Dairy Margin Coverage – the new margin protection plan for … · The original margin calculation was based on the cost of feeds to make 100 pounds of milk and the feed supporting

1

DairyMarginCoverage–thenewmarginprotectionplanfordairyproducers

BriefingPaper18-2Updated11December2018

AndrewM.Novakovic*

MarkStephenson*

TheLegislativeChangestoMPP-Dairy

TheAgricultureImprovementActof2018completesalegislativeprocessthatbeganoverayearagowitharecognitionthattheMarginProtectionProgramforDairyProducerslaunchedwithgreathopefouryearsearlierdidnotliveduptotheexpectationsofeitherdairyfarmersoritsauthorsandsponsors.Earlierthisyear,theBipartisanBudgetActof2018includedrevisionstotheoriginalMPP-Dairythatcreatedauniqueopportunityfordairyfarmerstoretroactivelyreconsidertheir2018enrollmentdecisionundermuchmorefavorablepremiums.Indeed,themarketsituationcombinedwithretroactiveenrollmentguaranteedthatallbutthelargestdairyfarmscouldreceiveanetcashbenefitin2018.

WhilethissecondversionofMPP-Dairywasunfolding,theHouseandSenateagriculturecommitteescontinuedtoworkonamorepermanentredesignoftheMarginProtectionProgram.Althoughthetwocommitteescameupwithslightlydifferentversions,fromthebeginningacouplethingswereclearlyinagreement:

1. Tocontinuewithapolicybasedonthegeneralconceptofprovidingcashsubsidiestodairyfarmerswhentheyexperiencedasqueezebetweenthepriceofmilkandthecostofbuyingthefeedtoproducethatmilk

*Andrew M. Novakovic is the E.V. Baker Professor of Agricultural Economics in the Charles H. Dyson School of Applied Economics and Management at Cornell University. Mark W. Stephenson is the Director of Dairy Policy Analysis at the University of Wisconsin. The Briefing Paper series is intended to provide logical and/or empirical analysis of dairy market economics or policy. The authors reserve all copyrights on this paper, but permission is granted to quote from the paper or use figures and tables, provided appropriate attribution is made.

2

2. Anapproachthatwouldcontinuetorequirefarmerstopayfortheprivilegeofcoverage(likeaninsuranceprogram)-highercoverage,higherpremiums-butto:

a. Increasethehighestcoveragethresholdforfarmsofaboutaveragesizeandsmaller,and

b. LowerthecostofcoverageforthosesamefarmsThisbriefingpapersummarizesthenewDairyMarginCoverageprogramandbeginsto

reviewthepossibleimplicationsofthechanges.Asiscommonwithanyagriculturalprogramlegislation,USDAwillneedtoreviewthelaw,makeafewdecisionsabouthowtoimplementthechanges,andissuenewormodifiedregulationsthatprovidespecificinstructionsaboutwhatfarmerscandoandwhentheycandoit.Itisanticipatedthatthisprocesswillhappenfairlyquickly.

Whilewewillnotexamineotherriskmanagementprogramsfordairyfarmers,keepinmindthat1)thefundingchangesthatallowfarmerstoaccesstheLivestockGrossMarginforDairyyeararoundand2)theindependentlycreatedDairyRevenueProtectionprogramremaininplaceandarenotalteredoraffectedbytheAgricultureImprovementActof2018.Oneverysignificantchange,however,isthatdairyfarmerswillnowbeabletosimultaneouslyusethenewDairyMarginCoverage(DMC)andLGM-DairyorDairyRP.ThelogicbehindthisisthatcropproducerscansimultaneouslyuseincomesubsidyprogramsadministeredthroughtheFarmServicesAgency(suchasARC/PLC)andinsuranceprogramsadministeredthroughtheRiskManagementAgency(suchasRevenueProtection).

BasicFeaturesofDMCandComparisontotheOriginalMPP-DairyFirst,keepinmindthatwhenCongressdecidestomodifyor"fix"apieceoflegislation,

ittypicallystartswiththelanguageoftheoldlawandsays:replacethiswiththat,deletethat,insertthis,etc.Thus,unlesstheAgricultureImprovementActof2018specificallychangessomethingoriginallyauthorizedbytheAgriculturalActof2014,theprovisionsoftheoriginalprogramwillsimplycontinue.Forexample,Congresschangedthepremiumstructureunderthenewlawbutleftalonethemethodfordeterminingaproducer'sProductionHistory.

Second,alsorememberthattherearenumerousdetailsinhowUSDAadministerstheprogram,detailsthatarenotspecifiedbythelegislation.USDAcanchangeitsregulations,followingrequiredadministrativeprocedures,atanytime,aslongastheproposedregulationsareconsistentwiththelegislation.Theseregulationsdonotimpactthebasicdesignofthenewprogram,discussedbelow.ProductionHistory

UndertheoriginalAgriculturalActof2014,farmerswhowishedtoenrollhadtoestablishanamountofmilkthatqualifiedfortheMPP-Dairyprogram.ThisamountiscalledtheProductionHistory(PH).Formostfarmers,thisamountwasbasedonthehighestannualmilkproductionmarketedineither2011,2012,or2013.Fordairyfarmsbusinessesthatdidnotexistbeforeearly2013,alternativerulestreatedthemasnewfarms.1Moreover,once 1 For additional details on how Production History is established, see Information Letter IL 14-02 at: https://dairymarkets.org/PubPod/Pubs/IL14-02.pdf

3

theoriginalProductionHistorywasset,itwasincreasedinfollowingyearsbythenationalannualincreaseinproduction.

