5/8/17

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@New10_AgEcon 1

“Crop Insurance” for Milk?

Dairy-Revenue ProtectionDr. John Newtonjnewton@fb.org

American Farm Bureau Federation

@New10_AgEcon 2

$55.

8

$40.

9

$38.

9

$10.

5

$4.9

$3.4

$2.0

$0

$10

$20

$30

$40

$50

$60

Corn Soybeans Dairy Wheat Cotton Rice Peanuts

Billion Dollars

Source: Congressional Budget Office

Congress Projected Annual Average Crop Market ValueDairy is the 3rd Biggest Crop

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@New10_AgEcon 3

4%

2%

0.19%26%

15%1%

12%

0%

5%

10%

15%

20%

25%

30%

Corn Cotton Dairy Peanuts Rice Soybeans Wheat

Percent

Source: Congressional Budget Office

Commodity Payments as Share of Crop Market ValueDairy Safety Net Does Not Reflect Value of Industry

@New10_AgEcon 4

Milk Production Areas Highlight Dairy Policy ChallengeWhat’s the Most Common Denominator, Price of Feed or Milk Pricing Framework?

Source: USDA NASS

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@New10_AgEcon 5

2016 State-Level All-Milk Price

Does One Size Fit All for Dairy Risk Management?Utilization %, Differentials, and Component Levels Create Farm-Level Basis Risk

Range: $13.90 to $19.60Average: $16.38

Source: USDA NASS

@New10_AgEcon 6

Percentage of Feed Purchased, 2016

Is Feed Risk Exposure the Same?Midwest Homegrown and Close Proximity to Feed, South and West Feed Purchasers

Source: USDA ERS

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@New10_AgEcon

13% 14%

23%

34%

19%

27%

11%

19% 17%

0%

20%

40%

Corn Milk Soy

Pre-RFS

RFS-Build

RFS-Capacity

7Source: USDA NASS and AFBF Calculations

The Risk Environment in Dairy Returned to Normal Coefficient of Variation by Era and by Commodity Complex

Policy Actions:1st: MILC Modified to Include Feed-Adjustor2nd: Income Over Feed Cost Policies Introduced

@New10_AgEcon 8Source: USDA NASS/WASDE

Billio

n D

olla

rs

Milk Revenue Down $10 Billion from 2014Yet MPP Margin Has Recovered Back to 2014 Levels of $10-$11 per hundredweight

$35 $35

$24

$31

$40$37

$40

$49

$36 $34 $38

$0

$10

$20

$30

$40

$50

2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017

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@New10_AgEcon

Farm Bureau Policy: Dairy Safety Nets Need to Be Enhanced MPP Performance During 2015 and 2016

Source: USDA FSA

@New10_AgEcon

61% 88% 98%

39% 12%

2%

0%

25%

50%

75%

100%

2015 2016 2017

$4.00 Catastrophic Coverage Buy-Up Coverage

Active Participation in MPP Has DeclinedPercent of Milk Enrolled in MPP by Coverage Election

Source: USDA FSA

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@New10_AgEcon

Farm Bill Prevents MPP & LGM-Dairy

Source: USDA FSA

@New10_AgEcon 12

Field Crops Have Revenue Risk Management ToolsAlso Have Title I Programs ARC (Revenue) and PLC (Price)

Harvest Price Option

Revenue Higher-of Spring or Harvest Price

Yield

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@New10_AgEcon 13Source: USDA NASS/RMA

Revenue-Based Policies Are Most Widely Used90% of Corn Acres Covered Under Crop Insurance, 80% Have Revenue Policy

0

10

20

30

40

50

60

70

80

90

100

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

2015

2016

Milli

on A

cres

Revenue Policies Non RP Policies Corn Acres Planted

@New10_AgEcon 14

We Can Improve Dairy Insurance, Dairy-Revenue Protection

• Direct Payment, i.e. Title I, programs face criticism in 2018 Farm Bill, 2023 Farm Bill, 2028 Farm Bill

• Crop Insurance for Milk = Based on actuarially sound procedures• “Skin in the Game” easy to defend

• Repeal of MILC in 2014 eliminated milk price support• No government tool to manage milk price/revenue risk, all policies include feed• Min-Feed LGM Policy is closest government instrument

• Early 2016 AFBF and AFBIS worked on concept for new insurance product to cover milk price/revenue risk

• Farm Bill Working Group and Stakeholder meetings across the country to gather input• Mix-Class III/IV milk or milk components• Policy is quarterly revenue, Jan-Mar, …, Oct-Dec• Farm-level customization on milk value protected• Custom mix of milk prices can significantly target basis risk relative• Basket option is a financial derivative and is a weighted average of a group of

commodities

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@New10_AgEcon

Dairy-Revenue Protection Rating Methodology…

Math

@New10_AgEcon

Dairy-RP Expected RevenuePolicy Purchased Nov. 2015 for 2Q 2016

Market Information at Hedging TimeA. Class III Milk Futures Price per cwt $16.26B. Class IV Milk Futures Price per cwt $15.94

Farmer's Choices D. Class III Milk Utilization Ratio 75%E. Total Milk Production Protected (cwt) 40,000F. Coverage Level (10% Deductible) 90%

Insurance Policy ParametersG. Expected Milk Price (D*A+(1-D)*B) $16.18H. Expected Milk Revenue (E*G) $647,200J. Revenue Guarantee (H*F) $582,480

Source: Dairy-RP 522

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@New10_AgEcon 17

Farmers May Self-Select Shallow Loss or Deep LossQuarterly Revenue Guarantee, 4 Mil Lbs.

