Insure your margin

Editor’s note: This article originally appeared in the November 2007 issue of Midwest DairyBusiness.

LGM-Dairy will allow dairy producers to purchase “margin” insurance

By Dave Natzke

Most dairy industry experts forecast moderating milk prices in 2008. With volatility in feed costs due to ethanol and export demand and the uncertainty of weather, dairy producers may be looking at ways to lock in profit margins.
One tool available to many producers in mid-2008 will be a newly approved, federally reinsured dairy insurance program run through the Federal Crop Insurance Corp., called Livestock Gross Margin for Dairy (LGM-Dairy).
According to Bruce Babcock, professor of economics and the director of the Center for Agricultural and Rural Development at Iowa State University who helped design the program, LGM-Dairy will provide protection against unexpected declines in gross margin on a targeted quantity of milk. The critical word in the equation is “margin.” Coverage is not based on a specific milk price or specific feed prices.
LGM-Dairy does not protect milk producers against anticipated declines in milk prices, or increased feed costs, Babcock warned. Nor does it protect against multiple-year declines in milk prices or increased feed costs. And, it does not insure against cattle death loss or any other cause of production loss or damage.

Margin projections
To determine margin, the producer must project the market value of his/her milk, as well as feed costs, on a per hundredweight basis. LGM-Dairy covers the difference between the gross margin submitted by the producer and approved by an adjuster, and the actual gross margin.
The all-milk price will be determined based on the simple average of daily settlement Class III milk futures on the Chicago Mercantile Exchange (CME) for a designated period. Producers will then add any basis, including premiums, to come up with their individual milk price. According to Babcock, Milk Income Loss Contract payments are not included.

Feed cost projection
To accurately determine feed costs, costs must be converted into:
• Energy: tons of corn equivalent
• Protein: tons of soybean meal equivalent
When determining actual feed costs, the corn price will be determined using a three-day average settlement price on Chicago Board of Trade (CBOT) corn futures contracts, plus a predetermined basis adjustment that varies by month and state, established by USDA’s Risk Management Agency.
For example, for a policy sales closing date of Feb. 25, the expected corn price for July in Maryland equals the simple average of the Feb. 24-26 CBOT daily settlement prices for July futures, plus the Maryland corn basis for July (+44¢/bushel).
For corn months without a futures contract, the corn price calculation will use futures contract prices for the two surrounding months that have futures contracts, plus the state-specific basis for the month.
For example, for a March 31 sales closing date, the expected corn price for April in Kansas equals the average of settlement prices for March and May CBOT futures contract prices over the last three trading days of March, plus the April Kansas corn basis.
The soybean meal price will be based on CBOT soymeal futures prices. There is no basis adjustments for soybean meal prices.

How much milk?
The final factor is the amount of milk to be covered. A producer can insure any amount of milk for which he or she has adequate dairy cattle to produce, designating a monthly maximum “Approved Target Marketings” total on the policy application. Total milk to be covered must be certified by the producer and is subject to inspection by the insurance company.
Target marketings must be submitted for each month. Failing to submit a Target Marketings Report by the sales closing date for the applicable insurance period means the amount of milk covered for that period is zero.

Ready to purchase insurance
Armed with the projected margin (expected milk price minus expected feed cost per hundredweight), the producer is ready to apply for margin insurance. USDA’s Risk Management Agency will validate price and margin data, and LGM-Dairy policies will be sold on the third to last business day of each month.
Producers have the option of either signing up for month-to-month coverage, or sign up for year-long coverage. There are 12 insurance periods in each calendar year, and each insurance period runs for 11 months. Coverage begins on producer’s milk one full calendar month following the sales closing date, provided the premium for the coverage has been paid in full.
For example, for a July 28, 2008 sales closing date, coverage begins on Sept. 1, 2008 and covers milk produced through July 31, 2009; or the last month of the insurance period in which the producer has submitted target marketings; or as otherwise specified in the policy.
If the end date is on a Saturday, Sunday or federal holiday, or, if for any reason the relevant report is not available on the day of the ending period, then the actual ending value will be based on the most recent reports.
After application acceptance, the producer may not cancel this policy for the initial insurance period.

Premiums, deductibles
Premium cost depends on a number of variables:
• amount of coverage selected
• producer’s marketing plan
• level of futures prices
• amount of price volatility
Premiums are set so that the producer gets out what he puts in over the long haul. In times of high price volatility, premiums will be high. Producers who insure 10 months together will pay less than producers who insure month to month.
As with virtually any insurance policy, dairy producers can select a deductible level to manage premium costs. Producers who insure 100% of their margin will pay more than those who take a deductible. Allowable deductibles range from $0.00-$2.00/cwt., in 10¢/cwt. increments.
The premium for the initial insurance period is due with the application. In subsequent insurance periods, if the premium is not paid in full by the applicable sales closing date, the target marketings will be reduced to zero for each month of the insurance period, and no coverage will be offered.

Payments
In the case of a payable loss on insured milk, producers will receive a notice of probable loss approximately 10 days after all actual gross margins applicable for the insurance period are released by USDA’s Risk Management Agency. Producers must submit a marketing report and sales receipts showing evidence of actual marketings within 15 days of receipt of the notice of probable loss.
Payment will be determined by subtracting the actual total gross margin (actual milk price minus actual feed cost per hundredweight) from the gross margin guaranteed by the policy. If the result is greater than zero, an indemnity will be paid.
In the event that the total of actual marketings are less than 75% of the total of targeted marketings for the insurance period, indemnities will be reduced by the percentage by which the total of actual marketings for the insurance period fell below the total of targeted marketings for the period.
Failure to provide written, verifiable records or accurately report actual marketings or other information will disqualify the producer from receiving indemnity payments. Payment will not be made on any milk above the volume designated for the coverage period.

Advantages
LGM-Dairy will offer producers two advantages, according to Babcock:
• Convenience: Producers can sign up 12 times per year and insure all milk they expect to market over a rolling 11-month insurance period.
• Customization. LGM-Dairy can be tailored to any size dairy.

Limitations
LGM-Dairy has limited underwriting capacity, and will be distributed on a first-come, first-served basis. Policies will not be sold after capacity is full.
In addition, LGM-Dairy is not available in all states. Producers in 30 states are eligible to participate, including:
• Midwest: Illinois, Indiana, Iowa, Michigan, Minnesota, Missouri, Nebraska, North Dakota, Ohio, South Dakota and Wisconsin.
• Northeast: Connecticut, Delaware, Maine, Maryland, Massachusetts, New Hampshire, New Jersey, New York, Pennsylvania, Rhode Island, Vermont and West Virginia.
•West: Arizona, Colorado, Kansas, Montana, Nevada, Oklahoma, Texas, Utah and Wyoming.

FYI
■ Bruce Babcock is professor of economics and the director of the Center for Agricultural and Rural Development  at Iowa State University. Contact him via phone: 515-294-6785 or e-mail:babcock@iastate.edu.
■ A list of participating insurance companies will be posted on the USDA Risk Management Agency web site, www.rma.usda.gov/tools/agent.html.

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