UnderDMC,anyfarmthathasanestablishedProductionHistorywillmaintainthatamountasitwasdeterminedfor2018.AnynewregistrantwillestablishaProductionHistorybasedontheoriginalrules.Inotherwords,thosenewregistrantshavetogobacktothe2011-2013yearsorwhenevertheirfarmfirststartedproducingmilk.However,therewillbenofutureadjustmentstoProductionHistoriesbasedonincreasesinUSproductionoranyotherfactors,foranyfarm.

CoverageElection

First,abitofMPP/DMCglossary:1. ActualDairyProducerMargin(ADPM)–thisissimplythenameforthemargin

valuethatUSDAcalculateseachmonthusingthepricesforAllMilk,Corn,SoybeanMealandAlfalfaHay.

2. CoverageLevelThreshold–thisisthedollarvalueoftheADPMthatthefarmerchoosesasthetriggerorthresholdatwhichbenefitpaymentswillbemade.Ifsheelects$7.50coverage,benefitsarepaidwhentheADPMgoesbelow$7.50.

3. CoverageLevelPercentage–thisisthepercentageofaproducer'sProductionHistorythathechoosestoenrollintheprogram.A50%CoverageLevelmeansthat50%oftheproducer'sPHisenrolledintheprogram.Notethatthisisnotthesameas50%oftheircurrentactualmarketings.

4. CoveredProductionHistory(CPH)–thisisthequantityofmilkenrolledintheprogram.ItissimplytheProductionHistory(hundredweight)multipliedbytheCoverageLevelPercentage.

Asbefore,farmershavetwobasicdecisionstomake:1)howmuchmilktocoverand2)thelevelofmarginatwhichabenefitwilltrigger.Undertheoriginalprogram,farmerscouldcovernolessthan25%oftheirproductionhistoryandnomorethan90%,inincrementsof5percentagepoints.

UnderDMC,theCoverageLevelPercentageisexpanded,onbothends,from5%ofProductionHistoryto95%.ThemuchlowerminimummakestheprogrammoreaccessibletoverylargefarmsthatwanttotakeadvantageofthelowTier1premiumsandnotbeexposedasmuchtothehigherTier2premiums.ThisisespeciallyimportantforthehighlevelsofCoverageLevelThreshold,forwhichtheTier2premiumsaremuchlargerthanTier1.Forexample,aproducermaydeterminethat$8.00coverageisattractiveforthecomingyearbutthattheveryhighTier2premiumsnegateorseverelydiminishthepotentialbenefit.If25%ofhisProductionHistoryputsalargeshareofhistotalCoveredProductionHistoryintoTier2,thenhemay,sensibly,decidenottoparticipateatthatCoverageLevelPercentage.ThereductionintheminimumamountofPHmilkthatmustbecoveredfrom25%to5%meansthatafarmhaving100millionpoundsofPH,orabout4,000cows,cannowfullyparticipateinTier1withoutanyTier2exposure.Ofcourse,itonlyappliesto5millionpoundsofmilk,butitissomethingthatwasn’tpossiblebefore.

4

ChangesinCalculationoftheMarginandPaymentTriggersTheAgricultureImprovementActof2018allowsTier1enrollmentat$8.50,$9.00and

$9.50CoverageLevelThresholds.Tier2continuestopeakoutatthe$8.00thresholdestablishedin2014.Thelowestthresholdlevel,referredtoas“catastrophiccoverage”,continuestobe$4.

Inallowingthehigherthresholds,theDMCcompensatesforachangemadetoMPP-Dairylateinthelegislativenegotiationspriortopassingtheoriginalbill.Before2014,theNationalMilkProducersFederationoriginallyproposedamargincalculationthatusedtheUSAllMilkPriceandpricesofthreefeedstuffsthatrepresentedthebulkofthevalueofadairyration.Theoriginalmargincalculationwasbasedonthecostoffeedstomake100poundsofmilkandthefeedsupportingtherestofanormalherd-youngstockanddrycows.Althoughthepricesofcorn,soybeanmealandalfalfahayarefundamentaltocalculatingthatcost,theothernecessarycomponentishowmuchofeachfeedstuffdoesafarmerneedtobuytomake100poundsofmilk.Everydairyfarmerknowsthatthereisnotoneration,anymorethanthereisonlyonepriceforcornorhay.Nevertheless,theobjectivewastocomeupwithasimpleformulathatusesreadilyavailable,reportedpricesandprovideareasonablerepresentationofanaveragecostoffeed.

OnefundamentalpartofthelegislativeprocessistoestimatehowmuchanewprogramorrevisionstoanexistingprogramwillcosttheUSgovernment.ThiscalculationisdonebytheCongressionalBudgetOfficeandiscalled"scoring".Onceabillhasbeenscored,thenumberbecomesafactofCongressionallife.Ifthescorerequiresmoremoneythanthebudgetallows,somewaymustbefoundtomaketheproposedprogramcheaper.Thissituationcameintoplayin2014.Thesimplebutnotparticularlysophisticatedsolutionthatwasusedwastosimplymultiplythefeedcostformulaby90%.Ineffect,ittooktheoldmargincalculationandsaidthatitwouldonlycover90%ofthecostoffeed.ThesimplearithmeticofthisisillustratedinTable1.

Table1.SampleImplicationsofthe2014AdjustmenttotheProposedMarginCalculation(dollarspercwt.)

MarginScenario MilkPriceOriginalProposal AgriculturalActof2014

FeedCost Margin FeedCost Margin

HighPrice–HighCost $18 $10 $8 $9 $9

HighPrice–LowCost $18 $6 $12 $5.40 $12.60

LowPrice–HighCost $14 $10 $4 $9 $5

LowPrice–LowCost $14 $6 $8 $5.40 $8.60

FromJanuary2007toDecember2014,theActualDairyProducerMarginthatwould

havebeencalculatedfromtheoriginalformulaaveraged$7.38.TheadjustmentsthatweremadefortheAgriculturalActof2014changedtheaverageto$8.50.Inthefirstcase,afarmerwouldhavereceivedabenefitpaymentat$8coverage,butnotinthesecondcase,eventhoughallthemilkandfeedpricesareidenticalinbothscenarios.Itisthissortofcalculation

5

thatledtothesimplified,approximateconclusionthatthenewcalculationwas"off"byabout$1.00.Congresschosetofixthisbyincreasingthehighestthreshold,asopposedtoalteringtheformula.

