A Theory of Subsidy Harvesting in Livestock Price Insurance

USDA designed the Livestock Risk Protection (LRP) program to help producers insure against declining prices for fed cattle, feeder cattle, and swine. Prices in derivatives markets determine program indemnities, making LRP policies similar to put options. Beginning in 2019, USDA made several changes to the program to encourage producer takeup, including increased premium subsidies. We introduce a theoretical model to show that subsidizing LRP premiums invites producers to “subsidy harvest,” i.e. extract the subsidy as an arbitrage by simultaneously taking an offsetting position in the options market—potentially removing the downside protection the program was intended to provide. The subsidy harvest is a pure rent and costlier than a direct payment because it requires administrative oversight and federally-subsidized delivery through approved insurance providers. According to the model, the government’s premium subsidy leads producers to favor LRP-oriented strategies over market options alone, while their choice to offset actual risk protection using options depends on individual risk tolerance and wealth objectives.