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Extension > Agricultural Business Management News > Does the Dairy MPP pay?

Wednesday, August 24, 2016

Does the Dairy MPP pay?

by Betty Berning
Extension Educator


In early August, the United States Department of Agriculture published the milk margin for May/June 2016 and it was $5.76.  The calculated USDA milk margin is used in the Margin Protection Program for Dairy (MPP) to determine at what levels (and if) this program will make a pay-out.
MPP is an insurance like program for dairy producers that was a product of the 2014 Farm Bill.  Dairy producers select a margin level that they’d like to protect on their milk sales.  Farmers can choose to protect margins from $4-$8/cwt.  The $4/cwt level costs $100 to cover administrative fees.  From the $4/cwt level, coverage levels increase by $0.50 increment (e.g. $4.50/cwt, $5.00/cwt, etc) to $8/cwt.  As the margin levels increase premiums also increase.
Table 1 shows the payout at each level for the May-June period.  Everyone with $6.00/cwt or more coverage received a payout.  This is the first time the program has paid at a $7.00/cwt or lower level.  There were a couple payments in 2015 at the $8.00/cwt level and a payout in Mar-pril 2016 at both the $8 and $7.50 coverage levels.  The May-June payout announcement last week is the largest in the programs two-year history.  It is indicative of the tight margins many dairy producers are experiencing. 
Table 1:  May-June MPP Pay-out at varying coverage levels
Coverage Level per cwt
Pay out for May-Jun per cwt
$4.00
$0.00
$4.50
$0.00
$5.00
$0.00
$5.50
$0.00
$6.00
$0.24
$6.50
$0.76
$7.00
$1.24
$7.50
$1.76
$8.00
$2.24
Some producers have questioned if MPP has been worth the cost of the premiums.  Let’s look at two farms:  a farm with a production history of 2,000,000 lbs (~80 cows) and a farm with a production history of 5,000,000 lbs (~220 cows).  If you recall, premiums are calculated from Tier 1 for covered production history up to 4 million pounds and from Tier 2 for covered production history exceeding 4 million pounds.  Tier 1 premiums receive a greater subsidy than do Tier 2 premiums.  In these two scenarios, we’ll assume that the farms signed up at the 90% coverage level and that they received the two annual production bumps.
Table 2:  2016 Net Gain (Loss) from MPP at varying coverage levels (2 million lb production history)
Coverage Level per cwt
Premiums
Payout
Net Gain (Loss)
$4.00
$100
$0
(-$100)
$4.50
$286
$0
(-$286)
$5.00
$566
$0
(-$566)
$5.50
$845
$0
(-$845)
$6.00
$1,125
$737
(-$388)
$6.50
$1,777
$2,289
$512
$7.00
$4,143
$3,842
(-$301)
$7.50
$5,689
$6,485
$796
$8.00
$8,949
$9,590
$641

Table 2 shows the net gain or loss using the herd with a 2,000,000 lb production history.  The far right column shows what this hypothetical farm would’ve netted out. Notice that some producers have made up the cost of their premium. Farms that opted for $6.50, $7.50, or $8/cwt coverage have come out ahead.  Farms that elected a different coverage level have not made up the cost of premiums.    What is important to note here is the amount of gains/losses.  Losses range from -$845 to gains of $796.  This is not a very wide range when we put this into the big picture of this farm’s finances.  A loss of ~$850, although not pleasant, is not insurmountable; nor does a gain of `$800 make for a banner year. 
For the bigger operation, production history of 5,000,000 lbs, look at Table 3. You can see that with the smaller premium subsidy, the losses are larger.  $6.50/cwt is the only level that has had a gain, $116, which is nominal.  $7.00/cwt experiences the greatest loss of $4,634. 
Table 3 2016 Net Gain (Loss) from MPP at varying coverage levels (5 million lb production history)
Coverage Level per cwt
Premiums
Payout
Net Gain (Loss)
$4.00
$100
$0
(-$100)
$4.50
$632
$0
(-$632)
$5.00
$1,363
$0
(-$1,363)
$5.50
$2,358
$0
(-$2,358)
$6.00
$3,319
$1,842
(-$1,477)
$6.50
$5,607
$5,723
$116
$7.00
$14,238
$9,604
(-$4,634)
$7.50
$19,071
$16,213
(-$2,858)
$8.00
$28,044
$23,976
(-$4,069)

MPP is intended to be an insurance program.  It is there for when times are economically very poor.  Just like car insurance, a payment is only made when something terrible happens.  A person doesn’t hope that car insurance will provide a payment; that means an accident has happened. 
What this analysis reveals is that this program is a relatively inexpensive insurance (under 10 cents/cwt for $6.50 coverage + administrative fees for Tier 1 coverage).  Without spending too much, a farm can ensure that if catastrophe strikes, it has some protection.  In years when things are not catastrophic, but they’re also not good, the program can provide enough of a pay out to cover the cost of premiums.
Because MPP is an insurance like program, it should be used in conjunction with other risk management tools.  This is particularly true for larger farms, as illustrated above.  MPP should not be a farm’s sole risk management tool. 
In a bad year, MPP will not save a farm.  It can provide some protection and income to help offset losses.  It will not make up for all of the loss, though.  That is where other risk management tools come in to play.  Understanding your cost of production and utilizing forward contracts and future should be utilized to lock in margins that will ensure a farm’s profitability.
MPP has been controversial at times.  We don’t know what the next Farm Bill will bring.  Perhaps changes will be made to MPP.  Perhaps not.  One thing that we do know is that careful risk management planning can help you stay ahead of the game.  

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