It’s important to understand what this program protects and what it doesn’t.
By Chip Whalen, CIH
Many dairy producers we work with have asked us recently about the new Margin Protection Program (MPP) that has been implemented as part of the 2014 Farm Bill.
As most readers are already aware, this insurance plan will replace the previous LGM program (Livestock Gross Margin for Dairy) in providing protection against deteriorating profit margins based upon a formula comparing the U.S. All-milk price against national average feed costs.
There is a $100 administrative fee to sign up, and the program will run for the next five years through 2018. The specific program details were finalized on Aug. 28. Dairy Today editor Jim Dickrell did a nice job of summarizing those details a couple weeks ago.
The one main question everyone appears to be asking is, "Now that the program is available and the sign-up period has begun, do I really need any other form of risk management for my dairy?"
First, it is important to understand what this program protects and what it doesn’t. Because the formula is based on national prices as released by USDA, the margins calculated may not accurately reflect actual profitability on any specific dairy farm. The calculation also does not take into consideration operating costs. As a result, an indemnity payment may not actually trigger, even if the dairy is already experiencing negative margins.
Moreover, it is also important to realize the intent of this program in the context of the larger farm bill. In the verbatim text of the National Milk Producers Federation (NMPF) narrative introducing the Dairy Producer to the Margin Protection Program, it states, "It will help prevent against the catastrophic losses that many dairy farmers experienced in 2009 and again in 2012." The overview of the Margin Protection Program on NMPF’s website also states, "Its focus is to protect farm equity by guarding against destructively low margins, not to guarantee a profit to individual producers."
Reading between the lines, one might interpret this to mean that the program is meant to address a disaster scenario of extremely negative margins as existed in those particular years. A little further into that same document, NMPF details a chart showing the MPP Margin and Coverage Levels over the past ten years from 2004 through 2014. They note that overall, the margin has averaged around $8.50/cwt. since 2004 (the chart is reproduced below).
The details of the program stipulate that a dairy producer can cover a maximum margin of $8.00/cwt. on up to 90% of historical production, which will be based on the dairy’s highest production in each of the past three years (2011-2013). For an operation producing in excess of 4 million pounds annually, insuring the production beyond that level will cost $1.36/cwt. NMPF also provides a table illustrating what the cost would be in dollar terms for a particular dairy. A typical 1,000-head dairy operation could expect to pay $266,206 in annual premiums to insure an $8.00/cwt. margin on 90% of their historical production.
Looking at the chart, the current MPP Margin is indicated at about $12.00/cwt., well above the historical average for the past 10 years.
Getting back to the original question of whether or not a dairy needs any other form of risk management besides this current program, an obvious question is, "What about the margin between the current $12.00/cwt. indicated by this chart and the maximum $8.00/cwt. margin that can be covered under this program?" If I am that typical 1,000-head dairy operation, I might also want to ask how else I might spend over a quarter million dollars to protect profitability in the open market. In other words, if I were to purchase options on the board to protect a minimum price of milk and a maximum feed price, might that possibly be a better deal?
It is important for individual producers to understand what their specific profit margins are projected to be through next year, and what alternatives are available to protect those margins. One interesting feature of the program is that the premiums are fixed over the next five years, and there is an annual signup provision. This means that a dairy producer can elect whether or not to participate in the program at all, or if they do, at what level of coverage they want to enroll for on an annual basis.
The signup period runs through Nov. 28 for the current year and all of 2015, and runs from July 1 to Sept. 30 next year for 2016 with a similar schedule for all subsequent years.
While the MPP may look quite compelling in the future depending on how profitability develops for dairy producers, it would at best appear to be an incomplete solution to managing the profitability and opportunities that exist today.
As Vice President of Education & Research at CIH, Chip Whalen is responsible for developing and conducting all of CIH’s Margin Management seminars. He is also the editor of CIH’s popular Margin Watch newsletters. Whalen can be reached at (312) 596-7755 or email@example.com.