Usingtheoriginal,proposedformula,sinceJanuary200058.7%ofthemonths(not2-monthaverages)hadamarginbelow$8.00.Usingthe2014formula,thereare57.8%ofthosemonthswhenthemarginfellbelow$9.50,thenewhighthreshold.Approximatelythesamesensitivitytomarketconditions…Problemsolved.

TheAgriculturalActof2014specifiedthattheActualDairyProducerMarginwouldbecalculatedmonthlybutthatpaymenttriggerswouldbebasedontwo-monthaverages:Jan-Feb,Mar-Apr,andsoon.TheBipartisanBudgetBillof2018changedthepaymenttriggertoonemonth.Thishadtheeffectofincreasinghowquicklyabenefitpaymentcouldbereceivedbutalsoeliminatedthepossibilitythatahighermargininonemonthmightpullupalowermarginintheadjacentmonthandtherebyresultina2-monthaveragethatnolongerqualifiedforpaymentorpaymentataparticularthreshold.

TheAgricultureImprovementActof2018continuestocalculatebenefitpaymentsonamonthlybasis.

ChangesinPremiumsGiventheexperienceoftheoriginalprogram,averyimportantgoalwastoraisethe

upperlimitsatwhichabenefitcouldbepaid,i.e.,tomakeitpayoutmorefrequently,aswasjustdiscussed.Arguablyanevengreaterobjectivewastomakeitmoreaffordable,i.e.,tolowerpremiums.HowthesechangeswerefinallyimplementedisillustratedinTable2,whichshowsbasicpremiumsundertheoriginalprogram(MPP-Dairy)andthenewprogram(DMC,showningreen).Inadditiontothestructureofthebasicpremiums,thereareacoupleofothernewwrinkles,whichwillbediscussedinpart3below.

Part1:NewPremiums

Table2illustratespremiumsunderthreeversionsofmarginprotection:1)theAgriculturalActof2014,2)theBipartisanBudgetActof2018,and3)theAgricultureImprovementActof2018.ItshowsthebasicpremiumsforTier1andTier2.Thereareseveralchangestoobserve:

1. ThequantitythresholdthatseparatesthelowerpricedTier1premiumsfromthehigherTier2wasincreasedfrom4millionpoundsto5millionpoundsundertheBipartisanBudgetAct.ThischangewasmaintainedinthenewDMC.BasedonUSaverageproductionpercowjustbeforethe2014and2018billswerepassed,theoldthresholdof4millionpoundsperyearequatestoaherdsizeofabout190cows.Thenewnumbersequatetoaherdofabout220cows.

2. ThelowestCoverageLevelThreshold,sometimesreferredtoascatastrophiccoverage,hasbeenandcontinuestobe$4.Thislevelofcoverageisavailablebyonlypayingthe$100enrollmentfeeandisautomaticallyappliedtothemaximumCoverageLevelPercentage–90%in2014and95%in2018.

3. ThehighestCoverageLevelThresholdwasraisedto$9.50underDMCbutonlyforTier1production.Itremainsat$8.00forTier2.

6

4. Tier1premiumsaremuchlowerunderDMCthanfortheoriginalversionofMPP-Dairy.2TherelativedifferencesareillustratedinFigure1.Forlevelsupto$6.50,theDMCpremiumsarenotmuchdifferentfromthe2014program.After$6.50,thepremiumsaredramaticallylower.

5. AsshowninFigure2,Tier2premiumsunderDMCarequiteabitlowerforthelowestCoverageLevelscomparedtoMPP-Dairy–below$5.50.However,theyincreasesignificantlyat$6coverageandhigher.Thus,pricesnearthe"catastrophic"levelaremuchmoreaccessibletolargerfarmersbutcoverageabovethat,eveninthemid-range,ismoreexpensive.Asnotedabove,coverageatthenewlevels,greaterthan$8,isnotavailableatanyprice.

Table2.PremiaforMarginPrograms,exclusiveof$100AdministrativeFee

(dollarspercwt.)

CoverageLevel

Threshold

Tier1MPP-Dairy,2016to2017

Tier1MPP-Dairy,

2018

Tier2MPP-Dairy

Tier1DMC

Tier2DMC

QualifyingProduction

4Mlbs.orless 5Mlbs.orless

above5Mlbs.

5Mlbs.orless above5Mlbs.

$4.00 $- $- $- $- $-$4.50 $0.0080 $- $0.0200 $0.0025 $0.0025$5.00 $0.0190 $- $0.0400 $0.0050 $0.0050$5.50 $0.0300 $0.0090 $0.1000 $0.0300 $0.1000$6.00 $0.0410 $0.0160 $0.1550 $0.0500 $0.3100$6.50 $0.0680 $0.0400 $0.2900 $0.0700 $0.6500$7.00 $0.1630 $0.0630 $0.8300 $0.0800 $1.1070$7.50 $0.2250 $0.0870 $1.0300 $0.0900 $1.4130$8.00 $0.4750 $0.1420 $1.3600 $0.1000 $1.8130$8.50 n.a. n.a. n.a. $0.1050 n.a.$9.00 n.a. n.a. n.a. $0.1100 n.a.$9.50 n.a. n.a. n.a. $0.1500 n.a.

