the livestock gross margin insurance program for dairy: potential for future research?

The Livestock Gross The Livestock Gross Margin Insurance Program for Dairy:Margin Insurance Program for Dairy:

Potential for Future Research?Potential for Future Research?

Brian W. GouldBrian W. GouldAssociate ProfessorAssociate Professor

Department of Agricultural and Applied EconomicsDepartment of Agricultural and Applied Economics

Victor E. CabreraVictor E. CabreraAssistant ProfessorAssistant Professor

Department of Dairy ScienceDepartment of Dairy Science

How Can Producers Control Milk Price Risk?How Can Producers Control Milk Price Risk? Forward Fixed Price Contracts via Cheese PlantForward Fixed Price Contracts via Cheese Plant

2008 Farm Bill: Private Firms Can Offer Fixed 2008 Farm Bill: Private Firms Can Offer Fixed Price Forward ContractsPrice Forward Contracts

Minimum Price Contracts with Cheese PlantMinimum Price Contracts with Cheese Plant Similar to Use of Class III Put OptionSimilar to Use of Class III Put Option

Traditional Hedging and Options StrategiesTraditional Hedging and Options Strategies Class III Futures Contract: Milk from average Class III Futures Contract: Milk from average

Wisconsin dairy farm with 125 cow herdWisconsin dairy farm with 125 cow herd

Dairy Price Risk: What are the AlternativesDairy Price Risk: What are the Alternatives

Livestock Gross Margin Insurance for Dairy (Livestock Gross Margin Insurance for Dairy (LGM-LGM-DairyDairy)) Available Starting in August 2008 Available Starting in August 2008 Protects Against Unanticipated Declines in Protects Against Unanticipated Declines in Gross Gross

MarginsMargins Where Where Gross Margin = Milk Revenue – Feed CostsGross Margin = Milk Revenue – Feed Costs

Purchased from Crop Insurance Agents Selling Federal Purchased from Crop Insurance Agents Selling Federal Crop Insurance ProductsCrop Insurance Products

LGM-Dairy: An OverviewLGM-Dairy: An Overview


Who is Eligible to Participate?Who is Eligible to Participate?

LGM-Dairy eligible statesshown in yellow

ID

AZ

UT

MT

WY

NM

CO

AL

FL

SC

TN

KY

INOH

NC

SD

KS

NE

MN

WI

IA

IL

MO

AR

MS

OK

ND

OR

CA NV

WA

PA

ME

VA

NY

CT

WVMD

NJ

VTNHMA

DE

RI

LA

MI

GA

TX

LGM-Dairy Similar to Combined Use of:LGM-Dairy Similar to Combined Use of: Put Option to Control Milk Price Downside RiskPut Option to Control Milk Price Downside Risk Call Options to Control Feed Cost Upside RiskCall Options to Control Feed Cost Upside Risk

LGM-Dairy is Customizable as to:LGM-Dairy is Customizable as to: Size of OperationSize of Operation

Up to 240,000 cwt Over 10 Months Up to 240,000 cwt Over 10 Months 1,500 Head Using Average Wisconsin Yield1,500 Head Using Average Wisconsin Yield

Months Insured (From 1 to 10 Months)Months Insured (From 1 to 10 Months) % of Monthly Gross Margins Covered% of Monthly Gross Margins Covered Gross Margin Deductible Range: $0 - $1.50/cwtGross Margin Deductible Range: $0 - $1.50/cwt


Definition of Gross MarginDefinition of Gross Margin Gross Margin = Total Value of Covered Milk – Gross Margin = Total Value of Covered Milk –

Total Total PurchasedPurchased Feed Costs Feed Costs Feed Does Not Actually Need to be Purchased Feed Does Not Actually Need to be Purchased

but Valued as if Wasbut Valued as if Was Both Milk Value and Feed Cost Both Milk Value and Feed Cost NOTNOT Based on Based on

Actual Farm PricesActual Farm Prices Milk Price: State All-Milk PriceMilk Price: State All-Milk Price Feed Prices: State Corn PriceFeed Prices: State Corn Price

U.S. Soybean Meal PriceU.S. Soybean Meal Price

LGM-Dairy: Definition of Gross MarginLGM-Dairy: Definition of Gross Margin

Expected Feed Use Over Contract Period Converted to Expected Feed Use Over Contract Period Converted to Corn and Soybean Meal EquivalentsCorn and Soybean Meal Equivalents Any Reasonable Conversion System AcceptableAny Reasonable Conversion System Acceptable UW UW Understanding Dairy MarketsUnderstanding Dairy Markets Website has Website has

