Is There Value to Dairy Revenue Protection Insurance?

Robin Schmahl Ag Dairy LLC and FYP Consulting

Dairy farmers need to have profitable prices to remain in business. This is true for any business as bills need to be paid and there needs to be a reward for the effort. The dairy industry has always had price cycles with times of profitability and times of low prices. These are generally driven by the balance of supply and demand. More supply means lower prices to increase demand while high demand means higher prices as supply tightens. Low prices signal to the market that supply needs to be reduced while high prices encourage production.

However, that is not economic reality for individual dairy farmers. Milk production is increased during high prices to take advantage of those high prices and to earn increased profitability. However, low milk prices result in higher milk production as farmers increase output to make up for the decline of milk prices. Milk price swings have also increased since the late 1990’s as greater volatility has been evident. The highs have been higher and the lows have been more devastating. In the past there had been a government support prices which helped to limit milk price declines. In recent years, there has not been that support leaving the market to the impact of supply and demand. The government initiating the Whole Herd Buyout in the mid-1980’s resulted in dairy product inventory declining substantially thereby temporarily supporting prices. There was the Milk Income Loss program which provided some benefit when milk prices declined. Now we have the Margin Protection Program which allows for the choice of an income over feed price of $4.00 to $8.00 and if margin falls below your selected level, payment is rendered.

Dairy futures are options were offered beginning in 1996 and have been available for protecting milk prices based on either Class III or Class IV milk. Producers have the ability of protecting contract sizes of 100,000 pounds or 200,000 pounds of milk for Class III and 200,000 pounds of milk for Class IV.

Livestock Gross Margin for Dairy also came on the scene as a way for dairy producers to protect their gross margin for milk rather than just a decline in milk price using the futures prices for Class III milk, corn, and soybean meal.

Dairy Revenue Protection Program

Now, dairy producers can add one more tool to their marketing toolbox. The Risk Management Agency has approved a new insurance product for dairy farmers titled Dairy Revenue Protection (Dairy-RP). This is a new insurance that is designed to insure against unexpected declines in the quarterly revenue of milk sales. Dairy-RP provides much flexibility as to the amount of milk that can be chosen to cover for the duration of each quarterly milk endorsement.

Dairy-RP insurance can be written by a licensed crop insurance agent who has been trained and approved by an Approved Insurance Provider. This insurance is different from crop insurance from the standpoint that a policy can be written at any time and each policy covers milk for a calendar quarter with endorsements able to be written up to five quarters in the future. There are deadlines for writing endorsements for nearby quarters. For instance, the ability to establish coverage for Dairy-RP will begin October 9 and can be established for up to five quarters in advance.  There are cut-off dates for establishing the nearest quarter as seen in the chart below.

The important thing to note is that there is no deadline to sign an application for Dairy-RP, but you must sign an application before an endorsement can be written to insure a chosen portion of your milk production.

Once the amount of milk and which quarters covered is desired, you will then need to decide what level of coverage for revenue guarantee you would like. Below is a chart of coverage levels and percent of subsidy.

Coverage Level Percent 70 75 80 85 90 95
Premium Subsidy Percent 59 55 55 49 44 44

Insurance premiums have not yet been established by the Risk Management agency and may not be available until October 9th and thereafter leaving us guessing as to the cost of coverage. These premiums may not be consistent but may change daily depending on released prices and volatility. Each quarterly period will also have a different premium with closer quarters having a lower premium than later quarters. Prices will be posted each day on the Risk Management Agency website (www.rma.usda.gov) by 4 pm Central time. The sales period each day will be from the time of the posting until 9 am Central time the following day. Unless it is a weekend at which time the sales period is from Friday at the time of posting until Monday at 9 am.

There are two revenue pricing options;

The Class Pricing Option uses a combination of Class III and Class IV milk prices as a basis for determining coverage and indemnities. These can be weighted for either class based on your area utilization or based on your choice.

The Component Pricing Option uses the component milk prices for butterfat, protein, and other milk solids. You may choose a butterfat test percentage and protein test percentage that best reflects the components of your milk.

