DAIRY REVENUE PROTECTION

John Newton, Ph.D.Director, Market Intelligence, American Farm Bureau Federation

A MERICA N FA RM BU REAU I N S U RA N CE S ERV ICES, IN C.

& A MERICA N FA RM BU REAU F ED ERATION

508( h ) P ROP OSA L TO FCIC BOA RD

N OV EMBER 29 , 2017

WHO IS INVOLVED• American Farm Bureau Insurance Services, Inc. • Submitting organization – Crop Insurance since 1995

• American Farm Bureau Federation• John Newton, PH.D – Expert Economist

• Marin Bozic, PH.D – Expert Economist• Joshua Woodard, PH.D – Expert Economist• American Agricultural Insurance Company (AIP)• COUNTRY Financial (AIP)

AGENDA

Economic Challenges in Dairy, Need for Proposed Plan of Insurance & Gap in Coverage

1What is Dairy Revenue Protection? How Does it Work?

2Advantages & DisadvantagesFarmer Responses and Marketability

3

U.S. MILK PRICE VARIABILITY, 2000 TOPRESENT

Class III Milk PriceCoefficient of

Variation 24%Class IV Milk Price

Coefficient of

Variation 25%

-50%

During 2015 Milk Prices Declined By:

ONE SIZE DOES NOT FIT ALL, MILK PRICES PAIDTO FARMERS DIFFER IN EVERY COUNTY IN U.S.

Source: USDA AMS

Class I Location DifferentialsEvery county in the U.S. has a regulated minimum price based on the county they are located in.

Differentials highest in South East deficit milk production regions.

Differentials are lower in milk surplus orders.

$6 per cwt.

$1.60 per cwt.

CURRENT DAIRY SAFETY NETS ARE MARGINBASED, BASIS RISK HIGH ON MILK & FEED

$2

$4

$6

$8

$10

$12

$14

$16

$18

2014

2015

2016

2017

$/cw

t

MPP Margin Max MPP $8 Coverage

Livestock Gross Margin Insurance Margin Protection Program

Source: USDA FSA, Farmdoc Daily

Cost of Homegrown Feed Not Reflected, Only Prices Paid

CROP PRICES HAVE DECLINED, REDUCINGMARGIN RISK ON PURCHASED FEED

Sub $4 Bushel Corn Likely for 2017/18 Crop

Soybean Prices Below Historic Highs

Corn Price Soybean Price

13% 14%

23%

34%

19%

27%

11%

19% 17%

0%

20%

40%

Corn Milk Soy

Pre-RFSRFS-BuildRFS-Capacity

Policy Actions:1st: MILC Modified to Include Feed-Adjustor2nd: Income Over Feed Cost Policies Introduced (LGM-D and MPP)

Coefficient of Variation by RFS Period and by Commodity

GAP IN RISK COVERAGE, EXISTING PRODUCTSMARGIN-BASED

GAP IN RISK COVERAGE, MILK PRICES HAVEFALLEN NEARLY 50%, REVENUE DOWN 20%

Billi

on D

olla

rs

$35 $35

$24

$31

$40$37

$40

$49

$36 $34

$38

$20

$30

$40

$50 Policy Actions for Dairy Risk

• New safety net in 2014 Farm Bill (Margin Protection Program) provided limited support

• Congressional actions included emergency cheese purchases in 2016, Senate Appropriations Package

Source: USDA NASS, AFBF Calculations

GAP IN RISK COVERAGE, MILK PRICE/YIELDVOLATILITY RESULTS IN UNCERTAIN REVENUE

Revenue VariabilityMonth to month changes in revenue vary by as much as 20 percent.

Milk is a “flow” commodity so farmers have no ability to store on farm and sell at more favorable prices.

