May 7, 2019

Did Dairy-RP Insurance Work?

 |  By: Robin Schmahl

The first quarter of Dairy Revenue Protection insurance is behind us and it has been met with mixed reactions, ranging from positive to very negative. There was much expectation for indemnity payments primarily because of low milk prices in January and February. However, those expectations many times were not based on the chosen price level and did not take into account the coverage level.

It was easy to anticipate payments would be received due to the continued decline of milk futures into the first quarter of the year. However, March rebounded in price offsetting some of the decline realized for January and February. Endorsement made later in November through December 15th for the most part did not receive indemnities due to the class and component settlement prices and the average for the first quarter coupled with percent of coverage. 

There were indemnity payments received by those who chose 95% coverage for the first quarter, but those endorsements were made in October through mid-November or there about. Indemnity payments were received for both class and/or component pricing. These indemnity payments varied by choice of class pricing, component values, and protection factor. It all depended on the time of implementation. 

This works similar to hedging with options on the CME. Timing is the same. It all depends on market movement and when the options were initiated. The difference would be that put options are on a monthly basis while Dairy Revenue Protection is calculated on the quarterly average which does dilute protection to some degree. If put options would have been initiated after mid-December they likely would have expired worthless, but would have accomplished the purpose of protecting a floor price.

I do not mean to make light of this that giving up the money for Dairy-RP insurance or the price of a put option is not a big deal, but the purpose of marketing is protecting equity and cost of production. As with any insurance, it comes with a price. 

However, this Dairy Revenue Protection insurance accomplished the purpose it was designed for and that is price protection. It established a floor price for the quarter and it delivered on that. It accomplished the same purpose as crop insurance does with the exception that coverage can be established on a quarterly basis rather than once per year. 

So, the settling of the first quarter of Dairy Revenue Protection insurance provided a better idea of how the insurance product works and this is more than any predictive model could show us.