Margin Protection Insurance 101

MT. JULIET, Tenn. (DTN) -- A federally subsidized, shallow-loss crop insurance product has largely flown under the radar since it was unveiled five years ago, but one expert urges farmers to take a look, as it seems tailor-made for the current price environment.

Steve Johnson, retired Iowa State University Extension farm management specialist, told DTN that high projected prices for 2022 crops make margin protection insurance appealing, but its mechanics make it one of the trickiest to explain. Not only does it have a lot of moving parts, but it also has an unusually early price discovery period and deadline to purchase compared to more common crop insurance products.

Farmers have until Sept. 30 to purchase margin protection crop insurance, which protects against declines in operating margins and includes both revenue and input cost components, for the 2022 crop. That's right as most producers are focused on harvesting the 2021 crop and far earlier than the March 15 deadline for making decisions regarding revenue protection and other add-on products like the Supplemental Coverage Option (SCO) and Enhanced Coverage Option (ECO). (You can find more on how SCO and ECO work here: https://www.dtnpf.com/….)

"The timing is terrible," Johnson said. "But the advantage of margin protection is it uses a price discovery period of mid-August to mid-September, and that's why it's really so attractive this year because we've got such high prices offered for the 2022 crop."

The projected prices are $5.06 per bushel for corn, $12.56 per bushel for soybeans and $7.76 per bushel for spring wheat.

Margin protection is similar to private insurance products that let you pick the price discovery period, but the advantage is that it's subsidized. That's key because as an add-on product where you can purchase coverage levels from 70% to 95%, premiums can be hefty, but so can payouts.

Johnson said he did a historical review of when margin protection insurance would have had large indemnities, and the crop years that stand out are 2013 and 2014, when prices were high the previous fall but collapsed throughout the next season.

"This is the first September that we've had relatively high futures prices since this product was launched in 2017," he said. "Let's say futures prices drop 5% between now and February. That's going to make margin protection look like a good decision. At least you've got some sort of revenue protection in place should these prices start to decline."

MAKING SENSE OF MOVING PARTS

Margin protection is an area-based product, meaning it pays based on county-level yield estimates. Johnson said it makes a good addition to a revenue protection policy and will work best for farms that tend to mirror county yields.

The unique thing about margin protection insurance is that it takes input costs into the equation. It uses a county yield and the projected price to calculate revenue, then subtracts costs to calculate an expected margin.

"A lot of the confusion I'm seeing and hearing is that farmers think this is a way to protect against those higher costs," Johnson said. "Yes and no. It does, but in a real funky way."

The cost calculations are not based on the producer's costs. Rather, they're determined by the Risk Management Agency and include both variable and fixed costs. RMA says in a factsheet that fixed costs aren't specifically identified, but include seed, machinery and operating costs other than fuel. They don't include land or labor. Variable costs that are subject to change during the fall and harvest price discovery periods are diesel, urea, DAP, potash and interest. (You can read RMA's full fact sheet here: https://www.rma.usda.gov/….)

Next, the producer selects a coverage level between 70% and 95%, and that's used to estimate a deductible. The deductible is subtracted from the expected margin to generate a trigger margin.

Once RMA finalizes county yields (by June 2023), it will calculate a harvest margin. Indemnities are determined by subtracting the harvest margin from the trigger margin and then are multiplied by the protection factor, which the farmer also chooses at sign-up. The protection factor can range between 80%-120%. Higher levels of coverage and higher protection factors result in higher premiums.

If a farmer also expects a payment from a revenue protection or yield protection policy, the farmer will receive the higher payment of the two. This also generates a premium credit to reflect that indemnity payments from one policy can offset payments from the other.

MARGIN PROTECTION FOR RISK MANAGEMENT

Johnson said a lot of farmers and insurance agents get caught up on the variable cost component. But many of those costs, like fertilizer, have already risen as much as 50% over the past year. Those could keep going up into April, when RMA calculates them again, but it's not the most likely way margin protection triggers an indemnity. Payments will be most common when futures prices drop. (You can read more on the latest fertilizer price movements here: https://www.dtnpf.com/….)

"As a crop risk-management tool, it's just going to add on to revenue protection, and it's not going to be your primary coverage. It's going to be your secondary coverage," he said, comparing it to buying up coverage on your automobile insurance.

He said margin protection insurance is a good fit for growers that are larger in scale and are pretty good at marketing and managing revenue risk. It's helpful to view it as a hedge against lower futures prices.

"As a tool, the government is paying at least 44% of the premium. If I buy it, I don't have to hedge and be subject to margin calls. If I bought a put option now, I'm paying all-time value," he said, adding that an at-the-money December 2022 corn put option premium would cost $90 per acre, which is more expensive than margin protection premiums are likely to be and could still expire worthless.

Locking in some crop insurance coverage now could help growers feel more confident in making forward sales for the 2022 crop, likely using forward cash or hedge-to-arrive contracts, Johnson said.

"I think there's more risk in the '22 crop than most people want to admit. It feels like prices will never go down, but that's how they felt back in 2012 and '13," he said.

Katie Dehlinger can be reached at katie.dehlinger@dtn.com

Follow her on Twitter at @KatieD_DTN

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