September 19, 2000

Although the emergency assistance packages have relieved immediate financial stress for many producers, risk management continues to concern farmers and farm policymakers. Risk management is likely to be part of the discussions of future farm legislation, particularly the 2002 farm bill. The Clinton Administration has called for longer-term economic safety-net legislation that would reduce the need for emergency assistance, and many Republicans have questioned whether a more farmer supportive approach is needed when the current farm law expires in 2002.

A new report from USDA's Economic Research Services discusses the emergence of risk management as a major farm policy consideration. "Interest in farm risk and risk management has increased in the past several years," the report notes. "Major reforms of the federal crop insurance program in 1994 and farm income support programs in 1996, followed by localized yield problems and declines in farm commodity prices, highlighted the need to better understand risk, and raised questions about government risk management assistance."

In the late 1990s and in 2000, Congress enacted emergency financial assistance packages for farmers--aimed at low prices and crop yield losses--as well as legislation to boost crop and revenue insurance coverage.

ERS has explored the subject of economic risk in agriculture in a recent report, Managing Risk in Farming: Concepts, Research, and Analysis, and in articles in Agricultural Outlook magazine, a collection of which was reprinted in February 2000 as Managing Farm Risk: Issues and Strategies.

Prior to the 1996 farm bill, the Federal Crop Insurance Reform Act of 1994 increased dramatically the scope of the crop insurance program. It added in 1995, a catastrophic (CAT) coverage level, a low level of yield risk protection similar to ad hoc disaster assistance that had been enacted between 1988 and 1994, the report says. In addition, revenue insurance products, providing protection from drops in revenue (the product of price and yield), were introduced for several major field crops at the time when the price deficiency payment program was discontinued.

Changes in farm policies meant that farmers had to consider different ways of doing business. According to USDA's Agricultural Resource Management Study (ARMS), producers in 1996 were most concerned about changes in government laws and regulations, decreases in crop yields and livestock output, and uncertainty in commodity prices. Specific concerns varied by type of farm enterprise and by location. Producers of major field crops tended to be more concerned about price and yield risk, while livestock and specialty crop producers were more concerned about changes in laws and regulations, including environmental regulations.

With the 1996 move toward less government intervention, farmers appeared to rely more on forward contracting and other risk management tools to reduce their risks. According to the ARMS, between 5 and 8 percent of the producers receiving government payments reported that they increased their use of at least one risk management strategy in response to the 1996 farm bill.

Farmers have many ways of managing risks, the report continues. For example, they can diversify their enterprise mix or make financial adjustments, such as cutting costs or borrowing on equity. In addition, farmers can use risk management tools, such as insurance and hedging. Most producers combine the use of a variety of farm management strategies and tools. And, off-farm earnings, a major source of income for many farm households, can help stabilize income.

Because risks and willingness and ability to bear risks differ from farm to farm, so do the risk management strategies used. According to the 1998 ARMS, operators of large farms (measured by gross sales) were more likely than operators of small farms to use strategies such as budgeting for cost control, managing debt for cash flow, and diversifying the number or type of farm enterprises. Also, operators of large farms and operators of grain farms were more likely to use options to forward price their production.

ERS analysis of combinations of crop and revenue insurance with forward pricing strategies indicates that effectiveness varies by crop and location, depending on yield variability and the degree to which a farm's yields and prices move together ("Insurance and Hedging: Two Ingredients for a Risk Management Recipe," in Agricultural Outlook).

After enactment of the 1996 farm bill economic conditions in the farm sector shifted. The report notes that prices for many field crops declined dramatically, primarily because of large global supplies and weak demand.

The season average price received for soybeans, for example, fell from $7.35 per bushel in 1996-97 to $4.93 in 1998-99; for 1999-00 it is projected to be the lowest since 1973. Similarly, cotton prices are projected to be the lowest since 1974.

Low commodity prices and crop yield losses in some areas led to financial stress and raised questions about the economic safety net available to farmers. Scheduled declines in "transition payments" under the 1996 farm bill coincided with commodity price declines. Loan deficiency payments (LDPs; based on the difference between the loan rate and the local market price) provided some income support, but many producers did not believe that transition payments and LDPs alone were adequate. At the same time, crop yield and revenue insurance, despite premium subsidies and modest growth in acres insured above the CAT level between 1996 and 1998, was said to offer too little coverage or to be unaffordable.

In response, emergency assistance packages were enacted in 1998 and 1999, each of which provided market-loss assistance (for low prices) and crop-loss assistance (for crop yield losses), including crop insurance discounts, in fiscal years 1999 and 2000. In 2000, the Agricultural Risk Protection Act, provided increased insurance premium subsidies in 2001-05 as well as market loss assistance for 2000 and 2001.

The emergency assistance package enacted in 1998 provided about $6 billion to farmers in fiscal year 1999 for market-loss assistance and crop-loss assistance, about $400 million of which was used for crop and revenue insurance premium discounts. The premium discounts, about 30% across all "buy up" (additional) coverages, were applied to the producer paid portion (after existing subsidy) of crop and revenue insurance premiums in 1999. Because insurance premiums are greater for higher yield coverage levels and for some revenue products, the across-the-board premium discount had a greater impact at these coverages. In 1999, acres insured at the buy up levels increased about 19%, according to this report.

In 1999, a second emergency assistance package was enacted. It provided about $9 billion in aid to farmers in fiscal year 2000, including market and crop loss assistance and crop and revenue insurance premium discounts similar to those offered in 1999.

The Agricultural Risk Protection Act of 2000, signed by the President in June, provided $5.5 billion in additional market loss assistance for 2000 and for 2001 and provided $8.2 billion to increase premium subsidies for buy up yield and revenue insurance. The Act also increased administrative fees paid by producers for CAT (from $60 to $100 per crop), modified the way that a farmer's yield history is used to establish insurance guarantees, directed that pilot programs be established, for livestock in particular, and directed that the private sector have a stronger role in research and risk management product development.

Increased premium subsidies under the 2000 Act will be effective beginning with crops planted in the fall of 2000 and will greatly reduce producer's costs of crop yield and revenue insurance, says the report. For example, the subsidy at what has been the most popular buy-up coverage level (65% yield indemnified at 100% of expected price, or 65/100) will increase from 42 to 59%. The subsidy rates on revenue insurance, which in many cases is more costly than yield only coverage, will also increase sharply.

While the amount of premium subsidy for revenue coverage was limited to the amount of subsidy for yield only coverage at the same percent (for example, the subsidy on 65% revenue coverage was capped at the amount of subsidy for 65% yield), under the Agricultural Risk Protection Act of 2000, both yield and revenue products will be subsidized at the same rate.

The entire ERS report is available on the Internet at http://www.ers.usda.gov/whatsnew/issues/risk/update.htm.