Wheat combine

A combine harvests wheat.

Some questions have been raised concerning the determination of the price used in calculating revenue crop insurance payments for Washington wheat producers. Selecting an insurance plan can be complicated, and there are lots of options to choose from, but the most popular is some form of revenue insurance. This article explains the way the USDA’s Risk Management Agency (RMA) goes about determining the initial guaranteed price side for a revenue insurance policy.

In general, for a revenue policy (RP) a producer selects the percent of average yield they would like to insure — usually between 50% and 75%, although in some areas it can be as high as 85%. In addition, producers can choose an RP that has a harvest price option or one with a harvest price exclusion.

If producers choose insurance with the harvest price option RMA will calculate their guaranteed revenue for insurance purposes using the higher of either the harvest price or the initial guaranteed price. Producers who choose RP with the harvest price exclusion will not benefit from higher harvest prices compared to the initial guaranteed price, but they also will pay less for crop insurance. That option is the focus of this discussion.

Prior to the insurance sign up date (usually Sept. 30 for Washington winter wheat producers), RMA determines the price that will be used to calculate the initial guaranteed revenue for next year’s crop.

In most parts of the U.S., RMA determines the price guarantee portion of the revenue product for major crops (corn, soybeans, winter wheat, spring wheat) by looking at the futures prices for harvest delivery prior to the insurance signup period, and then estimating the risk that the price will change using the implied volatility (IV) calculated from options being traded on the harvest period futures. Options provide futures traders the right to buy or sell futures contracts before they expire, and the relationship between the futures price on any given day, and the cost of a futures option on that same day provides a measure of the market’s perception of the risk that futures prices will change going forward. This risk measure is used in determining the insurance premiums for revenue products.

For a hard red winter wheat producer in Kansas, a revenue insurance policy with harvest price exclusion will guarantee the futures price for hard red winter wheat trading on the Kansas City futures exchange for next year’s harvest, multiplied by the guaranteed yield the producer faces (the guaranteed yield is determined based on historical yields). If the harvest price multiplied by the harvest yield is less than the revenue that was guaranteed by the revenue insurance policy a payment is made.

For Washington producers (and other PNW producers including California), the price used in the revenue insurance product is calculated differently.

First, all winter wheat is insured at the same price regardless of class (this is not true in other parts of the country — someone producing soft red winter wheat in Wisconsin does not have the same price guarantee as someone producing hard red winter wheat in Kansas). Thus, red winter wheat and white winter wheat are insured at the same price for PNW producers.

To determine the insurance price for Washington winter wheat producers, RMA collects the daily futures price from Aug. 15 to Sept. 15 for the September soft red wheat futures contract expiring the following year. For example, during the August-September price discovery period in 2020, RMA recorded the closing futures price each day from Aug. 15, 2020 though Sept. 15, 2020 for the September 2021 soft red wheat futures contract. The average price over that four-week period was then calculated to determine the guaranteed futures price for revenue crop insurance for the crop to be harvested summer 2021.

For PNW producers, RMA then converts the soft red winter wheat futures price to an equivalent price for soft white wheat in Portland. This is done by collecting the Portland cash price for soft white wheat everyday between Aug. 1 and Aug. 31, and calculating the soft white premium on a daily basis. They take the average white wheat premium between Aug. 1 and Aug. 31 over the last 5 years and add that to the average August-September soft red wheat futures price for next year’s September futures contract. This becomes the producers’ guaranteed price, and it is the same for all PNW producers.

Figure 1 shows this for the 2021 crop. The prices under “ending value” are the prices for the 2021 September soft red wheat futures contract observed between Aug. 15 and Sept. 15 of 2020. The average of the “ending value” in 2020 was $5.60 per bushel (this was the average futures price for the September 2021 soft red contract between Aug. 15 and Sept. 15, 2020).

The “price” column shows the “forecast” of the Portland soft white wheat price based on the September 2021 soft red futures price using the average Portland price premium in August the previous 5 years (the revenue insurance product is guaranteeing revenue for August of the next year). In September 2020, RMA “forecast” the Portland price for winter wheat to be $6.33 per bushel in August 2021 — they took the average futures price of $5.60 for the September 2021 futures contract and added $0.73 per bushel to adjust for the historical relationship between soft red wheat futures and the Portland cash price in August over the last 5 years. This $6.33 price would have been multiplied by a producer’s historical yield to determine the producer’s insured revenue. For example, if the farmer had proven yields of 70 bushels per acre, a revenue insurance policy with the harvest price exclusion would have guaranteed the farmer $433 per acre.

The actual Portland wheat price has averaged about $9.44 per bushel through Aug. 18 of this year (Figure 2). If at the end of August $9.44 is still the average August price, the actual revenue calculated by RMA would be the farmer’s actual yield multiplied by that price. If a producer had a normal year and harvested 70 bushels to the acre (his/her proven yield from the example above), RMA would calculate their revenue as $9.44 per bushel times 70 bushels per acre, or $660.80 per acre and no crop insurance indemnity payments would be made.

However, even though the harvest price this year is well above the guaranteed price set last September, if yields fall below expectations such that total revenue is less than the guaranteed $433 per acre (again, from the example above), an insurance payment would be made to the producer. If, for example, the producer only harvested 40 bushels per acre this year rather than the 70 bushels per acre expected, then RMA would calculate his/her total revenue to be $377.60 per acre, less than the $433 guarantee, and thus a payment would be forthcoming.

Even if a payment is made, however, the guaranteed revenue is not based on the current market price for producers who elected to purchase the less expensive RP with harvest price exclusion, but rather the price forecast the previous fall. High prices this year do not increase the level of insurance coverage signed up for last year if harvest price exclusion was chosen.

However, higher prices will impact coverage levels for the following year. For example, the current price for the September 2022 soft red wheat futures contract has averaged about $7.35 per bushel between Aug. 15 and Aug. 18 this year, well above last year’s average for the September 2021 contract of $5.60 per bushel. In addition, because Portland prices have been quite strong this year, the 5-year average Portland premium is closer to $0.96 per bushel compared to last year’s premium of $0.73. If these relationships hold through the end of the price discovery period, the price guarantee for Washington producers for next year’s wheat crop would be about $8.31 per bushel compared to the guarantee for this year of $6.33. The Portland price premium to be added to futures will be announced on or about Sept. 1 (after all the August Portland prices have been collected), and the average September 2022 futures price just after Sept. 15, so there is still time for the price relationships to change a bit.

However, even if prices change over the next few weeks, we will still be looking at higher price guarantees in next year’s revenue insurance products compared to this year’s.

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T. Randall Fortenbery is the Thomas B. Mick Endowed Chair in the School of Economic Sciences at Washington State University.

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