Know Your Market
Making the Decision: Margin Protection vs. LGM-Dairy
Aug 18, 2014
While awaiting details on USDA’s Margin Protection Program, consider these examples and comparisons with the LGM-Dairy program.
By Ron Mortensen, Dairy Gross Margin, LLC
As of this writing, we all are waiting for the Milk Protection Program (MPP) details and regulations from the USDA.
The biggest unknown surrounds the possible proration of premiums for producers of more than 4 million pounds of milk.
Another question that needs to be answered is when the MPP premium will be payable. Will it be at the beginning of each year or maybe quarterly or monthly?
The next question is if producers can use the Livestock Gross Margin for Dairy (LGM-Dairy) program one year and MPP the next. We already know if a producer has an LGM policy in place, the USDA will honor it. If a dairyman has signed up for the MPP, after the LGM coverage expires, the MPP starts automatically.
The USDA is required to get the MPP program in place in September. We will have to see if they are able to pull this off. As we wait, please understand LGM-Dairy is still available. There is subsidy money available and policies are being written.
MPP vs. LGM Research
We have spent a lot of time comparing MPP to LGM. We used a dairy producing 2 million pounds per month. For the MPP, we assumed the premium would be pro-rated (we do not know if this is correct). We did adjust the premium to reflect 100% coverage, even though the MPP will only cover 90% of a dairy’s historical production. For the LGM program, we also covered 100% of production.
We assumed we would buy the LGM policy in November and to cover January through October. In January, we would purchase coverage for November and December. Only once in 10 years did the LGM policy have an indemnity payment for November and December.
If you picked the $4.00 MPP for the last 10 years, your premium would have been $1,000, or $100 per year. The estimated payout for the 10 years was $166,142. The payout was $100,597 in 2009 and $65,545 in 2012. For the 10-year period, the net payout was $165,142 ($.068/cwt). The highest payout net was in 2009 for $100,497 ($.42/cwt).
If you picked $6.50 MPP for the last 10 years, your premium would have been $685,000, or $68,500 per year ($.285/cwt). The estimated payout for the 10 years was $943,945. Payouts occurred in 2009, 2012 and 2013. For the 10-year period, the net payout was $258,945 (.108/cwt). The highest payout net was in 2009 for $525,190 ($1.93/cwt).
For this research, we used LGM with feed coverage similar to the MPP program (please remember, LGM does not include hay). The premium for the last 10 years would have been $535,727, or $53,572 per year ($.22/cwt). The estimated payout for the 10 years was $958,467. Payouts occurred in 2006, 2008, 2009, 2010 and 2013. The net payout was $422,740 ($.176/cwt). The highest payout was in 2009 for $593,703 ($2.47/cwt).
The best value was to just buy LGM in November and just cover January to October. Only one small indemnity payment in November and December 2012 would have been missed. For this research, we used LGM with the lowest allowed feed coverage. The premium for the last 10 years would have been $280,168, or $28,016 per year ($.14/cwt). The estimated payout for the 10 years was $690,627. Payouts occurred in 2006, 2008, 2009, 2010 and 2013. The net payout was $410,459 ($.205/cwt). The highest net payout was in 2009 for $583,018 ($2.92/cwt).
What are the potential issues with this research? The LGM has a better risk/reward ratio than the MPP. In other words, you get more bang for your buck (premium paid). Because the MPP has a lot of corn, soybean meal and hay, the calculation may not reflect what you are doing on your farm. If you buy a lot of feed and hay, the MPP may be more appropriate.
Also, size does matter in the decision-making process. If you have less than 150 cows, the MPP may be your best choice because the premiums are highly subsidized. If you have more than 3,500 cows, you may be better off with the MPP because LGM has a limit of 240,000 cwt. If you are a larger producer, you may want to buy the LGM in November 2014. Then, if the subsidies run out, you can always move to the MPP program. It’s a process--step one and step two.
Note the premiums for LGM were cheaper prior to 2006 because volatility was lower. I would expect premium costs to come down a little as the volatile markets subside (for example, corn prices are now under $4.00, versus $5.00-$7.00). Remember the MPP premiums are fixed. The LGM premiums more accurately reflect market risks.
The LGM program performed surprisingly well in this historical analysis and was equal to or even better than the MPP. The $4.00 MPP payments in 2009 would not have saved the family dairy with payouts of about $100 per cow. The $6.50 MPP program was more expensive than the LGM. LGM will be a good alternative to the MPP if your dairy has between 150 and 3,500 cows.
Ron Mortensen is principal of Dairy Gross Margin, LLC, an agency that specializes in LGM-Dairy products, and owner of Advantage Agricultural Strategies, Ltd., a commodity trading advisor. Reach him at firstname.lastname@example.org, or visit www.dairygrossmargin.com.