Revenue is subject to these marketing constraints and changes in animal productivity -20%

-15%

-10%

-5%

0%

5%

10%

15%

20%

25%

1/1/

2000

1/1/

2001

1/1/

2002

1/1/

2003

1/1/

2004

1/1/

2005

1/1/

2006

1/1/

2007

1/1/

2008

1/1/

2009

1/1/

2010

1/1/

2011

1/1/

2012

1/1/

2013

1/1/

2014

1/1/

2015

1/1/

2016

1/1/

2017

Perc

ent C

hang

e in

U.S

. Milk

Re

venu

e

GAP IN COVERAGE, HOW MILK IS ACTUALLYPRICED

FMMO Pricing Regulations, Component and Skim-Fat OrdersMultiple Component Pricing:Paid for the components in the milk (butterfat, protein, other milk solids)

Skim-Fat:Paid for the butterfat content in the milk. All other components paid a uniform price, “skim price”

Source: USDA AMS

GAP IN COVERAGE, USDA END-PRODUCT MILKPRICING FORMULAS

USDA Survey

USDA Formula & Regulated Prices

Guaranteed to Farmers

USDA Formula for Price Index

Source: USDA AMS

SUMMARY OF CHALLENGES AND GAPS INCOVERAGE• Existing dairy safety net programs developed in 2008 to

address rising livestock feed costs• Does not reflect cost of growing feed or cover replacement

costs• Basis risk is high on crop prices and milk prices

• LGM-D is based on Class III milk price only, does not reflect how milk is priced in U.S./California

• No insurance product available to cover revenue variability, i.e. price/yield risk

AGENDA

Economic Challenges in Dairy, Need for Proposed Plan of Insurance & Gap in Coverage

1What is Dairy Revenue Protection? How Does it Work?

2Advantages & DisadvantagesFarmer Responses and Marketability

3

WHAT IS DAIRY-REVENUE PROTECTION?• Dairy Revenue Protection (Dairy-RP) is a quarterly area based dairy

revenue insurance product covering both yield and price risk• Based on average milk yields per cow at a state level (published by

USDA NASS quarterly)• Policies cover a three month quarter corresponding to quarters of

the calendar year, available for purchase up to 5 quarters• Sales periods would occur daily

• Actuarially appropriate, all data used to rate product is publicly available USDA/CME

• Addresses gap in risk coverage by addressing basis risk and covers revenue, not income-over-feed-cost margin

DAIRY-RP PRICING OPTIONS• Two pricing options to choose from:• Class Pricing Option based on mix of CME Class III and IV milk

that settle to USDA Agricultural Marketing Service announced milk prices• Farmer chooses “mix” of Class III and Class IV

• Component Pricing Option based on CME-implied milk component prices that settle to USDA Agricultural Marketing Service announced milk prices• Farmer chooses the butterfat and protein tests, higher test levels

have higher value of milk

DAIRY-RP OPTIONAL DECLARATIONS• Milk Price Basis• A range from $0 (default) to $6 per hundredweight from the milk

value covered under the policy• Protection Factor• Similar to protection factor on other area-bases products• Increase dollar value of insurance by up to 50%

• Allow producers to choose the appropriate level of coverage based on their dairy operation, since farm-level yield and price risk/volatility tend to be greater than indicated by state-level numbers.

DETERMINATION OF EXPECTED PRICES, FINALPRICES ANNOUNCED BY USDA-AMS

Month 1 of Quarter

Price Used in Dairy-RP

Milk and Dairy Product Futures (CIII, CIV, Butter, Cheese, Dry Whey)

Month 2 of Quarter

Month 3 of Quarter

$18.25 $18.50 $18.75

$18.50

Milk or Component Prices Are Averaged for the 3 Months of the Quarter.

