LGM-Dairy: A
Wisconsin Example
LGM-Dairy: A New Risk Management Tool
(Workshop Section II)
Overview of Workshop Section II
 Review a hypothetical dairy farm example
 Farm characteristics
 LGM-Dairy contract characteristics
 Overview of Behind the Scenes calculations
 Expected milk and feed prices
 How your premiums are determined
 Comparison of use of options vs. LGM-Dairy
 Review premium calculation software and analysis
 UW LGM-Dairy premium calculators
2
LGM-Dairy: Wisconsin Example
 Farm characteristics
 250 milk cows
 Average per cow productivity: 19,769 lbs
 WI 200-499+ herd size category average
→
Herds
% of Herds
% of Prod.
Avg. Yield
1-29
1,900
13.2
1.5
11,586
30-49
3,600
25.0
10.0
16,092
50-99
6,100
42.4
29.0
17,778
100-199
1,800
12.5
18.5
19,310
200-499
750
5.2
19.0
19,769
500+
250
1.7
22.0
24,750
Total
14,400
100.0
100.0
19,305
3
LGM-Dairy: Wisconsin Example
 Insurance contract purchased on February 25th
3rd to last
business day
Insurance
Purchase
Day
Last
Business
Day
4
LGM-Dairy: Wisconsin Example
 Feb. Purchase Date → Possible 10-Month
Coverage Period: Apr. 2009 – Jan. 2010
 Cow productivity changes by month
 Based on Wisconsin monthly yield profile
 Expected Feed Use
 966 Tons Corn Equivalent
 213 Tons SBM Equivalent
 We assume producer insures 100% of expected
production
5
LGM-Dairy: Wisconsin Example
(Feb. 09 Contract)
Prod./Cow
(lbs)
Production
(cwt)
Corn Equiv.
(Tons)
SBM Equiv.
(Tons)
Apr `09
1,645
4,113
95.8
21.1
May `09
1,736
4,340
101.1
22.3
Jun `09
1,675
4,188
97.6
21.5
Jul `09
1,696
4,240
98.8
21.8
Aug `09
1,675
4,188
97.6
21.5
Sep `09
1,609
4,023
93.7
20.7
Oct `09
1,630
4,075
94.9
20.9
Nov `09
1,615
4,038
94.1
20.8
Dec `09
1,625
4,063
94.7
20.9
Jan `10
1,660
4,149
96.7
21.3
Total
16,556
41,417
965.0
212.8
Month
Calculation of Expected Prices
 With Feb 25th insurance purchase date
 Expected Price Measurement (EPM) period :
Feb. 23st, 24th and 25th
 To determine the Gross Margin Guarantee at
contract sign-up we need:
 Expected monthly milk and feed prices
 Producer elected deductible
7
LGM-Dairy: Wisconsin Example
 Insurance contract purchased on February 25th
Average Settle Prices
Over These Days for
Expected Prices
Purchase
Day
3rd to last
business day
8
Calculation of Expected Prices
 Monthly expected prices for Apr`09 – Jan `10
 Expected Wisconsin All Milk price
= Expected Class III prices + Wisconsin [AllMilk – Class III] Basis
 Expected Wisconsin Corn Grain price
= Expected Corn prices + Wisconsin [Corn Price
Received – Corn Futures] Basis
 Expected U.S. Soybean Meal prices (no local
basis)
9
Calculation of Expected All-Milk Prices
 The program uses the EPM period’s Class III futures
settle prices to determine expected Class III prices
 Feb. 23rd, 24th and 25th
 There are Class III futures contracts traded for
each month
10
Calculation of Expected All-Milk Price
Class III Futures Settle Price ($/cwt)
Contract Months
Month
Expected WI
WI Milk
All Milk
Basis
Price
($/cwt)
($/cwt)
[5]
[6]
Feb 23
[1]
Feb 24
[2]
Feb 25
[3]
Avg.
