Livestock gross margin insurance available for dairy producers
Carol Stender
Date Modified: 12/10/2009 10:19 AM
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Agri News staff writer
LONG PRAIRIE, Minn. -- Todd County Extension educator Randy Pepin wants dairy producers to consider a milk pricing plan alternative that uses margins.
Pepin says the milk marketing tool has been available since August 2008 and could give the dairy industry flexibility.
USDA's Risk Management Agency calls it the "Livestock Gross Margin for Dairy." It's available in Minnesota and 35 other states.
The Livestock Gross Margin for Dairy focuses on the margin between the milk price and feed inputs and not the actual price of milk or the actual cost of feed inputs, he said.
"A rough description of this margin might be the term, 'Income Over Feed Costs,'" he said. "It is essentially equivalent to obtaining a put option on Class III milk and call options on corn grain and soybean meal, but doing it all in one transaction."
Usually, to do this, a producers would need to enter into three separate option contracts which, due to minimum size requirements, eliminates smaller farms from participating. The Livestock Gross Margin for Dairy has no minimum size requirements, but the maximum milk volume a farm can purchase insurance for is 24 million pounds of milk per year.
Just like an option contract, if the actual margin is better than the insured amount, the producer can take advantage of the actual prices, he said.
Livestock Gross Margin for Dairy is an insurance policy designed for milk producers and isn't available to speculators, he said. The dairy farm must work with an insurance agent certified to handle the program which is a separate certification through the RMA Federal Crop Insurance Program.
The program only considers the futures market settlements for the month under consideration, not actual feed costs, actual milk price or milk contracts a dairy farm may have. When a dairy farm makes an insurance claim for a given month's margin, that farm must bring in a month's milk receipts to justify the insurance payment.
Before signing an insurance contract, the dairy farm must examine its grain and protein usage, use formulas created by RMA to convert commodities to corn and soybean meal and then determine the appropriate amount of corn and soybean meal to use.
The farm then evaluates the margins on the board for the next eleven months, not including the next month, for a net of 10 months, Pepin said.
"In other words, if the dairy farm is considering this at the end of December, the farm can buy insurance on the margins for the months of February through November," he said.
RMA posts the average futures settlements based on the last three trading days at 3:30 p.m. on the last business Friday of each month. The dairy farm has until 8 p.m. the next day, Saturday, to purchase the insurance. If the farmer likes the margin for a given month, the farm can lock in any amount of milk volume up to the expected milk sales for that month and buy an insurance policy on that margin.
The last decision to be made is how much of a deductible to take. Like all insurance deductibles, the higher the deductible, the lower the premium, he said. Deductibles can range from $0 to $1.50 per hundredweight of milk.
Until all calculations are given for a given month, the amount of the insurance premium for the program can't be determined, he said. The premium amount will vary with the milk dollar per hundredweight deductible, number of months in the contract, the present market volatility and the amount of corn and soybean meal included in the policy. Insurance premiums have ranged from 10- to 85-cents per hundredweight of milk. RMA requires advance payment of insurance premiums.
There are few insurance agents who have taken the measures necessary for certification to handle the Livestock Gross Margin for Dairy program, Pepin said.
"One thing the dairy industry may have learned over the last couple of years is the need to do more than just lock in a "good" milk price," Pepin said. "Dairy producers must also protect themselves on the input side. The Livestock Gross Margin for Dairy program is not a perfect system and cannot always place a farm in a profitable position. However, it may allow a producer to lock in some higher margins that periodically appear on the futures market. IN the end, it is really the profit margin and not the actual prices that count."