Set your strategy for 2016 Margin Protection Program
It's that time of year. State Fair? Well, yes, but not what I was thinking. Haying? Again, yes, but not what I was thinking! It is time to enroll in the Margin Protection Program (MPP) for 2016. The enrollment period for the 2016 MPP began on July 1, 2015 and will end on September 30, 2015. If you recall when you enrolled in MPP at the end of 2014, you signed up to participate in MPP until 2018 and need to pay a $100 administrative fee each year. You're not just paying a fee, though; this also nets you the "catastrophic" coverage of a $4.00/cwt margin. Producers who have previously enrolled will receive a 2.61% "bump" on their production history. If you haven't enrolled previously, now is an excellent time to consider if this program is a good risk management tool for your operation.
What, exactly, is MPP? MPP was part of the 2014 Farm Bill and is an "insurance-like" program. The intent of MPP is to provide farmers with margin protection during times of financial distress. MPP takes the difference between milk price and feed cost to calculate a margin. This calculation is made by USDA and is based on the All-Milk price; NASS prices for alfalfa and corn; and AMS prices for soybean meal. These prices may be different than the milk price you receive or your actual feed costs.
Producers enrolling in MPP select a margin level to insure between $4.00 and $8.00/cwt (coverage is available in $0.50 increments). They also opt to enroll a percentage of their milk, which can range from 25% to 90%. The premiums for MPP vary depending on the margin level selected and production history. Premiums are subsidized heavily to $6.50/cwt margin and climb rapidly after that. Premiums for covered production history of less than 4 million pounds are less than premiums for covered production history of greater than 4 million pounds. At $4.00/cwt coverage, there are no premiums for either group. See Table 1.
Table 1. Premium rates for MPP
|Margin level protected ($/cwt)||Covered production history of 4M lbs||Covered production history of 4M lbs|
Source: Farm Service Agency.
Now that you've had your MPP refresher, you may be wondering what coverage level you should select for this year. To help you make this decision, you can use the on-line tool found at the USDA Farm Service Agency. Click on "Dairy Margin Protection Program web tool". This tool allows you to enter your farm's production history and estimate your payments based on today's futures markets. An added feature to the tool this year is the ability to enter in your own assumptions for 2016 prices. The tool will help you determine the cost of each strategy along with payment, given today's future markets or your forecast.
I suggest looking at three options to evaluate your decision:
Option 1 is catastrophic coverage, i.e. enrolling at $4.00/cwt and paying the $100 administrative fee. While there is no cost to enroll at this level, this is "catastrophic" coverage. You will only get paid if margins are near historical lows. As I review margin data from the past 8 years, there are only a couple of times that this strategy made a payment (see Figure 1). One of those times was in 2009, which was a very difficult year financially for dairymen. This strategy is basic coverage at a very low cost.
Option 2 is a risk management strategy of enrolling at $6.50/cwt. This provides more coverage than Option 1 and it avoids the large premium increase at coverages over $7.00/cwt. Again, as I review the margin data in Figure 1, I can see MPP margins since 2007 have been $8.00 or less almost half the time. Most of the time, these margins have been in the $4.50 to $8.00/cwt range. In other words, historically Option 2 would have paid more frequently than Option 1.
Option 3 is to maximize your predicted net return. In this scenario, the on-line tool is used to predict which coverage level will provide the greatest returns. The tool will analyze both expected margin and the cost of premiums to determine your net return at varying coverage levels. You choose the greatest return. It is important to note that the tool is estimating margins based on futures markets, which are subject to change. This strategy requires more analysis than the others.
As you think about your options, talk with your banker or other trusted financial adviser about what fits best with your operations.
Figure 1. MPP margins 2007 - Present.
One last consideration, as I wrote in the beginning, MPP is intended to be an "insurance-like" program. It is there for the bad times. Just like car insurance, I may pay my premium, but I hope I don't have to use it! If MPP is not paying, it's an indication that margins are strong and dairy farmers are experiencing a time of prosperity. MPP is there to help producers navigate through the tougher times.
Don't forget to get your FSA office to make you 2016 elections by September 30, 2015!