Althoughtherewerequiteanumberofspecificchanges,themainresultsarethatpremiumsandCoverageLevelThresholdoptionsaremuchimprovedforTier1,whichwillapplytothefirst5millionpoundsenrolledregardlessofhowbigafarmis,andDMCismoreaccessibletolargefarmsatthemoremodestcoveragelevelsunderTier2.

2 The Agricultural Act of 2014 provided premium discounts for farmers who enrolled in 2014 and/or 2015. The levels shown in the table were the undiscounted premiums that applied in 2016 and thereafter.

7

Figure1.Tier1Premiumsunderthreeversionsofmarginprotection

Figure2.Tier2Premiumsundertwoversionsofmarginprotection

$-

$0.0500

$0.1000

$0.1500

$0.2000

$0.2500

$0.3000

$0.3500

$0.4000

$0.4500

$0.5000

$4.00 $4.50 $5.00 $5.50 $6.00 $6.50 $7.00 $7.50 $8.00 $8.50 $9.00 $9.50

MPPDairy2014 MPPDairy2018 DMC

$-

$0.0025$0.005

$0.100$0.310

$0.650

$1.107

$1.413

$1.813

$-$0.0200

$0.0400

$0.1000$0.1550

$0.2900

$0.8300

$1.0300

$1.3600

$0.00

$0.20

$0.40

$0.60

$0.80

$1.00

$1.20

$1.40

$1.60

$1.80

$2.00

$4.00 $4.50 $5.00 $5.50 $6.00 $6.50 $7.00 $7.50 $8.00

DMC MPP-D

8

Part2:SeparateCoverageLevelThresholdElectionsbyTier

AswastruewithMPP-Dairy,afarmcanenrollaProductionHistoryofmorethantheTier1maximum(5millionpoundsforDMC),butanymilkinexcessof5millionpoundsispricedatTier2premiums.

UnlikeMPP-Dairy,farmershaveanopportunitytoselectadifferentCoverageLevelThresholdinTier2.

1. Ifafarmerelects$8coverageorless,thenhemustselectthesamecoveragelevelinTier2,but

2. Ifafarmerelects$8.50ormore,thenhemayselectanydifferentcoveragelevelinTier2.

Whatthisallowsisalargefarmtoelectahighcoveragelevelonthefirst5millionpoundsenrolledintheprogrambutalower,andthereforemuchcheaper,coverageinTier2.Ofcourse,aslongas5%ofthefarm'stotalPHisnomorethan5millionpounds,thefarmerdoesn'thavetoelect"buy-up"coverageatanylevelinTier2.Regardless,95%ofhisPHiscoveredatthe$4levelsimplybyvirtueofenrolling.ConsidertheexamplesinTable3.Table3.ExamplesofCoverageElectionforthreefarms.

Medium Large VeryLarge

CurrentMarketings(lbs) 5,000,000 16,500,000 75,000,000

Cows 250 750 3,000

Yield(lbs/cow) 20,000 22,000 25,000

ProductionHistory(lbs)-anexample 4,750,000 15,500,000 69,000,000

Buy-UpCoverage-anexample

CoverageLevelPercentage 95% 75% 50%

Tier1

CoveredProduction(lbs) 4,512,500 5,000,000 5,000,000

CoverageLevelThreshold-1 $9.50 $9.50 $9.50

Tier2

CoveredProduction(lbs) 0 6,625,000 29,500,000

CoverageLevelThreshold-2 n.a. $5.00 $5.00

CatastrophicCoverage

Coveredat$4(lbs) n.a. 3,100,000 31,050,000

CurrentMarketingsNotCovered(lbs) 487,500 1,775,000 9,450,000

9

Intheexampleabove,theMediumsizedfarmhascurrentmarketingsof5millionpoundsperyearbuthisProductionHistoryis4.75millionpounds.OfthatPH,hecanenrollupto95%,oramaximumof4.5125millionpounds.Ifhechoosestoenrollthemaximumatabuy-upCoverageThresholdLevelof$9.50,hismargincoveragewillbeasfollows:3

1. IfADPMisabove$9.50,hereceivesnobenefitpayment2. IfADPMfallsbelow$9.50inaparticularmonth(let'ssayits$7.23),thenhis

resultsforthatmonthare:a. $9.50-$7.23=$2.27percwt.b. $2.27percwttimes1/12of4,512,500poundsor.0227times376,041.7,

whichequals$8,5363. IfADPMfallsbelow$4inaparticularmonth,thenthefarmgetsabigger

paymentbutthepoundsofmilkonwhichthemargindifferenceiscalculatedremainsthesameasabovebecausethefarmenrolled95%-themaximumallowed.

4. NomatterwhattheADPMisduringtheyear,487,500poundsofhiscurrentannualproductionisnotcoveredbyDMC.

NowconsidertheLargefarmillustratedinTable3.Inthisexample,thefarmhascurrentmarketingsof16.5millionpoundsperyearandaProductionHistoryequalto15.5millionpounds.Let'ssupposethisfarmerdecidesshewantstotakefulladvantageofTier1butonlycoverabout30%ofhertotalmarketingsunderTier2.SheselectsaCoverageLevelPercentageof75%.Shefurtherdecidestoselect$9.50coveragefor5millionpoundsinTier1andtheremainingenrolledPHat$5.00inTier2.Anexampleofherpossibleresultsisillustratedasfollows:

1. RegardlessofwhathappenstoADPMduringtheyear,1,775,000poundsofhercurrentmarketingsarenotcoveredunderDMC.

2. IfADPMfallsbelow$9.50inaparticularmonth,butisabove$5(let'ssayits$7.23),thenherresultsforthatmonthareonlyforTier1milk:

a. $9.50-$7.23=$2.27percwt.b. $2.27percwttimes1/12of5,000,000poundsor.0227times416,666.7,

whichequals$9,458.3. IfADPMfallsbelow$5.00inaparticularmonth,butisabove$4(let'ssayit's

$4.65),thenherresultsforthatmonthare:

a. InTier1:$9.50-$4.65=$4.85percwt.b. $4.85percwttimes1/12of5,000,000poundsor0.0485times

416,666.7,whichequals$20,208.

