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The Dairy Revenue Protection Program: Another tool for dairy risk management

Monday, October 1, 2018   (0 Comments)
Posted by: Lauren Brey
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By Brian Gould, Renk Professor of Agribusiness, Deptartment of Agricultural and Applied Economics, University of Wisconsin-Madison

Starting this month, the Risk Management Agency of USDA will make a new risk management tool available for the dairy industry: Dairy Revenue Protection (DRP). This insurance product allows dairy farmers to ensure that a minimum level of revenue will be forthcoming over insured three-month periods. Up to five quarters (i.e., 15 months) of revenue can be protected on any day with each quarter coverage being a separate insurance endorsement. For this program, milk revenue is not defined in $/cwt but in terms of total revenue received (i.e., $/cwt × cwt sold).

Under DRP, the producer will have to make five decisions:

  1. The method by which milk value is determined
  2. The amount of milk production to cover
  3. The percent of guaranteed revenue per cow to insure (70 percent to 95 percent in 5 percent increments)
  4. Which quarterly contract(s) desired to be purchased
  5. Whether to purchase an optional protection factor (100-150 percent in 5 percent increments) to account for farm specific production characteristics.

The DRP allows for two methods to determine quarterly per cwt milk value: producer-specified weighted quarterly average of announced Class III and IV milk prices ($/cwt) vs. quarterly average announced Class III component (i.e., fat, protein and other solids) per lb. values. The first option allows farmers to more accurately reflect the value of standard milk sold in their locality (i.e., standard milk has 3.5 percent fat, 2.99 percent protein and 5.7 percent other solids). 

Alternatively, farmers can value their milk based on the minimum value of the components in their herd’s milk. This method allows farmers to account for differences in farm-specific component composition vs. that of standard milk.

Unlike the Livestock Gross Margin for Dairy (LGM-Dairy) insurance program, there is no limit to the amount of milk that can be insured. The maximum amount of milk that can be insured is determined by the maximum of the annual amount of milk produced over the 2011-13 period. Under the same contract design, premiums do not differ according to the amount of milk insured.

With a determination of the amount of milk that will be produced during a quarter, the farmer must decide on the amount of milk to insure, in the range of 70-90 percent of production in 5 percent increments. The percentage insured can vary across quarters insured.

On any purchase occasion, the farmer needs to identify which of the next five quarters to insure. The covered quarters do not need to be consecutive and do not have to include the nearest quarter.

DRP contracts will be sold daily starting on Oct. 9. Premiums will be contract-specific and actuarily fair in that the premium will equal the expected indemnity to be paid (plus 3 percent). In general, contracts with a higher level of liability or covering more deferred quarters will be more expensive.

With the addition of the DRP, dairy farmers have another system for managing the extreme price/revenue risk that is characteristic of today’s milk markets. This program will complement the existing risk management alternatives: LGM-Dairy, the Margin Protection Program, cash forward contracts and futures/options-based strategies. Each system has its own strengths and weaknesses. The challenge facing dairy farmers is determining the system(s) that will help them achieve revenue/margin objectives. 

For more information contact Prof. Brian Gould at bwgould@wisc.edu.


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