I gave a talk yesterday at the Minnesota Dairy Leaders Roundtable. I originally thought that would be a closed-doors meeting, so did not plan to upload slides, nor did I bother to record audio like I usually do. However, since reports of my talk have appeared in the press, I thought I should change my approach and make slides public. I envisioned this talk as a meditation on crop insurance, and lessons that can be drawn. Unfortunately, the supply management is such a hot topic that it sucks air out of coverage of other important issues. Therefore, let me use my blog to deliver my points on crop insurance lessons for dairy programs:
The question in the title is an important one – as we design new dairy programs, what can we learn from crop insurance? I think there are several points of interest. First, timing matters. If you want to buy the Crop Revenue Coverage, which protects not just yield, but also total revenue (yield x expected price), you have to buy the insurance before you plant. In fact, you have to buy the insurance by March 15, before even Prospective Plantings report is published. You don’t have to pay for the insurance up front, but you do need to make your selection choice early. That way, you cannot base your protection against production risks based on weather conditions in the current growing season. We should follow the same principle in dairy programs. Insurance should be available, affordable and flexible. But it should be designed in such way that participation is based on risk tolerance, not financial wherewithal to abuse the fragile margin insurance design by utilizing IOFC margin forecasting models to decide when to over-insure, and when to under-insure. A simple way to address this problem is to use the 6-months gap between the insurance selection point, and the beginning of margin protection coverage period. It may make the most sense to align the dairy margin insurance sign-up deadline with crop insurance deadline – March 15. Coverage period would then be fiscal, rather than a calendar year, with coverage starting on October 1, rather than January 1.
The second point we can learn from crop insurance is that payment date does not need to coincide with insurance selection date. In particular, in crop insurance for corn or soybeans, premium billing date is October 1 – very close to harvest date. How would application of that principle look like in dairy? In order to align production date and premium billing date in the margin insurance programs, implementation rules could specify that premiums will be billed at the end of each “two consecutive months” period. For example, if we assume that indemnities for Jan-Feb period would be paid out in March, we could have premiums deducted from indemnities before indemnity checks are mailed. And if no indemnities are due, March would be a good time to bill participating producers for the previous two-month period. Very similar principle is employed since 2010 in LGM-Dairy insurance, and is generally praised by dairy producers as friendly to their cash-flow.
The final learning point from crop insurance regards the subsidy levels. In crop insurance, two-stage process is used to determine policy premiums. First, USDA employs sophisticated models to determine a fair premium level for each individual producer. Then, based on chosen yield coverage level, subsidies are applied as specified in the law. The law does not specify actual premiums, just subsidy as a percentage of fair premium. There might be advantages to not following that principle. In particular, by hard-wiring premiums in the law, subsidies can be made to be pro-cyclical. Coverage option that may be rather pricey in “ordinary” times (e.g. $1.06 for $8.00/cwt supplemental margin protection) may be the politically most feasible way to automatically deliver ‘disaster aid’ if the dairy sector faces a prolonged down period. In a scenario where some ‘black swan’ external factor would cause dairy margins to be below e.g. $5.00 for two consecutive years, which would be rather dramatic affair indeed, what better way to help producers than to allow them to buy “in-the-money” put on IOFC margins with the strike of $8.00/cwt and a premium of $1.06/cwt, a level that would be very cheap in that state of the world? However, while this feature may sound appealing, it is also the point where the newly proposed safety net is the most fragile. For subsidy levels may turn out to be endogenous if we are not careful. What that means is that overly generous margin insurance may spur oversupply, depressing prices, and rendering that $8.00/cwt level designed for extended disaster-aid purposes a level that most producers navigate to because of the price dynamics induced by the program itself, rather than adverse external factors. Hybridizing margin insurance to contain elements of countercyclical income support is tricky business. To add robustness, we must go back to the first point I raised above – timing matters. A lot.
My slides from the Minnesota Dairy Leaders Roundtable are available here.