Crop insurance proved to be a lifesaver for farmers in 2012; and, according to one Purdue expert, it is a good bet for managing risk in 2013. There are many tools farmers can use to manage risk and protect against uncertainty. According to Dr. Chris Hurt, ag economist at Purdue, the best ones are those that protect you on the down side while letting you take advantage of the upside, “The key to risk management is to protect against the potential bad outcomes, but still leave opportunities to capitalize on potential good outcomes.” Hurt says crop insurance in a tool that will do both, “Sometimes growers are hesitant to sign up because the premiums have to be paid regardless of whether coverage is used. But I think a lot more people understand the value after the drought this year. If not for crop insurance, it would be depression in many farming communities right now.”
Forward-contracting is another tool, but Hurt says this only protects you against price drops and takes away your chance of cashing in if prices go higher, “Growers should forward-contract only a portion so that, if prices go up, they still have money to gain. It’s common to forward-contract 25-30 percent of expected production for new crop delivery.” Farmers who do forward-contract can also consider purchasing an out-of-the-money call option against their forward contracts. The option allows the opportunity for farmers to gain revenue if prices go up after contracts are made. An example Hurt gave is that of a farmer who opts to sell corn for $6 per bushel in a forward-contract. By purchasing a call option on futures at $7.50 per bushel, the farmer could add $2.50 a bushel to the $6 if corn prices ended up moving to $10 because of drought. “The call option costs some money but provides upside opportunity in case prices move sharply to the up side,” he said.
While we do not have a new government farm program for 2013 yet, Hurt thinks that, when a Farm Bill is adopted, it will contain a safety net program that will not make direct payments to growers but will provide an additional level of protection under crop insurance coverage. For example, if a farmer elected a crop insurance coverage level of 70 percent and the federal government offered an additional 8-10 percent, farm finances would be protected at 78-80 percent. “The foundation of risk management in 2013 would still be crop insurance,” Hurt said. “But this could add another modest layer of protection and build a little more confidence.”
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