Why Every Producer Needs to Take a Fresh Look at ARC and PLC

Tony Jesina, senior vice president of insurance and consumer lending at Farm Credit Services of America and Frontier Farm Credit, sat down with Matt Erickson, our Associations’ agriculture, economic and policy advisor, and Paul Neiffer, CPA, tax principal and agribusiness and business advisor, to talk about the factors that go into this year’s crop insurance decision.

The scenarios discussed are for illustrative purposes only.

Tony: Matt, could you discuss some of the economic changes that producers need to account for when developing their 2024 risk management plan?

Matt: Farmer sentiment is changing. Farmers are feeling some cost-price squeeze. Commodity prices are going down and inputs are increasing. The golden rule, when we talk about how to plan and think about your risk management strategies and practices, is know your breakeven price forward and backward. We have to know the breakeven price for each commodity on our operations. Once we have figured that out, we can understand how to lower those breakeven costs in a tight margin environment.

I've got three factors that I want to talk through here in terms of overall risk management strategies.

1. Make sure you have a strong balance sheet and that it's resilient in today's agricultural economy. That means managing working capital is critical. Working capital serves as a buffer to market volatility and is the basic premise of a solid risk management plan.

2. Manage volatility. Understanding historical seasonality trends for commodities is really important. I know we continue to do that every year. But this year, as we go through this cost-price squeeze, understanding these seasonality trends will be really important. Answering a couple of questions will be important:

• Are there risks throughout the growing season that I'm worried about? We can't predict the future, but we can make the decisions today if we're worried about some of those risks within the growing year.

• Are there products that you can purchase to help alleviate and protect revenue against the revenue side of the ledger? I think that's also important to think about as part of your risk management strategy.

3. Mitigate your downside risk – but also remember to take advantage of upside opportunity when it comes into play. This is the action phase of the three-step approach – employ marketing strategies when it makes sense for your operation and set floors when the market says it's time to act.

This means you have to know your margin forward and backward for 2024 so you can take advantage of those profitable sales opportunities when they come about. Understand that hitting the market high is nearly impossible. Do what's comfortable within your margin.

Tony: Those are excellent points. Our lenders are getting into balance sheets as they're doing line of credit renewals. We've seen a huge difference in the financial performance of operations where producers took advantage of opportunities that were available last year. If they didn't take advantage of some of those market opportunities throughout the year, we’ve seen a lot of erosion in the balance sheet, just because the commodity didn't get sold for what was on the balance sheet for a year ago.

Now, you're looking at a further squeeze in the current market environment, which has not been favorable yet this year.

Matt: I always say, in terms of planning, a pencil does have an eraser and it's okay to erase things and sensitize your budgets. When you get more of the cost ledger side of the things locked in, knowing your margin also means knowing the different price and yield scenarios that make sense for your revenue.

Tony: You also talked about taking advantage of ways to mitigate the downside. I want to pick Paul's brain here because the last couple of years, the decisions you made around ARC and PLC didn't really have much impact, as far as mitigating downside risk. But I think that's changed this year.

So, Paul, let's change gears and talk about ARC and PLC considerations. As producers are looking at Farm Bill elections, what should they be thinking about heading into this current environment?

Paul: The last few years, unless you really had a drastic reduction in your county yields, ARC generally didn't pay and certainly PLC did not come close to paying. So why is 2024 different?

Why is 2024 Different?
     • Increase in effective reference prices
     • Increase in benchmark price for ARC
     • Compression of crop margins makes this a more pertinent decision

Well, we have an increase in effective reference prices. Corn has historically been stuck at the $3.70 level since 2014. This year it has actually increased. The same with soybeans.

But more importantly, in my opinion, we have an increase in what we call the benchmark price for ARC. What is the benchmark price? Well, it's the Olympic average price. In some cases, it's substantially higher than what the effective reference price is. So that likely leads us to think that ARC is going to be better than PLC.

Now the one area – and certainly, you have to discuss this with your crop insurance agent – if you need to take SCO or want to elect SCO, you do have to elect PLC. But I think, at least in the Iowa market, I typically don't see too much SCO. But that may change for your operation.

And as Matt mentioned, we have a deep compression in crop margins. It may be difficult, based on current prices, to even have the breakeven this year, compared to the last three years.

So, what is our effective reference price? Corn increases from $3.70 to $4.01 for the ‘24 crop. But for the ‘25 crop, if the Farm Bill extends, it will actually go up to $4.26. That's the maximum it can reach. Your maximum is 115% of the regular reference price.

Soybeans for this year increase from $8.40 to $9.26 and likely will be $9.66 for the 2025 crop. Wheat remains at $5.50. There could be a little bit of a bump in 2025.

What’s our benchmark price? Corn is $4.85 compared to the $4.01 effective reference price. That means if your county yield stays exactly the same as the benchmark yield, corn on ARC will make a payment if price drops below $4.17.