3 Please note that these examples are illustrations. Actual benefit payments will be slightly different as USDA applies a greater degree of precision (decimal points) to its calculations than we use for this illustration.

10

c. InTier2:$5.00-$4.55=$0.45percwt.d. $0.45percwttimes1/12of6,625,000poundsor0.0045times552,083.3

pounds,whichequals$2,484.

e. Thisyieldsatotalbenefitpaymentof$22,692.4. NowsupposetheADPMfallsbelow$4.00inaparticularmonth(let'ssayits

$3.25),thentheresultsforthatmonthare:

a. InTier1:$9.50-$3.25=$6.25percwt.b. $6.25percwttimes1/12of5,000,000poundsor.0625times416,666.7,

whichequals$26,042.

c. InTier2:$5.00-$3.25=$1.75percwt.d. $1.75percwttimes1/12of6,625,000poundsor0.0175times

552,083.3,whichequals$9,661.e. IntheCatastrophiccategory,$4.00-$3.25=$0.75f. $0.75percwttimes1/12of3,100,000poundsor0.0075times

258,333.3,whichequals$1,938.g. Thisyieldsatotalbenefitpaymentof$37,641.

Ofcourse,theresultsfortheVeryLargefarmwouldbecalculatedinthesamemanneraswasshownfortheLargefarm.Atthenumbersshowninthisillustration,ifthisVeryLargefarmchosetoenroll5%ofitsPH,itwouldhave1.55millionpoundsofunusedspaceinTier1.Ifitchose10%,itwouldhave1.9millionpoundsthatwouldhavetobeenrolledinTier2.

Part3:DiscountsandCredits

Certaindiscountsandcreditscanalsobeappliedtopremiumpayments.Therearetwomotivationsbehindthesefeatures.

First,somepeoplethoughtthatakindofrewardoughttobeprovidedtofarmerswhoconsistentlyparticipateintheprogram.ThiswasreflectedinthelanguageoftheoriginalbillfromtheHouseofRepresentativesthatlockedallfarmsintoonedecisionthatappliedtoeachyearofthe5-yearprogram.TheSenateproposeddiscountsbasedonthesizeofthefarminstead.ThetwoconceptsweremoreorlessmergedunderDMCintoadiscountforalong-termenrollmentthatlocks-incoveragelevels.Thus,ifafarmercommitstoanenrollmentthatspansthefullfiveyearsofthenewprogramatthesameCoverageThreshold($/cwt)andpercentofhistoricproduction(pounds)eachyear,shewillgeta25%discountonpremiumsineachofthoseyears.Otherwise,CoverageThresholdandCoverageLeveldecisionscanbemadeannually,includingtonotenrollatall.

Secondly,everyonerecognizesthattheoriginalMPP-Dairycollectedalotmoremoneyinpremiumsthanitpaidoutinbenefits(2014-2017),andatatimewhengettingabenefitfeltwarranteddespitetheofficialcalculationoftheADPM.Asakindofcompensationforthatunexpectedoutcome,theDMCcreatesacreditforeachfarmerthatisequalto75%ofthetotalpremiumspaidunderMPP-Dairyminusthetotalbenefitsreceived.Thatamountofmoneycanbeusedtopaynewpremiumsunderenrollmentsmadein2019orafterwards.

11

Alternatively,afarmercanrequestthat50%ofthatdifferenceinoldpremiumsandbenefitsberefundedincashnow.Ownersoffarmsthathaveceasedoperationsarealsoeligibleforarefund,basedontheirownershipshareduringthetimewhenpremiumswerepaid.ThisisapartfromwhathappenedtotheProductionHistoryfortheherdafterthesale.USDAwillnodoubthavemorespecificrulesforhowthiswillworkinduecourse.

EnrollmentPeriodTheActspecifiesthatUSDAmustopenenrollmentnomorethan60daysfromthedate

theActbecomeseffective.ThismeanstheymustwriteandpublishthemoredetailedrulesabouthowDMCwilloperate.ItislikelythatmanyoftheseruleswillbethesameasweredevelopedforMPP-Dairy,butthereobviouslyaresomechangesthatmustbemadeandperhapstheywillmakesomechangesthatarenotstrictlyrequiredbutwhichtheythinkarebothbeneficialandconsistentwiththenewlaw.TheAgricultureImprovementActof2018becomeseffectiveon1January2019.Thus,theenrollmentperiodshouldbeginsomewherearound,oratleastnotlaterthan,March1.

TheActfurtherrequiresthatUSDAholdthe2019enrollmentperiodopenforatleast90days.Thus,theenrolmentperiodmustextendatleastuntilabout30May.Farmersmayenrollatanytimeduringtheenrollmentwindow.Obviously,theycan'treceivepaymentsuntiltheyhavemadetheircoveragedecisions.Waitingtothelastminutegivesonethemaximumtimetopredictwhatwillhappen,butpostponesgettingbenefits.Atthecurrentexpectedpricesfor2019,itappearsthatthereisastrongpossibilityofreceivingbenefitpaymentsfor$9.50coveragethroughtheentireyear,certainlythefirst10months.

Ifafarmerelectstomakeadecisionin2019towhichshewillcommitforthenextfiveyear,annualenrollmentthereafterisautomatic.Otherwise,futureenrollmentandcoveragedecisionswillbemadeannually,withenrollmentprobablyoccurringattheendofthepreviousyear.Inotherwords,2020enrollmentdecisionswillbemadeinthelastfewmonthsof2019.

