Disclaimer: This web page is designed to aid farmers with their marketing and risk management decisions. The risk of loss in trading futures, options, forward contracts, and hedge-to-arrive can be substantial and no warranty is given or implied by the author or any other party. Each farmer must consider whether such marketing strategies are appropriate for his or her situation. This web page does not represent the views of Kansas State University. 

Is GRIP/GRP A Good Buy For My Farm (Update 3/8/2006)?[1]

Group Risk Income Protection (GRIP) and Group Risk Plan (GRP) for additional crops and Kansas counties were approved for the 2006 crop year.  GRIP is a “put option” on expected county revenue and GRP is a “put option” on expected county yield.  Similar to Chicago Board of Trade put options on futures, growers retain the basis risk in GRIP/GRP.  All of the basis risk in GRP and most of the basis risk in GRIP is generated from yield risk.  If growers suffer a 50% yield loss but their county only suffers a 10% yield loss then their GRIP/GRP contract will under compensate growers for their loss and growers retain this basis risk.  The worse case scenario is growers could have a total crop loss and receive no payment.  For example, in the drought year of 1988 GRIP without the Harvest Revenue Option would have made no indemnity payment in Clay County, Indiana on corn (see county results below).  It is also possible for growers to suffer no loss but receive a payment. 

In order for growers to transfer risk it will require growers to have yields that are highly correlated with county yields.  If a grower farmed the whole county then the farm yield and county yield are the same and correlation is a perfect fit.  Therefore “large” farms that are spread out across the county will likely have a higher correlation between farm yield and county yield causing better risk transfer under GRIP/GRP then will “small” farms.

So why would any one select GRIP/GRP and accept the basis risk?  In Kansas there are some locations that have had multiple year droughts.  This has caused growers’ APHs to decline and increased their premium rates to the point the coverage being offer at the higher premium costs no longer makes sense.  Because the subsidies are over 50% of premium, there are very few cases where no insurance will be the better alternative over the long run.  If growers are considering dropping their coverage under MPCI-APH, RA or CRC, then they should at least look at the coverage offered under GRIP/GRP. 

If growers make the change to GRIP/GRP it strongly suggested they maintain their yield records so they maintain the alternative to switch back to an APH based product in future years.  Also growers insured under GRIP/GRP need to recognize they will have no effective hail coverage or protection from any other spot loss such as prevented planting or quality loss adjustment.  Spot losses are effectively excluded because it will require wide spread damage across the whole county to trigger payments based on county yields with no adjustment for quality. 

Because county yields vary less than farm yields it is recommended that growers buy a lower deductible.  The optimal coverage level for most growers is 90% and nothing less than 85% under GRP/GRIP.  In the higher risk growing areas, GRP will often out perform GRIP.  Growers that have a normal APH will discover they will not save a lot of premium by switching to GRIP/GRP. 

Growers that are using their RA-HPO and CRC coverage to maintain a hedge position with pre-harvest crop sales will likely not find GRIP/GRP to their advantage.  Also many ag lenders may not be willing to finance margin calls if the marketing plan is backed with GRIP/GRP.  Remember even under a forward contract all margin losses are effectively covered by growers at delivery time either with bushels or cash cancellation penalties. 

Currently the Kansas City wheat market has increased by more than a $1 above the RA-HPO price election.  RA-HPO insured growers have forward priced wheat for July delivery knowing they will either have the bushels or enough indemnity dollars to replace the lost bushels at current market prices.  The CRC contract has a $2 limit on price increases.  To have nearly the same coverage as RA-HPO, CRC insured growers will need to buy calls with a $5.50 strike.  RA or MPCI-APH insured growers can not get similar coverage to CRC/RA-HPO because the market has already moved a dollar higher.  Their only alternative on wheat at this point is to buy at the money calls and the dollar is already lost if bushels must be replaced. 

Growers who are forward pricing 2007 wheat and want to maintain their hedge can buy RA-HPO on the 2007 crop this fall.  In fact wheat growers could increase their 2007 wheat coverage up to 85% RA-HPO coverage in the fall if they forward sell a large amount of 2007 wheat production.  I make no recommendation on 2007 wheat sales but I have been told by some wheat growers they have started pricing 2007 wheat production.  Growers may also want to check on Dr. Mike Woolverton’s wheat market outlook paper posted on AgManager.info.

