In order to determine how this MILC-Insurance policy option would perform the margin insurance and MILC benefits were modeled for 5000 representative farms and four IOFC margin scenarios. Milk production data for 48 months was simulated for the representative farms. The data were structured to include consolidation trends, herd demographics, seasonal production patterns, and farm growth rates common to U.S. farms. In all of the analyses we use the milk marketings in months 1-36 to construct the production history and months 37-48 are used to analyze the performance of the margin insurance program, MILC, and MILC-Insurance.
Four beginning-of-the-year expected margin scenarios are identified that should well cover the space of likely expected margin environments:
(i) Catastrophic Margins. Expected margins are well below long-run average, but revert to mean by the end of the year.
(ii) Mean-Reverting Margins. Expected margins for the first quarter of the year are well above historical average, but revert to long-run average.
(iii) Above-Average Margins. Expected annual average margin is almost $1 per cwt above average.
(iv) January 15, 2013. Expected margins derived using January 15, 2013 futures and options prices.
These scenarios, depicted in Figure 2, are based on actual expected margins, as observed on January 15 in one of the previous seven years. The simulation techniques used for this analysis are similar to those employed in Newton, Thraen, and Bozic (2013).
Consider first the benefits of DFA (Table 1), when anticipated IOFC margins are catastrophic the net benefits of DFA are up to three times greater than payments under a counter-cyclical payment program for the 5000 farms in this analysis. For example, given 2013 margins DFA would provide $76 million dollars in revenue support while the MILC program would provide only $23 million dollars (Note: Financial outlays reflect only the simulation results and are not indicative of total dairy farm safety net outlays by the Government). During favorable margin outcomes such as a mean-reverting margin or an above-average margin the support from DFA is less than the support received from MILC. In fact, during an above-average margin outcome MILC would still provide a marginal amount of income support while the margin insurance program support is near zero. This disparity is due to the fact that during times of low milk and low feed prices an IOFC program may not pay an indemnity, while the MILC program may still trigger a payment if the feed adjusted Boston class I price of milk is below $16.94/cwt.