Dairy-RP can be used in conjunction with the Margin Protection Program (MPP). This combination provides revenue protection on the value of you milk and provides income over feed protection. However, Dairy-RP cannot be used in conjunction with LGM Dairy to cover milk in the same quarter and you cannot have MPP and LGM Dairy. You can choose to have a policy for one quarter insuring revenue through Dairy-RP and another quarter insuring income over feed through LGM Dairy, but they cannot overlap. If they do, the earliest date of endorsement will be in force with the other endorsement void. Again, if you have MPP you cannot use LGM dairy for the entire year, but you can use Dairy-RP and MPP together.

There is no limit on the size of the dairy that can participate in Dairy-RP unlike many of the previous programs. The other great aspect of this insurance is that insurance premiums are not due until the end of the covered insurance period.

The insured can have multiple coverage endorsements for the same quarterly insurance period, but these endorsements cannot cover the same milk. Each endorsement can cover different amounts of milk production and are not confined to specific percentages or contract sizes. This makes Dairy-RP extremely flexible. Producers will be paying the insurance premium after the quarter in which insurance coverage was placed. There is no limit on the size of the dairy that can participate in Dairy-RP, unlike many of the previous programs.

Dairy producers will have five decisions that need to be made for Dairy-RP.

  1. Pricing method using either Class III/Class IV or Component Pricing
  2. Amount of milk to cover
  3. Level of coverage
  4. Choice of quarterly contract periods
  5. Protection factor (1.00-1.50 in .05 increments)

The Protection Factor is a numeric chosen for each pricing option and coverage level chosen. It impacts the premium and indemnity proportionately. The higher the protection factor, the higher the premium and the higher the indemnity.

There is also a Yield Adjustment Factor which is calculated by Expected Milk Production divided by Actual Milk Production. For example: Expected Milk Production for the quarter covered is 5,000 pounds per cow and the Actual Milk Production is 5,100 pounds per cow, the Yield Adjustment Factor is 1.02 (5,100/5,000 = 1.02). If the Yield Adjustment Factor is below 1.00, it will increase the indemnity payment because it will reduce the actual milk revenue.

All in all, Dairy-RP seems to be a welcome addition to the risk management toolbox for dairy farms. This insurance and the decisions made for endorsements must be made with the whole scope of managing risk for the dairy operation. Dairy-RP may make sense at times while other marketing tools may make sense at other times. A marketing plan for the dairy should be established and marketing strategies implemented protect income and reach goals.

Robin Schmahl is a market analyst and risk management consultant in Elkhart Lake, Wis. He was raised  on his family’s fourth generation dairy farm, operating it until starting his brokerage firm AgDairy LLC in 1996.  Robin co-developed a dairy marketing program for DTN Ag1 in 2000-2003.  He writes twice-daily dairy commentary for DTN, regularly interviews with radio and television on grain and dairy markets and speaks frequently on marketing at farm and industry meetings throughout the country.  In addition to his brokerage work Robin is a licensed crop insurance agent.  He currently raises Highland beef cattle on the family farm and direct markets grass fed beef to consumers.

FYP Consulting, LLC

“To help dairy producers create a profitable business with happy people and animals”.  That’s our mission at FYP Consulting.  We believe dairy farmers deserve fast access to expertise that is helpful and unbiased.  Our team answers questions, provides new ideas and unique insights and does the research necessary to help producers make good decisions.  We help with managing profit margin, milk and feed price risk, animal welfare, people development, and public relations/crisis response planning. FYP Consulting is based in Visalia, CA and founded by Lee and Roxanne Gross.

We understand the challenges of marketing milk and managing feed prices. FYP Consulting can work with your dairy to establish a complete marketing plan for your business, not only to protect milk price using current marketing tools, but also feed prices and other input costs.  This will give you confidence in making hedging decisions.

Let us know how we can help:  559-972-0207, [email protected], or visit us at www.fypconsulting.com.