May 29, 2018
Rethinking ARC and PLC
By David Widmar
At present, it appears the new Farm Bill programs – at least for ag producers- will look a lot like the previous programs. In some ways maintaining the status quo may in itself be a victory for agriculture, but we thought it would be useful assess the current Agricultural Risk Coverage (ARC) and Price Loss Coverage (PLC) components of the farm bill.
The 2014 farm bill gave producers the option to choose between the ARC or the PLC programs. The ARC-CO program was designed to make payments when actual county revenues fall below 86% of a county’s benchmark revenue guarantee and cannot exceed 10% of the benchmark revenue. The benchmark revenue is calculated by multiplying the 5 year olympic average county yield by the 5 year olympic average of the market year average price for a given commodity.
The determination of PLC program payments is more straightforward. Payments are triggered when the price of the given commodity falls below the commodity’s reference price. Payments are then determined by multiplying the price difference by a farm’s PLC yield for that commodity.
Corn and soybean farmers overwhelmingly chose to enroll in the ARC-CO program, with 91% of corn and 96% of soybean farmers making the ARC-CO election. ARC-CO was also popular with wheat producers as 66% of the wheat farms selected ARC-CO.
We have discussed how the structure of the ARC-CO program basically results in falling payments in the face of prolonged declines in farm incomes (here and here). If you hadn’t already guessed, we feel that there are a few undesirable features of the ARC-CO program. With that in mind, we will try to lay out some of these below. While we understand that it is difficult to write a perfect program, there are likely a few changes that might improve the program.
1. ARC and PLC are Poor Risk Management Programs
Risk management is apparently the trending phrase or buzzword for agriculture. You see it everywhere and expect it to be used to described the upcoming Farm Bill and associated ARC and PLC programs. In our opinion, this is big stretch. Specifically, ARC and PLC are poor risk management programs based on two factors:
Consider this, for corn and soybeans planted and harvested in 2018, the payments will be made in the fall of 2019. This is a significant disconnect between the economic challenges triggering a potential payment and the economic benefit the program would potentially create.
On the surface, the reason for the delay is that payments are calculated using market year average prices (MYA). These prices take nearly a year to calculate. For the corn crop planted in 2018, the MYA will be set between September 2018 to August 2019 (for the 2017/2018 MYA price). For more, see our post here.
The rationale is that payments cannot be made until the MYA price is calculated, hence the year delay. However, other risk management tools, such as crop insurance, use different and more timely payment methods.
It’s worth pointing out that, for the 2018 corn and soybean crops, payments will be made in the Fall of 2019, which happens to be the Federal government’s 2020 budget year. So the crop is planted in 2018, payments are made in fall of 2019 and booked on the federal government 2020 budget. The reason behind this is beyond the scope of this post, but chalk it up to creative accounting and negotiating the budget impact of the Farm Bill.
It’s hard to imagine fixing this payment gap as it would require 1) skipping payments for a production year or 2) making payments for two years of production in one government budget year.
Payments Unknown, Nearly Impossible to Predict
The second element of any risk management tool is being able to anticipate the size of any potential payment. Again, think about crop insurance. Producers in March have a really good idea about revenue guarantees and worst-case scenarios for the upcoming crop year – before the crop is planted.
In addition to contributing to delayed payments, using MYA prices creates uncertainty as to the magnitude of the payments. For corn, the final MYA price for the crop planted in 2018 won’t be final until after August 2019. While MYA prices can be, and regularly are, forecasted, these are forecasts and it takes months to get confidence in what the final number might be.
Uncertainty about payments also comes from county-level yields for the ARC-CO program. As of writing this post (end of May), county-level yields for ARC-CO are not posted from 2017. While there are ways to estimate them from other reported yields, it’s an estimate, and it’s not something most farmers will do.
2. County-Level Data Headaches
For the popular ARC-CO program, county-level yield data are necessary for 1) setting the payment benchmark and 2) determining payment edibility. The determination of payments based on county yields is a good idea, but difficult to execute. Getting enough data – usually survey data- about each county to have statically reliable yield estimates can be difficult.