[4]
Apr `09
10.35
10.27
10.27
10.30
1.40
11.70
May `09
10.86
10.67
10.65
10.73
1.23
11.96
Jun `09
11.49
11.33
11.25
11.36
1.11
12.47
Jul `09
12.61
12.40
12.35
12.45
1.11
13.56
Aug `09
13.37
13.17
13.10
13.21
1.16
14.37
Sep `09
13.89
13.72
13.68
13.76
1.37
15.13
Oct `09
14.05
13.98
13.95
13.99
1.77
15.76
Nov `09
14.47
14.40
14.33
14.40
1.91
16.31
Dec `09
14.47
14.38
14.34
14.40
1.77
16.17
Jan `10
14.61
14.50
14.45
14.52
1.94
16.46
Note: [4] = ([1] + [2] + [3])/3 [6] = [4] + [5] [4] are rounded values 11
Calculation of Expected Gross Revenue
 With estimation of 10 expected Wisconsin All-Milk
price values one knows
 Expected Gross Revenue (EGR) at sign-up
 EGR is the product of expected All-Milk price
times covered milk production
 Covered production could be less than
allowable target as elected by the producer
 Different price and covered production each
month
12
Calculation of Expected Gross Revenue
Month
Expected WI
All Milk Price
($/cwt)
[1]
Apr `09
11.70
4,113
48,122
May `09
11.96
4,340
51,906
Jun `09
12.47
4,188
52,224
Jul `09
13.56
4,240
57,494
Aug `09
14.37
4,188
60,182
Sep `09
15.13
4,023
60,868
Oct `09
15.76
4,075
64,222
Nov `09
16.31
4,038
65,860
Dec `09
16.17
4,063
65,699
Jan `10
16.46
4149
68,293
41,417
594,870
Total
Covered
Expected
Marketings
Gross
(cwt)
Revenue ($)
[2]
[3]
Note: [ 1] obtained from previous table [3] = [1] * [2]
13
Calculation of Expected Feed Prices
 Like Class III, EPM period’s futures settle prices
used in calculation of expected corn and SBM
prices
 Fed. 23rd, 24th and 25th
 Calculate expected prices for each month of
contract
 Unlike Class III contracts, corn/soybean meal
futures contracts do not exist for every month
14
Calculation of Expected Corn Price
Corn Futures Settle Prices ($/bu)
Contract Months
Month
Mar `09
Apr `09
May `09
Jun `09
Jul `09
Aug `09
Sep `09
Oct `09
Nov `09
Dec `09
Jan `10
Feb `10
Mar `10
Nov 21 Nov 24 Nov 25
[1]
[2]
[3]
Avg
[4]
3.5175
----3.6075
----3.7075
----3.8000
--------3.9150
--------4.0400
3.57
----3.65
----3.75
----3.84
--------3.97
--------4.09
3.5425
----3.6300
----3.7250
----3.8150
--------3.9425
--------4.0675
3.6375
----3.7225
----3.8200
----3.9075
--------4.0375
--------4.1650
Imputed
Price
Basis
$/bu)
($/bu)
[5]
[6]
----3.61
3.65
3.70
3.75
3.80
3.84
3.88
3.93
3.97
4.01
---------
-----0.11
-0.12
-0.12
-0.12
-0.15
-0.11
-0.15
-0.18
-0.22
-0.14
---------
Expected WI
Corn Price
($/bu)
[7]
----3.50
3.53
3.58
3.63
3.65
3.73
3.73
3.75
3.75
3.87
---------
Note: [4] = ([1]+[2]+[3])/3, [5] = weighted average, [7] = [5]+[6]
15
Calculation of Expected Corn Costs
 With calculated monthly expected corn
 Multiply each months covered corn equivalents
times the expected price to estimate expected
corn costs
 Covered corn equivalents is equal to total
corn equivalents multiplied by % of
production covered
16
Calculation of Expected Corn Cost
Month
Apr `09
May `09
Jun `09
Jul `09
Aug `09
Sep `09
Oct `09
Nov `09
Dec `09
Jan `10
Expected WI Covered
Expected
Corn Price Corn Equiv. Corn Cost
($/bu)
(tons)
($)
[1]
[2]
[3]
3.50
95.8
11,975
3.53
101.1
12,746
3.58
97.6
12,479
3.63
98.8
12,809
3.65
97.6
12,723
3.73
93.7
12,482
3.73
94.9
12,642
3.75
94.1
12,603
3.75
94.7
12,683
3.87
96.7
13,365
Total
965.0
126,507
Note: [1] obtained from previous table [5] = [4]*(2000/56)* [3]
17
Calculation of Expected SBM Costs
 Similar procedure is used to estimate SBM costs
 Use same EPM period to obtain SBM futures
settle prices
 No basis added
18
Calculation of Expected SBM Price
Feb 23
[1]
Feb 24
[2]
Feb 25
[3]
Avg.
