As Cornbelt farmers head into 2007 with their risk management program in place (crop insurance, marketing plan, etc.), something may seem a bit unsettling. Crop insurance, at least the revenue kind, is based on expected production and the expected market, which is based on domestic and foreign demand. But the USDA-funded crop insurance program and prices have a common bond with the World Trade Organization. And the WTO is trying to dismantle the US farm subsidy program, which includes crop insurance, and a variety of other farm program benefits. Suddenly, it appears to be a house of cards which is about to collapse around the hundreds of thousands of dollars of inputs about to be buried out in the field. Is this a nightmare or is it reality? Wake up and …

USDA’s recent Outlook Forum explored risk management and trade issues and Mississippi State University agricultural economist Keith Coble says it is clear that US cotton subsidies could not withstand challenges with the World Trade Organization, and its effort to decouple farm supports and make the US farmer more responsive to the market runs counter to current risk management practices, such as the use of federal crop insurance. And Coble’s concerns about the future of farm programs are amplified by his beliefs that current high prices will not last, and that is something that will aggravate the writing of a new farm policy.

In brief, Coble believes the ultimate outcome of the 2007 Farm Bill to be WTO compliant will feature one of two alternatives, “Essentially the two best bets for WTO compliance appear to be either the current direct payment program with the fruit and vegetable restriction eliminated, or some type of whole-farm revenue guarantee with a 70 percent trigger that would subsume all enterprises, including crop and livestock revenue.” The latter is a low level of financial protection, closer to 65% MPCI insurance than today’s versions of CRC, RA, and GRIP that have much higher financial guarantees.

Coble says with the trend toward revenue insurance, as opposed to insuring price and yield separately, it is important to note the homogeneous relationship with major commodities and their price variability of the past 30 years. In essence there is very little difference from one commodity to another; and from one region to another, “Likewise, because of spatial arbitrage, the price variability for soybeans in Mississippi and the price variability for soybeans in central Illinois are quite similar. Therefore, the current as well as previous sets of commodity programs protect against price risks that are remarkably similar on a per unit basis across commodities.” However, yield risk is much different, and the variability may be 4-5 time greater in one region than another. But since revenue risk is determined 80% by yield, then the revenue guarantees of Farm Bill proposals are more difficult to reconcile.

However, Coble reminds you that once programs are computed on a national scale, the yield or revenue variability diminishes considerably. But on a farm level the variability is increased and yield variability is nearly as large as the revenue variability for the primary crops. Cornbelt corn and soybean producers are more likely to understand the benefits of a revenue-trigger for farm programs than other farmers, because of the correlation between yields and price for corn and soybeans. But the same strong inverse relationship for corn yield and price and bean yield and price does not always exist with other government supported commodities. For cotton, the revenue variability is driven by region. Coble says, “However, the relative magnitudes of revenue risk are greater in other regions and for other commodities. This suggests revenue triggered programs might shift benefits away from the Midwest corn and soybean producers. This will be particularly true if the revenue trigger is based on state, crop reporting district, or county revenue measures. As a result there appear to be significant trade-offs between the magnitude of payments and correlation of payments with producer risk.”

Coble says it is a terribly complex task to manage LDPs, Counter-cyclical Payments, crop insurance, and forward pricing strategies all at the same time. But he says it can be done with success, “Producers, if they choose to consistently adjust their forward pricing strategies in recognition of the commodity programs and crop insurance programs available to them, can create a portfolio of risk management tools that in many instances will provide quite effective risk management coverage.”

Coble believes that the best program for USDA is to help insure yield risk, because that is the least likely option to be available from the private sector for a reasonable price. With higher prices, there will be less government outlay for commodity supports, and more need for crop revenue insurance guarantees. Giving support to improvements in the actuarial foundation of the program, Coble says that helps justify the program and its reinsurance agreement with the private companies that write policies. Not being an advocate of ad hoc disaster programs because of their redundancy, Coble says risk management programs should be carefully written because of their potential to trigger trade complaints and put USDA spending over budget.

Summary:
In a time of budget deficits and trade complaints, the risk management program of the new Farm Bill needs to be carefully constructed, something difficult to do given the different price and yield characteristics of primary commodities. While revenue for corn and soybeans is a function of the inverse relationships of price and yield, such is not always the same for other commodities. And while national averages may have small annual variation, farm-level statistics can have significant variation. Ag economist Keith Coble of Mississippi State says his suggestion would be to keep government risk management programs tied to yield protection, for which the private sector is the least likely to provide economical programs. The balance of risk management can be managed with forward pricing alternatives.