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Posted by: Sarah Drollette on Sep 7, 2010

LGM Dairy Insurance

In 2008, USDA’s Risk Management Agency announced that the Livestock Gross Margin for Dairy Cattle Insurance Policy would be available to Utah dairy producers.  This insurance policy is designed to protect dairy farmers from a loss of a gross margin between the revenue from milk produced and the cost of feed.  Of course, the insurance policy has a premium cost that may have deterred many dairy producers from purchasing LGM Dairy insurance two years ago.  However, given the volatility of the milk and feed markets over the past two years, producers may now be wondering if purchasing the insurance would have helped or hurt them.  

The LGM Dairy insurance policy uses futures prices for milk, corn, and soybean meal (adjusted for the state-specific basis) to calculate expected and actual gross margins for producers’ dairies.  A gross margin guarantee is calculated as the expected gross margin minus the deductible.  If the actual gross margin is less that the gross margin guarantee, an indemnity payment is received.  The premium is calculated based on the expected gross margin and the deductible level.[i] 

Gross margin guarantees, premium costs, and indemnity payments were calculated for a fictitious dairy in Cache County, Utah for the past year.  These numbers were calculated using a deductible level of zero and are based on a dairy producing 1560 cwt of milk each month (“target marketings”) and feeding 20.5 tons of corn and 6 tons of soybean meal each month (“target feed”).  The premium cost for each insurance period was over $10,000, but the indemnity payments were greater than the premium cost for all insurance periods except the most recent three.  This means that even after the premium payment, the example dairy ended up being better off for nine of the twelve insurance periods and was better off overall even given the three months when indemnity payments were less than premium costs.  

So, would purchasing LGM insurance have helped or hurt dairy producers over the past year?  While exact numbers would be different for each individual dairy based on specific production, feed and deductible information, this example suggests that some producers would have benefitted 9 of the past 12 insurance periods from a purely pecuniary perspective.  However, each dairy producer should take into account non-pecuniary costs and benefits of purchasing LGM insurance when deciding whether or not to include it in their risk management strategy.  For example, a producer should consider the opportunity cost of the time that would have been spent in the application process or the possible benefit of knowing that, despite how prices moved, he would have received at least the minimum of the gross margin guarantee.



[i] Premium quotes can be obtained using the premium calculator available on the RMA website: http://www.rma.usda.gov/tools/premcalc.html

 

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