Conversion Software AvailableConversion Software Available SpreadsheetSpreadsheet Web-BasedWeb-Based

Feed Equivalents Need to be in Very Broad Ranges:Feed Equivalents Need to be in Very Broad Ranges: Corn: 0.00364–0.02912 Tons/cwtCorn: 0.00364–0.02912 Tons/cwt

• 0.13 – 1.04 bu Corn equivalent/cwt Milk0.13 – 1.04 bu Corn equivalent/cwt Milk Soybean Meal: 0.000805–0.006425 Ton/cwtSoybean Meal: 0.000805–0.006425 Ton/cwt

• 1.61 – 12.85 lb Meal equivalent/cwt Milk1.61 – 12.85 lb Meal equivalent/cwt Milk

LGM-Dairy: Definition of Gross MarginLGM-Dairy: Definition of Gross Margin

What Impacts Total Insurance Contract Premium?What Impacts Total Insurance Contract Premium? Amount of Milk and Feed Insured (Amount of Milk and Feed Insured (++)) Proportion of Gross Margin/cwt Not Covered Under Proportion of Gross Margin/cwt Not Covered Under

LGM-Dairy Contract (LGM-Dairy Contract (--))

Expected Milk Price (+)Expected Milk Price (+) Corn and Meal Prices (-)Corn and Meal Prices (-) Expected Price Volatility Over Contract Period (Expected Price Volatility Over Contract Period (++))

LGM-Dairy: Program CharacteristicsLGM-Dairy: Program Characteristics

Determined by Futures/Options Settle Prices at Sign-up and BeyondProducer Control

Determined by Producer

Example of One Possible Insurance StrategyExample of One Possible Insurance Strategy Purchase Insurance in FebruaryPurchase Insurance in February

Feb ′09Mar ′09

Apr ′09

May ′09

Jun ′09

Jul ′09

Aug ′09

Sep ′09

Oct ′09

Nov ′09

Dec ′09

Jan ′10

1 2 3 4 5 6 7 8 9 10

Purchase at End of

Month

NoCover-

ageInsurance Contract PeriodInsurance Contract Period

CoveredMonths

Apr May Jun Sep Oct Nov

Possible Production Months CoveredPossible Production Months Covered


Have from 4 pm (EDT) on 3rd to last business day of purchase month to 9 am (EDT) on the following day to make purchase decision(i.e., 17 hour-period)

GMGGross Margin Guarantee

AGMActual Gross Margin

EGMExpected Gross Margin

DLDeductible Level

EFCExpected Feed Cost

EMPExpected Class III

Price

SMBState Milk Basis

EMRExpected Milk Revenue

ECCExpected

Corn Cost

ESCExpected

SBM Cost

CMEClass IIIFutures

SCBStateCornBasis

CBOTCorn

Futures

CBOTSBM

Futures

AFCActual Feed Cost

CMEActual

Class IIIPrice

Settlement

AMRActual Milk Revenue

CBOTActualFeedsCosts

Settlement

TMTarget Marketings

PREMPremium

Cost

EFQExpected Feed Quantity

INDIndemnity

Producer Data/Decision

Policy Rules

Exogenous Data


Premium Estimates Available via RMA Website Premium Estimates Available via RMA Website www.rma.usda.gov/tools/premcalc.htmlwww.rma.usda.gov/tools/premcalc.html on Purchase on Purchase DayDay

UW has developed an unofficial web-based premium UW has developed an unofficial web-based premium calculator using current futures and optionscalculator using current futures and optionshttp://future.aae.wisc.edu/premium/http://future.aae.wisc.edu/premium/

You Want to Purchase a Contract, How are You Want to Purchase a Contract, How are Expected Expected PricesPrices Determined? Determined? Futures Settle Price Averaged Over 3Futures Settle Price Averaged Over 3rdrd, 4, 4thth and 5 and 5thth

Last Business Days of Insurance Purchase Month Last Business Days of Insurance Purchase Month Corn, Soybean Meal and Class III FuturesCorn, Soybean Meal and Class III Futures


Farm characteristicsFarm characteristics 250 milk cows250 milk cows Average per cow productivity: 19,769 lbsAverage per cow productivity: 19,769 lbs

