Commercial Poultry Compensation Stephen L. Ott, Ph.D. Appraisal-Indemnity-Compensation Specialist February, 2010

Presentation Overview Why Compensation Compensation & Biosecurity How Appraisals Are Done Indemnity Payments Valuation Methodology Appraisal Calculators Data Sources

What Compensation is Not Not required by U.S. Constitution, taking clause 5 th Amendment  Disease animals can be considered a public nuisance and thus be ordered destroyed by government through its police powers Not to provide income subsidies to producers. Not to put producers back into business  It is a secondary benefit  If producers are concerned about getting back in business or losses not covered by government indemnity, then they should purchase business interruption insurance

What Compensation Is Compensation recognizes there is a disconnect between producers’ incentive not to report disease and industry and governmental desire for quick reporting to limit the spread of disease  Known as an externality  Private behavior can be influenced through taxes or income transfers (indemnity payments) Thus, the economic reason for paying indemnity for diseased animals is to encourage rapid reporting to animal health officials

Compensation Law & Regulations Animal Health Protection Act 2002  Part of 2002 Farm Bill  Pay fair market value  Indemnity is for assets destroyed  Lost income not covered  Federal indemnity reduced by any other indemnity received  Values not subject to judicial review Title 9 Code of Federal Regulations  Part 53: Foreign Animal Diseases  Part 56: Avian Influenza

Compensation and Biosecurity

Does On-Farm Biosecurity Increase or Decrease Profits? Function of costs and benefits Optimal biosecurity occurs where costs equals benefits Benefits function of  Effectiveness of biosecurity measures to prevent disease  Amount of potential losses  Value per head  Number of head

Government Compensation & Farm Biosecurity Expenditures Q. What is the impact of government compensation programs on optimal on-farm biosecurity expenditures? A. Indemnities paid reduce losses realized  Which reduces benefit of biosecurity  Which reduces optimal on-farm biosecurity expenditures Conclusion: government compensation programs reduce private incentive to practice good biosecurity

Government Compensation & Farm Biosecurity Expenditures Consequently, too high indemnity payments can contribute to future disease outbreaks as biosecurity is reduced Thus, there is tension between encouraging disease reporting (high indemnity payments) and encouraging disease prevention through increased biosecurity (low indemnity payments)

Poultry Appraisal

Poultry Appraisal Poultry Appraisal Use price lists developed from appraisal calculators  Broilers: Meat & Breeders  Turkeys:  Meat: Hens & Toms  Breeders: Hens & Toms  Table Egg Layers: Layers & Breeders Value by age  Meat: day-of-age  Breeders / Layers: week-of-age

Poultry Appraisal Poultry Appraisal Obtain bird count and age from owner or contract grower Look up per bird value from price list Total flock appraisal value = count x value per bird

Poultry Indemnity Poultry Indemnity Total indemnity = appraisal value x indemnity percentage  Indemnity percentage may be less than 100% for large scale producers who do not participate in the National Poultry Improvement Program (NPIP) Indemnity payment maybe split between owner and contract grower  Contract grower indemnity payment = (expected earnings (based upon previous flocks) prorated by actual production length – any company payments already received) x indemnity rate  Company indemnity = total indemnity – any indemnity payments to contract grower

Appraisal Valuation Methods Two Basic Appraisal Methods  Revenue Minus  Start with value of final product and work backwards subtracting costs and share of retained earnings for each downstream production/processing phase  Cost Plus  Appraisal value is equal to cost of production plus accumulated shares of retained earning for each upstream production/processing phase  Both methods produce the same exact value, thus provide internal check that spreadsheet equations are correct  Cost Plus will be discussed

Cost Plus Appraisal Value Valuation based upon cost of production and allocated retained earnings Retained earnings = net margin (gross profit) – income taxes – return to owner equity (dividends)  Assumed to be 1/3 of net margin, based upon US Bureau of Economic Analysis data  If net margin is negative then retained earnings are set to zero  This method guarantees companies at minimum will be compensated for their unrecouped costs Retained earnings are allocated across the various production/processing phases based upon each phase’s share of total cost

Appraisal Calculators Spreadsheets used to determine value  Broilers:  Meat  Breeders (Parents)  Turkeys  Meat: Hens & Toms  Breeders: Hens & Toms  Table Egg: Layers Uses national numbers so as not to identify any one company Updated Monthly  Meat & egg prices  Feed price index

Customized Values A poultry company has the option of basing appraisal value on their own cost of production data where value equals unrecouped cost  Meat birds value = cost of production  Breeder/layers value = capitalization cost - depreciation Documentation  Computerized Records  Productivity data  Cost of production data

