A Risk Analysis of Adjusted Gross Revenue-Lite on Beef Farms Art Barnaby, Jeff Williams, Andrew...

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A Risk Analysis of Adjusted Gross Revenue-Lite on Beef

Art Barnaby, Jeff Williams, Andrew Saffert, and Michael Langemeier

Department of Agricultural EconomicsKansas State University

Presented at the 2009 National Extension Risk Management Conference

Reno, NV March 31 –April 1, 2009

Adjusted Gross Revenue-Lite (AGR-Lite) A Whole Farm Revenue Protection Plan Provides protection against loss of revenue

from natural and named disasters and/or market fluctuations

Examine impact of participation in AGR-Lite as a stand-alone program for SE Kansas Beef Farms on farm income variability and risk reduction

Objective

Motivation

76 % of Kansas’ $8.7 billion in agricultural production is without risk protection (NASS, 2008)

Beef largely remains without protection

Overview of Analysis

Generate Net Farm Income (NFI) distributionsWith and without AGR-Lite participation

Examine change inMean Standard DeviationCoefficient of Variation (CV)Minimum

Simulation & Econometrics to Analyze Risk (SIMETAR©) is used to perform Stochastic Efficiency with Respect to a Function (SERF) Analysis. This analysis determines the preferred strategy (AGR-Lite or no AGR-Lite) at various levels of risk aversion for each farm.

Analysis Methods

How is Coverage Established?

Federal Income Tax RecordsUsually IRS Schedule F form 1040

Current Year’s Farm PlanAnnual Farm Report

Data (continued)

KFMA data59 SE Kansas Beef Farms – Most diversified

area with little irrigation (20 counties)Schedule F not available but reproduced

necessary dataContinuous annual farm level data (1993-2007)

Two data sets 15 yrs. - 1993-2007 - Need 5 years of previous data

excluding the immediate previous year for current insurance year applicant.

9 yrs. - 1999-2007 - Used for creating NFI distributions and evaluation.

Farm Category50% or more of average total income 1993 to

2007 from Beef

Data (continued)

NFI Characteristics 1999 - 2007 - Beef

Mean $56,100

$51,281

Standard Deviation

Average Coefficient of Variation1 1 Includes only positive Coefficient of Variations for 54 of 59 farms.

Data (continued)

AGR-Lite Critical Values

Allowable Farm Income (AFI) - Used for establishing guarantee (liability)Schedule F items directly related to production Excludes custom work, insurance indemnities

and ag program payments.

AGR-Lite Methodology Overview

Allowable Farm Income (AFI)Calculate 5-year average of AFI - called AGRCalculate indexed AGR if necessary for growth

or contractionDetermine expected income (EI) - annual farm

report that projects incomeDetermine approved AGR - Minimum of AGR

AGR-Lite Example Claim

1From the annual “farm plan” for the upcoming year.

YearTax ReturnInformation Trend

IndexedRevenue

Expected Income1

Historical Year 1 265,000Historical Year 2 250,000 0.943

Historical Year 3 260,000 1.040

Historical Year 4 287,000 1.104Historical Year 5 271,330 0.945Historical Year 6

a. Income Trend Factor 1.033b. 5-year Average 266,666c. Expected Income for Insurance Year Total 290,000d. 5-year Average Indexed (a b) 275,478e. Lesser of Indexed AGR or Expected Income 275,478f. Coverage Level 75%g. Payment Rate 90%h. AGR-Lite Loss Inception Point (e f) 206,609i. AGR-Lite Liability ($ of Coverage) (h g) 185,948

Adjusted Gross Revenue to Count (AGRC) Used for Establishing Claim equals AFI generated for current year

+ insurance payments

+ accrual adjustments (accounts receivable,

crop, and livestock inventory)

AGR-Lite Critical Values

AGR-Lite Example Claim

1From the annual “farm plan” for the upcoming year.

YearTax ReturnInformation Trend

IndexedRevenue

Expected Income1

Historical Year 1 265,000Historical Year 2 250,000 0.943

Historical Year 3 260,000 1.040

Historical Year 4 287,000 1.104Historical Year 5 271,330 0.945Historical Year 6

a. Income Trend Factor 1.033b. 5-year Average 266,666c. Expected Income for Insurance Year Total 290,000d. 5-year Average Indexed (a b) 275,478e. Lesser of Indexed AGR or Expected Income 275,478f. Coverage Level 75%g. Payment Rate 90%h. AGR-Lite Loss Inception Point (e f) 206,609i. AGR-Lite Liability ($ of Coverage) (h g) 185,948j. Adjusted Gross Revenue to Count 150,000k. Insurable Loss (h - j) 56,609l. Indemnity (j g) 50,948

AGR-Lite Methodology Overview

Allowable Expenses (AE)No direct impact in determining initial AGR-

Lite guaranteeHowever, effective guarantee reduced in claim

filing process if expenses significantly less than 5 year average expenses

Schedule F items directly related to production excluding some items such as interest, taxes, and rent.

