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DairyMarginCoverage–thenewmarginprotectionplanfordairyproducers
BriefingPaper18-2Updated11December2018
AndrewM.Novakovic*
MarkStephenson*
TheLegislativeChangestoMPP-Dairy
TheAgricultureImprovementActof2018completesalegislativeprocessthatbeganoverayearagowitharecognitionthattheMarginProtectionProgramforDairyProducerslaunchedwithgreathopefouryearsearlierdidnotliveduptotheexpectationsofeitherdairyfarmersoritsauthorsandsponsors.Earlierthisyear,theBipartisanBudgetActof2018includedrevisionstotheoriginalMPP-Dairythatcreatedauniqueopportunityfordairyfarmerstoretroactivelyreconsidertheir2018enrollmentdecisionundermuchmorefavorablepremiums.Indeed,themarketsituationcombinedwithretroactiveenrollmentguaranteedthatallbutthelargestdairyfarmscouldreceiveanetcashbenefitin2018.
WhilethissecondversionofMPP-Dairywasunfolding,theHouseandSenateagriculturecommitteescontinuedtoworkonamorepermanentredesignoftheMarginProtectionProgram.Althoughthetwocommitteescameupwithslightlydifferentversions,fromthebeginningacouplethingswereclearlyinagreement:
1. Tocontinuewithapolicybasedonthegeneralconceptofprovidingcashsubsidiestodairyfarmerswhentheyexperiencedasqueezebetweenthepriceofmilkandthecostofbuyingthefeedtoproducethatmilk
*Andrew M. Novakovic is the E.V. Baker Professor of Agricultural Economics in the Charles H. Dyson School of Applied Economics and Management at Cornell University. Mark W. Stephenson is the Director of Dairy Policy Analysis at the University of Wisconsin. The Briefing Paper series is intended to provide logical and/or empirical analysis of dairy market economics or policy. The authors reserve all copyrights on this paper, but permission is granted to quote from the paper or use figures and tables, provided appropriate attribution is made.
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2. Anapproachthatwouldcontinuetorequirefarmerstopayfortheprivilegeofcoverage(likeaninsuranceprogram)-highercoverage,higherpremiums-butto:
a. Increasethehighestcoveragethresholdforfarmsofaboutaveragesizeandsmaller,and
b. LowerthecostofcoverageforthosesamefarmsThisbriefingpapersummarizesthenewDairyMarginCoverageprogramandbeginsto
reviewthepossibleimplicationsofthechanges.Asiscommonwithanyagriculturalprogramlegislation,USDAwillneedtoreviewthelaw,makeafewdecisionsabouthowtoimplementthechanges,andissuenewormodifiedregulationsthatprovidespecificinstructionsaboutwhatfarmerscandoandwhentheycandoit.Itisanticipatedthatthisprocesswillhappenfairlyquickly.
Whilewewillnotexamineotherriskmanagementprogramsfordairyfarmers,keepinmindthat1)thefundingchangesthatallowfarmerstoaccesstheLivestockGrossMarginforDairyyeararoundand2)theindependentlycreatedDairyRevenueProtectionprogramremaininplaceandarenotalteredoraffectedbytheAgricultureImprovementActof2018.Oneverysignificantchange,however,isthatdairyfarmerswillnowbeabletosimultaneouslyusethenewDairyMarginCoverage(DMC)andLGM-DairyorDairyRP.ThelogicbehindthisisthatcropproducerscansimultaneouslyuseincomesubsidyprogramsadministeredthroughtheFarmServicesAgency(suchasARC/PLC)andinsuranceprogramsadministeredthroughtheRiskManagementAgency(suchasRevenueProtection).
BasicFeaturesofDMCandComparisontotheOriginalMPP-DairyFirst,keepinmindthatwhenCongressdecidestomodifyor"fix"apieceoflegislation,
ittypicallystartswiththelanguageoftheoldlawandsays:replacethiswiththat,deletethat,insertthis,etc.Thus,unlesstheAgricultureImprovementActof2018specificallychangessomethingoriginallyauthorizedbytheAgriculturalActof2014,theprovisionsoftheoriginalprogramwillsimplycontinue.Forexample,Congresschangedthepremiumstructureunderthenewlawbutleftalonethemethodfordeterminingaproducer'sProductionHistory.
Second,alsorememberthattherearenumerousdetailsinhowUSDAadministerstheprogram,detailsthatarenotspecifiedbythelegislation.USDAcanchangeitsregulations,followingrequiredadministrativeprocedures,atanytime,aslongastheproposedregulationsareconsistentwiththelegislation.Theseregulationsdonotimpactthebasicdesignofthenewprogram,discussedbelow.ProductionHistory
UndertheoriginalAgriculturalActof2014,farmerswhowishedtoenrollhadtoestablishanamountofmilkthatqualifiedfortheMPP-Dairyprogram.ThisamountiscalledtheProductionHistory(PH).Formostfarmers,thisamountwasbasedonthehighestannualmilkproductionmarketedineither2011,2012,or2013.Fordairyfarmsbusinessesthatdidnotexistbeforeearly2013,alternativerulestreatedthemasnewfarms.1Moreover,once 1 For additional details on how Production History is established, see Information Letter IL 14-02 at: https://dairymarkets.org/PubPod/Pubs/IL14-02.pdf
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theoriginalProductionHistorywasset,itwasincreasedinfollowingyearsbythenationalannualincreaseinproduction.
UnderDMC,anyfarmthathasanestablishedProductionHistorywillmaintainthatamountasitwasdeterminedfor2018.AnynewregistrantwillestablishaProductionHistorybasedontheoriginalrules.Inotherwords,thosenewregistrantshavetogobacktothe2011-2013yearsorwhenevertheirfarmfirststartedproducingmilk.However,therewillbenofutureadjustmentstoProductionHistoriesbasedonincreasesinUSproductionoranyotherfactors,foranyfarm.
