Downside Price Risk? Can Hedge Be Lifted Early? Prevent Upside Price Potential? Basis Risk Protection? Brokerage Account Needed? Hedge Sale Prices? Hedge Purchase Prices? Some Some In the Margin In the Margin Have To Own The Livestock? Contract Sizes? Insurable Limits? Availability? Price/Premium Slippage? Can Margin Be Hedged? Fixed Regular Market Hours Possible Requires Multiple Positions Fixed Regular Market Hours Possible Requires Multiple Positions Variable 5 pm - 9 am, Tues-Sat Only In Tandem With Futures/Options Variable Last Day of Month 26

27 February 15 to March 6, Can I Buy LRP and LGM Insurance During the Same Crop Year? If it is NOT on the same cattle at the same time If it is on the same cattle at the same time A producer could have feeder cattle LRP, and once the SCE expires and it is cancelled with the insurance company, producer could then purchase LGM insurance 160 Price // Futures Based Price Forecast, Nebraska Direct Steers 3-Year Avg. Basis Most Pos. Basis Most Neg. Basis Feb- Mar- Apr- May- Jun- Jul- Aug- Sep- Oct- v- Dec- Jan-08 Source: UNL Month // Futures Based Price Forecasts Nebraska lb. Med. & Large Feeder Steers // Futures Based Price Forecasts Nebraska lb. Med. & Large Feeder Steers Price Year Avg. Basis Most Neg. Basis Most Pos. Basis Price Year Avg. Basis Most Neg. Basis Most Pos. Basis Mar Source: UNL Apr May Jun Jul Aug Sep Oct v Dec Jan Mar Source: UNL Apr May Jun Jul Aug Sep Oct v Dec Jan 08 Price ($/bu) Mar 2// Futures-Based Price Forecasts Nebraska State Average Corn Price Apr Source: UNL Avg Basis Most Neg Basis Most Pos Basis May Jun Jul Aug Sep Oct v Dec Jan 08 Feb Feeding Yearling Steers Feb 7, At $3.75/bu Corn 750 lb $100/cwt $ lb gain $71.34/cwt $357 Total Cost $1,1 Break-even $1,1 1,250= $88.54 Feb 7, At $4.00/bu Corn 750 lb $100/cwt $ lb gain $73.84/cwt $369 Total Cost $1,119 Break-even $1,119 1,250= $

28 February 15 to March 6, Feeding Steer Calves Feb 7, At $3.75/bu Corn 550 lb $120/cwt $ lb gain $70.67/cwt $459 Total Cost $1,119 Break-even $1,119 1,200= $93.28 Feb 7, At $4.00/bu Corn 550 lb $100/cwt $ lb gain $73.84/cwt $476 Total Cost $1,136 Break-even $1,136 1,200= $ Can You Hedge The Cattle You Fed? Yearling Steers In- 2/7/ Breakeven $ Out- 7/6/ Steer Calves In- 2/7/ Breakeven $ Out- 9/4/ 167 What Should You Do? 168 More Information On Livestock Insurance Calculate breakeven cost of production 2. Determine what prices are risky to you 3. Identify which tools can protect against those risks 4. Evaluate how much of the risk can be offset by the tool(s) you select 5. Decide whether you need protection & implement hedge if you do 28