Grandparent Valuation Grandparents and parent layers are generally produced by a few genetic poultry companies Valuation will have to be customized  Use same valuation approach as for parent/layers  Data requirements  Productivity data  Cost of production data  Revenue data If unwilling to provide this data, then valuation will equal that of parent/layers

Appraisal Calculators For each species  Over 100 input parameters  Prices, Costs & Productivity data  Over 200 equations  With feed costs feedback loops Broilers  3 sizes of meat birds  Breeder birds Turkeys  2 sizes of hens and toms  Breeders: hens and toms Layers  3 laying periods

Meat Bird Valuation Slaughter Value = cost of production + allocated retained earnings of any upstream production phases, e.g. breeder birds & hatchery in an integrated broiler company Initial value: day-old chick cost + (slaughter value – final production cost) x livability %

Mid-Age Meat Bird Valuation Linear interpolation between beginning value and ending (slaughter) value  Beginning value + beginning age ÷ slaughter age * (slaughter value – beginning value)  Age expressed in days in barn

Breeder & Layer Valuation Three valuation points  Initial (Day-old chick)  Maximum (Beginning of Lay)  Final (Salvage) = Spent hen price

Breeder & Layer Valuation Beginning of lay valuation  Value = capitalization cost + allocated retained earnings from future egg production  Retained earnings based upon 12 month rolling average price  Value declines linearly to salvage (spent hen) value Day-old chick value  Value = day-old chick cost + (beginning of lay value – capitalization cost) * livability %  Linear interpolation between day-old value and beginning of lay value

Breeder & Layer Valuation Broiler & Layer Breeders all valuation is in the hen, therefore, don’t count roosters in bird inventory Assume a single lay Value at beginning of lay when molted  Capitalization cost (value at molting age plus costs during molting) plus allocated retained earnings of expected egg production

Brown & Organic Table Egg Layers Brown Egg Layers  Value determine using brown egg price and brown egg layer productivity  Brown egg layer productivity determined by comparing breeding companies production guides for white & brown table egg layers  Organic: Value at capitalization assumed to be 50% greater than that of brown egg layers

Turkey Breeder Valuation Turkey hens & toms valued separately  Allocated retained earnings divided evenly between hens and toms  Since one tom services several hens allocated retained earnings per tom is greater than that of hens  Thus toms have greater value than hens

Cost Data Cost Data National productivity and cost data from 2005  Updating with 2009 data is planned Monthly adjustments for feed costs based on changes in feed costs used by USDA-NASS to calculate its broiler- feed, turkey-feed, and market egg-feed ratios.  2005: broiler feed, $6.20/cwt, Dec ’09, $10.69/cwt  10.69/6.20 = 172, i.e. feed cost up 72% since 2005  Changes in feed costs not only impact the cost of feeding a meat bird or producing an egg, but also the costs to produce a breeder/layer which impact bird depreciation cost in egg production. The change in egg production costs in turn impacts the cost of a day-old chick which changes total production cost of a meat bird. Day-old chick cost: annually NASS’ Agricultural Prices

Broiler Price Data Meat: USDA-ERS’ monthly composite wholesale price for broiler meat  Dec ’09: current, $0.719/lb 12-month avg., $0.755/lb 12-month avg., $0.755/lb Spent Hens: average of USDA-AMS’ Monthly Heavy Hens, Southeastern & South Central Regions  Dec ’09: $0.1284/lb

Turkey Price Data Meat:  Light Hens & Toms (up to 98 days old): USDA-AMS’ Monthly Frozen Whole Body, Young Turkeys, Grade A  Dec ’09current12-month avg. Hens$0.8381/lb$0.7936/lb Toms$0.8387/lb$0.7928/lb  Heavy Hens & Toms: Monthly composite price based upon AMS’ National Young Turkey Parts and Bulk Meat & AMS’ percent carcass breakout  Dec ’09current12-month avg. Hens$0.9936/lb$0.9107/lb Toms $1.0011/lb$0.9160/lb  Spent breeder price = 2005 spent price * current NASS live turkey price ÷ 2005 NASS live turkey price  Dec ’09: Hens, $0.2396/lb; Toms, $0.2515/lb

Layer Price Data Table Eggs  White & Brown Egg prices calculated from AMS’ Monthly Trailer Load Egg Sales  Dec ’09 12 month avg.:  white, $0.6723/doz; brown, $0.6893/doz  USDA-NASS market egg price, $0.656/doz  Spent Hens: normally a cost to remove spent layers, assume minimum layer value of $0.01/bird

Data Needs Layers  Better brown egg layer cost & productivity data  Organic eggs: prices, costs & productivity data  Breeders: revenues, costs & productivity data Broilers  Grandparent breeder information  Colored bird: meat & breeder information Turkeys  Light tom productivity information  More breeder tom information  Grandparent breeder information