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February 13, 2006
FEFO 06-02

EXPECTED YIELD INCREASES AND CHOICE BETWEEN GROUP AND FARM CROP INSURANCE

The Risk Management Agency (RMA) increased the expected yields used to calculate guarantees for Group Risk Plan (GRP) and Group Risk Income Plan (GRIP), group insurance products that base payments on county yields. Increases in expected yields from 2005 to 2006 averaged 7.6 bu. for corn and 1.6 bu. for soybeans across all Illinois counties. Higher expected yields result in higher guarantees. Higher guarantees then increase chances of receiving insurance payments and increase the amount of payments when they occur. Thus, expected yield increases make group products more attractive and may cause some farmers to switch to group products from farm products such as Actual Production History (APH), Crop Revenue Coverage (CRC), Income Protection (IP), and Revenue Assurance (RA).

Expected Yields and Group Product Guarantees

GRP is a yield insurance whose guarantee equals the expected yield times the coverage level. An expected yield of 171.5 bu. and a coverage level of 90% results in a yield guarantee of 154.4 bu. (171.5 x .90). Payments occur when county yield, as determined by the National Agricultural Statistical Service (NASS), is less than 154.4 bu.

GRIP is revenue insurance that has two options: GRIP without the harvest revenue option (GRIP-NoHR) and GRIP with the harvest revenue option (GRIP-HR). GRIP-NoHRís revenue guarantee equals the expected price times the expected yield times the coverage level. The expected price is the average of settlement prices of Chicago Board of Trade (CBOT) contracts during the month of February (December contract for corn and November contract for soybeans). Given an expected price of $2.40, an expected yield of 171.5, and a coverage level of 90%, the guarantee equals $370 ($2.40 x 171.5 x .9).

GRIP-NoHR makes payments when the actual county yield times the harvest price is below the revenue guarantee. For corn, the harvest price is the average of settlement prices during the month of October of the December CBOT contract. The harvest price is limited to a $1.50 move from the expected price (the harvest price can not be less than $1.50 plus the expected price or greater than $1.50 plus the expected price). For soybeans, the harvest price is the average of settlement price during October for the November contract. The harvest price is limited to a $3.00 move from the expected price for soybeans.

GRIP-HRís revenue guarantee differs from GRIP-NoHR in that the higher of the expected price or the harvest price is used in calculating the guarantee. GRIP-HRís guarantee will always be at least as high as GRIP-NoHRís guarantee. Hence, payments from GRIP-HR will be at least as great as from GRIPNoHR, given that similar coverage and protection levels are chosen.

Expected Yield Increases

To put expected yield increases in perspective, county corn yields for McLean County, Illinois are shown in Figure 1. Actual county yields as determined by NASS are shown for 1972 through 2004. The 2005 yield has not been released as of the writing of this paper. The 2005 yield was estimated based on yields reported for the Central Crop Reporting District.

Also shown in Figure 1 are expected yields used in the calculating group product guarantees. These expected yields are RMAís estimate of the ďmost-likelyĒ yield in a county. If a year could be repeated a number of times, the average of the repeated years would equal the most-likely yield. In 2006, the expected county yield is 171.5 bu. for McLean County. If 2006 could be repeated ten times, the average of the ten years would be close to 171.5 bu. if RMA is correct in its estimate of the expected yield.

GRP became available in 1995 and had an expected yield of 136.9 in that year. Expected yields gradually increased up until 2005 when the expected yield was 159.1 bu. Between 2005 and 2006, the expected yield had a substantial increase of 12.4 bu. up to 171.5 bu. Note that the 171.5 expected yield is higher than all county yields except two: the 2003 and 2004 yields.

The substantial increase occurred because RMA appears to place large weights on yields of recent years. When the 2006 expected yield was calculated by RMA, yields up to 2004 were available. The 2003 yield of 182 bu. and the 2004 yields of 185 bu. were substantially higher than any other previous yield (see Figure 1). These recent high yields caused the expected yield to increase.

Corn yields have been increasing at a faster pace since 1995 than prior to 1995. For McLean County, the average yearly increase in corn yields was 3.3 bu. between 1995 through 2005 compared to 1.8 bu. between 1973 through1995. There is some argument whether these increases are due to improved genetics and the introduction of genetically modified hybrids or whether the increases are simply due to favorable weather. If due to favorable weather, the expected yields may overstate most-likely yields.

APH Yields of Farm Products

Expected yield calculations stand in contrast to the way in which APH yields are calculated. The APH yield is used to set guarantees on farm products (APH, CRC, IP, and RA) and is based on a yield history from a farm or a unit. The yield history can be based on a minimum of four yields up to a maximum of eleven consecutive yields. Due to yield variability, a farmís APH yield can be substantially different from the most-likely yield. In some cases APH yields will be higher than expected yields and vice versa. While the relationship may vary on individual farms, calculating the APH yield based on a yield history will result in the average APH yield being below the most-likely yield in an environment of increasing yields.

To gain a feel for the downward bias, average yields for the last five years (2001 through 2005) and last ten years (1996 through 2005) were calculated for McLean County. These would be the APH yields for a farm that had the same yields as the county and had yields based on five-years of yields and ten-years of yields, respectively. Overall, one would expect these averages to be close to the average of APH yields in McLean County. The five-year average yield for McLean County was 165 bu., 6.5 bushels below the 2006 expected yield. This suggests that, on average, farms with APH yields based on 4 to 6 years of yields will have APH yields about 6.5 bu. below most-likely yields. The ten-year average yield was 155.6 bu., 15.9 bu. below the 2006 expected yield. This suggest that, on average, farms with APH yields based on between 9 and 11 years of data will have APH yields about 15.9 bu. below most-likely yields.

Relationships between expected and average yields for McLean County are not unique. Across all Illinois counties, the 2006 expected yield for corn is 2.6 bu. higher than the five-year average yield (see Table 1). The 2006 expected yields averaged 14.7 bu. higher than the ten-year average yields across all Illinois counties.

Choice of Group or Farm Product

Having APH yields substantially below most-likely yields greatly reduces the chances of receiving payments from insurance products. This reduces risk reductions offered by crop insurance. Hence, farmers may wish to compare their APH yields to what they would consider most-likely yields. If APH yields are below most-likely yields, group products become more attractive compared to farm products. Conversely, farm products will be more attractive than group products when APH yields are above mostlikely yields.

The comparison of most-likely to APH yields should be only one consideration in the crop insurance choice decision. Another should be the financial position of the farm. Farms in vulnerable financial position will find farm products more attractive because farm products use farm yields in calculating insurance payments. Another criterion should be how well farm yields track county yields. Farms who have yields that closely track the county will find group products more attractive.

Summary

The increase in 2006 expected yields increases the attractiveness of group products. Farmers may want to compare there APH yield to the most-likely yield. Group products become more attractive as the APH yield declines relative to the expected yield.

Increases in expected yields may be a short lived phenomenon. Expected yields can decrease if county yields are below average in future years.

Issued by: Gary Schnitkey, Department of Agricultural and Consumer Economics

 


  

Department of Agricultural and Consumer Economics    College of Agricultural, Consumer and Environmental Sciences
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