1. Analysis of Alternative LGM-Dairy Contracts: A Wisconsin Case-Study Brian W. Gould Department of Agricultural and Applied Economics University of Wisconsin-Madison University of Wisconsin Extension November 25, 2013

2. Website Address: http://future.aae.wisc.edu LGM-Dairy Website

5. 5 Bundled Options UW Understanding Dairy Markets Database System LGM-Dairy Insurance System Rules http://future.aae.wisc.edu/lgm_analyzer/ UW LGM-Dairy Integrated Software System UW Feed Converter IOFC Estimator Actual Contract Performance Least-Cost Contract Least-Cost Contract Premium Estimator Premium Estimator LGM-Dairy Analyzer LGM-Dairy Tutorial

6. 6 Use of the UW LGM-Dairy Analyzer  Let's look at how one can use the LGM- Dairy Analyzer (Premium Estimator)  Can look forward to next two contracts or historically to previous periods  Historical analysis based on actual data used to determine LGM-Dairy premiums  Future analysis can look 1 or 2 months in advance Based on futures/options data available on the date when the analysis is undertaken Based on futures/options data available on the date when the analysis is undertaken

7. 7 Structure of the LGM-Dairy Premium Estimator Premium Estimati on Premium Estimati on Historical Analysis ? Select Premium Estimator Previously Entered Data Production, Feed Equiv., Coverage %, Deductible Input Form Choose Date of Contract Offering Summary Table Premium Sensitivity Analysis Indemnity Determinatio n YES NO Indemnity Sensitivity Analysis Futures and Options Data Save to Excel File

8. 8  Farm characteristics  500 milk cows  Purchase October 2010 contract  Cover a portion of Mar – Jun 2011 margin  20,820 lb/cow annual whole herd average LGM-Dairy: A Wisconsin Case Study  Contract defined by monthly % insured  44% of March - June production insured Oct ′10 Nov ′10 Dec ′10 Jan ′11 Feb ′11 Mar ′11 Apr ′11 May ′11 Jun ′11 Jul ′11 Aug ′11 Sep ′11 12345678910 Purchase No Cover -age Insurance Contract Period Percent Insured 75%50%25% 2

9. 9  Contract defined by contract deductible  Base example deductible: $1.00/cwt TEGM  Contract defined by declared feed use  Two feed use assumptions Ration 1: Declare 100% of corn and SBM equiv. Ration 1: Declare 100% of corn and SBM equiv. Ration 2: Declare only purchased feed Ration 2: Declare only purchased feed No corn silage No corn silage 25% of SBM equiv. met from own supplies 25% of SBM equiv. met from own supplies  Files can be downloaded from the following future.aae.wisc.edu/lgm-dairy/wisc/WI_ration1_badgerland.csv future.aae.wisc.edu/lgm-dairy/wisc/WI_ration2_badgerland.csv LGM-Dairy: A Wisconsin Case Study Initial Ration

10. 10 Month(2011) Yield per Cow (#/mth) Milk Marketings (cwt) Total Feed Quantity Feed Ration 1 Feed Ration 2 Corn Eq. (T/mth) SBM Eq. (T/mth) Corn Eq. (T/mth) SBM Eq. (T/mth) Mar1,8519,255 194.1 109.1 117.5 77.6 Apr1,8149,070 187.9 105.5 113.7 75.1 May1,8799,395 194.1 109.1 117.5 77.6 Jun1,7968,980 187.9 105.5 113.7 75.1 4-Mo.1,8359,175764.0429.2 462.4305.4 LGM-Dairy: A Wisconsin Case Study

11. 11 Month Oct 2010 Expected Prices Actual Prices Actual – Expected Prices Class III ($/cwt) Corn ($bu) SBM ($/ton) Class III ($/cwt) Corn ($bu) SBM ($/ton) Class III ($/cwt) Corn ($bu) SBM ($/ton) Mar-1114.165.9233919.456.773485.290.858.63 Apr-1114.155.9533916.806.813472.650.868.21 May-1114.135.9833916.536.863472.400.887.80 Jun-1114.356.0033919.236.943484.880.948.85 Average14.205.9633918.006.853483.810.888.37  Average Actual − Expected % differences:  Class III: +26.8%  Corn: +14.8%  SBM: +2.5% LGM-Dairy: A Wisconsin Case Study

