Editor’s Note: The recently passed farm bill includes a whole new dairy program designed to help producers manage risk. Producers will be able to buy insurance that pays off if the milk price margin over feed costs falls to less than $8 per cwt of milk. USDA is still drafting the rules but the program is scheduled to be in place by September 1. Here are some of the provisions of the new program.

The new farm bill includes major changes to traditional dairy programs, but the USDA rules and regulations are still being written. According to the language in the farm bill the new program is to be in place no later than September 1, 2014. (Thus, our analysis of this new program is subject to change when the new rules are actually put in place.)

A look at the new dairy margin protection programThe new dairy program will be designed to give milk producers an opportunity to buy insurance that will pay off if margins (milk prices over feed costs) fall below protected levels. There is only a small $100 administrative fee for protection if the margin falls below $4 per cwt but additional protection is available for purchase for margins between $4 and $8 per cwt. The premiums for the protection will be set this year and will not change over the life of the farm bill.

Any payments under the program will be based on the dairy farm's established production history – not on actual current production. The production history will be the highest annual production in any of the 2011, 2012, or 2013 years. A producer’s production history will be adjusted each year based on the increase in total U.S. production in subsequent years. The premiums for the first 4 million pounds of production will be significantly lower than those for production above 4 million pounds. Premiums for coverage below the $8 level will be discounted by 25 percent for 2014 and 2015 for the first 4 million pounds of milk.

Producers will be able to select protection for margins between $4 and $8 per cwt in 50 cent increments. They can also select how much of their production to cover – from 25 percent to 90 percent in 5 percent increments. The program will have an annual signup so producers can change the coverage levels based on current and expected prices for milk and feed.
The margin is calculated based on the following formula, using national average prices:

A look at the new dairy margin protection program

If this margin is below the protected level for a consecutive 2-month period, producers will receive a payment. If the margin falls below $4 per cwt and stays below that level 2 months, USDA will purchase dairy products for a maximum of 3 months and distribute the products purchased to organizations that provide food for low-income populations. These domestic purchases will stop if U.S. prices are 5 percent or more above world prices.

The new margin protection program can be an effective risk management tool for producers.

The insurance can protect against margin squeezes, such as the ones that occurred in 2009, 2012 and 2013. Producers can use futures prices as one factor in determining what margin level to choose and how much of their production history to cover.

There are still important questions to be answered. For example – how will the signup period correspond to the start of the program each year? With signup right before the start of the program year, producers could have more information about what level of margin to expect. However, a recent report suggests that signup may be as much as 120 days before the start of the program! It is not clear when the premium will be paid; up front or after the year is over. Hopefully, the official rules for the program will be available by late summer.

Current milk and feed prices suggest that milk production margins will be pretty good this year and margin insurance may not be needed. But things can change pretty quickly over the spring and summer months, depending on crop production prospects.

With the delay in getting the program rules in place, milk producers will probably have good information on the outlook for crop prices. That may not be the case in future years. Each year producers will have to make decisions about how to manage the risks associated with milk prices and feed costs. Nonetheless, this new program will be a very important tool for managing price risks.