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Analysis of Alternative LGM-Dairy Contracts: A Wisconsin Case-Study

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

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Analysis of Alternative LGM-Dairy Contracts: A Wisconsin Case-Study

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

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

  4. 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 6

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

  6. LGM-Dairy: A Wisconsin Case Study • 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 • Contract defined by monthly % insured • 44% of March - June production insured 8

  7. LGM-Dairy: A Wisconsin Case Study • 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 2: Declare only purchased feed • No corn silage • 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 Initial Ration 9

  8. LGM-Dairy: A Wisconsin Case Study 10

  9. LGM-Dairy: A Wisconsin Case Study • Average Actual − Expected % differences: • Class III: +26.8% • Corn: +14.8% • SBM: +2.5% 11

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  11. October 2010 Contract Sales Date 13

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

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

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  17. LGM-Dairy: A Wisconsin Case Study • With Oct. 2010 contract completed all actual pricesknownby 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 19

  18. LGM-Dairy: A Wisconsin Case Study 20

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

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

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

  22. LGM-Dairy: A Wisconsin Case Study • 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 all corn silage and 25% of SBM equivalent not declared • Same amount of milk insured as in ration 1 24

  23. LGM-Dairy: A Wisconsin Case Study • Lets compare Ration 1 vs. Ration 2 • Note how with Ration 2, the TGMG↑ while the premium ↓ compared to Ration 1 25

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

  25. 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 27

  26. October 2008 Contract Sales Date 28

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  28. LGM-Dairy: A Wisconsin Case Study October 2008 Contract Offering 30

  29. LGM-Dairy: A Wisconsin Case Study • Let’s compare contract costs of 2008 vs. 2010 (Ration 1) 31

  30. LGM-Dairy: A Wisconsin Case Study • Lets compare 2008 vs. 2010 (Ration 1) 32

  31. LGM-Dairy: A Wisconsin Case Study • Lets compare 2008 vs. 2010 (Ration 2) 33

  32. LGM-Dairy: A Wisconsin Case Study • Lets compare 2008 vs. 2010 (Ration 2) 34

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

  34. LGM-Dairy: A Wisconsin Case Study • 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

  35. LGM-Dairy: A Wisconsin Case Study • 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

  36. LGM-Dairy: A Wisconsin Case Study Note: 2013-2014 expected prices obtained from an analysis undertaken on November 22nd 38

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  39. LGM-Dairy: A Wisconsin Case Study 41

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

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

  42. 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)263-3212 • bwgould@wisc.edu

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