2007 WI 200-499+ herd size category average2007 WI 200-499+ herd size category average

LGM-Dairy: Wisconsin ExampleLGM-Dairy: Wisconsin Example

HerdsHerds % of Herds% of Herds % of Prod.% of Prod. Avg. YieldAvg. Yield

1-291-29 1,9001,900 13.213.2 1.51.5 11,58611,586

30-4930-49 3,6003,600 25.025.0 10.010.0 16,09216,092

50-9950-99 6,1006,100 42.442.4 29.029.0 17,77817,778

100-199100-199 1,8001,800 12.512.5 18.518.5 19,31019,310

200-499200-499 750750 5.25.2 19.019.0 19,76919,769

500+500+ 250250 1.71.7 22.022.0 24,75024,750

TotalTotal 14,40014,400 100.0100.0 100.0100.0 19,30519,305

→→

Purchase insurance in Jan. Purchase insurance in Jan. → p→ possible 10-Month ossible 10-Month insurance period: Mar `09 – Dec `09insurance period: Mar `09 – Dec `09 Cow productivity changes by monthCow productivity changes by month

Based on Wisconsin monthly yield profileBased on Wisconsin monthly yield profile Amount of feed expected to be usedAmount of feed expected to be used

966 tons Corn equivalent966 tons Corn equivalent 213 tons SBM Equivalent213 tons SBM Equivalent

Insure 100% of production (extreme example)Insure 100% of production (extreme example)



MonthMonthProd./Cow Prod./Cow

(lbs)(lbs)Production Production

(cwt)(cwt)Corn Equiv. Corn Equiv.

(Tons)(Tons)SBM Equiv. SBM Equiv.

(Tons)(Tons)

Mar Mar `̀0909 1,6851,685 4,2134,213 98.198.1 21.721.7

Apr Apr `̀0909 1,6451,645 4,1134,113 95.895.8 21.121.1

May `May `0909 1,7361,736 4,3404,340 101.1101.1 22.322.3

Jun `Jun `0909 1,6751,675 4,1884,188 97.697.6 21.521.5

Jul `Jul `0909 1,6961,696 4,2404,240 98.898.8 21.821.8

Aug `Aug `0909 1,6751,675 4,1884,188 97.697.6 21.521.5

Sep `Sep `0909 1,6091,609 4,0234,023 93.793.7 20.720.7

Oct Oct `̀0909 1,6301,630 4,0754,075 94.994.9 20.920.9

Nov Nov `̀0909 1,6151,615 4,0384,038 94.194.1 20.820.8

Dec Dec `̀0909 1,6251,625 4,0634,063 94.794.7 20.920.9

TotalTotal 16,59116,591 41,48141,481 966.3966.3 213.2213.2

With January 28With January 28thth insurance purchase date insurance purchase date Expected Price Measurement Period Expected Price Measurement Period (EPM): (EPM):

January 26January 26thth, 27, 27thth and 28 and 28thth

To determine the Gross Margin Guarantee at contract To determine the Gross Margin Guarantee at contract sign-up we need:sign-up we need: Expected monthly milk and feed pricesExpected monthly milk and feed prices Producer elected deductibleProducer elected deductible

Calculation of Expected PricesCalculation of Expected Prices

Purchase Insurance

Monthly expected prices for MarMonthly expected prices for Mar`09`09 - - DecDec`09`09 Expected Expected Wisconsin All MilkWisconsin All Milk price price

= Expected Class III prices + Wisconsin [All-Milk = Expected Class III prices + Wisconsin [All-Milk – Class III] Basis– Class III] Basis

Expected Expected Wisconsin Corn GrainWisconsin Corn Grain price price= Expected Corn prices + Wisconsin [Corn Price = Expected Corn prices + Wisconsin [Corn Price

Received – Corn Received – Corn Futures] BasisFutures] Basis

Expected Expected U.S. Soybean MealU.S. Soybean Meal prices (no local basis) prices (no local basis)

Calculation of Expected PricesCalculation of Expected Prices

Calculated from futures settleprices on January 26th – 28th

With the estimation of 10 expected Wisconsin All-Milk With the estimation of 10 expected Wisconsin All-Milk price values one canprice values one can Calculate Expected Gross Revenue (Calculate Expected Gross Revenue (EGREGR) at sign-) at sign-

upup EGREGR is the product of expected All-Milk price is the product of expected All-Milk price

times covered milk productiontimes covered milk production Covered production could be less than allowable Covered production could be less than allowable

target as elected by the producertarget as elected by the producer Different price and covered production each Different price and covered production each

monthmonth

Calculation of Expected Gross RevenueCalculation of Expected Gross Revenue

MonthMonth

Expected WI Expected WI All Milk PriceAll Milk Price

($/cwt)($/cwt)[1][1]

