Know Your Market
LGM for Dairy: A Bridge between Lender and Producer
May 22, 2014
This milk price protection plan program can manage your risk and offer lenders the financial security they seek.
By Ken Hartzell, Dairy Gross Margin, LLC
Dairying in 2014 and beyond will be as challenging as it has ever been. It is no secret it will require more capital. Plus, like the past 10 years, there is more price commodity price volatility. More money and more price risk add up to increased risk for both the producer and the lender.
As the need for capital grows and risk increases, how does a producer ask for capital and yet satisfy the lender’s need to reduce risk? The first step is, of course, communication. The second is a risk management plan. Think about it from a lender’s perspective. As some bankers have commented, their goal is to have "security without micromanaging."
One way to help provide this "security" could be a Livestock Gross Margin for Dairy (LGM-Dairy) policy. The idea behind LGM seems complicated, yet it is really very simple. It offers a milk price protection plan with a feed component thrown in.
Here are some key points about an LGM-Dairy policy:
1. The premium (using a two-month coverage minimum) is subsidized at 18%-50%, depending upon the deductible chosen.
2. The premium is due at the END of the insurance period.
3. The producer chooses amount of milk to insure each month (does not have to insure 100% production).
4. The producer chooses amount of energy (corn) and protein (soybean meal) in the equation. It is flexible. At least a small amount of feed is required by the policy.
5. The producer chooses the deductible (usually a balance between coverage, break-even and premium).
6. LGM-Dairy does NOT influence the price you receive for milk. It allows for full advantage if prices go higher than predicted.
How does this work for lenders?
1. They know, for whatever time period and whatever quantity of milk, you have a floor under a portion of your production.
2. They know in a "worst case scenario" where you will be.
3. They can treat your policy as collateral.
4. They know there is reduced vendor risk because LGM is backed by the government.
5. They know it is a true hedge, and unlike put options or futures, can’t be sold or offset in the middle of the timeframe.
6. They know it can be budgeted for since the premium is not due until the end of the insurance period.
7. They know the producer is being proactive and is looking for ways to manage risk.
8. They know LGM is a way for them to have security without managing the operation.
What does this do for producers?
1. It provides peace of mind. When prices are dramatically lower than predicted, they have protection. LGM protects their major source of income for family living, balanced against a premium they choose.
2. It allows the flexibility to protect whatever quantity of milk for which policy months they choose.
3. It protects what affects their income the most: milk price and feed inputs.
4. It allows them to routinely protect revenue almost a year into the future.
LGM-Dairy can provide protection for a 10-month period, starting two months from now. For example, a policy purchased at the end of May (the sales date is the last business Friday, so May 30) could cover July 2014 through April 2015. A producer can insure a single month but must insure milk at least two months to receive a government subsidy on the premium (which can be as high as 50%). He can choose to insure any combination of months or he can insure all 10 months. Listed below are just some of the examples for a policy that could be purchased on May 30:
1. Cover July 14 through April 15 (10 months)
2. Cover last quarter of 2014 (3 months)
3. Cover first quarter 2015 (3 months)
4. Cover both last quarter 2014 and first quarter 2015 (6 months)
When thinking about how much milk to protect, the flexibility of this product is also key. A producer can "layer" or "stack" coverage. For example, on May 30, he can purchase coverage of 20% of his production for October-December. Then, on June 27, he can purchase coverage of another 20%.
Ken Hartzell is an agent with Dairy Gross Margin, LLC, an agency that specializes in LGM-Dairy products. Reach him at firstname.lastname@example.org or visit www.dairygrossmargin.com.