[4]
Imputed
SBM Price
($/ton)
[5]
Mar `09
276.30
278.80
272.80
275.97
-----
Apr `09
-----
-----
-----
-----
273.94
May `09
273.30
275.00
267.40
271.94
271.94
Jun `09
-----
-----
-----
-----
271.44
Jul `09
272.80
273.90
266.20
270.97
270.97
Aug `09
270.00
270.40
263.10
267.83
267.83
Sep `09
262.10
261.40
254.10
259.20
259.20
Oct `09
254.30
252.40
245.60
250.77
250.77
Nov `09
-----
-----
-----
-----
249.80
Dec `09
252.30
250.50
243.70
248.83
248.83
Jan `10
253.30
251.50
244.70
249.83
249.83
Soybean Meal Futures Settle Prices ($/Ton)
Contract Months
Month
Note: [4] = ( [1] + [2] + [3] )/3 [5] = average of preceding and following
19
value of [4] if no futures contract, [4] otherwise
Calculation of Expected SBM Cost
Month
Apr `09
May `09
Jun `09
Jul `09
Aug `09
Sep `09
Oct `09
Nov `09
Dec `09
Jan `10
Avg. Settle
Price
($/Ton)
[1]
273.94
271.94
271.44
270.97
267.83
259.20
250.77
249.80
248.83
249.83
Total
Note: [3] = [1]* [2]
SBM
Equiv
(Ton)
[2]
21.1
22.3
21.5
21.8
21.5
20.7
20.9
20.8
20.9
21.3
212.8
Expected
SBM Cost
($)
[3]
5,780
6,064
5,836
5,907
5,758
5,365
5,241
5,196
5,201
5,321
55,670
20
Calculation of Gross Margin Guarantee
 Expected Gross Margin = EGR – EFC
Expected Gross Revenue
Expected Feed Costs
 Gross Margin Guarantee (GMG)
 GMG = Expected Total (Over Entire Contract)
Gross Margin – [Deductible x Total Covered
Milk Marketings]
21
Calculation of Gross Margin Guarantee
 Summary of Enrollment Data:
 Expected Milk and Feed Prices
 Calculated by RMA from Futures Market
 Statement of Insured Marketings
 Monthly Target Marketings
 Desired Coverage %
 Statement of Expected Feed Use
 Deductible ($ GMG/cwt):
22
Calculation of Gross Margin Guarantee
Month
Expected
Expected Feed
Revenue ($)
Costs ($)
[1]
[2]
Deductible
($)
[3]
GMG
($)
[4]
Apr `09
48,122
17,755
4,113
26,254
May `09
51,906
18,810
4,340
28,757
Jun `09
52,224
18,315
4,188
29,722
Jul `09
57,494
18,716
4,240
34,539
Aug `09
60,182
18,481
4,188
37,512
Sep `09
60,868
17,848
4,023
38,997
Oct `09
64,222
17,883
4,075
42,264
Nov `09
65,860
17,799
4,038
44,023
Dec `09
65,699
17,884
4,063
43,752
Jan `10
68,293
18,687
4,149
45,457
Total
594,870
182,177
41,417
371,277
Note: [4] = [1] – [2] – [3], $1.00 GMG/cwt deductible assumed
23
Calculation of Insurance Premiums
 As noted in Section I of this workshop, there is No
Producer Premium Subsidy
 For each of 5,000 simulations
 RMA simulates Class III, corn grain and
SBM prices using data obtained from the
EPM period
 Generate simulated total gross margins
 Determine insurance payout where
Insurance Payout = Max(0, Total GMG –
Simulated Total Gross Margin Guarantee)
 Premiums = Average of Simulated Payouts + 3%
24
Calculation of Insurance Premiums
 For each simulated price scenario the simulated
prices are generated following historical correlations
between Class III, Corn and SBM
 For example, when simulating a high corn price a
high SBM price is likely to be obtained
25
Calculation of Insurance Premiums
 The Understanding Dairy Markets website
maintains a database of 5,000 simulated price
scenarios
 Aug. 2008-Present actual RMA premium data
 Prior to Aug. 2008 we generated our own price
scenarios
