Mad cow: last minute insurance stampede

Risk & Insurance, March, 2004 by Kim Bower-Spence

Gena Ott was running a Christmas errand a few minutes before 5 p.m. Dec. 23 when her cell phone rang. Bovine spongiform encephalopathy--mad cow disease--had infiltrated the United States, and three cattle producers waited at her office to buy Livestock Risk Protection insurance.

This financial officer and crop insurance agent wheeled her car back to Frontier Farm Credit, Emporia, Kan. "The office was filling up with people," she recalls. "People were anxious."

Before Dec. 23, she had written five LRP endorsements. "We wrote another 12 endorsements that night coveting over 5,800 head of cattle. We have a waiting fist of another 20 producers who were interested in coverage that evening or since then."

They were still waiting in late January as the U.S. Department of Agriculture's Risk Management Agency evaluated LRP for fed cattle and feeder cattle pending suspension of sales about 7:30 p.m. Dec. 23. "We're waiting for the market to stabilize," reports spokeswoman Shirley Pugh, explaining why RMA had yet to resume sales. "We've made no decision."

"The insurance business should not be a guessing business," she adds. "We owe it to the taxpayers and to the Congressional oversight to have an actuarially sound program." LRP-Swine insurance continues to be offered.

The BSE news sent cattle producers, who had been riding record high cattle prices through fall, stampeding to protect profits with LRP. Premium sold in this pilot program, available for feeder and fed cattle just since June 2003, leapt from $1.67 million the week prior to Dec. 23 to $3.63 million by the time RMA halted sales. That's according to Applied Analytics Group, which developed and maintains the product for RMA.

"Our liability more than doubled in the two and a half hours between the time that the secretary made the announcement and we stopped the sales," from $60 million to $128 million, notes Pugh.

BSE is a degenerative neurological disease in the stone family as chronic wasting disease in deer and elk, and Creutzfeldt-Jakob disease in humans. BSE rouses fear because a new variant of fatal CJD is thought to result from eating cattle products contaminated with the agent that causes BSE.

The LRP-Feeder Cattle coverage was available in Colorado, Iowa, Kansas, Nebraska, Nevada, Oklahoma, South Dakota, Texas, Utah and Wyoming. The fed cattle product was offered in Illinois, Iowa and Nebraska.

LRP allows producers to protect against tumbling prices by buying an insurance contract with a specified coverage price. Premium rates, coverage prices and actual ending values had been posted online daily.

Producers had until 8 p.m. to buy based on the previous day's market price. "I saw this as somewhat of a selling point," says John Lawrence, Iowa State University ag economist and director of the Iowa Beef Center. Guaranteeing the previous day's price after a market-altering event "was an idea that resonated with people."

Kansas State University agricultural economist Art Barnaby says, "I told farmers to immediately get themselves a policy, that it had this hole in it that could allow them to buy in light of a disaster." He likens it to buying fire insurance as the house burns--also called adverse selection.

David Bracht, an attorney and risk management consultant for the industry group Nebraska Cattlemen, argues it's not adverse selection because rebounding cattle prices mean policy holders might not collect indemnities. "We won't know until March 22," when the first fed cattle contracts written Dec. 23 expire. The question is, he says: "Is my house burning three months from now?" Product developer Peter Griffin, Applied Analytics Group, contends the program "is actuarially sound." But he concedes it would probably perform better if sales were spread more over time.

Barnaby advises limiting daily sales to a percentage of the total book sold. Another option would be to automatically shut down sales if the market lock-limits up or down. The agriculture secretary must possess authority to suspend sales at any time for any reason, and that must be made clear to producers, he asserts.

Bracht reasons, "That's why you have pilots."

Barnaby hopes RMA will revise and move forward with the program. "The longer they leave it off the market, they're sending the message that they're not a reliable risk management source." Lawrence believes it will take a while to rebuild trust among producers.

Late-January cattle prices hovered $3 above the Dec. 22 guarantee, Barnaby notes. Griffin contends the cattle market had stabilized. Applied Analytics Group at that time projected indemnities at about $3 million, on $3.7 million in premium. Actual calculated indemnities for the 2004 reinsurance year stood at about $68,000. So going back to the fire analogy, it looks like the fire department may have arrived in time to limit damage to only the deductible, says Barnaby.

That's OK with cattleman Lonnie Roth of Wisner, Neb., who was among those who successfully scrambled for LRP hours before it closed. "I felt better" says Roth, who also had some protection with futures. "I just was hoping it was something we wouldn't be able to collect on."