Covered Covered Marketings Marketings

(cwt)(cwt)[2][2]

Expected Expected Gross Gross

Revenue ($)Revenue ($)[3][3]

Mar Mar `̀0909 12.0012.00 4,2134,213 50,55650,556

Apr Apr `̀0909 12.1712.17 4,1134,113 50,05550,055

May `May `0909 12.4512.45 4,3404,340 54,03354,033

Jun `Jun `0909 13.2213.22 4,1884,188 55,36555,365

Jul `Jul `0909 14.2214.22 4,2404,240 60,29360,293

Aug `Aug `0909 15.1815.18 4,1884,188 63,57463,574

Sep `Sep `0909 15.8415.84 4,0234,023 63,72463,724

Oct Oct `̀0909 16.2716.27 4,0754,075 66,30066,300

Nov Nov `̀0909 16.5816.58 4,0384,038 66,95066,950

Dec Dec `̀0909 16.5216.52 4,0634,063 67,12167,121

TotalTotal 41,48141,481 597,972597,972Note: Note: [ 1][ 1] and and [2] [2] obtained from previous table obtained from previous table [3][3] = [1] * = [1] * [2] [2]

Calculation of Expected Gross RevenueCalculation of Expected Gross Revenue

With calculation of expected feed prices for each monthWith calculation of expected feed prices for each month Multiply each months covered feed equivalents times Multiply each months covered feed equivalents times

the expected price to obtain expected feed coststhe expected price to obtain expected feed costs Covered feed equivalents equal to total feed Covered feed equivalents equal to total feed

equivalents multiplied by % of production equivalents multiplied by % of production coveredcovered

Unlike Class III contracts, corn/soybean meal futures Unlike Class III contracts, corn/soybean meal futures contracts may not exist for every month of insurance contracts may not exist for every month of insurance contractcontract

Calculation of Expected Feed CostsCalculation of Expected Feed Costs

MonthMonth

Corn Futures Settle Prices ($/bu)Corn Futures Settle Prices ($/bu)Imputed Imputed

PricePrice$/bu)$/bu)[5][5]

BasisBasis($/bu)($/bu)

[6][6]

Expected WI Expected WI Corn PriceCorn Price

($/bu)($/bu)[7][7]Jan 26Jan 26

[1][1]Jan 27 Jan 27

[2][2]Jan 28Jan 28

[3][3]Avg.Avg.[4][4]

Mar Mar `̀0909 3.93753.9375 3.77503.7750 3.84503.8450 3.853.85 3.853.85 -0.17-0.17 3.683.68

Apr Apr `̀0909 ------------ ------------ ------------ ------------ 3.913.91 -0.11-0.11 3.803.80

May `May `0909 4.04754.0475 3.88503.8850 3.99503.9950 3.963.96 3.963.96 -0.12-0.12 3.843.84

Jun `Jun `0909 ------------ ------------ ------------ ------------ 4.024.02 -0.12-0.12 3.903.90

Jul `Jul `0909 4.15254.1525 3.99253.9925 4.06254.0625 4.074.07 4.074.07 -0.12-0.12 3.953.95

Aug `Aug `0909 ------------ ------------ ------------ ------------ 4.124.12 -0.15-0.15 3.973.97

Sep `Sep `0909 4.25754.2575 4.09504.0950 4.16504.1650 4.174.17 4.174.17 -0.11-0.11 4.064.06

Oct Oct `̀0909 ------------ ------------ ------------ ------------ 4.224.22 -0.15-0.15 4.074.07

Nov Nov `̀0909 ------------ ------------ ------------ ------------ 4.264.26 -0.18-0.18 4.084.08

Dec Dec `̀0909 4.39004.3900 4.23004.2300 4.30004.3000 4.314.31 4.314.31 -0.22-0.22 4.094.09Note: Note: [4][4] = ([1]+[2]+[3])/3, = ([1]+[2]+[3])/3, [5][5] = weighted average with weights based = weighted average with weights based on months from contract expiration, on months from contract expiration, [7][7] = [5]+[6] = [5]+[6]

Calculation of Expected Corn PriceCalculation of Expected Corn Price

MonthMonth

Expected WI Expected WI Corn PriceCorn Price

($/bu)($/bu)[1][1]

CoveredCoveredCorn Equiv. Corn Equiv.

