"Because counter-cyclical (CC) payments are not based on a farmer's current production, they are often thought of as having an insurance effect, where an indemnity is triggered by the season average price," says Robert Hauser, U of I Extension marketing specialist. "Our study indicates that CC payments and multi-peril crop insurance (MPCI) payments are not highly correlated and the CC program should not be viewed as an important substitute for crop insurance."
The study, "Counter-Cyclical Payments Versus Crop Insurance," was conducted by Hauser and colleagues Bruce Sherrick and Gary Schnitkey in the U of I Department of Agricultural and Consumer Economics. It is available online in the Illinois Rural Policy Digest at http://www.farmdoc.uiuc.edu/policy/digest/digest.html.
During the spring, agricultural producers make decisions to purchase or not purchase crop insurance policies and Hauser and his colleagues believe it is important to correct the misperception that the CC payments provide, in effect, a form of crop insurance.
Under the 2002 Farm Bill, the size of CC payments is determined by the average market price during the year in which the crop is marketed. CC payments received by farmers between 2002 and 2007 will not depend on how much is produced on the farm during this 2002-07 period.
"CC payments will vary with market prices," says Hauser. "Lower market prices can lead to higher CC payments and vice versa. Some have argued that this relationship creates an insurance effect where CC payments help offset the negative impacts of low prices."
To test this idea, Hauser, Sherrick and Schnitkey constructed an economic model that tested the "insurance" value of CC payments versus MPCI. A number of scenarios, each generating a distribution of 3,500 revenue outcomes, were played out through the model.
"If CC payments represent a form of insurance, then a reasonable question is whether CC payments behave similarly to payments from existing MPCI products," says Hauser. "It turns out that they do not. CC payments are triggered differently so it is not surprising that there is not a high correlation between CC payments and MPCI.
"The principal reason for this is simple. In March, if the new-crop price is relatively low, there is a high probability of a CC payment. If the price is high, there is a low probability of receiving a CC payment. On the other hand, the probability of receiving an October MPCI payment does not depend greatly on whether the new-crop price level in March is relatively high or low."
The study also indicates that producers need to establish an appropriate revenue measure when considering the risk-reducing effects of MPCI products.
"The type of risk reduced by the MPCI products is fundamentally different than that reduced by the CC program," says Hauser. "MPCI products reduce risks within the year, but do not help maintain income at a particular level across years. The CC program helps maintain income across years, to the extent that price reflects income."