CME Prices AveragedClass IIIClass IVButterCheese

Dry Whey

EXPECTED STATE-INDEXED MILK PRODUCTION PERCOW, ACTUAL ANNOUNCED BY USDA-NASS

5,770 Lbs/Qtr

Policy Indemnity Would go DOWN if State-Level Milk

Per Cow INCREASED

State’s ExpectedMilk per Cow

5,909 Lbs/Qtr

5,654 Lbs/QtrPolicy Indemnity Would go UP if State-Level

Milk Per Cow DECREASED

173 Cows X 5,770 Lbs/Cow = 1,000,000 LbsDeclared Covered Milk Production

173 Cows X 5,909 Lbs/Cow = 1,022,257 LbsState-Indexed Milk Production

173 Cows X 5,654 Lbs/Cow = 978,142 LbsState-Indexed Milk Production

EXAMPLE OF DAIRY REVENUE PROTECTIONUNDER DIFFERENT PRICE/YIELD SCENARIOS

EXAMPLE OF DAIRY REVENUE PROTECTIONUNDER DIFFERENT PRICE/YIELD SCENARIOS

AGENDA

Economic Challenges in Dairy, Need for Proposed Plan of Insurance & Gap in Coverage

1What is Dairy Revenue Protection? How Does it Work?

2Advantages & DisadvantagesFarmer Responses and Marketability

3

ADVANTAGE, CAPTURES MORE OF USDA END-PRODUCT MILK PRICING FORMULAS

USDA Survey

USDA Formula for Price Index

USDA Formula & Regulated Prices

Guaranteed to Farmers

ADVANTAGE, CAN SCALE UP TO REFLECT HIGHERMILK COMPONENTS AND REDUCE BASIS RISK

3.00

3.20

3.40

3.60

3.80

4.00

4.20

Jan Feb Mar Apr May Jun Jul Aug Sep

Butte

rfat T

est

2.80

2.90

3.00

3.10

3.20

3.30

3.40

Jan Feb Mar Apr May Jun Jul Aug Sep

Prot

ein

Test

Range of Market Average Butterfat Tests, 2017

Range of Market Average Protein Tests, 2017

2.99% Protein Used in LGM-D Policy3.5% Butterfat Used in LGM-D Policy

Source: USDA AMS

ADVANTAGE, DAIRY RP CAPTURES MORE OFDAIRY MARKET RISK

$67,741

$70,447

$72,508

$68,299

$65,000

$66,000

$67,000

$68,000

$69,000

$70,000

$71,000

$72,000

$73,000

LGM-D Dairy-RPExpectedActual

Policies Purchased Feb 2016 for 2Q 2016 CoverageOnly 33% Captured by Class III (LGM-D)

84% Of U.S. Milk Price and Revenue Risk Captured by Class III and IV (Dairy-RP).

For these policies, Class III milk price increased 25¢ per hundredweight, while Class IV milk prices declined by $2 per hundredweight.

Source: USDA AMS, AFBF Calculations

ADVANTAGE, PROPOSED FOR DAIRY RP TO BESOLD DAILY

Daily49%

Not at All4%

Monthly16%

Weekly31%

How often do you monitor market prices for milk or your milk components, e.g. cheese price, butter price or Class III milk price?

80% of respondents monitor market prices at least weekly

16% monthly, LGM-D sales frequency inadequate for risk management needs

ADVANTAGE, DAIRY-RP POLICY SIMPLICITY• Under Dairy-RP Farmer Has Few Decisions to Make:

1. Value of Milk2. Amount of Milk to Cover3. Coverage Level (70% to 95%)

• Under LGM-D Farmer Has Complex Decisions to Make (>20K Combinations):1. Hundredweight of Milk Insured2. Corn Fed in Bushels (0.13 bushel to 1.36 bushels)3. Soybean Meal Fed in Tons (1.61 lbs. to 26 pounds)4. Number of Months to Cover (1 to 10 months)5. Deductible Level ($0 to $2 per hundredweight)

ADVANTAGE, DAIRY-RP INDEMNIFICATIONOCCURS QUICKLY

October November December JanuaryPolicy Active Policy Active Policy Active USDA Milk Prices and

Milk Production

October November December January February MarchPolicy Active Policy Active Policy Active

Milk Prices for Oct. and Nov.