(tons)(tons)[2][2]

ExpectedExpectedCorn CostCorn Cost

($)($)[3][3]

Mar Mar `̀0909 3.683.68 98.198.1 12,89312,893

Apr Apr `̀0909 3.803.80 95.895.8 13,00113,001

May `May `0909 3.843.84 101.1101.1 13,86513,865

Jun `Jun `0909 3.903.90 97.697.6 13,59413,594

Jul `Jul `0909 3.953.95 98.898.8 13,93813,938

Aug `Aug `0909 3.973.97 97.697.6 13,83813,838

Sep `Sep `0909 4.064.06 93.793.7 13,58713,587

Oct Oct `̀0909 4.074.07 94.994.9 13,79413,794

Nov Nov `̀0909 4.084.08 94.194.1 13,71213,712

Dec Dec `̀0909 4.094.09 94.794.7 13,83313,833

Total Total 966.4966.4 136,056136,056

Calculation of Expected Corn CostCalculation of Expected Corn Cost

Note: Note: [ 1] [ 1] andand [2] [2] obtained from previous tables, obtained from previous tables, [3][3] = [1]*(2000/56)* [2] = [1]*(2000/56)* [2]

MonthMonth

Imputed Imputed PricePrice

($/Ton)($/Ton)[1][1]

SBMSBMEquiv Equiv (Ton)(Ton)

[2][2]

Total Total Cost Cost ($)($)[3][3]

Mar Mar `̀0909 312.13312.13 21.721.7 6,7736,773

Apr Apr `̀0909 311.85311.85 21.121.1 6,5806,580

May `May `0909 311.57311.57 22.322.3 6,9486,948

Jun `Jun `0909 311.94311.94 21.521.5 6,7076,707

Jul `Jul `0909 312.30312.30 21.821.8 6,8086,808

Aug `Aug `0909 309.43309.43 21.521.5 6,6536,653

Sep `Sep `0909 300.43300.43 20.720.7 6,2196,219

Oct Oct `̀0909 285.70285.70 20.920.9 5,9715,971

Nov Nov `̀0909 284.70284.70 20.820.8 5,9225,922

Dec Dec `̀0909 283.70283.70 20.920.9 5,9295,929

TotalTotal 213.2213.2 64,51064,510

Note: Note: [1] [1] andand [2] [2] obtained from previous tables, obtained from previous tables, [3][3] = [1]* [2] = [1]* [2]

Calculation of Expected SBM CostCalculation of Expected SBM Cost

Summary of information required for enrollment:Summary of information required for enrollment: Estimation of expected milk prices and feed costsEstimation of expected milk prices and feed costs Statement of insured marketingsStatement of insured marketings

Monthly target marketings (TMMonthly target marketings (TMii)) Desired coverage % (CoverDesired coverage % (Coverii))

Statement of expected feed use Statement of expected feed use Deductible ($ GMG/cwt):Deductible ($ GMG/cwt):

Given above, one can calculate Given above, one can calculate Gross Margin Gross Margin GuaranteeGuarantee (GMG) (GMG) = Expected = Expected totaltotal gross margin – gross margin – deductible*covered milk marketingsdeductible*covered milk marketings

Calculation of Gross Margin GuaranteeCalculation of Gross Margin Guarantee

MonthMonthCorn Corn

Costs ($)Costs ($)[1][1]

SBM SBM Costs ($)Costs ($)

[2][2]

Feed Feed Costs ($)Costs ($)

[3][3]

Revenue Revenue ($)($)[4][4]

Deductible Deductible ($)($)[5][5]

GMGGMG($)($)[6][6]

Mar Mar `̀0909 12,89312,893 6,7736,773 19,66619,666 50,55650,556 4,2134,213 26,67726,677

Apr Apr `̀0909 13,00113,001 6,5806,580 19,58119,581 50,05550,055 4,1134,113 26,36126,361

May `May `0909 13,86513,865 6,9486,948 20,81320,813 54,03354,033 4,3404,340 28,88028,880

Jun `Jun `0909 13,59413,594 6,7076,707 20,30120,301 55,36555,365 4,1884,188 30,87630,876

