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A Better Way

November 28, 2012
By: Jim Dickrell, Dairy Today Editor
p10 A Better Way
Some tweaks and more regular offerings, say ag economists, would make LGM-Dairy a better risk management strategy.  

With fixes, LGM-Dairy could prove a useful tool

While more than 4,800 Livestock Gross Margin for Dairy Cattle (LGM-Dairy) policies have been written since 2008 and nearly 2,500 have been utilized, it’s a program that is rife with problems.

First and foremost, the contracts have been offered only sporadically since USDA began subsidizing premiums in December 2010. The volume of milk covered has been very low—less than 1% of annual national milk production prior to the subsidies and 2.5% since the subsidies were offered.

Subsidy funding is refreshed every October, the beginning of the federal fiscal year. When those subsidies run out, however, USDA must stop offering contracts—at any price (see below).

Payouts have been meager. Dairy farmers received about $1.8 million in indemnity payments from fiscal year 2008 to 2012. But they paid $25 million in premiums. USDA further subsidized premiums with an additional $21 million and another $10 million in direct payments to insurers for administrative and operating costs.

In other words, participating dairy farmers received just 4% back in indemnities paid and less than 2% of the total cost of the program. In contrast, crop farmers received indemnities equal to an average of 70% of their premiums between 2008 and 2011. If income over-feed-cost (IOFC) margins were good, that level of indemnity payout might not be surprising. After all, you don’t buy fire insurance hoping that it will pay off.

But remember, the period covered is August 2008 through September 2012. "For those 50 months, the number of months a producer could execute a contract is 22," says Andy Novakovic, a dairy economist with Cornell University. "However, 20 of the 22 months during which a producer could buy coverage were among the worst margin performance months for dairy farmers in the last 80 years."

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The implication: It would be easy to expect that indemnity payments would represent a higher percentage of the total cost of the program. By the same token, dairy farmers were constrained by the number of months they could execute a contract, and it’s unknown which months coverage was taken within each contract.

Despite this disappointing performance, dairy economists who participated in a recent research project say LGM-Dairy could still prove to be a useful tool. Working on the project were Marin Bozic of the University of Minnesota; John Newton and Cameron Thraen of The Ohio StateUniversity; and Brian Gould of the University of Wisconsin.

In fact, if the program had been offered on a monthly basis and producers bought contracts in a disciplined manner, dairy farms that grow most of their feed would have cruised through 2009 with barely a scratch. Farms that purchase all of their feed could have eliminated nearly 50% of their IOFC shortfall, Bozic says.

The key is to buy insurance early, often and regularly. Once milk prices fall or feed prices jump, locking in a favorable margin in the near term is virtually impossible.

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FEATURED IN: Dairy Today - December 2012

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