Transcript Livestock Gross Margin Insurance for Dairy Cattle

December 14, 2010
Katie Behnke
UW-Extension
Agriculture Agent
Overview
 12:30 – Overview of LGM-Dairy
 1:00 – Join Webinar
 Overview of the cash and futures markets
 Overview of LGM-Dairy structure
 Review of actual and expected price determination
 Comparison of November and December contracts
 Use of LGM-Analyzer for historical analysis and
monitoring future contracts
 Questions from attendees
Dairy Price Risk Management
 How can dairy producers control their milk price?
 Plant sponsored fixed price contracts


Similar to a Class III hedge to lock in a price
No upside potential
 Plant sponsored minimum price contracts

Similar to a Class III put option
 Traditional hedging and options strategies



Many alternatives – lock in a Class III price, establish a
minimum price
Contract lumpiness
Margin calls with hedging
Dairy Revenue Risk Management
•
How can a producer establish a floor on Income over
Feed Costs (IOFC)?
• Class III put options: Creates milk revenue floor
• Feed call options: Establishes feed cost ceiling
• Using this bundled option strategy, producer can
establish an IOFC floor
$/cwt
Milk revenue
floor
Minimum IOFC
Feed cost ceiling
Dairy Revenue Risk Management
$/cwt
Announced Class III ↑,
→ Don’t use Class III Put
IOFC
IOFC*
Class III Put
IOFC* > IOFC
Feed Calls
$/cwt
Class III Put
IOFC
IOFC*
IOFC* > IOFC
Feed Calls
Feed Price ↓ → Don’t
use Corn/SBM Calls
LGM-Dairy Overview
 Livestock Gross Margin Insurance for Dairy
 Insurance policy used to set an IOFC floor
 First contracts offered August 2008
 Administered by the USDA Risk Management Agency
and purchased from firms selling Federal crop insurance
projects
 Similar to the use of bundled options, except
 LGM-Dairy has no minimum size limit
 Upper limit of 240,000 cwt over a 10 month period
 No actual futures market activity
LGM-Dairy Overview
 LGM-Dairy is customizable with respect to:
 Number of months insured

1-10 months
 Percent of IOFC (production) covered


0-100% of certified production each month
Percentage covered can vary across months
 LGM-Dairy is available on the last business Friday of
the month until 8:00 PM on Saturday
LGM-Dairy Overview
 Gross Margin Guarantee (GMG) =
Expected value of milk – Expected feed cost – Declared Deductible
 Actual Gross Margin (AGM) =
Actual value of milk – Actual feed cost
 Only one GMG and AGM per contract – evaluated over the entire
contract period
 Indemnity (payout) occurs if AGM is less than GMG
Gross Margin
Guarantee
Actual Gross
Margin
Expected Gross
Margin (IOFC)
Expected Milk
Revenue
CME
Class III
Futures
Settle
Prices
Desired
Coverage
Deductible
Level
Expected
Feed
Cost
CME
Corn
Futures
Settle
Prices
CME
SBM
Futures
Settle
Prices
Expected Feed
Quantity
?
Insurance
Payout
Premium
& Subsidy
Actual Milk
Revenue
CME
Final
Class III
Settle Prices
Actual Feed
Cost
CME
Final
Corn, SBM
Settle Prices
Market Data
Program Rules
Producer Data/Decision
LGM-Dairy Overview
 Class III, corn, and soybean meal futures markets used
as information source to determine Expected and
Actual Prices
 No futures market transactions associated with LGM-
Dairy
 Actual farm prices not used
 Once LGM-Dairy is purchased, the insured IOFC
calculated cannot be lower than the GMG
LGM-Dairy Overview
 At sign-up, the producer declares milk production and
feed equivalent to insure
 Producer defines Expected feed use in terms of corn
(energy) and soybean meal (protein) equivalents
 Allowable declared feed equivalents:



Corn: 0.13 - 1.04 bu/cwt of milk
Soybean Meal: 1.61 - 12.85 lb/cwt of milk
Program default values are:
Corn=0.5 bu/cwt and SBM = 4.0lbs/cwt
Insurance Deductible
 Producer chooses the amount of gross margin not
covered by insurance
 Deductible ranges from $0 to $2 (new!)
 Higher deductible
Lower premium
Premium
 Based on the average of CME Group futures contract
daily settlement prices
 Subsidy available
 Contract must be at least two months
 Subsidy is based on deductible
 Deductible = $0.00, Subsidy = 18%
 Deductible ≥ $1.10, Subsidy = 50%
 Due at the end of the contract period
 Previous analysis calculates the LGM-Dairy premium
to be about half the cost of investing in a bundled
options strategy (before the premium!)
Indemnity
 If total GMG > total AGM
Indemnity paid
No indemnity paid
 If total GMG < total AGM
 Market conditions are more favorable than existed at
sign-up
 Higher Class III price, lower feed price, or both
LGM-Dairy Program Updates
 Changes take effect December 17, 2010
 Premiums – now due at the end of the coverage period
 Higher deductibles – up to $2
 Subsidy – A premium subsidy is available based upon
the selected deductible level
 Adjustment of feed values
Questions?