CoverageElection
First,abitofMPP/DMCglossary:1. ActualDairyProducerMargin(ADPM)–thisissimplythenameforthemargin
valuethatUSDAcalculateseachmonthusingthepricesforAllMilk,Corn,SoybeanMealandAlfalfaHay.
2. CoverageLevelThreshold–thisisthedollarvalueoftheADPMthatthefarmerchoosesasthetriggerorthresholdatwhichbenefitpaymentswillbemade.Ifsheelects$7.50coverage,benefitsarepaidwhentheADPMgoesbelow$7.50.
3. CoverageLevelPercentage–thisisthepercentageofaproducer'sProductionHistorythathechoosestoenrollintheprogram.A50%CoverageLevelmeansthat50%oftheproducer'sPHisenrolledintheprogram.Notethatthisisnotthesameas50%oftheircurrentactualmarketings.
4. CoveredProductionHistory(CPH)–thisisthequantityofmilkenrolledintheprogram.ItissimplytheProductionHistory(hundredweight)multipliedbytheCoverageLevelPercentage.
Asbefore,farmershavetwobasicdecisionstomake:1)howmuchmilktocoverand2)thelevelofmarginatwhichabenefitwilltrigger.Undertheoriginalprogram,farmerscouldcovernolessthan25%oftheirproductionhistoryandnomorethan90%,inincrementsof5percentagepoints.
UnderDMC,theCoverageLevelPercentageisexpanded,onbothends,from5%ofProductionHistoryto95%.ThemuchlowerminimummakestheprogrammoreaccessibletoverylargefarmsthatwanttotakeadvantageofthelowTier1premiumsandnotbeexposedasmuchtothehigherTier2premiums.ThisisespeciallyimportantforthehighlevelsofCoverageLevelThreshold,forwhichtheTier2premiumsaremuchlargerthanTier1.Forexample,aproducermaydeterminethat$8.00coverageisattractiveforthecomingyearbutthattheveryhighTier2premiumsnegateorseverelydiminishthepotentialbenefit.If25%ofhisProductionHistoryputsalargeshareofhistotalCoveredProductionHistoryintoTier2,thenhemay,sensibly,decidenottoparticipateatthatCoverageLevelPercentage.ThereductionintheminimumamountofPHmilkthatmustbecoveredfrom25%to5%meansthatafarmhaving100millionpoundsofPH,orabout4,000cows,cannowfullyparticipateinTier1withoutanyTier2exposure.Ofcourse,itonlyappliesto5millionpoundsofmilk,butitissomethingthatwasn’tpossiblebefore.
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ChangesinCalculationoftheMarginandPaymentTriggersTheAgricultureImprovementActof2018allowsTier1enrollmentat$8.50,$9.00and
$9.50CoverageLevelThresholds.Tier2continuestopeakoutatthe$8.00thresholdestablishedin2014.Thelowestthresholdlevel,referredtoas“catastrophiccoverage”,continuestobe$4.
Inallowingthehigherthresholds,theDMCcompensatesforachangemadetoMPP-Dairylateinthelegislativenegotiationspriortopassingtheoriginalbill.Before2014,theNationalMilkProducersFederationoriginallyproposedamargincalculationthatusedtheUSAllMilkPriceandpricesofthreefeedstuffsthatrepresentedthebulkofthevalueofadairyration.Theoriginalmargincalculationwasbasedonthecostoffeedstomake100poundsofmilkandthefeedsupportingtherestofanormalherd-youngstockanddrycows.Althoughthepricesofcorn,soybeanmealandalfalfahayarefundamentaltocalculatingthatcost,theothernecessarycomponentishowmuchofeachfeedstuffdoesafarmerneedtobuytomake100poundsofmilk.Everydairyfarmerknowsthatthereisnotoneration,anymorethanthereisonlyonepriceforcornorhay.Nevertheless,theobjectivewastocomeupwithasimpleformulathatusesreadilyavailable,reportedpricesandprovideareasonablerepresentationofanaveragecostoffeed.
OnefundamentalpartofthelegislativeprocessistoestimatehowmuchanewprogramorrevisionstoanexistingprogramwillcosttheUSgovernment.ThiscalculationisdonebytheCongressionalBudgetOfficeandiscalled"scoring".Onceabillhasbeenscored,thenumberbecomesafactofCongressionallife.Ifthescorerequiresmoremoneythanthebudgetallows,somewaymustbefoundtomaketheproposedprogramcheaper.Thissituationcameintoplayin2014.Thesimplebutnotparticularlysophisticatedsolutionthatwasusedwastosimplymultiplythefeedcostformulaby90%.Ineffect,ittooktheoldmargincalculationandsaidthatitwouldonlycover90%ofthecostoffeed.ThesimplearithmeticofthisisillustratedinTable1.
Table1.SampleImplicationsofthe2014AdjustmenttotheProposedMarginCalculation(dollarspercwt.)
MarginScenario MilkPriceOriginalProposal AgriculturalActof2014
FeedCost Margin FeedCost Margin
HighPrice–HighCost $18 $10 $8 $9 $9
HighPrice–LowCost $18 $6 $12 $5.40 $12.60
LowPrice–HighCost $14 $10 $4 $9 $5
LowPrice–LowCost $14 $6 $8 $5.40 $8.60
FromJanuary2007toDecember2014,theActualDairyProducerMarginthatwould
havebeencalculatedfromtheoriginalformulaaveraged$7.38.TheadjustmentsthatweremadefortheAgriculturalActof2014changedtheaverageto$8.50.Inthefirstcase,afarmerwouldhavereceivedabenefitpaymentat$8coverage,butnotinthesecondcase,eventhoughallthemilkandfeedpricesareidenticalinbothscenarios.Itisthissortofcalculation
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thatledtothesimplified,approximateconclusionthatthenewcalculationwas"off"byabout$1.00.Congresschosetofixthisbyincreasingthehighestthreshold,asopposedtoalteringtheformula.
