VS Livestock Compensation and Appraisal The Secrets of Livestock Compensation Revealed Stephen L. Ott, Phd

Presentation Road Trip Part I: Overview of Appraisal, Indemnity, and Compensation  Why Indemnity  Positive – Negative Impacts on Indemnity  How Value is Determined (Appraisal Methodology) Part II: Understanding APHIS’ Livestock Appraisal Calculators  Putting Appraisal Theory into Practice Part III: Using Appraisal Calculators  Understanding Dairy Cow Records

Which Is Most Important? A. Livestock Disease Control: Eliminating disease whenever found B. Disease Prevention: Preventing disease introduction or spread if already endemic

Main Reason Why APHIS Should Pay Livestock Indemnity A. Taking Clause, 5 th Amendment US Constitution B. Animal Health Protection Act, 2002 C. Alleviate the difference between private incentive and public interest in disease reporting and control D. Producer Financial Wellbeing, Keep in Business

Does The Taking Clause of the 5 th Amendment Applies to Diseased Animals? A. Yes, APHIS has to pay for any diseased animals order destroyed B. No, diseased animals are a public nuisance and Constitutionally may be destroyed without paying indemnity

Why Not Animal Health Protection Act? What Congress Gives, Congress can take away  Animal Health Protection Act  APHIS shall pay producers  Plant Protection Act, 2000  APHIS may pay producers Validates the point made about diseased animals and the Takings Clause

Should There Be Producer Financial Consequences for Having a Foreign Animal Disease? A. No B. Maybe: No if practicing good biosecurity; if not then Yes C. Yes

Should There Be Producer Financial Consequences for Having a Regulatory Animal Disease? A. No B. Maybe: No if practicing good biosecurity; if not then Yes C. Yes

Externality Private Incentive vs. Public Interest

Disease Reporting Individual Perspective Individual Perspective to Suspicion of a highly contagious disease  Hoped for response  Call veterinarian or animal health official  Consequences if disease positive  Herd / flock depopulated  Surrounding herds / flocks depopulated  Economic losses  Genetic losses  Reduction in available meat protein  Media Spotlight

Disease Reporting Individual Perspective Because of previous listed consequences, producers potential response could be  Keep quiet, hope animals get better  Try to market sick animals before they die Both lead to greater spread of the disease

Disease Reporting Industry / Government Perspective Individuals should report disease  Quick response is critical in limiting disease spread Difference between Individual Incentive and Public Interest is an Externality Photo credit: Geni Wren, “Bovine Veterinarian ”

Dealing with Externalities If public interest is to reduce a particular private behavior, then tax or regulate (prohibit) the activity If public interest is to increase a particular private behavior, then subsidize the activity

Economic Justification for Indemnity Payments Producer cooperation is the economic justification for government to be involved in disease compensation The greater the indemnity paid the greater the incentive producers have to cooperate by reporting disease and agreeing to animal depopulation

Moral Hazard

Moral Hazard (Risks & Returns) RisksReturns Do the returns justify the risks? Activities / Programs that reduce the consequences of a risky choice gone “bad”, encourages people to engage in such behavior

Paying Indemnity ___ producer financial consequences of VS disease control measures A. Reduces B. Doesn’t Impact C. Increases

With indemnity reducing the financial impact of disease control, producer incentive to prevent disease is ______ A. Increased B. Not Impacted C. Decreased

Influence of Indemnity on Disease Control vs. Disease Prevention Consequently, within VS we have internal conflict between disease prevention and disease control  Indemnity improves producer cooperation in disease control  Indemnity reduces producer incentive to practice good biosecurity Greater the indemnity level desired, the more you prefer disease control over disease prevention

Which Do Feel Is VS’ Primary Focus? A. Livestock Disease Control B. Livestock Disease Prevention

Appraisal Methodology

What is an Appraisal? An Appraisal can be of the following  An estimate of cost  A determination of value  A forecast of earnings  A non-monetary opinion as to authenticity or quality of a property Notice the use of the words estimate, determination, forecast, opinion

What is an Appraisal? An appraisal is not a precise measurement, neither is it a guess; it is an estimate or an opinion based on supporting facts.  Yin-Yang of appraisal:  art vs. science  subjective vs. objective  To be in agreement appraisals should have similar, but not necessarily the same valuation  Ultimate goal of an appraisal is to convince others that your estimate of value is valid or reasonable, not necessarily that your values are precisely correct.

Methods for Determining Market Value Sales Comparison Approach  Most common method used  Appraisal value function of observed sales Income (Net Present Value) Approach  Useful in valuating income producing assets such as breeding animals Cost-of-Replacement (Production) Approach  Useful in valuating younger animals

Sales Comparison Approach Compare actual sales to subject property No two assets are exactly alike so must make adjustments for differences in quality  age, sex, breed, weight, milk production, body condition, body soundness, location, etc The impact on value due to differences in quality characteristics is at the heart of appraisal

Quantifying Quality Impacts on Value Analyze previous sale records to determine quality characteristic impacts (regression modeling) Cost of production studies— enterprise budgets  Useful for measuring impact of weight, age, productivity levels (milk or egg production) Appraisal value then equals sale values adjusted by the value of the differences in quality characteristics

Animal Health Protection Act of 2002 “…compensation shall be based on the fair market value, as determined by the Secretary, of the destroyed animal, article, facility, or means of conveyance.”

Animal Health Protection Act of 2002 “…the amount to be paid under this subsection shall be final and not subject to judicial review or review of longer than 60 days by any officer or employee of the Federal Government other than the Secretary or the designee of the Secretary.”

Definition of Fair Market Value “The price at which property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or sell and both having reasonable knowledge of relevant facts.”  Internal Revenue Section 1.170A- 1(c)(2) Often determined through an appraisal

Factors Affecting Livestock Fair Market Value Health Status:  Free of disease  Exposed to disease  Infected with disease APHIS assumes the animals are free of the disease  They are valued as if they don’t have the disease nor have been exposed to it  Thus, appraisal value can be greater than true market value

Factors Affecting Fair Market Value What others are willing to pay  Demand & supply situation  Rare/unique breeds: valuable because few suppliers or worthless because nobody wants them.  Often expressed in auction markets

Factors Not Included in Fair Market Value The animals are family Family financial needs Bonus for cooperation  Need appraisal objectivity  Can lead to domino affect where future owners won’t cooperate without bonus  Don’t do it!!

The Appraisal Process According to USDA-OGC the appraisal process is NOT a series of negotiations between USDA and the owner  Don’t use the term “offer”, use “proposed value, subject to approval”  But need owner’s signature for voluntary destruction associated with program diseases

When you are asked to provide livestock values, don’t worry Appraisal Man is Here