Dairy Programs in the 2013 Farm Bill:

LGM-Dairy - The Forgotten Third Pillar

Dr. Marin BozicUniversity of Minnesota

Prepared for 4-State Dairy Nutrition & Management Conference

June 13, 2013 Dubuque, IA

Our group…

John Newton Cameron Thraen Mark Stephenson Brian Gould Chris Wolf Marin Bozic

http://aede.osu.edu/dairybriefing

Dairy Policy Timeline (hopefully)

June 2013: Senate and House pass their versions of 2013 Farm Bill

July-August 2013: Differences reconciled in Senate-House Conference Committee

September 2013: Both chambers pass 2013 Farm bill.

2014: Dairies will have one-year to sign up for new programs.

Dairy Policy Timeline

Speaker Boehner: “I’ve got concerns about the farm bills, I told our members. But doing nothing means that we get no changes in the farm program, no changes in the nutrition program. And as a result, I’m going to vote for the farm bill to make sure that the good work of the agriculture committee and whatever the floor might to do improve this bill, that it gets to a conference so that we can get the kind of changes that people want in our nutrition programs and our farm programs.” June 12, 2013

New face of volatility: Income-over-feed-costs margin risk

Three Pillars of New Federal Dairy Policy

Dairy Producer Margin

Protection Program(PDMPP)

Dairy Market Stabilization

Program(DMSP)

Livestock Gross Margin Insurance for Dairy Cattle(LGM-Dairy)

• All-Milk ($/cwt)- 1.0728 x Corn ($/bu)- 0.00735 x Soybean meal ($/ton)- 0.0137 x Alfalfa hay ($/ton)

• Feed ration per cwt of milk: • 30 pounds of shell corn, • 106.4 pounds of corn silage, • 14.7 pounds of soybean meal• 27.4 lbs of alfalfa hay

Income over Feed Costs Margin

• Official name: Dairy Producer Margin Protection Program (PDMPP)

• Two layers: • Basic Margin Protection – “Free” protection at

$4.00 margin• Supplemental Margin Protection – Can buy up

from $4.50 to $8.00 margin in 50 cents increments (called “Coverage Level”)

Subsidized Margin Insurance

Jan-04 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12$0.00

$2.00

$4.00

$6.00

$8.00

$10.00

$12.00

$14.00

$16.00

Basic Margin Protection

Jan-04 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12$0.00

$2.00

$4.00

$6.00

$8.00

$10.00

$12.00

$14.00

$16.00

Supplemental Margin Protection: $6.50 Coverage Level

Jan-04 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12$0.00

$2.00

$4.00

$6.00

$8.00

$10.00

$12.00

$14.00

$16.00

Supplemental Margin Protection: $8.00 Coverage Level

Supplemental Margin Protection - Premiums

Coverage Level Premium Per Cwt (under 4 mil lbs)

Premium Per Cwt(over 4 mil lbs)

$4.00 $0.000 $0.000$4.50 $0.010 $0.015$5.00 $0.025 $0.036$5.50 $0.040 $0.081$6.00 $0.065 $0.155$6.50 $0.090 $0.230$7.00 $0.434 $0.434$7.50 $0.590 $0.590$8.00 $0.922 $0.922

Consecutive Two-Month

Periods2012

Two-month

Average

January 7.57February 5.82 6.70

March 4.94April 4.26 4.60May 3.41June 3.51 3.44July 2.74

August 2.98 2.86

• Calendar year is divided into consecutive two-month periods

• Average margin must be below the purchased coverage level in order for indemnities to be due.

DPMPP: What triggers it exactly?

Consecutive Two-Month

Average

Jan – Feb 6.72Mar-Apr 4.59May-Jun 3.44Jul-Aug 2.86Sep-Oct 5.90

• Basic Margin Protection

The difference between the actual margin and $4.00, except that, if the difference is more than $4.00, the Secretary shall use $4.00

• Example: Jerry subscribed for basic margin protection. For Jul-Aug, payment rate was $1.14 per cwt. If Jul-Aug margin was -$0.50, payment would have been $4.00 per cwt.

DPMPP: What is the payment rate?

Consecutive Two-Month

Average

Jan – Feb 6.72Mar-Apr 4.59May-Jun 3.44Jul-Aug 2.86Sep-Oct 5.90

• Supplemental Margin Protection:

The difference between coverage level and the greater of actual margin and $4.00.

Example: Jerry also subscribed for supplemental margin protection at $6.50 coverage level. For Jul-Aug, the payment rate on supplemental was $6.50- max($4.00, $2.86) = $2.50

DPMPP: What is the payment rate?

Consider the example of a Five Flags Dairy

2013 Expected production: 91,618 cwtHappy IOFC margin: $8.00/cwtHappy IOFC revenue: $732,944

Basic Production History: 89,821 cwtAnnual Production History: 89,821 cwt

Bad memories: 2009 IOFC margin: $4.522012 IOFC margin: $5.31

What would $6.50 coverage level mean under different margin scenarios?

Average Annual Simulated Margin

Probability DMSP Price Boost Shortfall for NON-PARTICIPATING

farm*

Less than $5.00 1.46% $88,620 -$311,509$5.00-$6.00 10.66% $71,405 -$214,702$6.00-$7.00 38.88% $41,191 -$134,956$7.00-$8.00 30.06% $17,377 -$50,761Over $8.00 18.94% $5,458 $69,932

What would $6.50 coverage level mean under different margin scenarios?