Usingtheoriginal,proposedformula,sinceJanuary200058.7%ofthemonths(not2-monthaverages)hadamarginbelow$8.00.Usingthe2014formula,thereare57.8%ofthosemonthswhenthemarginfellbelow$9.50,thenewhighthreshold.Approximatelythesamesensitivitytomarketconditions…Problemsolved.
TheAgriculturalActof2014specifiedthattheActualDairyProducerMarginwouldbecalculatedmonthlybutthatpaymenttriggerswouldbebasedontwo-monthaverages:Jan-Feb,Mar-Apr,andsoon.TheBipartisanBudgetBillof2018changedthepaymenttriggertoonemonth.Thishadtheeffectofincreasinghowquicklyabenefitpaymentcouldbereceivedbutalsoeliminatedthepossibilitythatahighermargininonemonthmightpullupalowermarginintheadjacentmonthandtherebyresultina2-monthaveragethatnolongerqualifiedforpaymentorpaymentataparticularthreshold.
TheAgricultureImprovementActof2018continuestocalculatebenefitpaymentsonamonthlybasis.
ChangesinPremiumsGiventheexperienceoftheoriginalprogram,averyimportantgoalwastoraisethe
upperlimitsatwhichabenefitcouldbepaid,i.e.,tomakeitpayoutmorefrequently,aswasjustdiscussed.Arguablyanevengreaterobjectivewastomakeitmoreaffordable,i.e.,tolowerpremiums.HowthesechangeswerefinallyimplementedisillustratedinTable2,whichshowsbasicpremiumsundertheoriginalprogram(MPP-Dairy)andthenewprogram(DMC,showningreen).Inadditiontothestructureofthebasicpremiums,thereareacoupleofothernewwrinkles,whichwillbediscussedinpart3below.
Part1:NewPremiums
Table2illustratespremiumsunderthreeversionsofmarginprotection:1)theAgriculturalActof2014,2)theBipartisanBudgetActof2018,and3)theAgricultureImprovementActof2018.ItshowsthebasicpremiumsforTier1andTier2.Thereareseveralchangestoobserve:
1. ThequantitythresholdthatseparatesthelowerpricedTier1premiumsfromthehigherTier2wasincreasedfrom4millionpoundsto5millionpoundsundertheBipartisanBudgetAct.ThischangewasmaintainedinthenewDMC.BasedonUSaverageproductionpercowjustbeforethe2014and2018billswerepassed,theoldthresholdof4millionpoundsperyearequatestoaherdsizeofabout190cows.Thenewnumbersequatetoaherdofabout220cows.
2. ThelowestCoverageLevelThreshold,sometimesreferredtoascatastrophiccoverage,hasbeenandcontinuestobe$4.Thislevelofcoverageisavailablebyonlypayingthe$100enrollmentfeeandisautomaticallyappliedtothemaximumCoverageLevelPercentage–90%in2014and95%in2018.
3. ThehighestCoverageLevelThresholdwasraisedto$9.50underDMCbutonlyforTier1production.Itremainsat$8.00forTier2.
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4. Tier1premiumsaremuchlowerunderDMCthanfortheoriginalversionofMPP-Dairy.2TherelativedifferencesareillustratedinFigure1.Forlevelsupto$6.50,theDMCpremiumsarenotmuchdifferentfromthe2014program.After$6.50,thepremiumsaredramaticallylower.
5. AsshowninFigure2,Tier2premiumsunderDMCarequiteabitlowerforthelowestCoverageLevelscomparedtoMPP-Dairy–below$5.50.However,theyincreasesignificantlyat$6coverageandhigher.Thus,pricesnearthe"catastrophic"levelaremuchmoreaccessibletolargerfarmersbutcoverageabovethat,eveninthemid-range,ismoreexpensive.Asnotedabove,coverageatthenewlevels,greaterthan$8,isnotavailableatanyprice.
Table2.PremiaforMarginPrograms,exclusiveof$100AdministrativeFee
(dollarspercwt.)
CoverageLevel
Threshold
Tier1MPP-Dairy,2016to2017
Tier1MPP-Dairy,
2018
Tier2MPP-Dairy
Tier1DMC
Tier2DMC
QualifyingProduction
4Mlbs.orless 5Mlbs.orless
above5Mlbs.
5Mlbs.orless above5Mlbs.
$4.00 $- $- $- $- $-$4.50 $0.0080 $- $0.0200 $0.0025 $0.0025$5.00 $0.0190 $- $0.0400 $0.0050 $0.0050$5.50 $0.0300 $0.0090 $0.1000 $0.0300 $0.1000$6.00 $0.0410 $0.0160 $0.1550 $0.0500 $0.3100$6.50 $0.0680 $0.0400 $0.2900 $0.0700 $0.6500$7.00 $0.1630 $0.0630 $0.8300 $0.0800 $1.1070$7.50 $0.2250 $0.0870 $1.0300 $0.0900 $1.4130$8.00 $0.4750 $0.1420 $1.3600 $0.1000 $1.8130$8.50 n.a. n.a. n.a. $0.1050 n.a.$9.00 n.a. n.a. n.a. $0.1100 n.a.$9.50 n.a. n.a. n.a. $0.1500 n.a.
