Spotlight on economics: The hole in the farm safety net

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The proposed farm bills (with one exception) for the 2013-2017 period are languishing in Congress and have a hole in the safety net. It would take a few years to expose the hole and odds now seem low that it would occur, but it is there just waiting.

The main safety net is crop insurance, with revenue insurance being the most popular type of policy. It accounted for 85 percent of the 189 million acres of corn, soybeans and wheat that were insured this year.

Revenue insurance uses average production history (APH) yield multiplied by price and then multiplied by level of coverage to determine the amount of revenue guarantee. Therefore, if the APH or price declines, so will the guarantee. The price used is determined from a relatively short period, which is one month.

Fortunately, we have experienced several years of historically high prices which have provided a strong crop insurance safety net. Unfortunately, this period, not coincidently, has ushered in record high costs. For example, the cost per acre of raising wheat in North Dakota has doubled since 2006.

The hole in the safety net will be exposed when there is a significant drop in prices. The crop insurance revenue guarantee will fall but costs likely will remain high, at least initially. Potentially, this can expose producers to a large financial loss.

In this situation, what can shore up income? Shallow-loss programs such as the proposed Agriculture Risk Coverage (ARC) of the Senate farm bill and the Revenue Loss Program (RLC) of the House farm bill are designed to only cover up to 10 percent of crop income shortfalls when certain criteria are met.

Also, these programs have similar shortcomings as revenue crop insurance does, but they are slower-acting. Limited payments are made when a calculated "actual crop revenue" is less than a calculated "benchmark revenue." Five-year Olympic average marketing year prices are used in the determination of the benchmark revenue. The impact of falling prices on these safety nets is slower because a multiyear average price is used.

In concept, the programs that provide the last line of defense against the impact of falling prices and could stuff this hole in the farm safety net are the current Marketing Loan and Countercyclical Payment programs and the proposed Price Loss Coverage (PLC) program in the House farm bill.

Loan rates under the current Marketing Loan program are an old component of the farm safety net dating back to the 1933 farm bill. Its mechanisms have evolved through time, but the loan rate essentially puts a revenue floor on each bushel produced. The higher the loan rate, the better the safety net. From 1998 through 2001, market prices were at or below loan rates and large loan deficiency payments were made to producers. However, loan rates have not kept pace to protect revenue against ever-escalating production costs.

Loan rates have changed little during the past 18 years. In fact, the current soybean loan rate is lower than it was in 1980! During the past five years (2007 through 2011), loan rates averaged less than one-half of market prices. All farm program proposals have no change in loan rates.

The Countercyclical Payment (CCP) program was initiated in the 2002 farm bill after a series of ad hoc disaster bills during low price years was necessary to shore up farm income. Countercyclical payments are determined by the relationship of target prices to market prices. If market prices are below the effective target price, payments are triggered.

Unlike loan deficiency payments, these payments are not tied to current production. Instead, payments are made based on historic production (program yields and base acres). Like loan rates, CCP target prices are too low to be considered an adequate safety net.

CCP is eliminated in the 2012 farm bills proposed in both the Senate and House versions.

The best chance to plug the hole in the price safety net is the Price Loss Coverage (PLC) program proposed in the House farm bill. Producers would have to choose between the PLC and RLC shallow-loss program if this bill becomes law.

Like the current CCP program, PLC payments are made when the market price is lower than a target or reference price. However, payments are made on 85 percent of current planted acres, not on historic base acres.

The PLC reference prices are much higher than the CCP target prices. For instance, the reference price under PLC would be $8.40 per bushel for soybeans, compared with the effective target price of $5.56 per bushel under CCP.

Source: Andy Swenson, Farm Management Specialist, NDSU Agribusiness and Applied Economics Department



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