An expert explains why LGM-Dairy has a better risk/reward ratio next year than the government’s new Margin Protection Program.
By Ron Mortensen, Dairy Gross Margin, LLC
In today’s market, milk has to take a significant drop in order to get an indemnity from the government’s new Margin Protection Program (MPP). Milk would have to fall $6.70/cwt. in order for the $4.00 MPP coverage level to pay an indemnity. If you pick $6.50 MPP coverage, milk prices will have to move $4.20 lower. With the $8.00 coverage from MPP, milk prices have to fall $2.70. This is assuming feed values do not change.
As of this writing, the average MPP guarantee (translated to a milk price) is $10.70 for 2015. As a reference, the average Class III milk price is $17.22 for 2015.
USDA’s Livestock Gross Margin for Dairy (LGM-Dairy) coverage with a $1.00/cwt. deductible would kick in an indemnity if milk prices fall $1.00/cwt. If you used the $2.00/cwt. deductible, you would receive a payment if milk falls $2.00/cwt.
If you use MPP with the $4.00 coverage level, milk prices will need to fall to $10.52/cwt., or drop $6.70 to get an indemnity. Using the $6.50 coverage level, milk would have to be below $13.02, or a $4.20 drop. The $8.00 coverage would pay if milk prices dropped $2.70/cwt. or below $14.52 (note the high premium charged for this coverage). This is based on an average milk price for 2015 and assumes feed prices do not change.
For LGM-Dairy coverage, a $1.00/cwt. drop in milk prices to $16.22/cwt. would start indemnities if you used the $1.00 deductible. The $2.00 LGM deductible would pay off if prices fall $2.00/cwt. to $15.22/cwt. Again, the assumption is feed prices do not change. Also note, for LGM, the lowest amount of feed possible was used for the calculation.
Next Question Dairymen Ask: How did MPP and LGM-Dairy perform in 2009?
How would MPP have performed in 2009? MPP is a catastrophic insurance policy. In 2009, the $4.00 coverage would have paid $.38/cwt. net after premium. The $6.50 coverage would have paid $1.89 net after premium, and the $8 coverage would have paid $2.67/cwt. net after premium. This is based on a producer with 4 million pounds or less. A larger producer with 24 million pounds of production would have paid higher premiums and netted $.65/cwt. less at $2.02/cwt.
LGM-Dairy performance in 2009 was better. LGM coverage using $1.00 deductible generated $3.14 net after premium. This is using the lowest amount of feed. See charts below.
Final Question Dairymen Ask: How much milk production is covered?
The MPP program is based on your milk marketings in the years 2011, 2012 and 2013. A payment is based on 90% of the highest number during those three years. For 2015-2018, your production number will increase based on the USDA’s national growth in milk yield per cow. For 2015, that increase is 0.87%. This means over the life of the program, if your production is increasing faster than the national average rate, the percentage of milk covered by MPP will drop. This is especially true if you are planning any sort of major expansion in the next four years.
For LGM, you can insure 100% of your production, up to 24,000,000 pounds per year.
Weigh the cost of MPP and LGM and then review the risk in your operation. The LGM has a better risk/reward ratio than the MPP for 2015. 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 produce less than 4 million pounds of milk, the MPP may be your best choice because the premiums are highly subsidized. If you are a larger producer, you may be better off with LGM. Very large producers may want to look at MPP because LGM has a limit of 240,000 cwt.
MPP calculator can be found at http://dairymarkets.org/MPP/Tool/
LGM-Dairy can be found at http://future.aae.wisc.edu/lgm_analyzer/
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.