Althoughtherewerequiteanumberofspecificchanges,themainresultsarethatpremiumsandCoverageLevelThresholdoptionsaremuchimprovedforTier1,whichwillapplytothefirst5millionpoundsenrolledregardlessofhowbigafarmis,andDMCismoreaccessibletolargefarmsatthemoremodestcoveragelevelsunderTier2.
2 The Agricultural Act of 2014 provided premium discounts for farmers who enrolled in 2014 and/or 2015. The levels shown in the table were the undiscounted premiums that applied in 2016 and thereafter.
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Figure1.Tier1Premiumsunderthreeversionsofmarginprotection
Figure2.Tier2Premiumsundertwoversionsofmarginprotection
$-
$0.0500
$0.1000
$0.1500
$0.2000
$0.2500
$0.3000
$0.3500
$0.4000
$0.4500
$0.5000
$4.00 $4.50 $5.00 $5.50 $6.00 $6.50 $7.00 $7.50 $8.00 $8.50 $9.00 $9.50
MPPDairy2014 MPPDairy2018 DMC
$-
$0.0025$0.005
$0.100$0.310
$0.650
$1.107
$1.413
$1.813
$-$0.0200
$0.0400
$0.1000$0.1550
$0.2900
$0.8300
$1.0300
$1.3600
$0.00
$0.20
$0.40
$0.60
$0.80
$1.00
$1.20
$1.40
$1.60
$1.80
$2.00
$4.00 $4.50 $5.00 $5.50 $6.00 $6.50 $7.00 $7.50 $8.00
DMC MPP-D
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Part2:SeparateCoverageLevelThresholdElectionsbyTier
AswastruewithMPP-Dairy,afarmcanenrollaProductionHistoryofmorethantheTier1maximum(5millionpoundsforDMC),butanymilkinexcessof5millionpoundsispricedatTier2premiums.
UnlikeMPP-Dairy,farmershaveanopportunitytoselectadifferentCoverageLevelThresholdinTier2.
1. Ifafarmerelects$8coverageorless,thenhemustselectthesamecoveragelevelinTier2,but
2. Ifafarmerelects$8.50ormore,thenhemayselectanydifferentcoveragelevelinTier2.
Whatthisallowsisalargefarmtoelectahighcoveragelevelonthefirst5millionpoundsenrolledintheprogrambutalower,andthereforemuchcheaper,coverageinTier2.Ofcourse,aslongas5%ofthefarm'stotalPHisnomorethan5millionpounds,thefarmerdoesn'thavetoelect"buy-up"coverageatanylevelinTier2.Regardless,95%ofhisPHiscoveredatthe$4levelsimplybyvirtueofenrolling.ConsidertheexamplesinTable3.Table3.ExamplesofCoverageElectionforthreefarms.
Medium Large VeryLarge
CurrentMarketings(lbs) 5,000,000 16,500,000 75,000,000
Cows 250 750 3,000
Yield(lbs/cow) 20,000 22,000 25,000
ProductionHistory(lbs)-anexample 4,750,000 15,500,000 69,000,000
Buy-UpCoverage-anexample
CoverageLevelPercentage 95% 75% 50%
Tier1
CoveredProduction(lbs) 4,512,500 5,000,000 5,000,000
CoverageLevelThreshold-1 $9.50 $9.50 $9.50
Tier2
CoveredProduction(lbs) 0 6,625,000 29,500,000
CoverageLevelThreshold-2 n.a. $5.00 $5.00
CatastrophicCoverage
Coveredat$4(lbs) n.a. 3,100,000 31,050,000
CurrentMarketingsNotCovered(lbs) 487,500 1,775,000 9,450,000
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Intheexampleabove,theMediumsizedfarmhascurrentmarketingsof5millionpoundsperyearbuthisProductionHistoryis4.75millionpounds.OfthatPH,hecanenrollupto95%,oramaximumof4.5125millionpounds.Ifhechoosestoenrollthemaximumatabuy-upCoverageThresholdLevelof$9.50,hismargincoveragewillbeasfollows:3
1. IfADPMisabove$9.50,hereceivesnobenefitpayment2. IfADPMfallsbelow$9.50inaparticularmonth(let'ssayits$7.23),thenhis
resultsforthatmonthare:a. $9.50-$7.23=$2.27percwt.b. $2.27percwttimes1/12of4,512,500poundsor.0227times376,041.7,
whichequals$8,5363. IfADPMfallsbelow$4inaparticularmonth,thenthefarmgetsabigger
paymentbutthepoundsofmilkonwhichthemargindifferenceiscalculatedremainsthesameasabovebecausethefarmenrolled95%-themaximumallowed.
4. NomatterwhattheADPMisduringtheyear,487,500poundsofhiscurrentannualproductionisnotcoveredbyDMC.
NowconsidertheLargefarmillustratedinTable3.Inthisexample,thefarmhascurrentmarketingsof16.5millionpoundsperyearandaProductionHistoryequalto15.5millionpounds.Let'ssupposethisfarmerdecidesshewantstotakefulladvantageofTier1butonlycoverabout30%ofhertotalmarketingsunderTier2.SheselectsaCoverageLevelPercentageof75%.Shefurtherdecidestoselect$9.50coveragefor5millionpoundsinTier1andtheremainingenrolledPHat$5.00inTier2.Anexampleofherpossibleresultsisillustratedasfollows:
1. RegardlessofwhathappenstoADPMduringtheyear,1,775,000poundsofhercurrentmarketingsarenotcoveredunderDMC.
2. IfADPMfallsbelow$9.50inaparticularmonth,butisabove$5(let'ssayits$7.23),thenherresultsforthatmonthareonlyforTier1milk:
a. $9.50-$7.23=$2.27percwt.b. $2.27percwttimes1/12of5,000,000poundsor.0227times416,666.7,
whichequals$9,458.3. IfADPMfallsbelow$5.00inaparticularmonth,butisabove$4(let'ssayit's
$4.65),thenherresultsforthatmonthare:
a. InTier1:$9.50-$4.65=$4.85percwt.b. $4.85percwttimes1/12of5,000,000poundsor0.0485times
416,666.7,whichequals$20,208.