Milk Price for Dec.

Policy Active Policy Active Policy ActiveCorn Prices for Oct to

Dec

Oct. SBM Contract Policy ActiveCME SBM for Nov. and

Dec.

Dairy-RPNotice of loss 20 days after quarter

LGM-DairyNotice of loss 60+ days after quarter. LGM-D prices updated based on corn settlement dates.

NUMBER OF DAIRY FARMERS AND INDUSTRYSTAKEHOLDERS PARTICIPATING IN FOCUS GROUPS

0

200

400

600

800

1,000

1,200

0

50

100

150

200

2501/

19/2

017

1/24

/201

71/

29/2

017

1/30

/201

72/

9/20

172/

15/2

017

2/16

/201

73/

2/20

173/

17/2

017

3/28

/201

74/

6/20

174/

12/2

017

4/18

/201

74/

21/2

017

5/3/

2017

5/23

/201

76/

14/2

017

6/23

/201

76/

29/2

017

6/30

/201

77/

11/2

017

7/20

/201

77/

30/2

017

8/2/

2017

8/15

/201

78/

17/2

017

8/30

/201

78/

31/2

017

9/6/

2017

9/6/

2017

9/11

/201

79/

11/2

017

9/11

/201

79/

12/2

017

9/13

/201

79/

14/2

017

9/15

/201

79/

26/2

017

Part

icip

ants

Participant Count Cumulative Participation (Right)

FOCUS GROUP: RISK MANAGEMENT TOOLSUSED OVER THE LAST 5 YEARS

16%

21%

26%

57%

62%

62%

84%

79%

74%

43%

38%

38%

0% 25% 50% 75% 100%

Livestock Gross Margin protection for Dairy Cattle

Futures and options contracts

Forward contract with milk handler or cooperative

Milk Income Loss Contract Program

Crop Insurance (i.e. Yield or Revenue Protection programs)

Margin Protection Policy

Utilized by Dairy Farmer in Last 5 Years Not Utilized in Last 5 Years

FAVORABLE FARMER RESPONSE TO DAIRY RP

No83%

Need more information

4%

Yes10%

Do not know

3%

Do you feel existing USDA programs provide an opportunity for you to manage risk?

Yes40%

Need more information

36%

No13%

Do not know11%

Given the example of DRP, would this new program help you to manage risk?

Neither option would be something I would consider

16%

Both options would be something I would consider

56%

The component based process

would be something I would consider

11%

A mix of Class III and Class IV

would be something I

would consider17%

Based on the above information, which tool would you consider to manage your risk?

LETTERS OF SUPPORT

• American Farm Bureau President Zippy Duvall• Farm Bureau Sales Personnel

• Blake Ashcraft• Brenda Szach• Loren West

• American Dairy Coalition• California Dairies Inc.• Center for Dairy Excellence (Pennsylvania)• Dairy Business Milk Marketing Cooperative (Upper Midwest)• Dairy Farmer State Dairy Committee from Florida Farm Bureau • Dairy Farmer State Dairy Committee from Michigan Farm Bureau • Dairy Farmer State Dairy Committee from Pennsylvania Farm Bureau • Dairy Farmer State Dairy Committee from Wisconsin Farm Bureau • Dairy Gross Margin, LLC (Iowa)• Dairy Producers of New Mexico

• Farm Credit East (Northeast U.S.)• Illinois Farm Bureau• Iowa State Dairy Association• Milk Producers Council (California)• Minnesota Milk Producer's Association• National All-Jersey• Nebraska State Dairy Association • Northeast Dairy Producers Association (New York)• Ohio Dairy Producers Association• Pennsylvania Secretary of Agriculture• South Dakota Dairy Producers Association • Southeast Milk, Inc.• Vita Plus Corporation• Western United Dairymen

DAIRY REVENUE PROTECTIONQUESTIONS?