Jul `Jul `0909 13,93813,938 6,8086,808 20,74620,746 60,29360,293 4,2404,240 35,30735,307

Aug `Aug `0909 13,83813,838 6,6536,653 20,49120,491 63,57463,574 4,1884,188 38,89538,895

Sep `Sep `0909 13,58713,587 6,2196,219 19,80519,805 63,72463,724 4,0234,023 39,89639,896

Oct Oct `̀0909 13,79413,794 5,9715,971 19,76619,766 66,30066,300 4,0754,075 42,46042,460

Nov Nov `̀0909 13,71213,712 5,9225,922 19,63319,633 66,95066,950 4,0384,038 43,27943,279

Dec Dec `̀0909 13,83313,833 5,9295,929 19,76219,762 67,12167,121 4,0634,063 43,29543,295

TotalTotal 136,056136,056 64,51064,510 200,566200,566 597,972597,972 41,48141,481 355,925355,925

Calculation of Gross Margin Guarantee (GMG)Calculation of Gross Margin Guarantee (GMG)

Note: Note: [3][3] = [1] + [2], = [1] + [2], [6][6] = [4] – [3] – [5], = [4] – [3] – [5], $1.00 GMG/cwt deductible assumed$1.00 GMG/cwt deductible assumed

There is There is NoNo Producer Premium SubsidyProducer Premium Subsidy RMA simulates 5,000 Class III, corn grain and RMA simulates 5,000 Class III, corn grain and

SBM prices using data obtained from SBM prices using data obtained from EPMEPM periodperiod Correlated pricesCorrelated prices

Options Options → Variance Futures → Means→ Variance Futures → Means Generates 5,000 simulated total gross marginsGenerates 5,000 simulated total gross margins

For each simulation, determine payout whereFor each simulation, determine payout whereInsurance PayoutInsurance Payout = = MaxMax(0, (0, TotalTotal

GMGGMG – – SimulatedSimulated TotalTotal GMGGMG))

Premiums = Avg. of 5,000 Simulated Payouts + 3%Premiums = Avg. of 5,000 Simulated Payouts + 3%

Calculation of Insurance PremiumsCalculation of Insurance Premiums

We have developed in-house premium softwareWe have developed in-house premium software Official random draws: Aug. 08+Official random draws: Aug. 08+ Simulate our own random draws: Jan. 00-July 08 Simulate our own random draws: Jan. 00-July 08 On-Demand software systemOn-Demand software system

RMA website provides official premiums at sign-upRMA website provides official premiums at sign-up For January 2009 example:For January 2009 example:

PremiumsPremiums decrease at a faster rate then decrease at a faster rate then GMGGMG as as deductibles increasedeductibles increase

Premium vs. Gross Revenue reduction depends on Premium vs. Gross Revenue reduction depends on price volatility at sign-up expected gross marginsprice volatility at sign-up expected gross margins

Payout probability decreases with higher deductiblesPayout probability decreases with higher deductibles

Calculation of Insurance PremiumsCalculation of Insurance Premiums

Insurance Premiums and Deductible LevelInsurance Premiums and Deductible Level(Jan. ′09 Example)(Jan. ′09 Example)

Note: % ↓ measured from $0 Deductible level

Deductible GMG PremiumPremium

Rate Rate ($/cwt)($/cwt)

[1][1]

TotalTotal($)($)[2][2]

TotalTotal($)($)[3][3]

% % ↓↓[4][4]

Total Total ($)($)[5][5]

Per Per CWT ($)CWT ($)

[6][6]% ↓% ↓[7][7]

00 00 397,406397,406 ---------- 34,62934,629 0.8350.835 ----------

0.100.10 4,1484,148 393,258393,258 -1.0-1.0 32,49032,490 0.7830.783 -6.2-6.2

0.300.30 12,44412,444 384,962384,962 -3.1-3.1 28,49728,497 0.6870.687 -17.7-17.7

0.500.50 20,74120,741 376,665376,665 -5.2-5.2 24,87624,876 0.6000.600 -28.2-28.2

0.700.70 29,03729,037 368,369368,369 -7.3-7.3 21,57121,571 0.5200.520 -37.7-37.7

0.900.90 37,33337,333 360,073360,073 -9.4-9.4 18,58818,588 0.4480.448 -46.3-46.3

1.101.10 41,48141,481 351,777351,777 -11.5-11.5 15,92615,926 0.3840.384 -54.0-54.0