Special,One-timeRetroactiveEnrollmentfor2018Asnotedearlier,theAgricultureImprovementActexplicitlyallowsadairyfarmerto

simultaneouslyenrollinDMCandoneoftheRMAdairyriskprograms–eitherLGM-DairyorDairyRP.Withthisinmind,CongressdecidedtoallowfarmerstoretroactivelyenrollinMPP-DairywhowereineligibletoenrollinMPP-Dairyduring2018becausetheyhadanLGM-Dairycontractforatleastpartof2018.Inotherwords,USDAhastoopenthe2018enrollmentforanysuchfarmerwhowaspreventedfromenrollinginanymonthormonthsof2018undertheoldrules.USDAisinstructedtoopenenrollmentthatendsnolaterthantheendofMarch(90days).Therewon'tbemanyfarmsinthiscategory,butitwillbeaverysimpledecisionforallofthem.OtherDairyProvisionsoftheAgricultureImprovementActof2018

FederalMilkMarketingOrderClassIPriceMover

FederalMilkMarketingOrdersestablishminimumpricesthatprocessorsmustpayforfarmmilk.Thepricesvarywiththeproductthemilkisusedtomake.Fourproductclassesareidentified.ClassIIIpricesareseteachmonthbasedonbenchmarkpricesforcheeseanddrywhey.ClassIVpricesaresetbasedonbenchmarkpricesforbutterandnonfatdrymilk.

12

Sincethismethodwasestablishedin2000,ClassIpricesaresetbasedonwhicheveroftheapplicableClassIIIorClassIVskimmilkpricesarehigher.Whilethiswasoriginallyseenasawaytoensureafairbuthighervaluetofarmers,overtimeitwasrecognizedthatthismadeithardertousefuturesmarketstoolstohedgeaveragefarmmilkprices.ThisisbecausethereisnofuturesmarketforClassImilk(orallmilkingeneral)andonehadtosomehowpredictwhetherthefutureClassIpricewouldbedrivenbyClassIIIorClassIVinfuturemonths.Thiscreatedanaddeddegreeof"basisrisk".Tomitigatethisproblem,itwasproposedtochangetheClassIpricemovertotheaverageofthemonthlyClassIIIandIVpricesusedintheformula.Tooffsetthefactthattheaveragewouldalwaysbelessthanthe"higherof",74centsperhundredweightwillbeaddedtotheaverageofthetwoclasses.

ThisrevisiontoFederalOrderprovisionsismandatedintheAgricultureImprovementActof2018.ThelegislationwillrequireUSDAtoamendallFederalMilkMarketingOrderstoconformwiththenewrequirement,anditwaivestherequirementsoftheAdministrativeProceduresAct.ThelatterwillallowUSDAtoamendtheunderlyingregulatorylanguagewithoutahearingorwithoutevenaninvitationforcomments.ItdoesnotpreventUSDAfromrequestingcommentsorhavingahearingtoconsiderhowthisnewprovisionmightentangleorimpactotheraspectsofOrderoperationsoranyotherFederalOrderissue.Whetheritchoosestoinviteproposalsforahearingonanotherorevenarelatedtopic,thereisnoquestionthatUSDAwillchangetheprocedurebywhichClassIpricesarecalculatedwillbeimplementedbynolaterthantheendofMarch.

ReauthorizeForwardPricingbyNon-CooperativeHandlers

FederalOrdersestablishminimumpricesthatmustbepaidbyprocessorstosuppliersofmilk.Futurescontractsenablebuyersandsellerstoagreetoaforwardorfuturepricethatisunderwrittenbythefuturescontract.Forwardpricing,backedbyfuturescontracts,hasthebenefitofreducinguncertaintyaboutfutureprices,buttheymayendupbeinghigherorlowerthanthecashmarketatthatfuturepointintime.Ofcourse,thereisnoFederalOrderproblemiftheforwardcontractpriceendsupbeinghigherthantheminimumcashprice,buttheoriginallegislationandfederalorderlanguagedidnotallowregulatedhandlerswhoarenotcooperativestopayalowerpricethanthemonthlyminimum,evenifaselleragreedtoitinaforwardpricecontract.Since2008,theDairyForwardPricingProgramallowsnon-cooperative,regulatedhandlerstoenterintoforwardpricingcontractswithinterestedsuppliersonmilkthatisregulatedasClassII,III,orIV.TheAgricultureImprovementActof2018reauthorizestheDairyForwardPricingProgramthrough2023.

CharitableDonationsofMilk

TheAgriculturalActof2014includedaDairyProductDonationProgramthatauthorizedUSDAtopurchasedairyproductsfordonationtopublicandprivatenot-for-profitorganizationsthatprovidefoodassistancetolowincomeindividualsandfamilies.TheprogramcouldonlybecomeactiveiftheADPMfellbelow$4fortwomonthsinarow.Theprogramnevercameclosetokickinginsince2014.

Manyfarmers,processorsandanalystshavefeltthatdoingsomethingtostimulateusagewouldbeapositivewaytoassistfarmerswhenprofitsarelowandthatthisalsohasthesalutaryeffectofbolsteringsales,especiallyforpopulationsthatdonothavesufficientincomesorarefoodinsecure.ThenewlegislationincludesaMilkDonationProgramthat

13

doesnotauthorizeUSDAtopurchasedairyproductsfordonationsbutrathertriestoprovidefinancialincentivestoencouragethedairysectortomakedonations.Underthisprogram,dairyorganizationscouldbereimbursedforcostsincurredfordonatingconsumer-packaged,beveragemilk.ThereimbursementisbasedonthedifferencebetweentheFederalOrderminimumClassImilkpriceandthelowestclassifiedpricefortheapplicablemonth(eitherClassIIImilkorClassIV).Thus,aprocessorwouldbuymilkthatnormallywillincurtheClassIpricebut,bymeansofareimbursement,willfaceanactualcostequalonlytothelowestClassprice.ThemilkwouldremainpooledatitsClassIvalueandfarmerswouldseethesameminimumblendprice.

