Dairy Revenue Program: Protection from Market Swing
January 11, 2019What is Dairy Revenue Protection?
Dairy Revenue Protection, DRP, is the latest tool for Dairy Producers to manage the increasingly volatile Milk Price received on the farm. This product was introduced on October 9, 2018 and tends to provide more options than other products. It is another product available to the dairyman along with Livestock Gross Margin-Dairy (LGM-Dairy) and the Margin Protection Program, (MPP), which is now replaced by the Dairy Revenue Coverage, (DRC).
LGM-Dairy
LGM-Dairy has been a tool available for a decade. It is designed to provide protection against both rising feed costs and declining milk prices. It was successful in some cases. But, the major pitfall was the fact that if milk prices fell it was often coupled with a decrease in feed costs as well.
Therefore, these two simultaneous movements would cancel each other out and it would negate any potential payout to the policyholder. It also was based strictly on Chicago Board, CME, and it did not accurately reflect the local markets very well. Also, it was only available to purchase once per month on the last business Friday of the month.
Dairy Revenue Coverage
The Dairy Revenue Coverage (DRC) program replaced the Margin Protection Program (MPP). It is a Government FSA program administered through the County FSA offices. The new DRC program is improved over the MPP program, but it continues to be geared more to a disaster-type scenario and is lacking in its ability for the dairy producer to customize the product for their individual operation.
How to Get Dairy Revenue Protection Coverage
DRP can be purchased any day of the month the Chicago Board of Trade is open. The dairy producer can purchase coverage based on Class III and Class IV milk or they may choose to purchase coverage based on their own historical butterfat and protein history. This allows the program to be customized more to the individual farm. Any volume of milk can be protected as long as the total amount does not exceed the actual amount produced by the dairyman.
Coverage is purchased based on 3-month intervals and can be bought to cover production out to 15 months. The producer is able to buy several units of protection for the same month intervals at varying times to maximize his protection so long as total milk covered does not exceed actual milk produced. Also, a dairyman can purchase an MPP policy for the same production covered by a DRP policy. Initially, the product may seem more complex than previous options, but ultimately it has fewer variables than its predecessors. Pricing is very competitive and cost-effective.
6 Highlights of the DRP Program
Here are a few of the highlights of the DRP Program:
1. You Can Get Coverage by the Quarter and Extend it
The producer covers a quantity of milk that they produce by the calendar quarter (i.e. Jan-Mar, Apr-June, etc.). They can purchase coverage out as far as 5 calendar quarters into the future. For example, as of the beginning of 2020, a producer can purchase coverage out through the 2nd quarter of 2021.
2. It Only Looks at Milk Components
This program only looks at the milk components or Class III/ Class IV. It does not take into consideration any feed component. Therefore, there is no situation where the price of feed would counterbalance a price in milk.
3. It Follows the Chicago Board Trading Schedule
This product is available any day that the Chicago Board is trading. There are a few days out of the month it may not be available due to reports being published, but there is more availability than other products.
4. You Can Choose Your Own Component Percentages or CME Class III or Class IV Milk
The dairy producer can either cover milk based on their own component percentages (i.e. butterfat and protein) or they may cover milk based on CME Class III or Class IV milk.
If the producer chooses to use their own component percentage, it is important to match what percent is historically produced. There is a 10% buffer allowed if the producer’s components are less than projected. For example, if the producer says they have 4% butterfat, as long as they are above the 3.6% threshold, there is no penalty and they are paid based on the 4% projection. If they would fall under the 3.6% level, then they will be paid based on their actual with no adjustment in premium.
If the producer chooses the class option, then the trigger calculation is based on Class III and Class IV pricing. The dairy producer can decide what percentages they want to use of each class (e.g. 40% Class III -60% Class IV, 55% Class III – 45% Class IV, etc.). It is recommended that the producer covers their milk the way they are paid by the Dairy.
5. You Can Purchase Multiple Contracts
The dairy producer does not have to cover all of their production in a quarter in one contract. They may purchase multiple contracts to cover their production in a quarter so long as the sum of the contracts does not exceed their actual production for that quarter. It may be advantageous to purchase multiple contracts and layer them in over the course of the quarter to capture and protect increasing volatility.
6. There is a “Protection Factor”
There is an option called the “Protection Factor”. This is a percentage increase that can be chosen by the dairy producer up to 1.5. If there is an indemnity, a payout, the amount will be increased by the factor chosen by the dairy producer.
It is a direct percentage increase as related to the guarantee and the payout. It is recommended to take advantage of the increased factor because the increased cost is minimal in relation to the enhanced benefit.
You may purchase a product like fire insurance because there is a slight chance your property might catch on fire and go a whole lifetime without a fire claim. But, you won’t go through an entire career in dairy without experiencing a crash in the milk price. All dairymen should take a serious look at this product to understand if it can be a valuable cash flow management tool for their individual operation.
Much like livestock risk protection is a cost-effective tool for beef and pork producers, DRP is a very cost-effective tool for dairy producers in managing the volatile milk market. It allows you to place a floor under the price of milk and secure that “projected high” or stop a “price slide”. You can control your destiny to a great degree with this tool.
Interested producers may contact our Agency, Ruhl Insurance, for more detailed information specific to their individual operation and some additional resources are available online from Rain and Hail. We can be reached at 717-665-8135, or nevin@iruhl.com.
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Disclaimer: Information and claims presented in this content are meant for informative, illustrative purposes and should not be considered legally binding.