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Extension > Agriculture > Dairy Extension > Marketing > Minnesota dairy operators utilizing Livestock Gross Margin as a risk management tool

Minnesota dairy operators utilizing Livestock Gross Margin as a risk management tool

Chuck Schwartau
Extension Educator

September 24, 2011

Over the past two years, the University of Minnesota Extension dairy team has worked with industry partners on programs to educate dairy producers about Livestock Gross Margin-Dairy (LGM-Dairy) insurance. LGM-Dairy is an insurance product developed by the USDA Risk Management Agency to protect producers' profit margins; much as similar crop insurance products help growers guarantee a profit margin. It is an insurance policy.

For those not familiar with LGM-Dairy, farmers are able to look at predicted margins between the anticipated value of milk produced and the feed costs to produce that milk for a year ahead. The predictions are based on prices offered in the futures markets. Farmers can look at those predicted margins, decide for themselves if any months look attractive enough to guarantee, and pick a deductible level that could lower their premium costs. Like any insurance policy, you hope you never have to collect. In this case, success would be an actual gross margin (milk value minus feed costs) that is higher than the predicted margin insured so one doesn't collect on the policy. If the actual margin is lower than the insured margin, the farmer collects on the policy.

LGM-Dairy isn't a real complex process, but it is different enough that it takes some study. Farmers have been accustomed to watching the milk price, not a margin. This is a new way of thinking about a business plan.

At its inception, LGM-Dairy had a slow adoption rate and had some barriers to acceptance. Crop insurance policies, which are pretty familiar, have had a subsidy to reduce premium costs, and the premiums were due at the maturity of the policy. Until November 2010, LGM-Dairy had no premium reducing subsidy and the entire premium was payable at the writing of the policy. Those two factors changed and LGM-Dairy became more popular.

It appears our educational program was successful and dairy operators saw an opportunity. According to Brian Gould, University of Wisconsin Department of Agriculture and Applied Economics, Minnesota LGM-Dairy contracts made up of 11.6% of all contracts written in 2010 and through March of 2011 (see Table 1). Only Wisconsin had a higher percentage (30%). Considering Wisconsin has about three times as many dairy farms as Minnesota, Minnesota had equally as high a participation rate. Minnesota farmers protected 4.9% of the production covered by LGM-Dairy policies. The amount of production compared to policy numbers suggests many smaller farmers were probably using the tool, and many may have been writing relatively small policies as they learned more about the system. One nice feature of LGM-Dairy is that even small farmers can use it since there aren't minimum amounts that must be covered in one contract as is the case with futures markets.

It appears the premium payment changes in November 2010, made a difference (see Table 2). From January to June 2010, 153 contracts covering less than 2 million hundredweights of milk were written nationwide. From July 2010 to January 2011, 690 contracts covering 19 million hundredweights of milk were written; but in February and March of 2011, alone, 719 contracts protecting over 27 million hundredweights of milk were written. The opportunity to protect some margin in the business became attractive to producers and probably made working with their lenders easier as they too saw less risk in the business.

What has happened since March of 2011? The program literally ran out of fuel. The USDA budget included limited funding to support the premium subsidy and the insurance agency commissions. The department redirected funds to increase the allocation, but the whole program still ran out of funds after only a couple hours of sales in March. The whole system came to a grinding halt. Some will say that is responsible government; spending only what was budgeted. Others will say it was poor planning to offer and implement a program they couldn't fully fund. Whichever group you happen to fall into, the losers are dairy operators who found a tool they could use for risk management, and now it has been suspended.

It is anticipated that the program will resume in October when a new fiscal year starts. The question remains, "What level of funding will be provided?"

Farmers will again have to make decisions again about participation. Will they look ahead, make decisions for the entire year and get in early, or will they hold off because of uncertain funding? LGM-Dairy certainly looks like a tool to be used, and it is a tool that has not been costly since very few indemnity payments have been made so far. Its prediction models have been working pretty well.

To learn more about LGM-Dairy, check out the University of Minnesota Dairy Extension web page on marketing or "Understanding Dairy Markets" from the University of Wisconsin.

Table 1. Participation in the LGM-Dairy Program by dairy state.

State

LGM-Dairy State Participation

Policies Sold

CWT Insured

Liabilities

Premiums

No.

% of Total

(000)

% of Total

$ (000)

% of Total

$ (000)

% of Total

CA

40

2.8

4,381

9.5

73,628

9.6

2,445

11.1

ID

28

2

1,405

3

22,132

2.9

628

2.8

IA

45

3.2

939

2

16,658

2.2

493

2.2

MI

119

8.4

4,723

10.2

80,072

10.4

2,503

11.4

MN

163

11.6

2,268

4.9

38,150

5

1,342

6.1

NY

86

6.1

3,259

7.1

55,355

7.2

1,950

8.8

PA

133

9.4

2,269

4.9

37,543

4.9

1,376

6.2

VT

94

6.7

4,746

10.3

76,965

10

2,172

9.9

WA

40

2.8

2,427

5.3

39,415

5.1

1,216

5.5

WI

422

30

9,273

20.1

154,487

20.1

5,038

22.9

Other

239

17

10,473

22.8

175,864

22.8

2,878

13.1

Total

1,409

-----

46,209

-----

770,270

-----

25,041

-----

Source: Gould, University of Wisconsin, July 2011.

Table 2. Summary data for the LGM-Dairy Program in 2010-11.

Insurance Year

LGM-Dairy Measures of Activity

Policies Sold (No.)

CWT Insured (000)

GMG
($000)

Premium $ (000)

Indem. Paid
$ (000)

Loss
Ratio

2010

153

1,872

24,915

782

280

0.36

July 2010 -- January 2011

690

19,025

303,715

9,100

0

0

February 2011

401

15,523

271,972

9,121

18

0

March 2011

318

11,660

194,583

6,820

40

0

2011 Total

1,409

46209*

770,270

25,041

58

0

*Represents approximately 2.4% of 2010 U.S. milk production.

Source: Gould, University of Wisconsin, July 2011.

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