 Evaluate hypothetical premiums
 Alternative market conditions
26
Calculation of Insurance Premiums
 USDA (RMA) Premium Calculator Website:
http://www3.rma.usda.gov/apps/premcalc/
 Understanding Dairy Markets Premium Calculator:
http://future.aae.wisc.edu/lgm_dairy.html#2
 Automatically evaluate program performance with
$0 - $1.50/cwt deductibles
 Total and per cwt premiums
 Premium as % of GMG
 Probability of simulated payouts
 We will review this software later
 Available for download and on your workshop CD
27
Calculation of Insurance Premiums
http://future.aae.wisc.edu/lgm_dairy.html#2
Actual
premium
data
28
Calculation of Insurance Premiums
 February 2009 example:
 Impact of increasing deductibles
 Premiums Decrease
 GMG Decrease
 Premiums Decrease at a Faster Rate than
GMG
 Relative Decrease of the Above Depends On
 Price Volatility at Sign-Up
 Expected Gross Margins at Sign-Up
 Payout Probability Decreases with Higher
Deductibles
29
Insurance Premiums and Deductible Level
(Feb. ′09 Example)
Deductible
GMG
Rate
($/cwt)
[1]
Total
($)
[2]
Total
($)
[3]
$/cwt
[4]
0
0
412,694
0.10
4,142
0.30
Premium
%↓
[4]
Total
($)
[5]
Per CWT
($)
[6]
%↓
[7]
9.96
-----
33,700
0.814
-----
408,552
9.86
-1.00
34,563
0.762
-6.34
12,425
400,269
9.66
-3.01
27,605
0.667
-18.09
0.50
20,709
391,986
9.46
-5.02
24,000
0.579
-28.78
0.70
28,992
383,702
9.26
-7.03
20,733
0.501
-38.48
0.90
37,275
375,419
9.06
-9.03
17,793
0.430
-47.20
1.10
45,559
367,135
8.86
-11.04
15,150
0.366
-55.04
1.30
53,842
358,852
8.66
-13.05
12,806
0.309
-62.00
1.50
62,126
350,569
8.46
-15.05
10,724
0.259
-68.18
Note: % ↓ measured from $0 Deductible level
30
Relative GMG and Insurance Premiums
(Feb. ′09 Example)
GMG and Premium ($/CWT)
10.50
0.85
GMG/cwt ($)
10.00
0.75
Premium/cwt ($)
0.65
GMG /cwt
0.55
9.00
0.45
8.50
0.35
8.00
0.25
0.0
0.2
0.4
0.6
0.8
1.0
Deductible ($/cwt)
1.2
Prem/cwt
9.50
1.4
31
Relative Premium Value and Deductible
(Feb. ′09 Example)
Premium as % of GMG
8.25
% of GMG
7.50
6.75
6.00
5.25
4.50
3.75
3.00
0.0
0.2
0.4
0.6
0.8
1.0
Deductible ($/cwt)
1.2
1.4
32
Determining Actual Indemnities
 Actual Prices Determined as Futures Expire
 Average Futures Settle Prices From 1st, 2nd, and
3rd days prior to last trading day
 Actual Gross Margin (AGM) = Actual Revenue –
Actual Feed Costs
 Actual Prices: State Average NOT Farm Price
 LGM-Dairy Actual Indemnity:
 Actual Indemnity = Max[0, Total GMG
– Total AGM]
 Total Refers to Sum Over All Months
33
Determining Actual Indemnities
 As an example:
July 2009 actual grain prices
 By rule, corn and SBM futures stop trading on
last business day prior to 15th of the futures
month
 July ‘09 corn/SBM last trading day: July 14th
 Actual price measurement period
 July ‘09: July 9th, 10th, and 13th
34
Determining Actual Indemnities
Actual Corn/SBM Price
Measurement Period
Corn/SBM
Last
Trading Day
Actual Class III Price
Measurement Period
Last Class
Class III
III Futures Announced
Trading Day
35
Cost Comparison of LGM-Dairy With
Options-Based Revenue Management
 LGM-Dairy similar to a bundled option
 How does LGM-Dairy compare to costs of setting
a Revenue Floor via Class III puts and Corn/SBM
calls?