Misrated APH products?  The other reason growers may switch to GRIP/GRP is because they believe the APH based products are overrated.  In Kansas with a 15 year 20 cent underwriting loss it is hard to argue many growers are overrated.  However, in some Corn Belt counties growers have generated a 50 cent underwriting gain.  Over the past 15 years Iowa and Illinois farmers have paid more in premiums than they have collected in indemnity payments meaning they have collected none of the subsidy.  Those underwriting gains have covered underwriting losses in the Great Plains.  While few farmer paid premiums covered any of the Great Plains’ underwriting losses their tax dollars did cover those losses.   

Many of those Corn Belt farmers don’t think that is “fair” and have shifted from APH based products to GRIP.  If we assume the GRIP is rated correctly then those farmers will expect to pay 50 cents in premiums and receive a dollar in indemnity payments.  It appears in some counties GRIP/GRP may even generate underwriting losses.  If true and enough Corn Belt farmers switch then there are no underwriting gains to offset underwriting losses in the Great Plains. 

Below are GRIP/GRP analyses for several counties.  GRIP/GRP payments were calculated based on the past 33 years of county yields.  For 2006 RMA changed the GRIP prices to the CRC prices so expected long run prices were used in the analysis not the actual prices in the GRIP contracts that were sold.  The prices used before the change on the 2006 contract actually increased payments. 

If KSU analysis shows an under writing loss on GRIP/GRP in my county does that mean it is a good buy for me?  Not necessarily because this analysis assumes there are no future rate changes or RMA does not change the method for setting prices or trend yield calculations.  Also growers will have to wait on any payments until 6 to 9 months after harvest because no payments are made until the USDA reports the county yield.  However, premiums are due and payable at harvest.  Depending on one’s equity position one’s ag lender may not be willing to provide the necessary operating funds while waiting on a GRIP/GRP payment.

Even if one is in a county showing a GRIP/GRP loss many Kansas farmers have APH contracts that have also generated underwriting losses because of recent dry weather.  But unlike Kansas many Corn Belt counties have shown underwriting grains under APH and those farmers have an economic incentive to switch to GRIP/GRP.  Also private hail rates are often less than a dollar per $100 of coverage so Corn Belt growers can replace the loss of hail coverage in the GRIP/GRP contracts with “very low” premium costs. 

The insurance industry also has doubts about the rating of GRIP/GRP.  RMA sets the rates and underwriting rules, therefore all a private company can do is lower commissions on contracts that they think will suffer underwriting losses.  Companies have also offered “high” commissions on APH based contracts in the Corn Belt that they think will generate underwriting gains.

It is hard to argue many Kansas growers’ crop insurance premiums are set too “high” therefore there is no rating incentive to switch to GRIP/GRP.  In some Kansas irrigated counties the KSU analysis even shows there may be underwriting gains, so growers would not want to buy GRIP/GPP in those counties.  The GRIP/GRP offer will look the best for large Kansas farms with multiple year losses.  The overrating issue in the Corn Belt does not hold for Kansas.

Neither the author nor KSU has given any opinion or implied warranty on the current GRIP/GRP rating methods.  Growers will need to reach there own judgment on the sufficiency of the APH or GRIP/GRP rates for their farm.  Rating analysis would require more sophisticated and rigorous analysis than presented in this paper. 

Growers with Excel experiennce may complete similar analysis for their crop and county.  There are power point slides on AgManager. Info that will lead one through the process located at:

http://agmanager.info/crops/insurance/workshops/ed06pdf/ABAMM.pdf

The selected county analysis for GRIP/GRP is presented below.

Summary.  The greatest interest by Kansas growers will likely be in cases where their APH has been greatly reduced caused by recent droughts and other disasters.  Kansas growers will need farm yields that are highly correlated with county yields in order to transfer risk. 

In the Corn Belt the issue is not to transfer risk.  Those growers believe (and with some evidence) the APH based products are overrated.  Those growers are accepting higher risk by retaining the basis risk in return for higher expected returns because the expect GRIP payout is higher per dollar of premium paid.  Also Corn Belt growers can cover the hail risk that is not effectively covered in GRIP/GRP at very low private hail rate compared to Great Plans growers.  Any risk transfer is a secondary consideration.