1.301.30 53,92553,925 343,481343,481 -13.6-13.6 13,53313,533 0.3260.326 -60.9-60.9

1.501.50 62,22262,222 335,184335,184 -15.7-15.7 11,39411,394 0.2750.275 -67.1-67.1

Relative GMG and Insurance PremiumsRelative GMG and Insurance Premiums(Jan. ′09 Example)(Jan. ′09 Example)

GMG and Premium ($) Per CWT

7.00

7.50

8.00

8.50

9.00

9.50

10.00

0.0 0.2 0.4 0.6 0.8 1.0 1.2 1.4Deductible ($/cwt)

GM

G /c

wt

0.20

0.30

0.40

0.50

0.60

0.70

0.80

0.90

Prem

/cwt

GMG/cwt ($)

Premium/cwt ($)

Deductible, Premium and GMG Changes

-80

-70

-60

-50

-40

-30

-20

-10

0

0.1 0.3 0.5 0.7 0.9 1.1 1.3 1.5Deductible ($/cwt)

% D

ecre

ase

fro

m B

ase

% Change Prem/cwt

% Change GMG/cwt

Effect of Deductible on Premium and GMGEffect of Deductible on Premium and GMG(Jan. ′09 Example)(Jan. ′09 Example)

GMG Premium $0: $397,406 $34,629$0.70: $368,369 $21,571$1.50: $335,184 $11,394

Relative Premium Value and DeductibleRelative Premium Value and Deductible(Jan. ′09 Example)(Jan. ′09 Example)

Premium as % of GMG

3.00

3.75

4.50

5.25

6.00

6.75

7.50

8.25

9.00

0.0 0.2 0.4 0.6 0.8 1.0 1.2 1.4Deductible ($/cwt)

% o

f G

MG

Effect of Deductible on Payout Probability

20.0

25.0

30.0

35.0

40.0

45.0

50.0

55.0

0.0 0.2 0.4 0.6 0.8 1.0 1.2 1.4Deductible ($/cwt)

Pro

bab

ilit

y o

f P

ayo

ut

Simulated Probability of Positive IndemnitiesSimulated Probability of Positive Indemnities(Jan. ′09 Example)(Jan. ′09 Example)

Payout probability ↓with higher deductibleas GMG decreases

Actual Prices Known → Calculate Actual Prices Known → Calculate Actual Gross MarginActual Gross Margin (AGM) = Actual Revenue – Actual Feed Costs(AGM) = Actual Revenue – Actual Feed Costs Actual Prices determined each month over contract Actual Prices determined each month over contract

life as futures contracts expirelife as futures contracts expire Similar to expected prices, actual prices are statewide Similar to expected prices, actual prices are statewide

averages averages notnot your farm price your farm price Uses settle prices on futures contracts 1,2, and 3 days Uses settle prices on futures contracts 1,2, and 3 days

priorprior to last trading dayto last trading day of a futures contract of a futures contract

LGM-Dairy Actual Indemnity:LGM-Dairy Actual Indemnity: Actual Indemnity = Max[0, Actual Indemnity = Max[0, TotalTotal GMG GMG

– – TotalTotal AGM]AGM] TotalTotal Refers to Sum Over All Contract Months Refers to Sum Over All Contract Months

Determining Actual IndemnitiesDetermining Actual Indemnities

Actual Class III and feed pricesActual Class III and feed prices Determined each month over insurance contract lifeDetermined each month over insurance contract life Uses settle prices on futures contracts 1,2, and 3 Uses settle prices on futures contracts 1,2, and 3

days days priorprior to last trading dayto last trading day of a particular futures of a particular futures contractcontract Averaged over these three daysAveraged over these three days

Determining Actual Class III and Feed PricesDetermining Actual Class III and Feed Prices

LGM-Dairy similar to a bundled optionLGM-Dairy similar to a bundled option

How do LGM-Dairy costs compare to the costs of How do LGM-Dairy costs compare to the costs of setting a similar revenue setting a similar revenue floorfloor via use of Class III puts via use of Class III puts and Corn/SBM calls?and Corn/SBM calls?

