USDA's Livestock Gross Margin Insurance for Dairy:
What is it and How Can it be Used for Risk Management?

Preface

Introduction

General Overview of the LGM-Dairy Program Structure

The risk management objective of the LGM-Dairy insurance program is to establish a floor on the level of income over feed costs (IOFC) available to a dairy producer for the marketing of insured milk. Note that with the establishment of an IOFC floor, the producer can take advantage of higher IOFC's regardless if this increase is due to higher milk prices, lower feed costs or both. The establishment of an IOFC floor is similar to the outcome that is obtained via the use of a bundled options strategy for revenue risk management. The following provides a brief overview of the use of bundled options for the established of a minimum IOFC. Understanding how a bundled options strategy can establish a floor of IOFC will be useful in understanding how LGM-Dairy can be used for revenue management and to provide a comparison of the relative costs of these two strategies.

What Factors Impact LGM-Dairy Insurance Premiums

Dairy producers must make several decisions when purchasing an LGM-Dairy policy that impacts the total insurance premium. These decisions include: (i) the percentage of milk production covered each month (%Cover_t); (ii) the profile of expected target marketings (EMM_t); (iii) the quantity of feed declared for insurance purposes (ECE_t, ESME_t); and (iv) the expected gross margin deductible rate (DL, $/cwt).

Detailed Description of the Determination of Indemnity Payments

An Example in the Use of LGM-Dairy

To further illustrate the structure of LGM-Dairy, we construct a general example of a medium sized operation with a milking herd of 350 cows. We use a general example not specific to a particular state as one characteristic of LGM-Dairy is that its per cwt of insured milk cost and performance are the same regardless of farm size if (i) the same LGM-Dairy contract design is used by the producer, (ii) declared feed use per cwt of milk is the same across operation and (iii) the per cow productivity does not differ across operation. The following example can easily be modified to reflect local feeding regimes, productivity, etc.

Undertaking an Historical Analysis Using the LGM-Dairy Analyzer

As indicated above, the LGM-Dairy Analyzer can be used to provide an estimate the costs of purchasing a particular insurance contract at the next contract offering, it can also be used to (i) evaluate not only the costs but also the actual indemnity that would have occurred to a completed LGM-Dairy contract and (ii) monitor an on-going LGM-Dairy contract to provide an assessment of whether an indemnity will be forthcoming at the end of the contract. In this section of the tutorial we present an historical analysis of a completed LGM-Dairy contract. For this analysis we will adopt the same percentage coverage pattern as in the current example except we will examine the cost and performance of the March 2009 contract when applied to a 350 head milking herd (i.e., 0% coverage in May and June 2009, etc). Under the March 2009 LGM-Dairy contract offering, the first month of possible coverage was May 2009.

We used average U.S. per cow productivity values for the May 2009 - Feb 2010 period. Similar to the current example we used default feed values. The same contract design will be used here but instead of applying the contract to the current contract offering (as defined by the relative percent coverage), we will examine contract cost and performance when applied to the March 2009 contract offering.   shows the allowable target marketings, declared feed use and the percentage of marketings to be insured. Over the entire May 2009 contract, 39.5% of the 10 month total marketings are insured.