3 Please note that these examples are illustrations. Actual benefit payments will be slightly different as USDA applies a greater degree of precision (decimal points) to its calculations than we use for this illustration.
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c. InTier2:$5.00-$4.55=$0.45percwt.d. $0.45percwttimes1/12of6,625,000poundsor0.0045times552,083.3
pounds,whichequals$2,484.
e. Thisyieldsatotalbenefitpaymentof$22,692.4. NowsupposetheADPMfallsbelow$4.00inaparticularmonth(let'ssayits
$3.25),thentheresultsforthatmonthare:
a. InTier1:$9.50-$3.25=$6.25percwt.b. $6.25percwttimes1/12of5,000,000poundsor.0625times416,666.7,
whichequals$26,042.
c. InTier2:$5.00-$3.25=$1.75percwt.d. $1.75percwttimes1/12of6,625,000poundsor0.0175times
552,083.3,whichequals$9,661.e. IntheCatastrophiccategory,$4.00-$3.25=$0.75f. $0.75percwttimes1/12of3,100,000poundsor0.0075times
258,333.3,whichequals$1,938.g. Thisyieldsatotalbenefitpaymentof$37,641.
Ofcourse,theresultsfortheVeryLargefarmwouldbecalculatedinthesamemanneraswasshownfortheLargefarm.Atthenumbersshowninthisillustration,ifthisVeryLargefarmchosetoenroll5%ofitsPH,itwouldhave1.55millionpoundsofunusedspaceinTier1.Ifitchose10%,itwouldhave1.9millionpoundsthatwouldhavetobeenrolledinTier2.
Part3:DiscountsandCredits
Certaindiscountsandcreditscanalsobeappliedtopremiumpayments.Therearetwomotivationsbehindthesefeatures.
First,somepeoplethoughtthatakindofrewardoughttobeprovidedtofarmerswhoconsistentlyparticipateintheprogram.ThiswasreflectedinthelanguageoftheoriginalbillfromtheHouseofRepresentativesthatlockedallfarmsintoonedecisionthatappliedtoeachyearofthe5-yearprogram.TheSenateproposeddiscountsbasedonthesizeofthefarminstead.ThetwoconceptsweremoreorlessmergedunderDMCintoadiscountforalong-termenrollmentthatlocks-incoveragelevels.Thus,ifafarmercommitstoanenrollmentthatspansthefullfiveyearsofthenewprogramatthesameCoverageThreshold($/cwt)andpercentofhistoricproduction(pounds)eachyear,shewillgeta25%discountonpremiumsineachofthoseyears.Otherwise,CoverageThresholdandCoverageLeveldecisionscanbemadeannually,includingtonotenrollatall.
Secondly,everyonerecognizesthattheoriginalMPP-Dairycollectedalotmoremoneyinpremiumsthanitpaidoutinbenefits(2014-2017),andatatimewhengettingabenefitfeltwarranteddespitetheofficialcalculationoftheADPM.Asakindofcompensationforthatunexpectedoutcome,theDMCcreatesacreditforeachfarmerthatisequalto75%ofthetotalpremiumspaidunderMPP-Dairyminusthetotalbenefitsreceived.Thatamountofmoneycanbeusedtopaynewpremiumsunderenrollmentsmadein2019orafterwards.
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Alternatively,afarmercanrequestthat50%ofthatdifferenceinoldpremiumsandbenefitsberefundedincashnow.Ownersoffarmsthathaveceasedoperationsarealsoeligibleforarefund,basedontheirownershipshareduringthetimewhenpremiumswerepaid.ThisisapartfromwhathappenedtotheProductionHistoryfortheherdafterthesale.USDAwillnodoubthavemorespecificrulesforhowthiswillworkinduecourse.
EnrollmentPeriodTheActspecifiesthatUSDAmustopenenrollmentnomorethan60daysfromthedate
theActbecomeseffective.ThismeanstheymustwriteandpublishthemoredetailedrulesabouthowDMCwilloperate.ItislikelythatmanyoftheseruleswillbethesameasweredevelopedforMPP-Dairy,butthereobviouslyaresomechangesthatmustbemadeandperhapstheywillmakesomechangesthatarenotstrictlyrequiredbutwhichtheythinkarebothbeneficialandconsistentwiththenewlaw.TheAgricultureImprovementActof2018becomeseffectiveon1January2019.Thus,theenrollmentperiodshouldbeginsomewherearound,oratleastnotlaterthan,March1.
TheActfurtherrequiresthatUSDAholdthe2019enrollmentperiodopenforatleast90days.Thus,theenrolmentperiodmustextendatleastuntilabout30May.Farmersmayenrollatanytimeduringtheenrollmentwindow.Obviously,theycan'treceivepaymentsuntiltheyhavemadetheircoveragedecisions.Waitingtothelastminutegivesonethemaximumtimetopredictwhatwillhappen,butpostponesgettingbenefits.Atthecurrentexpectedpricesfor2019,itappearsthatthereisastrongpossibilityofreceivingbenefitpaymentsfor$9.50coveragethroughtheentireyear,certainlythefirst10months.
Ifafarmerelectstomakeadecisionin2019towhichshewillcommitforthenextfiveyear,annualenrollmentthereafterisautomatic.Otherwise,futureenrollmentandcoveragedecisionswillbemadeannually,withenrollmentprobablyoccurringattheendofthepreviousyear.Inotherwords,2020enrollmentdecisionswillbemadeinthelastfewmonthsof2019.
