Will dairy margin insurance be for you?

CEWN-MR-1-Dairy Margin Insuranceby Steven E Smith

By Sept. 1, the U.S. dairy industry should have an entirely new USDA dairy policy in place. Once the new program rules of the Agricultural Act of 2014 are in place, gone will be decades old milk price support programs, the Dairy Exports Incentive Program and the limited MILC program. Without the weighty coexistence of the SNAP and other domestic food assistance, the 2014 Farm Bill, known as the “Farm Only Bill” includes the provision of federal margin insurance program for the U.S. Dairy industry in this era of global marketing expectations and a shift from disaster payments to risk management.

Farming by the numbers

Profitability in dairy farming is becoming closely linked to the business manager’s penchant for knowing their numbers. The new Farm Bill program will provide an opportunity to couple that management practice with insurance coverage for periods of low milk price and/or high feed price. The insurance is designed to generate a payment for program participants according to the profitability of marketing milk with respect to a national margin calculation. Margin is defined as the difference between feed cost and the national all milk price. The program will use the national all milk price less an equation to arrive at the average feeding cost derived from the value of corn, soybean meal and alfalfa hay. The value for all milk, corn and alfalfa hay prices will be those reported in the national average agricultural prices report published at the end of each month. The soybean meal price will be from the Central Illinois region quote reported by Agricultural Marketing Service of USDA.

Premiums

While the USDA is still developing the specific rules for this program, the current projections are the following. Farms that participate must register their operation. This is projected to be an annual $100 registration fee for the first four millions pounds of production at the $4 margin level. At each annual registration, the farm business can buy up additional coverage in 50 cent increments and elect the percentage of coverage. Those premium costs per hundredweight are two separate cost structures based on the farm’s base production levels below and above 4 million. A table explaining the premium costs for each production level from www.pubs.ext.vt.edu was included. These premium costs are fixed for the life of the Farm Bill. Note that the premium costs are reduced by 25 percent for years 2014 and 2015.
Besides having the flexibility to determine the margin level, the dairy producer can also select the percentage of coverage which can range from 25 percent to 90 percent of the annual base. By giving the dairy producer the power to determine their level of coverage, this is the most flexible farm program that has ever been offered.

Base and payment

Each farm program participation cost will start by considering the annual production base. The annual production base for existing farms will be derived from the high of milk produced in either 2011, 2012 or 2013. New operations will have an annual base assigned relative to their cow numbers or when present, partial year records. Payments are generated when the national margin falls to the program participation level selected by the farm. National margins will be determined for six specific bi-monthly periods starting with January-February. Since the margin calculation will be generated from national price figures, the expectation is that payments in periods of low margin will generate after prices are reported and USDA offices complete individual calculations for participants.
Donation program
Another element of the 2014 Farm Bill that will assist the industry when margins are low is the Dairy Product Donation Program. This program can be implemented by the Secretary of Agriculture when the U.S. Dairy Margin calculation falls below $4 per hundredweight for the preceding two months. The program permits the Secretary to purchase specified dairy products at prevailing market prices which are distributed to public and private not-for-profit organizations to distribute to low income families. The donation program is suspended when either it has run for three consecutive months of operation or the margin increases above $4 or the U.S. margin is between $3 and $4 and the U.S. prices exceed the world prices by more than 5 percent or the U.S. margin stays below $3 but the U.S. prices exceed the world prices by 7 percent or more. Although the current legislation provides only vague guidelines for the amount of purchases, an improved feature of this program is that the Secretary’s purchases are not going into storage to only negatively impact prices in the future when those would be released.

Things to consider

The U.S. dairy industry felt the impact of the challenging years of 2006, 2009 and 2012. When considering the new margin insurance program, dairy businesses may consider how the program would have worked during the recent past. While developing this Farm Bill, legislators had the Congressional Budget Office calculate the historical margins for milk over the time period from 1997 to 2013. That national average for margin between feed and all milk found the margins for 2006, 2009 and 2012 to be roughly, $6, $2 and $3 margin per hundredweight for the aforementioned years.

It would be very advisable for farms to know their own margin. Those businesses that can determine their margin and evaluate it in comparison to the national margin calculation will have a better understanding of how this program could assist them to avert their risks. Additionally, consider the industry participation when considering whether to opt out or not. With the program, if the U.S. dairy producers experience lower margins in a year when there is high national participation it could be possible for the low margin scenario to persist longer.

It’s about risk management

High Risk operations might be wise to closely evaluate the insurance program features. When considering what participation in this new program will look like, farm businesses will want to know their own margin and what factors could affect it. For farms that purchase most of the nutrition such as complete feeds as well as some of their forage, then the relative trend of feed costs could represent a greater risk to their margin. Likewise, when dairy farm businesses are evaluating their future margins, they need to consider what may happen with their milk price. Currently, the dairy industry is experiencing higher margins than previous years because there has been a reduction in the cost of feed ingredients while the foreign demand for dairy products has increased the price for milk. Interaction with agricultural lenders to determine level of risk could provide insight. It is also possible that lenders were advice specific borrowers to buy coverage based on the financial stability of the farm business.

While the USDA is currently developing and refining program rules that will align with the federal legislation, the U.S. dairy industry needs to begin to consider how using insurance to protect during low margin time periods will provide features and benefits that best suit their particular farms. By looking at the calculation and understand your specific farm’s margin, dairy business managers can make the consideration now for how this new, dynamic risk management program could serve be a better government program for dairy businesses in the future.

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