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Livestock Gross Margin Insurance for Dairy Cattle

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

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Livestock Gross Margin Insurance for Dairy Cattle

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  1. Livestock Gross Margin Insurance for Dairy Cattle December 14, 2010 Katie Behnke UW-Extension Agriculture Agent

  2. 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

  3. 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

  4. 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

  5. Dairy Revenue Risk Management $/cwt Announced Class III ↑, → Don’t use Class III Put Class III Put IOFC* IOFC IOFC* > IOFC Feed Calls $/cwt Class III Put IOFC IOFC* > IOFC IOFC* Feed Calls Feed Price ↓ → Don’t use Corn/SBM Calls

  6. 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

  7. 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

  8. 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

  9. Gross Margin Guarantee Actual Gross Margin Insurance Payout Premium & Subsidy Expected Gross Margin (IOFC) Deductible Level Expected Milk Revenue Expected Feed Cost Actual Milk Revenue Actual Feed Cost CME Final Class III Settle Prices CME Final Corn, SBM Settle Prices CME Class III Futures Settle Prices CME Corn Futures Settle Prices CME SBM Futures Settle Prices Program Rules Market Data Desired Coverage Expected Feed Quantity Producer Data/Decision ?

  10. 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

  11. 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

  12. Insurance Deductible • Producer chooses the amount of gross margin not covered by insurance • Deductible ranges from $0 to $2 (new!) • Higher deductible Lower premium

  13. 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!)

  14. Indemnity • If total GMG > total AGM Indemnity paid • If total GMG < total AGM No indemnity paid • Market conditions are more favorable than existed at sign-up • Higher Class III price, lower feed price, or both

  15. 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

  16. Questions?

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