Average Annual

Simulated Margin

Shortfall for NON-

PARTICIPATING farm

Premium for $6.50

coverage

Average Realized

Indemnity

DMSP Penalty

Shortfall for PARTICIPATI

NG farm

Less than $5.00 -311,509 -13,803 153,669 -23,881 -195,524

$5.00-$6.00 -214,702 -13,803 81,760 -14,348 -161,092

$6.00-$7.00 -134,956 -13,803 39,107 -7,807 -117,460

$7.00-$8.00 -50,761 -13,803 17,565 -4,267 -51,266

Over $8.00 69,932 -13,803 7,141 -2,195 61,074

Expected impacts of DPMPP on a 360 cow farm in 2013 (based on information on Jan 15)

Coverage Level

Fees & Premium

Expected Indemnity

DMSP Penalty*

DMSP Price Boost*

Net Revenue

$4.00 250 959 -6,612 31,178 -5,903$4.50 1,283 2,260 -6,612 31,178 -5,634$5.00 2,764 4,785 -6,612 31,178 -4,591$5.50 5,322 9,552 -6,612 31,178 -2,382$6.00 9,540 18,260 -6,612 31,178 2,108$6.50 13,803 32,797 -6,612 31,178 12,382$7.00 35,334 52,873 -6,612 31,178 10,927$7.50 47,945 77,081 -6,612 31,178 22,524$8.00 74,784 104,676 -6,612 31,178 23,280

Trigger:- Actual margins of $6.00

or less for each of the immediately preceding two months

- Actual margin of $4.00 or less for the immediately preceding month

Month 2012January 7.57

February 5.82March 4.96April 4.26May 3.41June 3.51July 2.74

August 2.98

Dairy Market Stabilization Program

DMSP: Stabilization base calculation is flexible

The Idea behind Dairy Market Stabilization Program: Small change in Q large change in P

S

D

S′

Quantity

Price

LGM-Dairy – The Forgotten Third Policy Pillar

Scenario Policies Sold

Premiums Paid

Indemnities Received

2008/2009 40 $287,201 $718,035

2009/2010 134 $781,589 $280,566

2010/2011 1,224 $25,012,757 $64,738

2011/2012 898 $19,153,150 $1,317,954

LGM-Dairy: Pricing method is out of date. It does not take into account milk-feed correlation.

Scenario Indemnities Received

Premiums RMA

method*

Premiums – Milk-Feed

Correlation*

Minimum Feed $532,406 $317,493 $316,248

Default Feed $478,725 $342,254 $289,622

Maximum Feed $490,672 $467,167 $327,925

Farm Profile: 500 cows, 9,000 cwt produced/month.LGM-Dairy Policy Profile: 1/3 of anticipated milk marketings in each of 3 most distant insurable months since Jan 2008. $1.10 deductible. LGM assumed continuously available.

LGM-Dairy: Lack of continuous availability is a major obstacle

“Out of fear that the program would run out of funds, many bought more months together than they should have rather than stacking coverage. For our part, we had to back off of selling LGM until we know that the farmer can start with a strategy of stacking coverage and the money will be there to finish the strategy…”

“I would prefer to make them three- or four-months contracts… But we didn't do that because we knew based on the available subsidy we would only have one shot at getting the grower insured.”

10-months contracts have a hidden cost – good margins may not be there when you come back!

Scenario Indemnities Received

Premiums paid (before subsidy

and AO)

Net Cash Flow (per

cwt)

October 2008 $227,886 $31,137 $2.19

December 2008 $105,610 $29,130 $0.84

January 2009 $16,880 $28,860 -$0.13“Looking Ahead”

(Continuous distant 3-month)

$401,986 $82,680 $3.55

LGM-Dairy Policy Profile: 9,000 cwt produced/month. $1.10 deductible. LGM assumed continuously available.

LGM-Dairy Needs to be Reformed

• It should be offered continuously, independently of available budget for subsidies. • Pricing should reflect positive correlation of milk and

feed futures. This can substantially reduce premiums for policies with high declared feed amounts. • Class IV milk should be included to reduce milk price

basis.• More flexibility on feed equivalents – e.g. perhaps

silage costs depend only on corn harvest futures price, not corn price at the later time milk is produced.

DPMPP vs. LGM-Dairy?

Feature DPMPP LGM-Dairy

Subsidies? Pro-cyclical Fixed as % of price

Guaranteed to be able to insure

decent margins?

Yes, price for $4.00-$8.00 is

fixed

No, you can only insure margins that are expected by the

market.

Strings-attached?Mandatory

participation in the stabilization

programNo strings attached.

Genuinely flexible dairy policy would offer a choice of reformed, continuously offered LGM-Dairy with no-strings attached, and with much smaller subsidies than in DPMPP.

Dairy Programs in the 2013 Farm Bill:LGM-Dairy - The Forgotten Third Pillar

prepared for 4-state Dairy Nutrition & Management Conference

Thursday, June 13, 2013Dubuque, IA

Dr. Marin Bozicmbozic@umn.eduDepartment of Applied EconomicsUniversity of Minnesota-Twin Cities