Amaximumof$5millionperyearwillbemadeavailableforthisprogram,butanyunspentfundswouldrolloverandbeavailableforsubsequentyears.Thisprogramfocusesonbeveragemilkproductdonationsinnosmallparttobolstersalesofaflagshipdairyproductthathassuffereddecliningpercapitaandtotalsales.

WhatWillorShouldDairyFarmersDo?AsaresultofthechangesmadeintheDMC,manymoredairyproducerswillhavenew

choiceswithregardtotheirmarketingstrategy.ThenewrangeonthepercentofProductionHistoryfrom95%downto5%meansthatmore,largerfarmscantakeadvantageofthelowerTier1premiumsontheirmilkproduction.WiththeTier1capof5millionpoundsofenrolledProductionHistory,farmswith100millionpoundsofmilkorlesscanqualifyforonlyTier1coverageonaportionoftheirmilk(5,000,000÷5%=100,000,000).Thisisafarmofapproximately4,000cows.Undertheoriginalprogram,thesamefarmwouldhavetoenrollatleast25%ofitsProductionHistory,whichmeansamuchmoreexpensivecoveragecost.

ThereareseveralapproachesthatcouldbetakentoexaminetheimpactofthechangesintheDMC.OneofthemistolookbackattheactualmarginsoverthelifeoftheAgriculturalActof2014toseewhatthenewruleswouldhavemeant.Overthose60months,Figure3andTable4showthemonthswhenthemargincalculationwouldhavebeenbelowcoveragelevels.HistoricReference

Althoughhistoriccalculationsarenoguaranteeoffutureperformance,itisclearthattheincreasesinCoverageLevelsfrom$8.00to$9.50maketheDMCmoresensitivetopotentialindemnitypayments.Overthelast5years,$9.00protectionwouldhavetriggeredapaymentslightlymorethanhalfofthetime,anda$9.50levelofprotectionwouldhaveprovidedpaymentsabouttwo-thirdsofthetime.Theexpectedpayoutwouldhaveaveragedfrom1¢to$1.00percwtofcoveredmilkfromthe$6.00levelofcoveragetothe$9.50level.AtTier1premia,$7.00coveragewouldhavebeenaboutbreakeven,andtherewouldhavebeenpositive,andincreasing,netbenefitsatalllevelsabovethat.

14

Figure3.MonthlyMilk-FeedMargins,January2014throughDecember2018

Table4.HistoricNumberofMonthsThatMPPMarginwasBelowCoverage.

ValueoftheLong-TermEnrollmentDiscountBasedonthecalculationsabove,the25%discountonpremiaforsigningupatthesame

coveragefortheentirelifeoftheprogramwouldhaveincreasednetbenefitsatmostbyless

CoverageLevel

MonthsBelow

PercentofMonthsBelow

ExpectedPayout Premia NetBenefit

NetwithDiscount

6.00$ 2 3% 0.01$ 0.050$ (0.04)$ (0.03)$6.50$ 2 3% 0.02$ 0.070$ (0.05)$ (0.03)$7.00$ 8 13% 0.06$ 0.080$ (0.02)$ 0.00$7.50$ 13 22% 0.14$ 0.090$ 0.05$ 0.07$8.00$ 19 32% 0.27$ 0.100$ 0.17$ 0.20$8.50$ 26 43% 0.47$ 0.105$ 0.36$ 0.39$9.00$ 31 52% 0.71$ 0.110$ 0.60$ 0.63$9.50$ 39 65% 1.00$ 0.150$ 0.85$ 0.89$

ForFirst5MillionPoundsofMilk

15

than4¢percwt.($0.150*25%=$0.0375).Forfutureenrollments,farmswouldbeexpectedtoevaluatethatdiscountagainstthebenefitofselectingalternativecoveragelevelsfortheupcomingyear.

TheMPPDecisionTool4usesfuturesandoptionsmarketstoestimatemarginsasseeninFigure4atthetimeofannualsignup.TheexampleinFigure4showsthefirstyearofsignupundertheoldprogramwithaforecastfor2014asofasignupdateofDecember13,2013.Actualmarginsin2014weremuchhigherthanforecast,butthetoolwouldhavecorrectlyforecastthatanannualdecisionfor2014wouldhavebeentoselectcatastrophiccoverageatthe$4.00levelastherewouldnotbeanexpectednetbenefitatanylevelabovethat(including$9.50).

Figure4.ExampleMarginForecastfor2014asofDecember13,2013.

LookingatthissamekindofdataanddecisionprocessfortheremainingyearsofthelastFarmBill,theDecisionToolwouldhavecorrectlyforecastthatanoptimalannualdecisionforproducerswouldhavebeencatastrophiccoveragein2014and2017butaselectionof$9.50forTier1coverageintheother3years.Hadaproducerfollowedthisstrategy,theaveragenetbenefitwouldhaveimprovedmarginallybyanadditional2.3¢percwt.atcoveragelevelsupthrough$8.50,beenofnoadditionalbenefitat$9.00,andwouldhavediminishedthevalueof$9.50coverageby2.3¢percwt.(Table5.)

Thereareafewfactorsatplayintheenrollmentdiscountexample.Oneisthatthereareafewmonthsofindemnitiesin2017atthetwohighestthresholdlevelsthatwouldhavebeenmissedifselectingcoverageannuallyusingthefuturesforecasttool.Anotherfactoristhatabsolutevalueofthediscountislargeronthemoreexpensivepremiums.