It’s worth pausing to consider how accurate the county-level yield estimates are. We would contend even small errors in a county-level yield estimate can have a major impact on payments made to producers. Specifically, when payments are “in the money” small errors can swing payments substantially. Each bushel increase or decrease swings the payment by the market year average price on the paid acres. Compounding the headache, a single yeild estimate is factored into 6 years of potential payments- the production year for the potential payment, and the following 5 years of benchmark yields.
This is a challenge the USDA is aware. In 2017, the National Academies of Science issued a report that noted this very issue:
“As demonstrated in a presentation to the study panel by FSA, relatively small variation in a county yield estimate can result in relatively large changes in subsidy payments and possibly in a payment’s not being triggered at all. Substantive variability in payment rates from one county to the next also can be driven by these yield differences.” – “Improving Crop Estimates by Integrating Multiple Data Source.” A report by The National Academies of Sciences, 2017.
To our knowledge, the potential errors with county-level yields have not been discussed beyond high-level thought exercises. It would be interesting to see data that 1) shows the statistical confidence of county-level yields and 2) discusses how errors with county-level compare to potential payments.
3. Loaded Dice: 5-year Olympic Average
The ARC-CO program relies on benchmark revenue target to trigger a payment. This benchmark relies on a 5-year Olympic of county-level yields. Setting an appropriate benchmark yield is, frankly, difficult. Benchmarking yields over a long period of time- say 10 or 15 years- falls victim to the upward trend in yields over time. On the other hand, a shorter period of time is heavily impacted by a couple of really good – or bad – years.
The 5-year Olympic average tries to strike a compromise between long and short run yields, but can still be frustrating as the Olympic average results in good outcomes for some and bad for others. It just depends on how close in time the really good or really bad yields are clustered.
In an early post, Brent took a closer look at how big of an impact this can have (here).
4. Fails to Manage Long-Lasting Risks
As the earlier point eluded to, the ARC-CO program really fumbles if producers are unfortunate to have a cluster of two or three really bad years. While the low yielding year may have triggered a payment, poor years erode future potential benefits.
This is also the case on the commodity price side. A single year dip in commodity prices isn’t a challenge (given the 5-year Olympic average method for calculating benchmark prices), but a string of low prices will erode the programs future coverage potential.
Think about the last 4 years. Most of the payments received from the ARC-CO program occurred because of high benchmark prices. These payments were very initially very helpful in the farm economy downturn. However, the ARC-CO program has reached a cliff of sorts in recent years. High prices are long gone and low prices dominate the benchmark. This means that even with continuing low farm income, payments will dwindle and reach zero for many.
Consider this, should the farm economic conditions of the last four years be repeated over the next four, ARC payments would be greatly reduced given the lower price benchmark. Or, in other words, the ARC program would pay less even though low prices and a difficult farm economy may persist.
Wrapping it Up
For many, the ARC program made substantial payments in the early years of the farm income downturn. While the payments have been helpful during the farm economy slowdown, it’s likely the nuances of the program have been overlooked by many. Furthermore, it’s likely these nuances will become quite frustrating and obvious when the ARC program is likely to pay less in the future. Or, in other words, a paying program has few faults, a program that doesn’t pay has lots of faults. That is clearly what ARC is on the verge of becoming.
If the current price situation remains depressed the PLC program, with its fixed reference price, will likely be preferred by most producers. This is not to say that the PLC program doesn’t suffer from some problems, but its simpler and more straight-forward payment mechanism is appealing. Further, the fixed reference prices associated with PLC provide more downside price protection in a depressed commodity price environment. Because PLC doesn’t require county level yields for payment determination, it would also be much easier to issue advance payments in times of low prices. This would help solve the timing problem and provide a better risk management option for many farmers.
The development of the new farm bill is sure to take many twists and turns in the coming months. It seems that there is quite a bit of momentum to produce a program that is similar to the last one. From our perspective, there are some significant problems with the ARC-CO program that reduces its ability to truly help with risk management. Of the two programs PLC probably has more potential to fill this role and could be more easily modified to do so. On the other hand, PLC won’t make payments when commodity prices take short-term dips from relatively high levels, like the ARC program. Farm policy is always constrained by many different factors from politics, to budgets, to economic considerations, to societal concerns and it will be interesting to see how this one evolves.