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Insuring dairy

Gary Kregel welcomes new
ideas that work on his northeast Iowa dairy farm. Just out of college, he was
among the first to use embryo transplants in his 240-cow herd. Today, he’s also
among very few dairy farmers to try insuring livestock gross margins on milk.
It was first offered in late 2008 by USDA’s Risk Management Agency (RMA) and is
sold by some crop insurance companies.

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“This is essentially a way
of buying a put on milk and buying a call on feed, and the premiums will be
less than buying either one of these on the board,” Kregel says. RMA self
insures, but the margins of milk price over feed costs that can be covered are
derived from CME futures prices for Class III milk, corn, and soybean meal on
the last three trading days of the month. The margin is set on the last
business Friday, and coverage starts one month later, running for up to 10
months. You can insure as little as one month. For the months you insure, if
the average margin on the board drops below your insured level, you get a
payment. “I like the idea of buying the spread instead of actually contracting
the milk,” Kregel says.

Pitfalls, Fixes

Kregel didn’t jump in right
away, though.

“The premiums were quite
high for the margins I could get,” he says. “Once we could get double-digit
margins for about 50¢ (per cwt), we bought some.”

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In early 2010, he locked in
a $12/cwt gross margin for the months of March, April, and May. The premium was
about 40¢/cwt. Prices fell enough to pay 80¢/cwt, so the farm netted 40¢/cwt.
He insured only about 60% of the milk produced. Concerned about rising feed
costs, he bought more coverage again before harvest.

The cost of premiums is just
one of several reasons Dairy Gross Margin insurance hasn’t taken off. Unlike
crop insurance, premiums were paid up front and there wasn’t any subsidy.
Starting December 17, RMA is making improvements.

  • Premiums can be paid at
    the end of the coverage period.
  • RMA will subsidize
    premiums for coverage of more than one month, starting at 18% if you don’t
    choose a deductible. When Dairy Gross Margin insurance started, you could lower
    premium costs by insuring up to $1.50 less of the available margin. Now the
    maximum deductible has been increased from $1.50 to $2. Premium subsidies go up
    along with the size of the deductible, up to 50% for policies with $1.10 or
    higher deductible. Subsidies apply if you cover more than one month.
  • The amount of feed you can
    insure was updated. It now ranges from 0.13 bushels to 1.36 bushels of corn per
    cwt of milk and 1.61 pounds to 26 pounds of soybean meal per cwt.

“It does give you
flexibility, whether you raise your corn or buy all your corn,” says Ron
Mortensen, a Fort Dodge, Iowa, marketing adviser and crop insurance agent who
helped start Dairy Gross Margin, LLC.

Mortensen, whose clients
include Kregel, sold the first Dairy Gross Margin coverage in the U.S. to
another producer in September 2008. Dairy Gross Margin insurance is cheaper
than buying a bundle of options for several reasons, he says. Farmers don’t pay
commissions. The difference between bid and ask in options trading adds cost,
too.

In early October, using
options to lock in a milk margin would have cost $1.14/cwt when the same coverage with margin insurance and no deductible cost
72¢/cwt, he says.

New subsidies make it even
cheaper. “We’re talking 8¢, 9¢, 10¢ per cwt for reasonable protection using
medium to high deductibles,” says Brian Gould, a University of Wisconsin ag
economist. Along with dairy scientist Victor Cabrera, Gould has developed Web-based
tools that you can use to estimate premium costs of Dairy  Gross Margin insurance. Another tool
calculates ways to lower premium costs for a desired level of margin
protection. [See Learn More.]

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“There’s an infinite number
of types of contracts,” Gould says. And RMA gives you little time to decide.
Coverage goes on sale at 4 p.m. Central time on the last business Friday of a
month. Sales stop at 8 p.m. on Saturday, a 27-hour window.

The Wisconsin calculator
uses the same data as RMA to estimate likely premium costs and level of
coverage before the insurance is sold.

“It allows producers to sit
down in an unhurried environment,” Gould says.

Any size of dairy can buy
Dairy Gross Margin contracts, although the total coverage is limited to 240,000
cwt of milk over 12 months. But it was designed for dairies that might be too
small to use futures contracts easily, says Chad Hart, one of three Iowa State
University economists who wrote the policy for RMA. “It scales to the size of
your farm,” he says.

Hart, who gets a small
payment for each policy sold, describes it as “a product that is really hit or
miss. It may pay nothing for two years straight, but when it does, it pays off
pretty significantly.”

Learn More

Understanding Dairy Markets

http://future.aae.wisc.edu/index.html

(Click on “LGM Dairy” tab at
top, then click on “Supporting Software” for calculators.)

Dairy Gross Margin, LLC

www.dairygrossmargin.com/sections/

dairygrossmargin/history.aspx

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