Difficult to compare given options lumpinessDifficult to compare given options lumpiness Assume options perfectly divisibleAssume options perfectly divisible Compare costs under alternative deductible levelsCompare costs under alternative deductible levels Use data for January 2008 LGM-Dairy contract Use data for January 2008 LGM-Dairy contract

given availability of actual 10-month price data given availability of actual 10-month price data

A Cost Comparison of LGM-Dairy WithA Cost Comparison of LGM-Dairy WithOptions-Based Revenue ManagementOptions-Based Revenue Management

Procedure for determining option premium costsProcedure for determining option premium costs Use expected prices observed on January 29Use expected prices observed on January 29 thth to to

determine nearby optiondetermine nearby option To determine ending option value we use final settle To determine ending option value we use final settle

price of futures contractprice of futures contract For missing months, we use average of For missing months, we use average of

surrounding futures contract on last business day surrounding futures contract on last business day prior to the 15prior to the 15thth of the missing month(s) of the missing month(s)


Class III Put ($/cwt) Corn Call ($/bu) SBM Call ($/Ton)

MonthMonth Put Actual Class

III

Put Value

Corn Call

ActualCorn

Corn Call

Value

SBM Call

Actual SBM

SBM Call

Value

Mar Mar `̀0808 17.0017.00 18.0018.00 00 5.005.00 5.45505.4550 0.45500.4550 340340 336.50336.50 00

Apr Apr `̀0808 16.5016.50 16.7616.76 00 5.105.10 6.00256.0025 0.90250.9025 340340 336.60336.60 00

May `May `0808 16.2516.25 18.1818.18 00 5.105.10 5.89755.8975 0.79750.7975 340340 348.00348.00 8.00 8.00

Jun `Jun `0808 16.0016.00 20.2520.25 00 5.205.20 7.24607.2460 2.04602.0460 350350 434.00434.00 84.0084.00

Jul `Jul `0808 16.2516.25 18.2418.24 00 5.205.20 6.57006.5700 1.37001.3700 350350 452.00452.00 102.00102.00

Aug `Aug `0808 16.5016.50 17.3217.32 00 5.205.20 5.68205.6820 0.48200.4820 340340 350.00350.00 10.0010.00

Sep `Sep `0808 16.5016.50 16.2816.28 0.220.22 5.205.20 5.47405.4740 0.27400.2740 340340 359.00359.00 19.0019.00

Oct `Oct `0808 16.2516.25 17.0617.06 00 5.105.10 4.11254.1125 00 330330 254.50254.50 00

Nov `Nov `0808 16.2516.25 15.5115.51 0.740.74 5.105.10 3.80253.8025 00 320320 265.50265.50 00

Dec `Dec `0808 16.2516.25 15.2815.28 0.970.97 5.105.10 3.59503.5950 00 320320 258.50258.50 00

We can compare the We can compare the net costsnet costs of the two programs of the two programs


We can compare the We can compare the net costsnet costs of the two programs of the two programs


Gross CostGross CostGross Gross

Cost/CwtCost/CwtNet CostNet Cost

Net Net Cost/CwtCost/Cwt

Put/Call OptionsPut/Call Options

$0 Deductible$0 Deductible $63,216$63,216 $1.524$1.524 $28,461$28,461 $0.686$0.686

$0.80 Deductible$0.80 Deductible $58,993$58,993 $1.422$1.422 $26,560$26,560 $0.640$0.640


LGM-DairyLGM-Dairy

$0 Deductible$0 Deductible $36,107$36,107 $0.870$0.870 $36,107$36,107 $0.870$0.870



Note: Under the options based strategy we reduce the options costs by Note: Under the options based strategy we reduce the options costs by the % reduction in GMG observed under the LGM-Dairy scenarios.the % reduction in GMG observed under the LGM-Dairy scenarios.

LGM-Dairy a challenge for producers to understand LGM-Dairy a challenge for producers to understand given the big black box of how premiums calculatedgiven the big black box of how premiums calculated

How can LGM-Dairy complement plant offered How can LGM-Dairy complement plant offered forward/minimum price contractsforward/minimum price contracts Portfolio of risk management strategiesPortfolio of risk management strategies Software systems for on-demand premiumsSoftware systems for on-demand premiums

Still trying to understand dairy producer risk preferencesStill trying to understand dairy producer risk preferences Farm characteristicsFarm characteristics Producer characteristicsProducer characteristics

LGM-Dairy: Future Research/Extension EffortsLGM-Dairy: Future Research/Extension Efforts

the livestock gross margin insurance program for dairy: potential for future research?

Documents

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contract period lgmdairy

dairy markets website

yellowlgmdairy similar

soybean meal pricelgmdairy

average wisconsin dairy

lgmdairy eligible statesshown

state corn price