Monthly Archives: August 2012

The first of the four papers my team has written on LGM-Dairy is now ready to go public. This article is currently in the second round of review with the Journal of Dairy Science, and we’ve been given very high remarks in a blind peer review process. Given the forthcoming LGM-Dairy sales event this Friday, I wanted to discuss our findings publicly in this blog.

Our basic finding is that farmers can do really well to protect their income over feed cost margins, but only if they regularly hedge distant months. Some of you may have heard me talk about this at one of the regional dairy meetings, and here’s our analysis to support my claim. In our paper we built two farm profiles: one that grows all needed livestock feed, and the other that buys all livestock feed. We examined what would have been the effect on realized IOFC margins in 2009, if a particular hedging strategy had been regularly followed. We made these two benchmark farms buy LGM-Dairy every month, and use one of four hedging strategy:

1) Insure 1/3 of expected milk marketings and associated feed costs for the 1st, 2nd and 3rd insurable month.
2) Insure 1/3 of expected milk marketings and associated feed costs for the 4th, 5th and 6th insurable month.
3) Insure 1/3 of expected milk marketings and associated feed costs for the 8th, 9th and 10th insurable month.
4) Insure 1/10th of expected milk marketings and associated feed costs for all 10 insurable months.

In each of these strategies deductible chosen is $1.10. If any of these strategies is followed month after month, pretty soon all expected milk marketings will be regularly insured. Imagine a farmer that expects to market 9,000 cwt of milk each month (for tractability let’s ignore seasonality, drought effects, etc.). Strategy 1 would imply they use August LGM sales event to insure 3,000 cwt in October, November and December. Then, under the assumption that LGM is offered again in September they would insure 3000 cwt in November, December and January, etc. 2nd strategy is pretty similar, except that our farmers use Aug. sales event to insure January, February and March. You get the drift.

Ok, so what did we find? We found that strategy 3 works the best.

This is one Figure from our paper, showing the boost in income over feed costs margin for Home-feed farm profile. This strategy managed to eliminate a full 93% of 2009 margin shortfall. Similar strategy formarket-feed eliminated close to 50% of risk. If lower deductible is chosen, risk protection can be even higher.

As you may have noticed, livestock revenue insurance receives $50 million under House version of the 2012 Farm Bill, and most of it would end up going to LGM-Dairy, if past utilization rates are any guide. This would make LGM-Dairy one of the most important pillars of federal dairy policy going forward. Our analysis shows that recent LGM-Dairy track record (ratio of premiums paid to indemnities paid out is close to 30:1, with close to 50 million paid in, and less than 2 million paid out) is not a good indication of the potential this program has to help dairy industry. If properly and regularly used, LGM-Dairy can effectively protect income over feed costs margins for dairy producers.

Full Paper Here

Update October 5, 2012: The paper has been accepted by the Journal of Dairy Science, and it is now available online.