Managing Cattle Market Risk with LRP Insurance
Price and market uncertainties pose a significant risk to cattle producers with a substantial amount of money invested in breeding livestock, land, and other infrastructure. Price protection through the Chicago Mercantile Exchange (CME) futures contracts and options can be used to help mitigate this risk but, in the case of futures contracts, they can also introduce financial burdens in the form of margin calls. Furthermore, many medium to small-scale producers prefer not to get involved with trading futures and options contracts.
Livestock Risk Protection (LRP) insurance became available in the early 2000’s from the USDA’s Risk Management Agency to provide cattle producers with a price risk management tool that helps protect against unexpected downswings in the national market price. LRP is a single-peril insurance product that provides an indemnity to insured producers if a national cattle price index falls below a selected coverage price on the end date of the policy. Even though it functions much like a put option in that it creates a floor on the national selling price for cattle at a future point in time while still allowing the producer to benefit from price increases, it is not an actual put option that can be exercised or sold at any time before expiration to turn a profit on its intrinsic value. LRP is a European put in principle. It is a commitment to an endpoint in terms of determining value. However, for cattle producers interested in protecting value at a particular date in the production year cycle, it may be a good choice to help them mitigate that market risk.