August 19, 2016

The ROI of the Dairy MPP

 |  By: Dairy Talk

Betty Berning, an Extension Educator with the University of Minnesota, pulled together an analysis of the costs and benefits of the Dairy Margin Protection Program.

Many (most?) dairy farmers have questioned whether the program is “paying off”—whether the indemnities received are providing a return on investment on the premiums paid. So Berning obliged, pulling together the analysis.

Still, it’s a bit of an odd question if you think of the MPP as risk management insurance. How many farmers hope to get a return on investment on put options they purchase? Or what’s the cost/benefit of fire or casualty insurance?

Berning’s analysis shows that smaller farms, those with less than four million pounds of annual production, are seeing a net return to the MPP program at coverage levels of $6.50, $7.50 and $8.00.  Herds with more than four million pounds of annual production (five million pounds in Berning’s example) only showed a net gain at the $6.50 margin level.

So what are the lessons here?

  1. The premiums Berning used are annual. The indemnities are year-to-date through June, so there’s a (remote) possibility of more payments.
  2. In times of poor, but not catastrophically low milk prices and moderate feed prices, MPP looks more like a break-even proposition than a big money maker.
  3. “What this analysis reveals is that MPP is a relatively inexpensive insurance (under 10 ¢/cwt for $6.50 coverage + administrative fees for Tier 1 coverage),” says Berning.  “Without spending too much, a farm can ensure that if catastrophe strikes, it has some protection.” 
  4. “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,” says Berning.
  5. “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,” she says.
  6.  “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,” Berning concludes.

The key point is that looking at the cost/return of the Dairy MPP program is an odd way to look at it. A better way is to consider the cost of MPP coverage versus other risk management tools: 

• What is the cost of locking in similar margins with your dairy co-op’s risk management program?

• What is the cost of puts and calls on milk and feed to provide similar protection?

• What would be the carrying costs of margin calls if you did the same level of margin protection with futures contracts?

• How much liquidity would you need to withstand losses if you do no risk management?

• And what is the opportunity cost of maintaining that level of liquidity by doing no risk management?

These really are the questions you need to ask—not hoping the barn will burn down so you can get a return on your fire insurance premiums.