Using crop insurance to guarantee debt obligation coverage is one of many ways insurance can be used as a risk management tool. Additionally, adequate crop insurance will often be a lender requirement on operating loans. Operating loans are typically revolving lines of credit that assist in covering pre-harvest expenses (e.g., seed cost, fertilizer, fuel, etc.). Table 1 below contains example revenue and pre-harvest expenses that might be incurred by a soybean and cotton producer in the southern region. Assume an example soybean producer in Crittenden County, Arkansas and a cotton producer in Lubbock County, Texas, where the farm-level soybean and cotton Actual Production History (APH) yields are equal to the state average of 50 bushels per acre and 1,196 pounds per acre, respectively. Furthermore, we assume the Projected Price for the 2024 growing season to be $12.60 per bushel for soybeans and $0.87 per pound for cotton.
Table 1. Simplified Sample Budget for a Southern Soybean and Cotton Producer
|APH Yield||Per Acre||50||1,196|
|Projected Price (USDA-RMA)||$12.60/bu||$0.87/lb|
|Expected Revenue (446 Acres)||$280,980.00||$464,072.00|
|Expected Pre-Harvest Expenses (446 Acres)||$144,058.00||$247,084.00|
Consider a producer who finances an operating loan to cover their pre-harvest expenses (e.g., $145,000 based on a 446-acre soybean operation). Additionally, they elect to use Revenue Protection (RP) crop insurance to guarantee a level of revenue. For example, at a coverage level of 50%, a soybean producer would be guaranteed $140,490 based on an expected revenue of $280,980 ($280,980 * 0.50 = $140,490). The question becomes, at what level will the RP guarantee cover the entire operating loan obligation in the case of a complete loss? Additionally, we consider a producer taking Catastrophic Risk Protection Endorsement (CAT) coverage that triggers in the event of a yield loss of 50% or more. CAT coverage provides producers with low-cost coverage on 50% of APH yield and 55% of the RMA projected price (Biram and Coble, 2023). We assume total yield loss (e.g., 0 bushels per acre). Tables 2 and 3 below highlight realized returns to a soybean and cotton producer net of their operating loan obligation. Returns are compared over an interest rate range of 5% to 10% (.5% increments), and RP elected coverage levels from 50% to 65% (5% increments).
Table 2. Returns Above $145,000 Operating Loan (Soybean)
Table 3. Returns Above $250,000 Operating Loan (Cotton)
If the dollar value within Tables 2 and 3 is positive, then operating loan debt is covered with additional funds to pay other obligations. If the amount is negative, a producer would be unable to re-pay their entire operating loan only using RP or CAT indemnities. It’s important to note that pre-harvest expenses are only an estimate. We assume an annual interest rate with the producer paying the operating loan in one lump-sum at the end of harvest; that is, if the annual interest rate is 5% and payment is made at the end of harvest (assuming 9 months) with an operating loan of $145,000, the final payment will be $150,529 (principal plus $5,529 accrued interest).
Crop type plays an important role in this decision since positive cash flow is heavily dependent on coverage levels and operating loan interest rates for a specific crop. Also, under no circumstance does CAT coverage ensure either producer can cover their operating loan debt at the representative loan, farm size, and crop type. Tables 2 and 3 show that operating debt coverage based on a 50% RP coverage level will be negative regardless of crop type. Increasing coverage to 60% would mean a soybean producer could guarantee covering their operating loan, while a cotton producer needs at least 65% coverage to guarantee operating debt repayment in the event of a catastrophic loss.
Biram, H.D. & Coble, K. H. (2023). A Brief History of Crop Insurance. University of Arkansas System Division of Agriculture, Cooperative Extension Service Fact Sheet No. FSA70. (Link)
USDA-NASS. (2023, February). Farms and Land in Farms 2022 Summary. Retrieved October 12, 2023, from https://downloads.usda.library.cornell.edu/usda-esmis/files/5712m6524/bk129p580/2z10z2698/fnlo0223.pdf.
USDA-NASS. (2023, January 12). Arkansas Crop Production. Retrieved October 12, 2023, from https://www.nass.usda.gov/Statistics_by_State/Arkansas/Publications/Crop_Releases/Annual_Summary/2022/arannsum22.pdf.
USDA-RMA. (2023, October 1). RMA Price Discovery. Retrieved October 12, 2023, from https://prodwebnlb.rma.usda.gov/apps/PriceDiscovery/Reports/CurrentPeriods.
Loy, Ryan, and Hunter Biram. “Crop Insurance as a Safety Net for Operating Loan Obligations.“ Southern Ag Today 3(43.3). October 25, 2023. Permalink