Pork producers are faced with an unfriendly financial future. Slaughter is at record levels. Production does not seem to be declining. But pork prices are declining and profits have disappeared for most producers. Will pork prices continue to decline and if so, how do you manage that risk? Is this a time for Livestock Risk Protection insurance?

Extension economist George Patrick and two colleagues at Purdue have finished an evaluation of the Livestock Rick Protection (LRP) for hogs which has been on the market for nearly 5 years. He is quick to say that is an insufficient time for an insurance product to prove itself, however producers are using it to manage their price risk. Their evaluation was based on the net cost of the insurance, which is the premium minus the indemnities paid.

LRP only insures against the decline in the lean carcass price of the hogs below an established level of coverage, similar to a crop insurance policy. The producer would select a coverage level, and an endorsement length, which is the time from the purchase to the time the hogs are sold, and those come in choices of 13, 17, 21, and 26 weeks. That allows coverage of both feeder pigs and finished hogs. The carcass weight is assumed to range from 150 to 225 lbs, and is determined by computing 74% of the live weight. Coverage ranges from 70% to 95% of the contract value. There are numerous other details which a crop insurance agent can provide, or can be obtained from the USDA’s Risk Management Agency website for LRP. Coverage prices, rates, and ending values are provided by USDA here.

Values for the insurance are based on The Chicago Mercantile Exchange contract for lean hog futures, and producers who utilize the futures market for pricing will be familiar with the pricing mechanism for the insurance policy. The actual prices are reported by USDA’s Agriculture Marketing Service and those prices are used by the CME for settlement. So how do you know if you are eligible for an indemnity payment? Patrick says, “If the actual end value on the end date of the insurance contract is less than the coverage price selected, the producer may be paid an indemnity for the difference between the coverage level price and actual end value.”

Your cost of the insurance coverage varies with the length of the coverage, and since there is more price uncertainty over a longer period of time, then longer coverage is more expensive. The cost is also determined by level of coverage, just like crop insurance. The Purdue economists evaluated the LRP-Swine during 2007 and found that indemnities were paid just over 20% of the time and were under $1. The cost for the highest level of protection was $1.66 for a 250 lb. hog, but ranged from 1% to 2.6% of production values.

Does that amount of price risk protection satisfy your needs? That depends on the producer, and for some it will and for others it will not. Economist George Patrick says for the risk neutral producers who forego the LRP insurance, they “are likely to have a higher average return with greater downside variability.”

Summary:
High production costs and low market prices face hog producers over the coming year with the result of operational red ink. To protect against hog prices falling further, USDA offers Livestock Risk Protection insurance, which indemnifies a producer from market prices falling during a set period of insurance coverage. Once a coverage level and period are set and the insurance is purchased, producers who are risk averse can protect their price, but at the cost of the policy. Producers without the insurance could have higher profitability, but face greater downside variability in prices.