$647 $582 $550 $518 $485 $453

$65 $97 $129 $162 $194

$0

$150

$300

$450

$600

$750

100% 90% 85% 80% 75% 70%

Thou

sand

Dol

lars

per

Qua

rter

Coverage Level

Revenue GuaranteeDeductible

Source: Dairy-RP 522

Shallow Loss Deep Loss

@New10_AgEcon

Dairy-RP PerformanceHedge Placed Nov 2015 for 2Q 2016

Market Information at Hedging TimeJ. Revenue Guarantee (H*F) $582,480

Actual Market InformationL. Final Class III Milk Price $13.20M. Final Class IV Milk Price $13.18N. Final Milk Price (L*D+M*(1-D)) $13.20O. Actual Milk Production (cwt)* 41,426P. Actual Revenue (N*O) $546,618

Dairy-RP PaymentQ. Indemnity (J-P, if positive) $35,862R. Policy Cost (K*E) $5,956S. Net Indemnity (Q-R) $29,906

Source: Dairy-RP 522

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@New10_AgEcon 19

$5

$9

$13

$17

$21

$25

2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

$/hu

ndre

dwei

ght

Class III Futures (2Q Strip)Actual Milk Price

Market BasedCannot Lock in Prices Above Market Traded

Levels

Dairy-RP Indemnifies Unanticipated Price Declines Keeps Upside Price Potential

Zero Deductible Policy Indemnities

Source: Dairy-RP 522

Farmer Receives Higher Prices, Pays Premium

@New10_AgEcon 20Source: Dairy-RP 522

Average Dairy-RP Premium Rates, 2008 to 2016Assumed Cost-Share (Subsidy) in Line With Existing Crop Insurance Policies

$0.09$0.21

$0.28$0.36$0.04

$0.08

$0.11

$0.14

$0.00

$0.10

$0.20

$0.30

$0.40

$0.50

$0.60

One Quarter Ahead Two Quarters Ahead Three Quarters Ahead

Four Quarters Ahead

Farmer Premium Govt Cost Share

90%

Cov

erag

e Le

vel

28%

Sub

sidy

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@New10_AgEcon 21Source: Dairy-RP 522

Average Dairy-RP Premium Rates, 2008 to 2016Assumed Cost-Share (Subsidy) in Line With Existing Crop Insurance Policies

$0.01 $0.03 $0.05 $0.08$0.01 $0.03 $0.05

$0.08

$0.00

$0.10

$0.20

$0.30

$0.40

$0.50

$0.60

One Quarter Ahead Two Quarters Ahead Three Quarters Ahead

Four Quarters Ahead

Farmer Premium Govt Cost Share

80%

Cov

erag

e Le

vel

48%

Sub

sidy

@New10_AgEcon 22Source: Understanding Dairy Markets

Dairy-RP Can Minimize Milk Price Basis RiskFarmers Choose a Utilization to Match Mailbox Price Risk, Farm-Level Customization

Cheese MilkHigher Weight on

Class III

Heavy Fluid MilkEven Weight III/IV

Lower Fluid UseEven Weight III/IV

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@New10_AgEcon 23

Comparison to Existing Risk Management ToolsWFRP LGM MPP Dairy-RP

Commodity Revenue Protection Yes No No YesMargin Protection No Yes Yes NoWorks with other Feed Insurance (e.g., Corn) Yes No N/A YesRegional N/A No No YesCoverage Election Yes Yes Yes YesCustomizable (components/classes etc.) No Low No Yes, HighVia FCIC Yes Yes No YesPrice Triggers Market Based N/A Yes No YesCovers Yield/Production Risk N/A No No YesBasis Risk Low High High LowReporting Requirements High Low Low LowDisappearing Deductible No No No YesDirectly Insure Milk Commodity or Indirectly via insuring Cash Flows from Live Animal Indirect Indirect Indirect DirectMarket Based Pricing No Yes No Yes

@New10_AgEcon 24

Portion of U.S. Milk Supply Hedged by Instrument

2%

6%

80%

LGM-D

CME Class III

MPP

MILC

30%

Forward Contracts

?

Source: USDA NASS, RMA, FSA, CME

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@New10_AgEcon 25

Submitted Concept Proposal in AprilNot a replacement for MPP

@New10_AgEcon

Livestock Insurance $20 Million Cap

Livestock Livestock CommodityCommodity

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@New10_AgEcon

Congressional Directive, May 1, 2017 Budget

@New10_AgEcon