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13. 13 October 2010 Contract Sales Date

14. 14 Upload previously saved data Select Year and Month Select Deductible This allows you to enter feed manually LGM-Dairy: A Wisconsin Case Study

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16. 16 Save all calculations to a spreadsheet file Note the difference between Farm milk vs. Covered milk LGM-Dairy: A Wisconsin Case Study

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19. 19  With Oct. 2010 contract completed all actual prices known by end of July 2011  June is last covered month  Software is smart enough to know which actual prices exist and evaluate actual indemnity  If at least 1 actual price is known (but not all) an estimate of the indemnity status will be generated  For those months with no actual prices, previous days futures used as an estimate LGM-Dairy: A Wisconsin Case Study

20. 20 LGM-Dairy: A Wisconsin Case Study

21. 21 Note: The TAGM was $146,204. The difference between the TAGM and TGMG was $66,407, much greater than the $4,293 subsidized premium paid.

22. 22 Net Premiums Under Alternative Deductibles Net Premium = Premium – Subsidy Oct. ′10 contract purchase Cover portion of Mar-Jun ′11 margins Oct. ′10 contract purchase Cover portion of Mar-Jun ′11 margins

23. 23 Net TGMG Under Alternative Deductibles Oct. ′10 contract purchase Cover portion of Mar-Jun ′11 margins Oct. ′10 contract purchase Cover portion of Mar-Jun ′11 margins Net TGMG = TGMG – Net Premium = TGMG – Premium – Subsidy Net TGMG = TGMG – Net Premium = TGMG – Premium – Subsidy

24.  Let’s compare the above results obtained where all feed is converted to corn and SBM equivalents to the same contract but different feed use  Use ration #2 where a ll corn silage and 25% of SBM equivalent not declared  Same amount of milk insured as in ration 1 24 LGM-Dairy: A Wisconsin Case Study

25. 25  Lets compare Ration 1 vs. Ration 2  Note how with Ration 2, the TGMG ↑ while the premium ↓ compared to Ration 1 TGMGNet PremiumNet TGMG Ration 1 Ration 2 Ration 1 Ration 2 Ration 1 Ration 2 Total $ 76,797123,3044,2933,34372,504119,961 $ Per CWT Insured Milk 4.787.670.270.214.517.46 $ Per CWT Farm Milk 2.093.360.120.092.093.27

26. 26 Comparison of Net TGMG’s Oct. ′10 contract purchase Cover portion of Mar-Jun ′11 margins Oct. ′10 contract purchase Cover portion of Mar-Jun ′11 margins Net TGMG = TGMG – Net Premium = TGMG – Premium – Subsidy Net TGMG = TGMG – Net Premium = TGMG – Premium – Subsidy

27. 27 Were There Indemnities?  Under both rations for the Oct. 2010 contracts there were no indemnities due to:  Significantly higher Class III milk prices  Relatively small increases in feed costs  As an alternative we will examine purchasing an October 2008 contract  Use same rations as before  Assume same milk production  Only difference is with respect to expected and actual prices

28. 28 October 2008 Contract Sales Date

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30. 30 Month Expected PricesActual Prices% Change Class III ($/cwt) Corn ($/bu) SBM ($/Ton) Class III ($/cwt) Corn ($/bu) SBM ($/Ton) Class III ($/cwt) Corn ($/bu) SBM ($/Ton) Mar '09 14.534.2828510.463.67284-28.0-14.3-0.5 Apr '09 14.774.3428710.763.92326-27.1-9.713.9 May '09 14.864.402889.834.17369-33.8-5.228.1 Jun '09 15.244.452909.943.83368-34.8-13.927.2 Average 14.854.37287.5010.253.90336.75-30.9-10.817.2 October 2008 Contract Offering LGM-Dairy: A Wisconsin Case Study

31. 31  Let’s compare contract costs of 2008 vs. 2010 (Ration 1) TGMGNet Premium Net TGMG 201020082010200820102008 Total $ 76,797115,0454,2935,02872,504110,016 $ Per CWT Insured Milk 4.787.160.270.314.516.85 $ Per CWT Farm Milk 2.093.130.120.141.983.00 LGM-Dairy: A Wisconsin Case Study

