Docstoc

Cattle Price Insurance Program

Document Sample
Cattle Price Insurance Program Powered By Docstoc
					Managing Risk in the Beef Cattle Industry
               Presentation to:
             AAEA Annual Meeting
              Red Deer, Alberta
                May 4, 2006
Managing Risk in the Beef Cattle Industry
               Presentation to:
             AAEA Annual Meeting
              Red Deer, Alberta
                May 4, 2006
                Introduction
• Our involvement began with the U.S. Livestock
  Risk Protection (LRP) program
• Recent border closure underscored
  shortcomings of using U.S. risk management
  products
• Recognized from the outset that no single risk
  management tool will appeal to all Alberta cattle
  producers
• Think long term! Where does the industry want
  to be 10 years from now?
              Background
• Alberta cattle producers perceive their
  price risk as having 3 components:
  – CME futures
  – C$/US$ exchange rate
  – Basis
• Currently there is no single risk
  management tool that captures all 3
  components
• No mechanism at all to manage basis risk
                                                       CPIP Fed Cattle Index Basis
                                                                   Jan/90 to Dec/05

                 10
                  5
                  0
                 -5
                -10
                -15
                -20
                -25
Cdn. cents/lb




                -30
                -35
                -40
                -45
                -50
                -55
                -60
                -65
                -70
                -75
                -80
                  1990   1991   1992   1993   1994   1995   1996     1997   1998   1999   2000   2001   2002   2003   2004   2005
    Approaches to Managing Price Risk
•   Self insurance
•   Diversification
•   Reliance on government support
•   Exchange-traded futures (CME)
•   Exchange-traded options (CME)
•   Forward currency market
•   Forward cash contracts
•   Insurance-based products
Cattle Price Insurance Program (CPIP)
              Background
• Original pre-feasibility study completed for ABP
• Subsequent funding was provided by the federal
  Private Sector Risk Management Partnerships
  Program (PSRMP)
• Insurance-based product versus financial
  derivative
• Price-related insurance is the fastest growing
  form of insurance in agriculture today
                                         FCIC Yield Versus Revenue Insurance Premiums
                                                             (Corn, Wheat and Soybeans)
                          $3,000


                                                                                                                 2,479
                          $2,500
U.S. Dollars (millions)




                          $2,000
                                                                                                       1,771



                          $1,500
                                                                                   1,256     1,299



                          $1,000                                         906
                                   761
                                                                695
                                             610     624
                                                              543      531
                                                                                 454       459       416
                           $500                                                                                359
                                               281     327


                                         0
                             $0
                                   1996      1997    1998     1999     2000      2001      2002      2003      2004

                                                     Yield Insurance         Revenue Insurance
          CPIP Basic Structure
- CPIP offers insurance for various delivery periods and
  coverage levels…throughout the year
- The orientation is that of a private insurance policy, not a
  government support program
- Premiums and coverage levels adjust to the underlying
  market
- The producer chooses the number of pounds to insure
  for each period and the coverage level
- The producer pays the premium up front
- The payout or “indemnity” is based on the difference
  between the Insured Price and the Index Settlement
  Value as of the claim date
      Sample CPIP Premium Sheet
                 Week     Week      Week       Week        Week        Week       Week        Week     Week
                  12       16        20          24          28         32          36         40       44
  CPIP Covg.                               CPIP FED CATTLE PREMIUM (C$/cwt)
Level (C$/cwt)                     No percentage load. No fixed load. 7-day early exercise.
      96                  1.1531
      94         1.0446   0.8327
      92         0.7119   0.5956
      90         0.4881   0.4341    1.2135
      88         0.3343   0.3104    0.8876                                                             2.1995
      86         0.2283   0.2193    0.6395                                                             1.8479
      84         0.1523   0.1581    0.4616      1.1801                                        2.0189   1.5748
      82         0.0978   0.1113    0.3356      0.8764     1.4674      1.5138     1.9523      1.6506   1.3253
      80         0.0653   0.0795    0.2440      0.6459     1.1179      1.1890     1.5463      1.3555   1.1485
      78         0.0418   0.0576    0.1783      0.4953     0.8577      0.9529     1.2406      1.1140   0.9604
      76         0.0276   0.0397    0.1275      0.3659     0.6633      0.7562     1.0115      0.9193   0.8159
      74         0.0189   0.0289    0.0901      0.2747     0.5057      0.5936     0.8315      0.7728   0.6935
      72         0.0099   0.0199    0.0686      0.2028     0.3901      0.4713     0.6742      0.6512   0.5795
      70         0.0072             0.0477      0.1514     0.3036      0.3734     0.5211      0.5270   0.4997
      68                            0.0337      0.1133     0.2413      0.3008     0.4369      0.4522   0.4149
      66                            0.0259      0.0831     0.1774      0.2391     0.3413      0.3619   0.3687
      64                                        0.0624     0.1436      0.1896     0.2798      0.3104
      62                                        0.0452     0.1005      0.1475     0.2327      0.2541
      60                                                   0.0798                 0.1864
             CPIP – Benefits
- Insurance is a concept that is well understood
  and possibly more “user-friendly”
- CPIP is based on Alberta cattle prices and will
  be effective under any “border” scenario
  - i.e., basis risk is covered
  - bundling of CME, C$/US$ and basis risk into one
    product
- CPIP is a simple program from the producer’s
  perspective
- Participation is voluntary
       CPIP – Benefits (con’t)
- CPIP is very flexible in terms of the coverage
  provided
- CPIP provides a predictable level of protection
  and easily calculated payout
- CPIP can be used for “disaster protection” or
  “margin management”
- CPIP has a fixed cost to the producer and no
  potential for margin calls
- CPIP requires producer to think proactively
  about his price risk
       CPIP – Key Challenges
- Requires “cultural change” in producer attitudes
  toward risk
- Requires construction of fed and feeder cattle
  indices for policy settlement
- Feeder cattle are more complex and likely
  require more than one product
- Some deficiencies in feeder cattle price data
- Quantifying “border risk” is problematic for a
  private insurer
               Index Design
- Insurance product depends on a viable
  underlying index
- CanFax only viable data source for fed cattle
- Auction markets key data source for feeder
  cattle
- Historical indices were created back to 1990
- Note: Index can provide a platform for a
  variety of risk management products!
        Policy Rating Methodology
-   CPIP similar to a put option
-   Underlying model used is Bermuda-Asian (FinCAD)
-   Non-tradability
-   Key inputs
    - volatility
    - forward price
- Premiums are 75-85% of comparable American style
  options (based on recommended methodology)
- Pricing “border risk” always reverts to the assumption
  used for the probability of it occurring
                     Summary
• Price insurance is one possible approach to
  developing a “made-in-Alberta” risk management
  product
• Fed and feeder cattle price indices may spawn
  other risk management products over time




   www.gibsoncapital.ca

				
DOCUMENT INFO