Special,One-timeRetroactiveEnrollmentfor2018Asnotedearlier,theAgricultureImprovementActexplicitlyallowsadairyfarmerto
simultaneouslyenrollinDMCandoneoftheRMAdairyriskprograms–eitherLGM-DairyorDairyRP.Withthisinmind,CongressdecidedtoallowfarmerstoretroactivelyenrollinMPP-DairywhowereineligibletoenrollinMPP-Dairyduring2018becausetheyhadanLGM-Dairycontractforatleastpartof2018.Inotherwords,USDAhastoopenthe2018enrollmentforanysuchfarmerwhowaspreventedfromenrollinginanymonthormonthsof2018undertheoldrules.USDAisinstructedtoopenenrollmentthatendsnolaterthantheendofMarch(90days).Therewon'tbemanyfarmsinthiscategory,butitwillbeaverysimpledecisionforallofthem.OtherDairyProvisionsoftheAgricultureImprovementActof2018
FederalMilkMarketingOrderClassIPriceMover
FederalMilkMarketingOrdersestablishminimumpricesthatprocessorsmustpayforfarmmilk.Thepricesvarywiththeproductthemilkisusedtomake.Fourproductclassesareidentified.ClassIIIpricesareseteachmonthbasedonbenchmarkpricesforcheeseanddrywhey.ClassIVpricesaresetbasedonbenchmarkpricesforbutterandnonfatdrymilk.
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Sincethismethodwasestablishedin2000,ClassIpricesaresetbasedonwhicheveroftheapplicableClassIIIorClassIVskimmilkpricesarehigher.Whilethiswasoriginallyseenasawaytoensureafairbuthighervaluetofarmers,overtimeitwasrecognizedthatthismadeithardertousefuturesmarketstoolstohedgeaveragefarmmilkprices.ThisisbecausethereisnofuturesmarketforClassImilk(orallmilkingeneral)andonehadtosomehowpredictwhetherthefutureClassIpricewouldbedrivenbyClassIIIorClassIVinfuturemonths.Thiscreatedanaddeddegreeof"basisrisk".Tomitigatethisproblem,itwasproposedtochangetheClassIpricemovertotheaverageofthemonthlyClassIIIandIVpricesusedintheformula.Tooffsetthefactthattheaveragewouldalwaysbelessthanthe"higherof",74centsperhundredweightwillbeaddedtotheaverageofthetwoclasses.
ThisrevisiontoFederalOrderprovisionsismandatedintheAgricultureImprovementActof2018.ThelegislationwillrequireUSDAtoamendallFederalMilkMarketingOrderstoconformwiththenewrequirement,anditwaivestherequirementsoftheAdministrativeProceduresAct.ThelatterwillallowUSDAtoamendtheunderlyingregulatorylanguagewithoutahearingorwithoutevenaninvitationforcomments.ItdoesnotpreventUSDAfromrequestingcommentsorhavingahearingtoconsiderhowthisnewprovisionmightentangleorimpactotheraspectsofOrderoperationsoranyotherFederalOrderissue.Whetheritchoosestoinviteproposalsforahearingonanotherorevenarelatedtopic,thereisnoquestionthatUSDAwillchangetheprocedurebywhichClassIpricesarecalculatedwillbeimplementedbynolaterthantheendofMarch.
ReauthorizeForwardPricingbyNon-CooperativeHandlers
FederalOrdersestablishminimumpricesthatmustbepaidbyprocessorstosuppliersofmilk.Futurescontractsenablebuyersandsellerstoagreetoaforwardorfuturepricethatisunderwrittenbythefuturescontract.Forwardpricing,backedbyfuturescontracts,hasthebenefitofreducinguncertaintyaboutfutureprices,buttheymayendupbeinghigherorlowerthanthecashmarketatthatfuturepointintime.Ofcourse,thereisnoFederalOrderproblemiftheforwardcontractpriceendsupbeinghigherthantheminimumcashprice,buttheoriginallegislationandfederalorderlanguagedidnotallowregulatedhandlerswhoarenotcooperativestopayalowerpricethanthemonthlyminimum,evenifaselleragreedtoitinaforwardpricecontract.Since2008,theDairyForwardPricingProgramallowsnon-cooperative,regulatedhandlerstoenterintoforwardpricingcontractswithinterestedsuppliersonmilkthatisregulatedasClassII,III,orIV.TheAgricultureImprovementActof2018reauthorizestheDairyForwardPricingProgramthrough2023.
CharitableDonationsofMilk
TheAgriculturalActof2014includedaDairyProductDonationProgramthatauthorizedUSDAtopurchasedairyproductsfordonationtopublicandprivatenot-for-profitorganizationsthatprovidefoodassistancetolowincomeindividualsandfamilies.TheprogramcouldonlybecomeactiveiftheADPMfellbelow$4fortwomonthsinarow.Theprogramnevercameclosetokickinginsince2014.
Manyfarmers,processorsandanalystshavefeltthatdoingsomethingtostimulateusagewouldbeapositivewaytoassistfarmerswhenprofitsarelowandthatthisalsohasthesalutaryeffectofbolsteringsales,especiallyforpopulationsthatdonothavesufficientincomesorarefoodinsecure.ThenewlegislationincludesaMilkDonationProgramthat
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doesnotauthorizeUSDAtopurchasedairyproductsfordonationsbutrathertriestoprovidefinancialincentivestoencouragethedairysectortomakedonations.Underthisprogram,dairyorganizationscouldbereimbursedforcostsincurredfordonatingconsumer-packaged,beveragemilk.ThereimbursementisbasedonthedifferencebetweentheFederalOrderminimumClassImilkpriceandthelowestclassifiedpricefortheapplicablemonth(eitherClassIIImilkorClassIV).Thus,aprocessorwouldbuymilkthatnormallywillincurtheClassIpricebut,bymeansofareimbursement,willfaceanactualcostequalonlytothelowestClassprice.ThemilkwouldremainpooledatitsClassIvalueandfarmerswouldseethesameminimumblendprice.