 For Comparison Example
 We assume options perfectly divisible
 Compare costs under variety of deductibles
 We use January 2008 data
Availability of actual 10-month price data
36
A Cost Comparison of LGM-Dairy With
Options-Based Revenue Management
 Expected prices for Jan. 2008 LGM-Dairy purchase
Expected Prices
Month
Class III
($/cwt)
Corn
($/bu)
SBM
($/Ton)
Mar `08
17.08
5.01
337.07
Apr `08
16.40
5.07
340.09
May `08
16.17
5.13
343.10
Jun `08
16.11
5.17
345.45
Jul `08
16.28
5.21
347.80
Aug `08
16.46
5.18
344.57
Sep `08
16.62
5.15
339.37
Oct `08
16.38
5.13
325.10
Nov `08
16.21
5.12
324.80
Dec `08
16.20
5.10
324.50
37
A Cost Comparison of LGM-Dairy With
Options-Based Revenue Management
 Puts and Calls on January 29, 2008
Month
Class III
Put
($/cwt)
Class III
Premium
($/cwt)
Corn
Call
($/bu)
Corn Call
Premium
($/bu)
SBM
Call
($/Ton)
SBM Call
Premium
($/Ton)
Mar `08
17.00
0.65
5.00
0.1775
340
11.60
Apr `08
16.50
0.84
5.10
0.3275
340
23.10
May `08
16.25
0.92
5.10
0.3275
340
23.10
Jun `08
16.00
0.90
5.20
0.4137
350
25.25
Jul `08
16.25
1.00
5.20
0.4137
350
25.25
Aug `08
16.50
1.14
5.20
0.4912
340
27.25
Sep `08
16.50
1.14
5.20
0.4912
340
27.25
Oct `08
16.25
1.18
5.10
0.5537
330
26.75
Nov `08
16.25
1.30
5.10
0.5537
320
30.40
Dec `08
16.25
1.35
5.10
0.5537
320
30.40
Note: The values in green correspond to the following months options given that38
options are not available for these months
A Cost Comparison of LGM-Dairy With
Options-Based Revenue Management
 Gross options costs
Month
Class III
Put
Corn
Call
SBM
Call
Total
Cost
Mar `09
$2,738
$622
$252
$3,130
Apr `09
$3,455
$1,121
$487
$3,946
May `09
$3,993
$1,183
$515
$4,633
Jun `09
$3,769
$1,442
$543
$5,259
Jul `09
$4,240
$1,460
$550
$5,371
Aug `09
$4,774
$1,712
$586
$5,592
Sep `09
$4,586
$1,644
$564
$6,329
Oct `09
$4,809
$1,877
$559
$6,675
Nov `09
$5,249
$1,861
$632
$6,819
Dec `09
$5,485
$1,873
$635
$7,106
Total
$43,099
$14,793
$5,324
$63,216
Cost of LGM-Dairy,
$0 Deductible: $36,107
Total Gross Cost of
Puts/Calls: $63,216
39
Cost Comparison of LGM-Dairy With
Options-Based Revenue Management
 We can compare the net costs of the two programs
Class III Put ($/cwt)
Corn Call ($/bu)
SBM Call ($/Ton)
Month
Put
Actual
Class
III
Put
Value
Corn
Call
Actual
Corn
Corn
Call
Value
SBM
Call
Actual
SBM
SBM
Call
Value
Mar `08
17.00
18.00
0
5.00
5.4550
0.4550
340
336.50
0
Apr `08
16.50
16.76
0
5.10
6.0025
0.9025
340
336.60
0
May `08
16.25
18.18
0
5.10
5.8975
0.7975
340
348.00
8.00
Jun `08
16.00
20.25
0
5.20
7.2460
2.0460
350
434.00
84.00
Jul `08
16.25
18.24
0
5.20
6.5700
1.3700
350
452.00
102.00
Aug `08
16.50
17.32
0
5.20
5.6820
0.4820
340
350.00
10.00
Sep `08
16.50
16.28
0.22
5.20
5.4740
0.2740
340
359.00
19.00
Oct `08
16.25
17.06
0
5.10
4.1125
0
330
254.50
0
Nov `08
16.25
15.51
0.74
5.10
3.8025
0
320
265.50
0
Dec `08
16.25
15.28
0.97
5.10
3.5950
0
320
258.50
40
0
A Cost Comparison of LGM-Dairy With
Options-Based Revenue Management
 We can compare the net costs of the two programs
Gross Cost
Gross
Cost/Cwt
Net Cost
Net
Cost/Cwt
Put/Call Options
Class III
$43,099
$1.039
$35,285
$0.851
Corn
$14,793
$0.357
-$7,332
-$0.177
SBM
$5,324
$0.128
$508
$0.012
Total
$63,216
$1.524
$28,461
$0.686
LGM ($0 Deductible)
$36,107
$0.870
$36,107
$0.870
Note: For options, the Net value represents the costs after subtracting the
option value from the initial premiums and then multiplying by the amount
purchased. For LGM-Dairy net cost is the calculated as premium costs
minus indemnity paid. For the January 2008 contract as specified, there
would not have been any indemnities paid.