32. 32  Lets compare 2008 vs. 2010 (Ration 1) IndemnityNet Indemnity 2010200820102008 Total $ 054,336-4,29349,307 $ Per CWT Insured Milk 03.38-0.273.07 $ Per CWT Farm Milk 01.48-0.121.34 LGM-Dairy: A Wisconsin Case Study

33. 33  Lets compare 2008 vs. 2010 (Ration 2) TGMGNet Premium Net TGMG 201020082010200820102008 Total $ 123,304151,0933,3434,200119,961146,894 $ Per CWT Insured Milk 7.679.400.210.267.469.14 $ Per CWT Farm Milk 3.364.120.090.113.274.00 LGM-Dairy: A Wisconsin Case Study

34. 34  Lets compare 2008 vs. 2010 (Ration 2) IndemnityNet Indemnity 2010200820102008 Total $ 054,902-3,34350,702 $ Per CWT Insured Milk 03.42-0.213.16 $ Per CWT Farm Milk 01.50-0.091.38 LGM-Dairy: A Wisconsin Case Study

35. 35  Ration impacts on 2008 covered milk net indemnities LGM-Dairy: A Wisconsin Case Study

36.  The previous analyses were looking at historical data  In the next example we want to obtain an estimate of the costs of a November 2013 contract  Unlike historical analysis we do not know expected prices 36 LGM-Dairy: A Wisconsin Case Study

37.  The LGM-Analyzer uses the most recent 3 days of futures and options when expected prices are not known  The closer one gets to actual contract purchase date, → more accurate premium estimates 37 LGM-Dairy: A Wisconsin Case Study

38. 38 Expected Prices Month 2013-20142010-112008-2009 Class III ($/cwt) Corn ($/bu) SBM ($/Ton) Class III ($/cwt) Corn ($/bu) SBM ($/Ton) Class III ($/cwt) Corn ($/bu) SBM ($/Ton) Mar 16.754.3239814.165.9233914.534.28285 Apr 16.734.3639414.155.9533914.774.34287 May 16.684.3939214.135.9833914.864.40288 Jun 16.824.4339014.356.0033915.244.45290 Average LGM-Dairy: A Wisconsin Case Study Note: 2013-2014 expected prices obtained from an analysis undertaken on November 22 nd

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41. 41 TGMGNet PremiumNet TGMG 201320102008201320102008201320102008 Ration 1 Total $ 126,278 76,797115,045 2,475 4,2935,028 123,803 72,504110,016 $/cwt Insured Milk 7.86 4.787.16 0.15 0.270.31 7.70 4.516.85 $/cwt Farm Milk 3.44 2.093.13 0.070.120.143.371.983.00 Ration 2 Total $ 168,327123,304151,0932,1833,3434,200166,144119.961146,894 $/cwt Insured Milk 10.477.679.400.140.210.2610.347.469.14 $/cwt Farm Milk 4.593.364.120.060.090.114.533.274.00 LGM-Dairy: A Wisconsin Case Study

42. 42 Nov. ′13 contract purchase Cover portion of Mar-June ′14 margins Nov. ′13 contract purchase Cover portion of Mar-June ′14 margins LGM-Dairy: A Wisconsin Case Study

43. 43 Net TGMG = TGMG – Net Premium = TGMG – Premium – Subsidy Net TGMG = TGMG – Net Premium = TGMG – Premium – Subsidy LGM-Dairy: A Wisconsin Case Study Nov. ′13 contract purchase Cover portion of Mar-June ′14 margins Nov. ′13 contract purchase Cover portion of Mar-June ′14 margins

44. 44 Contact Information  The Univ. of Wisconsin Dairy Marketing Website: http://future.aae.wisc.edu  Livestock Gross Margin Insurance: http://future.aae.wisc.edu/lgm_dairy.html  To join the LGM-Dairy Mailing List: http://future.aae.wisc.edu/lgm_dairy.html#5  Brian W. Gould (608)263-3212bwgould@wisc.edu