4 https://DairyMarkets.org/MPP/Tool/ or https://www.fsa.usda.gov/programs-and-services/farm-bill/farm-safety-net/dairy-programs/mpp-decision-tool/

16

Table5.Tier1HistoricValueoftheDiscount.2014Through2018.

TheDecisionforLargeandVeryLargeFarms

Manyfarmswithmorethan5millionpoundsofProductionHistorycanbenefitfromtheDMC.Forexample,a1,000cowfarmwithaPHof25millionpoundscanselectaTier1CoveragePercentageof20%andcover5millionpoundsoftheirmilkatthehighestThreshold.Thiswouldhaveprovided89¢netbenefitwiththe5-yearpurchasediscounton20%oftheirmilkwhichamountstoanetbenefitofabout18¢onallmilkproduction.

FarmswithaPHupto100millionpounds(about4,000cows)couldhavefollowedasimilarstrategytocover5%oftheirhistoricproductiontonet89¢benefiton5millionpoundsTier1coverageoranaveragenetbenefitof4.4¢onallmilk.

VerylargefarmscannotavoidsomeTier2coverage,giventhe5%minimumCoveragePercentage.Forexample,afarmwithaPHof250millionpounds(about10,000cows)couldchoose5%percentandwouldhave5millionpoundsof$9.50coverageatTier1andcouldcovertheremaining7.5millionpoundsataTier2levelofsay$5.00.Thiswouldstillprovideanetbenefitofabout1.8¢onallmilkproduction.Recall,largefarmscanonlyemploythisstrategyiftheirTier1thresholdselectionis$8.50orabove.

Thus,theDMCisespeciallyappealingforaverageandsmallersizedfarms,butitdoesprovidereasonable,affordableopportunitiesforvirtuallyallfarmsizes.TheabilitytouseDairyRevenueProtectionorLivestockGrossMargininsuranceinadditiontoDMCmakesforreasonableriskmanagementoptionsatallsizelevels.

UsingtheMPP-DairyCreditFarmerswhohaveMPP-Dairynetpremiumsareabletotake75%ofthatvalueasa

credittowardsfutureDMCpremiums(regardlessofanybenefitthatmaysubsequentlybepaid)orreceive50%ofthatamountascash.Thisisadecisionmanyfarmerswillhavetomake.Eithermethodcanbeasensiblechoice.Factorstoconsiderare1)howmuchnetpremiumdoyouhave,2)theextenttowhichyouwanttoparticipateinDMC,and3)thetaximplicationsoftakingacashpaymentin2019.

Threshold

5-Year Commitment with Discount

Annual Choice Using Futures

Forecast Difference6.00$ (0.105)$ (0.082)$ 0.023$ 6.50$ (0.088)$ (0.065)$ 0.023$ 7.00$ (0.048)$ (0.025)$ 0.023$ 7.50$ 0.024$ 0.046$ 0.023$ 8.00$ 0.158$ 0.180$ 0.023$ 8.50$ 0.355$ 0.378$ 0.023$ 9.00$ 0.597$ 0.606$ 0.009$ 9.50$ 0.886$ 0.863$ (0.023)$

Net Benefit per cwt.

17

SummaryCongresshasincorporatedthebasicideasoftheoldMarginProtectionPrograminthe

newDairyMarginCoverageprogram,butithasmadesignificantchangeswhichmaketheprogrammoreresponsivetomarketconditionsandwhichbettermatchfarmer'sperceptionsofadownmarket.Mostnotably,increasingthemaximumCoverageLevelThresholdfrom$8.00to$9.50inTier1willallowmoreindemnitytriggersovertime.LoweringthepremiaonTier1coveragemakestheinsuranceinvestmentallthemoreattractive.Tier2premiaarestillmuchmoreexpensivethanTier1abovethe$5.00coveragelevel,butTier1volumeshavebeenincreasedfrom4millionto5millionpoundsofProductionHistoryandtheCoverageLevelPercentagehasbeenloweredtoaslittleas5%ofPH.Althoughfarmslargerthanabout4,000cowswillhavetopurchasesomeTier2protection,thenewDMCallowstheTier2ThresholdLeveltobedifferent(lower)thantheTier1selectionifTier1isat$8.50orabove.Coverageat$5.50orbelowisattractivelypricedinTier2.

Producerswillhavetheoptionofelectingcoverageannually,ortheycanchoosetoelectcoverageonceforthelifeoftheFarmBillandreceivea25%discountontheirpremiumcosts.Basedonhistoricvalues,theremaybeasmallbenefittoamoreflexibleannualselection,butthediscountcanbetemptingforthesimplicityofaone-timechoice.Thelackofannualflexibilitymayhaveminimalcostsatthehighestthresholdlevels.FarmershowevershouldbewaryoflockinginalowCoverageThresholdthatwouldrequiresomepremiumbutseldomkicksin.

ThenewhigherCoverageLevelThresholdshavethepotentialtotriggerindemnitiesmorefrequentlythanwasthecasewithMPP-Dairy.BecauseofthisandthenewlowercostsoftheTier1premiums,inmostyearstheoptimumannualchoicewilleitherbetopurchaseatthehighestlevelofprotectionforTier1oratthecatastrophiclevel.

Thenewprogramshouldprovideagoodlevelofriskprotectionforsmallerfarmsataveryreasonableprice.Itwillalsoprovideabasiclevelofprotectionforlargerfarms.However,largerfarmsmayalsowishtoemployamorecompleteriskmanagementprogrambyusingofLGM-Dairy,Dairy-RP,futures,optionsorcashforwardcontractingastherearenorestrictionsforjointuseofDMCwithotherprograms.