AFBF briefs Pa. producers on new dairy insurance plan
If approved by the Federal Crop Insurance Corporation, the Dairy Revenue Protection plan would allow dairy farmers to purchase risk management protection against declines in quarterly milk sales revenue. Unexpected declines can be in milk prices, production, or both.
Developed by the American Farm Bureau Federation, American Farm Bureau Insurance Services and other collaborators, Dairy-RP would fill a gap in risk coverage. This plan would function similar to crop revenue protection policies—the revenue guarantee would be based on futures prices, expected production, and market-implied risk, and employ actuarially appropriate methods. It addresses two key sources of risk for dairy farms—milk price basis and variability in milk production. Combined, both can lead to significant changes in milk revenue from month to month and from farm to farm.
The descriptions which follow here are derived from “What is Dairy Revenue Protection,” which can be found at the website fb.org/marketintel/.
In the U.S., Newton pointed out, there is not a uniform price of milk. Farmers receive different prices because milk prices and the value of milk components are formula-based and directly tied to the wholesale commodity prices for cheddar cheese, butter and dry milk powders. The final farm-gate milk price depends on those regulated milk prices, the components in the milk produced by the farmer, plus the financial return from market-wide revenue sharing pools and from any farmer-negotiated premiums and marketing fees.
Regional prices vary considerably. In 2016 the average mailbox-milk price was $15.95 per hundredweight. But it ranged from $14.31 in Michigan to $17.27 in New England. There is not currently a USDA-sponsored risk management tool that captures regional price variability. Because Dairy-RP would allow a farmer to value milk based on the milk components or a mix of Class III and Class IV milk prices, much of this farm-level basis risk can be addressed.
In addition, milk cow productivity varies from farm to farm due to factors such as the breed, climate conditions, feed quality, and lactation stage. During 2016, the average U.S. dairy cow produced 62 pounds of milk per day. However, in Alabama the average production of a milking cow was 36 pounds per day; a Colorado average milking cow produced 71 pounds.
The monthly revenue generated by a dairy cow depends not only on productivity but also on the monthly average value of the milk. This revenue, too, is different for every farmer. In 2016 the weighted average annual revenue per milking cow was $3,712, with a range of $2,186 for Arkansas to $4,339 for Colorado. Delaware’s 2016 average was $3,247, Maryland $3,426, New Jersey $2,858, Pennsylvania $3,518, and Virginia $3,446. New York’s average was $4,049.
Dairy-RP provides an opportunity to protect the revenue generated per milking cow by protecting against quarterly revenue losses caused by declines in the value of milk or milk components, or by unexpected declines in milk production. This policy would be in addition to margin insurance and protection programs currently available to dairy farmers from USDA.
In the Dairy-RP plan, farmers would purchase coverage for a quarter, up to five quarters, and select the level of coverage from 70 to 90 percent, and the amount of milk production to be covered. In addition, for each quarterly policy, the dairy farmer would choose either a milk-based or component-based pricing policy.
For the milk price policy, the farmer would choose an average milk price for the quarter based on a combination of Chicago Mercantile Exchange milk futures for Class III and IV milk. For a component-based policy, the farmer would choose the amount of milkfat and protein to cover during the quarter. These component levels are multiplied by the implied CME prices for butterfat, protein and other milk solids to determine the component-value of the milk.
The farmer would then choose how much milk production to cover during the quarter. The farmer’s elected volume of milk would be indexed using the average expected state milk yield per cow. For example, a farmer who elects to insure 1 million pounds of milk with an expected state milk yield average of 5,000 pounds would be covering the equivalent of 200 milking cows. These animal unit equivalents would be used to determine the actual state-indexed milk production volume and actual revenue once USDA announces the final milk and component prices. An example of the calculations can be found at the above referenced Farm Bureau website.
The expected revenue during the quarter would be the product of the value of milk and the amount of covered milk. The product of the expected revenue and the coverage level is the Dairy-RP revenue guarantee. With a 90 percent coverage level, the farmer is electing a 10 percent policy deductible.
Once the monthly milk and component prices are announced for the quarter, and USDA’s milk production report identifies the actual milk production per cow for each state, the state-indexed actual revenue will be compared against the revenue guarantee. If the actual revenue is above the revenue guarantee the farmer pays only the policy premium. If the actual revenue is below the guarantee, the farmer is paid a policy indemnity based on the difference.
Dairy-RP policies would be sold daily by USDA-approved insurance providers. The price would vary daily based on the parameters the farmer selected and on the expected risk in the market. USDA would provide a premium discount to purchase Dairy-RP which would increase as the farmer’s elected deductible increased. Preliminary analyses indicate a Dairy-RP policy that covers 90 percent of the milk revenue could cost 5 to 40 cents per hundredweight, depending on the quarter of the year covered and other policy parameters.
In 2016, nearly 90 percent of corn, cotton, rice, soybean and rice acres were protected by an insurance policy. $2.2 billion in insurance indemnities were made to those crop farmers due to declining crop prices. Many dairy farmers had no similar safety net, Newton stressed. He told the group that Dairy-RP would have provided similar protection in 2015 and 2016 when milk prices fell by nearly 50 percent and the total U.S. farm value of milk fell by nearly $15 billion.
American Farm Bureau Insurance Services’ website, farmbureausellscropinsurance.com, contains a survey for dairy farmers to gather input for their policy development.
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