Amaximumof$5millionperyearwillbemadeavailableforthisprogram,butanyunspentfundswouldrolloverandbeavailableforsubsequentyears.Thisprogramfocusesonbeveragemilkproductdonationsinnosmallparttobolstersalesofaflagshipdairyproductthathassuffereddecliningpercapitaandtotalsales.
WhatWillorShouldDairyFarmersDo?AsaresultofthechangesmadeintheDMC,manymoredairyproducerswillhavenew
choiceswithregardtotheirmarketingstrategy.ThenewrangeonthepercentofProductionHistoryfrom95%downto5%meansthatmore,largerfarmscantakeadvantageofthelowerTier1premiumsontheirmilkproduction.WiththeTier1capof5millionpoundsofenrolledProductionHistory,farmswith100millionpoundsofmilkorlesscanqualifyforonlyTier1coverageonaportionoftheirmilk(5,000,000÷5%=100,000,000).Thisisafarmofapproximately4,000cows.Undertheoriginalprogram,thesamefarmwouldhavetoenrollatleast25%ofitsProductionHistory,whichmeansamuchmoreexpensivecoveragecost.
ThereareseveralapproachesthatcouldbetakentoexaminetheimpactofthechangesintheDMC.OneofthemistolookbackattheactualmarginsoverthelifeoftheAgriculturalActof2014toseewhatthenewruleswouldhavemeant.Overthose60months,Figure3andTable4showthemonthswhenthemargincalculationwouldhavebeenbelowcoveragelevels.HistoricReference
Althoughhistoriccalculationsarenoguaranteeoffutureperformance,itisclearthattheincreasesinCoverageLevelsfrom$8.00to$9.50maketheDMCmoresensitivetopotentialindemnitypayments.Overthelast5years,$9.00protectionwouldhavetriggeredapaymentslightlymorethanhalfofthetime,anda$9.50levelofprotectionwouldhaveprovidedpaymentsabouttwo-thirdsofthetime.Theexpectedpayoutwouldhaveaveragedfrom1¢to$1.00percwtofcoveredmilkfromthe$6.00levelofcoveragetothe$9.50level.AtTier1premia,$7.00coveragewouldhavebeenaboutbreakeven,andtherewouldhavebeenpositive,andincreasing,netbenefitsatalllevelsabovethat.
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Figure3.MonthlyMilk-FeedMargins,January2014throughDecember2018
Table4.HistoricNumberofMonthsThatMPPMarginwasBelowCoverage.
ValueoftheLong-TermEnrollmentDiscountBasedonthecalculationsabove,the25%discountonpremiaforsigningupatthesame
coveragefortheentirelifeoftheprogramwouldhaveincreasednetbenefitsatmostbyless
CoverageLevel
MonthsBelow
PercentofMonthsBelow
ExpectedPayout Premia NetBenefit
NetwithDiscount
6.00$ 2 3% 0.01$ 0.050$ (0.04)$ (0.03)$6.50$ 2 3% 0.02$ 0.070$ (0.05)$ (0.03)$7.00$ 8 13% 0.06$ 0.080$ (0.02)$ 0.00$7.50$ 13 22% 0.14$ 0.090$ 0.05$ 0.07$8.00$ 19 32% 0.27$ 0.100$ 0.17$ 0.20$8.50$ 26 43% 0.47$ 0.105$ 0.36$ 0.39$9.00$ 31 52% 0.71$ 0.110$ 0.60$ 0.63$9.50$ 39 65% 1.00$ 0.150$ 0.85$ 0.89$
ForFirst5MillionPoundsofMilk
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than4¢percwt.($0.150*25%=$0.0375).Forfutureenrollments,farmswouldbeexpectedtoevaluatethatdiscountagainstthebenefitofselectingalternativecoveragelevelsfortheupcomingyear.
TheMPPDecisionTool4usesfuturesandoptionsmarketstoestimatemarginsasseeninFigure4atthetimeofannualsignup.TheexampleinFigure4showsthefirstyearofsignupundertheoldprogramwithaforecastfor2014asofasignupdateofDecember13,2013.Actualmarginsin2014weremuchhigherthanforecast,butthetoolwouldhavecorrectlyforecastthatanannualdecisionfor2014wouldhavebeentoselectcatastrophiccoverageatthe$4.00levelastherewouldnotbeanexpectednetbenefitatanylevelabovethat(including$9.50).
Figure4.ExampleMarginForecastfor2014asofDecember13,2013.
LookingatthissamekindofdataanddecisionprocessfortheremainingyearsofthelastFarmBill,theDecisionToolwouldhavecorrectlyforecastthatanoptimalannualdecisionforproducerswouldhavebeencatastrophiccoveragein2014and2017butaselectionof$9.50forTier1coverageintheother3years.Hadaproducerfollowedthisstrategy,theaveragenetbenefitwouldhaveimprovedmarginallybyanadditional2.3¢percwt.atcoveragelevelsupthrough$8.50,beenofnoadditionalbenefitat$9.00,andwouldhavediminishedthevalueof$9.50coverageby2.3¢percwt.(Table5.)
Thereareafewfactorsatplayintheenrollmentdiscountexample.Oneisthatthereareafewmonthsofindemnitiesin2017atthetwohighestthresholdlevelsthatwouldhavebeenmissedifselectingcoverageannuallyusingthefuturesforecasttool.Anotherfactoristhatabsolutevalueofthediscountislargeronthemoreexpensivepremiums.