Assumptions for Analysis

Every farm insured every year 75% Coverage Level and 90% Payment

Rate Expected Income from "farm report" for

insurance year (EI) equals 5-year Average AFI

Examine AGR-Lite as stand-alone Actuarially fair premiums by farm category

Actuarially Fair Average % Rate

= Total $ indemnities for farms with claims / total $ liability for farms with claims

Applied to all farms

Premium Calculation

Premiums Summary

FarmsWith

ClaimsWithoutClaims

Premium rate1 3.78% 3.78% 3.78%

Average Premium $5,009 $5,214 $4,749

Minimum Premium $353 $496 $353

Maximum Premium $26,584 $26,584 $21,5441Percent of liability

Income values for 59 SE Kansas beef farms from 1993 through 2007

-$25,000$0

$25,000$50,000$75,000$100,000$125,000$150,000$175,000$200,000$225,000$250,000$275,000$300,000

AFI NFI VFP AGRC

Results –Indemnities and Liabilities

Farms with Claims1 33

Average Indemnity1 $22,702

Average Liability1 $137,7961Farms with at least one claim.

NFI Characteristics 1999 - 2007With

Claims

Without Claims

Mean 54,538 58,083

Standard Deviation 47,289 56,347

Coefficient of Variation 1.57

Average Minimum -14,835 -15,659

Average Maximum 127,948 159,627

NFI Results

FarmsWith

ClaimsWithoutClaims

(59) (33) (26)

Average Without $56,100 $54,538 $58,083

Average With $54,008 $54,538 $53,334

Average Percent -3.73% 0.00% -8.14%

Standard Deviation

Average Without 51,281 47,289 56,342

Average With 50,655 46,213 56,294

Percent Change -1.22% -2.28% -0.09%

Coefficient of Variation

Average Without 1.43 1.57 1.23

Average With 1.32 1.13 1.58

Percent Change -7.38% -28.21% 28.51%

NFI Results (continued)

FarmsWith

ClaimsWithoutClaims

(59) (33) (26)

Minimum

Average Without -15,214 -14,835 -15,695

Average With -12,630 -6,533 -20,368

Percent Change 16.99% 55.96% -29.77%

Maximum

Average Without 141,908 127,948 159,627

Average With 141,872 131,712 154,768

Percent Change -0.03% 2.94% -3.04%

SERF Risk Premium Results

AGR-Lite not preferred on 37 farms at all levels of risk aversion. They would need increased returns or a payment to use AGR-Lite.

26 had 0 indemnities. 7 had 1 indemnity. 3 had 2 indemnities. 1 had 3 indemnities.

SERF Risk Premium Results (continued)

AGR-Lite preferred on 10 farms at all levels of risk aversion. They would pay an additional amount for AGR-Lite.

1 had 1 indemnity.1 had 2 indemnities.2 had 3 indemnities.4 had 4 indemnities.1 had 5 indemnities.1 had 7 indemnities.

AGR-Lite not preferred by 7 risk neutral managers became preferred on 7 farms as risk aversion increased.

All 7 had 1 indemnity.

AGR-Lite preferred by 5 risk neutral managers but became not preferred on 5 farms as risk aversion increased. AGR-Lite actually increased risk because indemnities paid in higher NFI years but not lower NFI years. In these cases AGRC and NFI did not correlate well.

2 had 1 indemnity.3 had 2 indemnities.

Correlation – All FarmsAGRC

Average 0.65

Minimum -0.30

Maximum 0.99

Negative Correlations 2Average correlations were slightly lower for farms with claims

This leads to indemnities based on AGRC in years when NFI is higher than average or the opposite for some farms.

Summary & Conclusions

NFI Results – 33 Farms with claimsReduced standard deviationsReduced CVIncreased minimums

SERF Results10 farms preferred AGR-Lite at all levels of

risk aversion 7 farms preferred at higher levels of risk

aversion

Summary & Conclusions (continued)

First attempt to evaluate whole-farm product

Future research Provisions of the contract Actual premiumsAnalysis by size of farm

Issues with AGR-Lite

AGRC and NFI not highly correlated for all farms Could have high cost year when AGRC is not

low enough to generate a claim

Issues with AGR-Lite (continued)

AGR-Lite does not adjust for feed purchased. If in a drought, and producers purchase hay to

replace lost forage, this loss will not be covered. The loss will lower net income, but not gross income .

If producers normally sell excess hay, then it is covered because there will be reduced hay sales.

Issues with AGR-Lite (continued)

AGR-Lite does not include indemnity payments when calculating 5-year average gross income that will set future guarantees. This has no impact on current year’s indemnity

payment but it lowers future guarantees reducing the effectiveness of AGR-Lite as a risk management tool for multiple year droughts.

Questions ?

A Risk Analysis of Adjusted Gross Revenue-Lite on Beef Farms Art Barnaby, Jeff Williams, Andrew...

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