November 5, 2018

There Advantages to Component Pricing for Dairy-RP

 |  By: Robin Schmahl

In my pervious article I explained the Class Pricing option for Dairy Revenue Protection (Dairy-RP insurance making some comparisons to the options market. This article will discuss the Component Pricing Option to provide a better understanding of how it works and when it should be used. I know there have been numerous articles and seminars done on Dairy-RP with the intent to increase the understanding of the program. I approach this insurance product from the standpoint of setting a floor price and using the marketing tools available to accomplish the purpose that best fits your dairy operation. 

The Component Pricing Option cannot really be compared to the options market as there is no options contract available through the CME group on components. Thus, we need to look at the daily announced prices released by USDA’s Risk Management Agency and put them into the calculator to see what the per hundredweight price and revenue you are protecting. That needs to be looked at as to cost of production. 

The Component Pricing option should be chosen if you have a dairy herd that has a mix of Holsteins and other higher component breeds or a herd that is strictly a breed of higher component animals. Your overall pay might be better, but herd average is generally lower. Thus it is better to utilize the pricing option best suited to your dairy herd. The ability to protect component values does offer a better opportunity to protect milk prices for a higher component herd than the current options market on the CME group. 

To put this in some perspective, if the Class Pricing Option is used and weighted 100% Class III and the Component Pricing Option is used using a 3.5 butterfat test and a 3.0 protein test at a 1.0 protection factor, the results were nearly the same at a price of $15.27 for class prices and $15.28 for component pricing using the released prices for November 2nd. The Class Pricing Option has no ability to change component values with only the ability to change the weighting factor between Class III and Class IV. 

Choosing the Component Pricing Option provides the ability to increase butterfat test from 3.50 up to 5.00 at 0.05 increments. Protein test can be raised from 3.00 to 3.85 keeping in mind that the declared butterfat test to declared protein test ratio can be no less the 1.15 and no more than 1.30. Other solids is fixed at 5.7.

Using the same prices released on November 2nd and raising butterfat to 4.50 and protein to 3.6 keeping the protection factor at 1.0, the milk price being protected changed to $18.84 per cwt. Thus you can clearly see how this would be the preferred method for higher component value herds. 
Changing the protection factor will change price per hundredweight considerably, but a higher protection factor will also increase the insurance premium. It also does not provide higher coverage unless there is a loss and indemnity is paid. If price does not fall below the base 1.0 protection factor, then more insurance coverage is paid for, but no indemnity is paid based on the higher protection factor. It seems cost effective to increase the protection factor to provide the opportunity to increase protection, but those will need to be evaluated as to cost based on protection factor and what one is willing to pay.  

There are myriads of combinations that can be chosen and if you have time, you can go the RMA’s website here and run the combinations. Otherwise, contact an insurance agent licensed in Dairy-RP and have them run the quotes for coverage and cost for making an informed decision. An agent knowledgeable of the dairy industry will be to help you with what is best for your operation. 

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