Flexible cash leases for cropland have grown in popularity in Iowa. A 2007 survey showed that 12% of the state's cash rent agreements had provisions for adjusting the rental rate based on actual yields, prices and/or other factors. Recent volatility in corn and soybean prices has pushed that percentage even higher.
Most flexible leases start with some measure of gross crop revenue for calculating the actual rent each year, explains William Edwards, Iowa State University Extension ag economist. The rent may be equal to some fixed percent of the gross revenue, or a rent bonus may be calculated based on a percent of the amount by which the gross revenue exceeds a base level of revenue. In either case, the gross revenue is the product of the farm level actual yield (or county yield) and some measure of actual market price.
Crop insurance indemnity payments—include them in gross crop revenue?
The widespread production losses due to hot, dry weather in 2012 have raised the question of whether crop insurance indemnity payments also should be included in the gross crop revenue used to determine the cash rent. Landowners who are part of a flexible lease contract cannot purchase crop insurance directly because they do not have an interest in the crop; that is, they never actually own any of the grain. However, they can indirectly "insure" their rental payment by including indemnity payments received by the tenant in the gross revenue calculation, says Edwards.
~~~PAGE_BREAK_HERE~~~The premiums paid by the tenant should be subtracted first, however. This is true even in years when no payments are received, he notes. That is, premiums should be subtracted from the gross revenue before the percentage is applied to calculate the rent or bonus. In this way, the landowner is indirectly paying for a share of the insurance coverage, which is supporting the gross revenue and rent each year. Edwards provides the following example.
Example of how to figure this for a crop Revenue Protection policy:
For example, assume a farm planted to all corn has a flexible rent equal to 30% of the gross revenue each year. The tenant purchases a Revenue Protection crop insurance policy with a 75% guarantee for a cost of $20 per acre. The farm's APH (actual proven history) yield is 160 bushels per acre, so the guarantee is for 120 bushels per acre. However, the actual yield turns out to be only 100 bushels per acre this year, 20 bushels per acre below the guarantee. If the indemnity price turns out to be $7.50 per bushel (average of the December corn futures contract price during the month of October), then the indemnity payment will be 20 bushels x $7.50, or $150 per acre.
Subtracting the original premium of $20 would leave a net insurance payment of $130 per acre. Adding this to the gross revenue would increase the flexible rent by $130 x 30%, or $39 per acre, enough to offset the loss in "actual" revenue. If there had not been a crop loss, the gross revenue estimate would have been decreased by the value of the premium, $20 per acre, and the rent would decrease by 30%, or $6 per acre, as a result.
Some flexible lease contracts that call for a base rent plus a bonus will set the base revenue value equal to the tenant's cost of production. If the crop insurance premiums are included in the cost of production value, then it would not be necessary to net them out of the gross revenue used to calculate the bonus -- they have already been accounted for.
Other considerations on handling crop insurance indemnities and premiums
Indemnities and premiums for production insurance policies for hail, wind and are losses can be handled in the same manner as multiple peril policies, says Edwards. If the acres included in the insurance unit include multiple rented or owned farms, it may be necessary to pro-rate the crop insurance proceeds among the farms, based on the size of the losses on each farm.
"How to handle crop insurance premiums and payments should be discussed at the beginning of the lease period," says Edwards. "If no consideration was given to including insurance indemnity payments in the 2012 lease, then the tenant would not be obligated to do so. However, some agreement should be reached about how to handle potential payments in the future."
For farm management information and analysis go to ISU's Ag Decision Maker site www.extension.iastate.edu/agdm and Extension farm management specialist Steve Johnson's site www.extension.iastate.edu/polk/farm-management