With all the attention on the new Margin Protection Program for Dairy Producers (MPP) let us not forget about Livestock Gross Margin Insurance for Dairy Cattle (LGM-Dairy). Similar to MPP, LGM-Dairy is also a USDA risk management instrument which offers protection against declines in average dairy income-over-feed-cost (IOFC) margins. Introduced in 2008, LGM-Dairy is an insurance product overseen by USDA's Risk Management Agency. Like crop insurance, LGM-Dairy is sold by private insurance agents and underwritten by the Federal Crop Insurance Corporation (for a complete description of LGM-Dairy rules see here).
As both LGM-Dairy and MPP are USDA programs, the 2014 Farm Bill allows dairy farmers to participate in either MPP or LGM-Dairy but they may not simultaneously use both programs. Given this one-or-the-other feature it is important to consider the benefits of each risk management instrument before making a participation decision. The features of MPP have been covered comprehensively here on farmdoc daily (see here and here). Today's post will complement previous posts on the dairy title and assist producers by reviewing the provisions and risk management opportunities under LGM-Dairy.
What is Livestock Gross Margin Insurance for Dairy Cattle?
The primary feature of LGM-Dairy is that it is highly customizable. As a risk management instrument LGM-Dairy insures average farmer-selected IOFC margins, rather than a sequence of bi-monthly margins, and offers protection against a decline in average margins over a period of up to 10 months. Farmers can purchase a single month or some combination of months during the 10-month contract period. Multiple contracts can cover a particular month's milk production so long as no more than 100% of milk marketed is insured. The feed ration consisting of corn and soybean meal can be customized to accommodate dairies that buy feed, those that grow feed, or those who face little feed market risk and want to use LGM-Dairy to insure milk revenue.
Under LGM-Dairy, an indemnity at the end of the coverage period is the difference, if positive, between the total guaranteed gross margin less the deductible, and the total actual gross margins realized over the coverage period. The guaranteed gross margin is the difference between revenue from milk sales and purchased feed costs and is determined upon the purchase of the insurance contract based on Chicago Mercantile Exchange (CME) futures prices for class III milk, corn, and soybean meal. The actual gross margin is based on CME settlement prices measured over the last three days prior to the applicable futures contract expiration. By insuring an average gross margin over the life of the contract it is possible for low margins in covered months to be offset by higher margins in other covered months with the net result that there is no payout at the end of the contract.
LGM-Dairy is Actuarially Fair
LGM-Dairy is an insurance product and as such is designed to reflect actuarially fair premiums. During every contract sales period the premiums for insurance coverage are recalculated based on farmer-selected parameters and price expectations in milk and feed markets. The premiums calculated during each sales period are contract specific and are equal to 1.03 times the expected indemnity less the declared deductible. For the details on the rating methodology or LGM-Dairy refer to here and here.
Premium subsidies from 18% to 50% are available and are determined based on the farmer-selected deductible level. Depending on underwriting capacity LGM-Dairy can be purchased once a month and is available on the last business Friday of each month on a first come, first served basis. Once the underwriting capacity has been reached sales of LGM-Dairy are suspended.
In order to illustrate how the risk management potential of LGM-Dairy is influenced by the rating methodology, a guaranteed gross margin using the maximum (red) and minimum (blue) allowable feed quantities per hundredweight (cwt) of milk was calculated. By using the maximum and minimum allowable feed rations a price range of available LGM-Dairy gross margins is formed. The guaranteed margins were calculated during the November sales period in order to establish a price floor for a 10-month LGM-Dairy insurance contract covering January through October of the following year. Adjustments were not made to account for milk and feed price basis.