Question on Crop Revenue Insurance and Forward Sales
I've never seen this extreme and hope I never do, but can't help but wonder and make sure I understand all the potential ramifications of marketing moves I either am making right now or would like to make for the 2011 corn crop.
What happens in this worst-case scenario:
I have 80% Revenue Insurance with Harvest Price Option this year on corn.
Let's say we get a total wipeout this year on my corn crop from a massive drought, greensnap, or you name the disaster.
(At this point, that looks far-fetched, but there's always the unknown. Just look at the wind storms that hit central Iowa earlier tis week. I remember well the one quote I read where a guy said something like "we thought we were going to have it all this year, great crop, great prices, and then it was all gone in a half-hour.)
Let's say I forward-priced production up to my 80% level for this fall into next spring at with cash forward contracts at cash prices that were significantly above the insurance price set last winter. (Prices like we're seeing right now.) Let's say we get to at least $1 above the insurance price.
Let's say then that the disaster is not widespread, which is more likely with wind damage than drought and the market tanks enough during the fall harvest re-pricing period that the spring price remains the high.
I'm going to have to buy corn then to fill my contracts right? Depending on when you buy the corn to fill the contract, you may pay more or less than the insurance guarantee right?
My question is then this: I hear a lot of talk about using your insurance guarantee as protection to make forward sales against, However, this can somewhat backfire can't it in this scenario if you're using strictly cash forward contracts? Is it really better then to be pricing even these "insurance bushels" with futures or options to allow some more flexibility?
Re: Question on Crop Revenue Insurance and Forward Sales
In my opinion, futures and options allow more flexibility than straight cash contracts, but for many, including myself, cash contracts are simpler and don't carry margin risk like a futures position.
Two things to watch out for in relying on your insurance guarantee: The first is basis. Insurance does not account for swings in basis. For instance, when you have to buy your contract out because your crop gets hailed out, your insurance will cover an increase in harvest future prices, but not a narrow harvest basis.
The second thing to watch out for is the harvest price increase is limited to 150% of the Feb. guarantee. Thus, that $6 guarantee will only cover you to $9 in the fall. If we have a national crop failure like 1993 or 1988, who says we can't see $12 corn. Then, if you also have a crop failure on your own farm and you contracted for $7, insurance would guarantee you $9 and you would pay $5 to get out of your contract. So that $7 contract just became a $4 per bushel net. The solution as I see it would be to buy a call to protect against this unlikely scenario. It would be really cheap insurance.