41
A Cost Comparison of LGM-Dairy With
Options-Based Revenue Management
 We can compare the net costs of the two programs
Gross Cost
Gross
Cost/Cwt
Net Cost
Net
Cost/Cwt
$0 Deductible
$63,216
$1.524
$28,461
$0.686
$0.80 Deductible
$58,993
$1.422
$26,560
$0.640
$1.50 Deductible
$55,301
$1.333
$24,898
$0.600
$0 Deductible
$36,107
$0.870
$36,107
$0.870
$0.80 Deductible
$21,147
$0.510
$21,147
$0.510
$1.50 Deductible
$12,144
$0.293
$12,144
$0.293
Put/Call Options
LGM-Dairy
Note: Under the options based strategy we reduce the options costs by
the % reduction in GMG observed under the LGM-Dairy scenarios.
42
UW LGM-Dairy Premium Calculators
 To complement RMA’s website, we developed
software systems for estimating premiums:
 We have 2 versions
 Based on historical data
 Use of current (previous 3 days) futures and
options to estimate future likely premiums
 Historical System:
“What if” I had purchase an LGMDairy contract 3 months ago?
 On-Demand System:
What will be my premium if I
purchase a contract at the end of this month?
43
UW LGM-Dairy Premium Calculators
 Historical Calculator
 Contains a database of actual premium information
since August, 2008
 Contains a database for premium calculation prior
to Aug. ′08: Jan. ′00 –July ′08
 Impacts under alternative market conditions
 Can be used for what-if type of analysis
 “What if I had purchased insurance during
Oct?”
 “How sensitive would my premiums have been
to changes in deductible?”
44
UW LGM-Dairy Premium Calculators
 University of Wisconsin Historical Premium Calculator:
http://future.aae.wisc.edu/lgm_dairy.html#2
 Automatically Evaluates the Impacts of $0 - $1.50/cwt
Deductibles
 Total and Per CWT Premiums
 Premium as % of GMG
 Probability of Simulated Payouts
45
UW LGM-Dairy Premium Calculators
 UW LGM-Dairy Historical Premium Calculator can be
found on the Understanding Dairy Markets website
http://future.aae.wisc.edu/lgm_dairy.html#2
46
UW LGM-Dairy Premium Calculators
 LGM-Dairy Premium Calculator Input Page
Select month
for analysis
Select your
state
Enter % coverage
Choose
deductible
Insert target
marketings
and feed
equivalents
47
UW LGM-Dairy Premium Calculators
 What kind of analyses are automatically displayed?
48
UW LGM-Dairy Premium Calculators
 What kind of analyses are automatically displayed?
49
Automatic Validation of Feed Equivalents
 To determine if are within allowable feeding ranges:
 UW premium calculator automatically checks your
feeding regime to determine if it falls within the
desired range
 Alternatively, you can access the standalone feed
conversion software
 Spreadsheet version
http://future.aae.wisc.edu/lgm-dairy/excel_files/feed_conversions_2.xls
 Web-based version
http://future.aae.wisc.edu/conversion/grains
50
Contact Information
 Brian W. Gould
Dept. of Agricultural and Applied Economics
University of Wisconsin-Madison
(608)263-3212
bwgould@wisc.edu
 Victor Cabrera
Dept. of Dairy Science
University of Wisconsin-Madison
(608)265-8506
vcabrera@wisc.edu
51