October 22, 2018

What We've Learned About Dairy-RP

 |  By: Robin Schmahl

Dairy Revenue Protection (Dairy-RP) insurance launched two weeks ago receiving a lot of interest, but limited participation. The first week there were 26 endorsements written on 222.5 million pounds of milk. At the end of last week, there have been a total of 89 endorsement written on 850.3 million pounds of milk.  Farmers are still in the learning and assessment mode and rightly so. Many farmers are busy harvesting and do not have the time to discuss the program or take the time to read much about it. There needs to be at least a basic understanding of what it is about and how it will fit into a marketing program. Without that understanding, you do not know what prices you are protecting. That is where you must have an insurance agent that not only understands Dairy-RP insurance, but also understands dairying and milk pricing and has your best interest in mind. 

So what has been learned over the course of the past two weeks? Dairy prices released by the Risk Management Agency (RMA) have moved more on a daily basis for Class III and Class IV futures which is understandable due to futures price movements on a daily basis. Component prices have moved, but not as much as Class III and IV future. This had been expected due to there being no daily futures for butterfat, protein, and solids. Unfortunately, class prices for the first two quarters have been declining steadily while quarters three and four have held up better. This is generally the case in the futures market. There is usually less trading activity and less volatility in later futures contracts. 

One thing that has been noticed is that RMA has not released any price for the fifth quarter. Apparently this is due to the fact that is yet to be any trading activity in either Class III or Class IV contracts. Even though these contracts are market-to- market each day, trading activity is the requirement. 

During this first two weeks, I have made a comparison between Dairy-RP and the options market and discovered some interesting aspects. If the insurance coverage level of 95% is chosen for either the first or second quarter offered, it favors the use of options rather than writing an insurance endorsement.  At first look it seems writing revenue protection on 95% of chosen milk production at a very inexpensive cost of about 14 cents (this does vary depending on state) seems like a no-brainer. However, when considering the floor price that is being protected, one needs to consider what will work best for what needs to be accomplished. 

As an example, I compared choosing 100% Class III for my calculations in order to compare apples to apples.  I took RMA’s released price for the first quarter of $15.52 on Thursday last week and $15.93 for the second quarter. A coverage of 95% nets a floor price of $14.74 for the first quarter and $15.13 for the second quarter. Making a comparison of Dairy-RP for the first quarter compared to purchasing put options favors using put options as it raises your floor price for your milk by an average of 45 cents per cwt. The second quarter favors using put options by an average of 18-20 cents per cwt. However, moving out to the third and fourth quarters, favors using Dairy-RP. These comparisons were made at the 95% coverage level. If coverage is reduced to lower levels the use of put options is clearly more beneficial. 

The benefit of Dairy-RP is that any amount of milk can be covered rather than being confined to 100,000 or 200,000 pound increments and the premiums are not paid until after the covered period. The above comparisons were made using 100% Class III milk. Due to length of this article, I have not covered the use of component pricing of which there is not futures market for comparison. I will write about component pricing in my next article. 

There is value to Dairy-RP and using the options market. This is what needs to be assessed when making the decision of which marketing option is best to use. I am licensed for Dairy-RP and can help you with your decisions.