Benchmark Price for 2024 Crops
Corn - $4.85 compared to $4.01 ERP
Corn below $4.17 pays if yields are constant

Beans - $11.12 compared to $9.26 ERP
Beans below $9.56 pays if yields are constant

Wheat - $6.21 compared to $5.50 ERP
Wheat below $5.34 pays if yields are constant

Now, if your county yield is down 5% or 10%, you definitely are going to get an ARC payment. Whereas if your county yield is higher, then the price would have to drop even lower.

Now the outlook just came out from USDA and they're projecting a $4.40 foreign price for this year. We'll see. That could be that could be accurate, or it might be 10, 20 or 30 cents lower or higher.

For beans, it’s $11 to $12 compared to $9.26. That's almost $2 higher. So, beans below $9.56 pays that if the yields are constant. Now I think the outlook came out with about $11 and change. So that's still quite a way to go.

Then wheat, $6.21 compared to $5.50. Wheat would have to drop below $5.34 if yields are constant. That means PLC would actually kick in quicker than ARC on wheat. 

If your PLC yield is 180 bushels per acre, your benchmark yield is 200. We take that, we multiply by the benchmark price. It's $4.85. We’ve got $970 of what we call benchmark revenue. Our maximum that we collect on ARC – and remember there is a maximum on ARC and there's not on PLC, other than the overall $125,000 per producer payment limit – so we have a maximum limit of $97 per acre. Our benchmark guarantee is 86% of that number. So, until our actual harvest revenue drops below $834.20, we're not going to collect anything.

Let’s just look at what the prices might be if our county yield is exactly equal to our benchmark yield. You know at $4.50, we're going to collect nothing. If it dropped down to $4, then we would collect $34 of ARC and $1.80 of PLC because remember $4.01 is where PLC starts kicking in. And if that dropped all the way down to $3, we’d have a tentative payment of $234 on ARC. But remember, we're limited to $97 per acre, and PLC would kick in around $180.

Now certainly nobody is rooting for pricing to drop all the way down to $3. But could it? We don't know. That's something to just to be aware of. 

I kept the yields the same. If our harvest price is exactly equal to the effective reference price, we would get a payment on soybeans and no payment on PLC. If soybeans were $8.50, we'd have a $58 payment on ARC and a $38 payment on PLC. Finally, if we drop all the way down to $8, that's at the point where PLC payment would be higher than ARC payment.

Now I don't think we're going to get that low. But this just gives you an idea of the type of payments that you might see.

At $7 of harvest price, which I think the current estimate is somewhere in the $6 range, we’d actually see a tentative payment. Now I did drop the county yield. So that's why we're showing a payment here. You can see tentative payment at $5.50 is $97.25, but we're limited to $49.68. There's no PLC payment. And then finally, if we drop all the way down to about $5, we're looking at about a $35 PLC payment and we're still maxed out on wheat.

In most situations, ARC will pay quicker, especially on corn, than PLC will pay now. That's assuming we don't have a dramatic increase in yields.

If we have a dramatic increase in yields and the price really drops, then likely, PLC is actually going to pay a little bit quicker due to the fact that the county yield has gone up so much.

Tony: Thanks, Paul. That’s very helpful. If your concern is prices, whether prices might slightly move higher or move lower, it looks like for corn, soybeans and wheat, ARC is likely the more viable option. If your concern is both lower prices and lower yields, then PLC probably needs to be considered, especially because with PLC, you can add on SCO.

Paul: Correct. You can still do ECO with either ARC or PLC. But if you want to add SCO, you have to elect PLC. Also, a lot of farmers have multiple farms. They may look at it and say on these three farms, maybe we’ll elect ARC and on these three farms, we elect PLC. Especially if they're likely to be substantially over the payment limit, you might as well even out your risk and spread it out between ARC and PLC.

Tony: Yes, you can hedge your risk a bit that way. Now another consideration that comes into play when you start looking at ARC and PLC is that both of those pay on base acres. It's an important consideration: What am I considering for planted acres relative to base acres? If you're going to have a big mismatch there, then some of these other options might come into play. If you've got a lot of exposure – you don't have a lot of base acres, but you're planting a lot of acres – then would you suggest you look at PLC and SCO? Or ECO also is an option because both ECO and SCO will pay on planted acres versus base acres.

Matt's comments earlier about how your best defense is your balance sheet and your working capital – that's the shock absorber for your operation. These are complex considerations. Coupled with the whole balance, your risk management plan has probably never meant more to your operation than it does this year.

Paul: Exactly. And again, we have to be cognizant that these payments will not come in this year. The earliest the payments would hit your balance sheet is October 2025. 

Tony: Good reminders. There’s just a lot of things to consider and I'm going to put in a plug that it's not business as usual. There's a lot more things to consider than just what we've had in front of us the last couple of years.

I'd highly recommend you work with a trusted advisor who has access to tools that allow you to do the what-if scenarios that Paul mentioned. What is your yield? What does your operation look like? What do your base acres and planted acres look like?

We've equipped our team members with those types of tools and can help producers make more informed decisions.

To start a conversation about your operation's risk management plan, reach out to your Farm Credit Services of America insurance officer or complete the request form.

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