With on-again, off-again import and export trade agreements and quickly changing domestic consumer beef demand characterizing the past couple of years, it seems that cattle prices have become more volatile. And the data supports it. The coefficient of variation (a “unitless” measure of risk created by dividing standard deviation by the average) for fed-cattle futures increased from 8.11 percent during 1990-2000 to 11.77 percent during 2001-05. Similarly, feeder-cattle futures saw an increase in its coefficient of variation from 11.53 percent to 14 percent during this period.

This increasing variability exposes cattle producers to more price risk. Thus, using risk management tools to protect against adverse price moves is becoming increasingly important. Seemingly confirming this, we saw a $20 per hundredweight drop in Nebraska dressed-steer prices this year alone, from January to June.

LRP: like puts

USDA’s Risk Management Agency began offering a new livestock insurance policy called Livestock Risk Protection Insurance (LRP) in 2002. While LRP offers its own unique advantages and limitations, it basically provides protection against declines in selling prices for fed cattle and feeder cattle while allowing producers to participate in price increases. LRP works similarly to hedging with put options. However, there is no minimum number of cattle to insure with an LRP policy and no futures/options trading to do. Thus, LRP can be a good hedging tool for producers with smaller herds and diversified operations. More information about LRP, including a self-study guide and video tutorials, is available at www.lrp.unl.edu.

In 2004 and 2005, University of Nebraska-Lincoln Extension partnered with Nebraska Cattlemen, Nebraska Pork Producers and Nebraska Farm Bureau to offer educational seminars and materials and conduct research on the use of LRP in Nebraska. In addition to more than 20 workshops conducted throughout the state for livestock producers and insurance agents, a number of distance education materials were produced and distributed via the aforementioned Web site.

After making these educational materials available for LRP, it’s interesting to examine whether use of this new management tool increased. Perhaps more important is whether producers are using new insurance products like LRP in light of USDA-RMA initiating additional new insurance products in Nebraska and the beginning of the rebuilding phase of the cattle cycle that will eventually lower prices.

Nebraska: major LRP buyer

Figures 1 and 2 show the number of fed-cattle and feeder-cattle LRP policies that were bought in Nebraska and the U.S. from 2003 through June 2006 on an insurance-year basis (July 1 through June 30). In 2004 and 2005, the number of fed-cattle policies sold nationally was fairly constant at about 215, but sales in 2006 dropped to 163 policies. However, the number of fed cattle insured with LRP in 2006 was 12 percent higher than in 2005, at 28,725 head. Nationally, 151,519 fed cattle have been insured with LRP since it was first offered.

Sales of LRP in its first two years were heavily weighted toward Nebraska, accounting for 70 to 80 percent of total U.S. cattle insured, because Nebraska was one of only three eligible states for fed-cattle LRP. Even as fed-cattle LRP was expanded to an additional 16 states in 2005 and 2006, Nebraska accounted for about one-quarter of fed-cattle LRP policies sold and nearly one-third of cattle insured. Since inception of fed-cattle LRP, Nebraska has accounted for 38 percent of all policies sold and 56 percent of fed cattle insured.

Figure 2 illustrates that feeder-cattle LRP use may be growing more quickly. Nationally, feeder-cattle LRP sales reached 1,262 policies in 2006, up 15 percent from last year. Nebraska was one of 10 states that had feeder-cattle LRP available in the first two years, and accounted for just under 10 percent of LRP policies sold in those years. In 2005 and 2006, Nebraska sold 16 percent and 17 percent, respectively, of all feeder-cattle LRP policies, even as an additional nine states began selling feeder-cattle policies. Since the beginning of the program, Nebraska has insured 39,241 feeder cattle with LRP, 12 percent of the total insured nationally.

Guard against the big drops

As producers, most of us want to know, “Does LRP pay off?”  The answer is “yes,” but only in the event of relatively large price decreases. The design of LRP is to protect against catastrophic price decreases, not smaller $1 to $2 per hundredweight declines. When insuring an expected ending value, producers select a deductible ranging from 5 to 30 percent. Essentially, the first 5 to 30 percent of a price drop is borne by the producer. Further decreases are covered by LRP.

Thus far, through June, $905,968 in indemnities have been paid to producers insuring feeder cattle and another $460,151 for fed cattle. Small indemnities for feeder cattle were paid in 2004, while the largest indemnities were paid in 2006. Nebraska feeder-cattle producers collected about 8 percent of the total indemnities paid nationally. LRP indemnities on fed cattle were also paid in 2004 and 2006, with about 80 percent and 26 percent going to Nebraska in those years.

Indemnities were paid out in 2004 on both fed cattle and feeder cattle because of the sudden price decline following the December 2003 case of BSE in Washington. The fed-cattle price decline of 2006 has prompted the payment of fed-cattle indemnities this year.

Is LRP a good alternative for managing risks in the upcoming years?  Yes. Will LRP pay indemnities in the next year or two?  I hope not, because it means prices dropped. As mentioned earlier, LRP protects against large price decreases, the type of drop that could be associated with the loss of all our export customers (as was the case in December 2003) or a highly communicable animal disease outbreak in the U.S. that would suddenly decrease prices. Hopefully, those types of events won’t happen. However, the 13-percent decrease sustained in fed-cattle prices in the first half of this year might translate into indemnities paid on policies purchased at the beginning of the year.

By Dr. Darrell Mark, UNL  Extension livestock marketing specialist.