Insuring Uncertainty in Value-Added Agriculture: Ethanol Production
Nick D. Paulson, Bruce A. Babcock, Chad E. Hart, Dermot J. Hayes
April 2004 [04-WP 360]
Paulson, N.D., B.A. Babcock, C.E. Hart, and D.J. Hayes. 2004. "Insuring Uncertainty in Value-Added Agriculture: Ethanol Production." Working paper 04-WP 360. Center for Agricultural and Rural Development, Iowa State University.
A wide variety of insurance products is available to agricultural producers to insure against yield or price risks in the markets for the raw commodities they produce. Value-added enterprises, such as ethanol production, have been expanding over the last decade. This paper outlines the development of an insurance product aimed at corn producers who are members of an ethanol production cooperative. The product has the potential to provide these producers with a new and useful risk management tool to insure against price risks in the markets for corn, distillers dried grains with solubles (DDGS), ethanol, and natural gas. Monte Carlo analysis is used to develop fair premiums at various coverage levels. A historical correlation structure is imposed on the simulated price data using a method proposed by Iman and Conover (1982), which maintains the marginal distributions of the variables. Historical analysis is carried out to examine how the product would have performed had it been offered over the last decade. The product is shown to perform as intended, paying indemnities in years of extreme price volatility.
Keywords: correlations, ethanol, insurance, risk management, value-added agriculture