4 https://DairyMarkets.org/MPP/Tool/ or https://www.fsa.usda.gov/programs-and-services/farm-bill/farm-safety-net/dairy-programs/mpp-decision-tool/
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Table5.Tier1HistoricValueoftheDiscount.2014Through2018.
TheDecisionforLargeandVeryLargeFarms
Manyfarmswithmorethan5millionpoundsofProductionHistorycanbenefitfromtheDMC.Forexample,a1,000cowfarmwithaPHof25millionpoundscanselectaTier1CoveragePercentageof20%andcover5millionpoundsoftheirmilkatthehighestThreshold.Thiswouldhaveprovided89¢netbenefitwiththe5-yearpurchasediscounton20%oftheirmilkwhichamountstoanetbenefitofabout18¢onallmilkproduction.
FarmswithaPHupto100millionpounds(about4,000cows)couldhavefollowedasimilarstrategytocover5%oftheirhistoricproductiontonet89¢benefiton5millionpoundsTier1coverageoranaveragenetbenefitof4.4¢onallmilk.
VerylargefarmscannotavoidsomeTier2coverage,giventhe5%minimumCoveragePercentage.Forexample,afarmwithaPHof250millionpounds(about10,000cows)couldchoose5%percentandwouldhave5millionpoundsof$9.50coverageatTier1andcouldcovertheremaining7.5millionpoundsataTier2levelofsay$5.00.Thiswouldstillprovideanetbenefitofabout1.8¢onallmilkproduction.Recall,largefarmscanonlyemploythisstrategyiftheirTier1thresholdselectionis$8.50orabove.
Thus,theDMCisespeciallyappealingforaverageandsmallersizedfarms,butitdoesprovidereasonable,affordableopportunitiesforvirtuallyallfarmsizes.TheabilitytouseDairyRevenueProtectionorLivestockGrossMargininsuranceinadditiontoDMCmakesforreasonableriskmanagementoptionsatallsizelevels.
UsingtheMPP-DairyCreditFarmerswhohaveMPP-Dairynetpremiumsareabletotake75%ofthatvalueasa
credittowardsfutureDMCpremiums(regardlessofanybenefitthatmaysubsequentlybepaid)orreceive50%ofthatamountascash.Thisisadecisionmanyfarmerswillhavetomake.Eithermethodcanbeasensiblechoice.Factorstoconsiderare1)howmuchnetpremiumdoyouhave,2)theextenttowhichyouwanttoparticipateinDMC,and3)thetaximplicationsoftakingacashpaymentin2019.
Threshold
5-Year Commitment with Discount
Annual Choice Using Futures
Forecast Difference6.00$ (0.105)$ (0.082)$ 0.023$ 6.50$ (0.088)$ (0.065)$ 0.023$ 7.00$ (0.048)$ (0.025)$ 0.023$ 7.50$ 0.024$ 0.046$ 0.023$ 8.00$ 0.158$ 0.180$ 0.023$ 8.50$ 0.355$ 0.378$ 0.023$ 9.00$ 0.597$ 0.606$ 0.009$ 9.50$ 0.886$ 0.863$ (0.023)$
Net Benefit per cwt.
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SummaryCongresshasincorporatedthebasicideasoftheoldMarginProtectionPrograminthe
newDairyMarginCoverageprogram,butithasmadesignificantchangeswhichmaketheprogrammoreresponsivetomarketconditionsandwhichbettermatchfarmer'sperceptionsofadownmarket.Mostnotably,increasingthemaximumCoverageLevelThresholdfrom$8.00to$9.50inTier1willallowmoreindemnitytriggersovertime.LoweringthepremiaonTier1coveragemakestheinsuranceinvestmentallthemoreattractive.Tier2premiaarestillmuchmoreexpensivethanTier1abovethe$5.00coveragelevel,butTier1volumeshavebeenincreasedfrom4millionto5millionpoundsofProductionHistoryandtheCoverageLevelPercentagehasbeenloweredtoaslittleas5%ofPH.Althoughfarmslargerthanabout4,000cowswillhavetopurchasesomeTier2protection,thenewDMCallowstheTier2ThresholdLeveltobedifferent(lower)thantheTier1selectionifTier1isat$8.50orabove.Coverageat$5.50orbelowisattractivelypricedinTier2.
Producerswillhavetheoptionofelectingcoverageannually,ortheycanchoosetoelectcoverageonceforthelifeoftheFarmBillandreceivea25%discountontheirpremiumcosts.Basedonhistoricvalues,theremaybeasmallbenefittoamoreflexibleannualselection,butthediscountcanbetemptingforthesimplicityofaone-timechoice.Thelackofannualflexibilitymayhaveminimalcostsatthehighestthresholdlevels.FarmershowevershouldbewaryoflockinginalowCoverageThresholdthatwouldrequiresomepremiumbutseldomkicksin.
ThenewhigherCoverageLevelThresholdshavethepotentialtotriggerindemnitiesmorefrequentlythanwasthecasewithMPP-Dairy.BecauseofthisandthenewlowercostsoftheTier1premiums,inmostyearstheoptimumannualchoicewilleitherbetopurchaseatthehighestlevelofprotectionforTier1oratthecatastrophiclevel.
Thenewprogramshouldprovideagoodlevelofriskprotectionforsmallerfarmsataveryreasonableprice.Itwillalsoprovideabasiclevelofprotectionforlargerfarms.However,largerfarmsmayalsowishtoemployamorecompleteriskmanagementprogrambyusingofLGM-Dairy,Dairy-RP,futures,optionsorcashforwardcontractingastherearenorestrictionsforjointuseofDMCwithotherprograms.
