November 1, 2022

Knowledge Exchange Partner

USDA Dairy Margin Coverage Program

Volume 16, Issue 11
November 2022

USDA Dairy Margin Coverage Program

Authorized in the 2018 Farm Bill, the Dairy Margin Coverage program (DMC) is a voluntary risk-management program that pays milk producers when the margin between the national price of milk and the calculated average cost of feed falls below a specified level.

Open now, the 2023 enrollment period runs through December 9. All dairy operations in the U.S. are eligible to participate. An eligible dairy operation must:

  • have a production history determined by the USDA Farm Service Agency (FSA).
  • register to participate during a signup announced by FSA.
  • pay a $100 administrative fee annually for each year of participation, except if the dairy operation qualifies for a waiver for limited resource, beginning, socially disadvantaged, or veteran farmers and ranchers.
  • select a coverage level ranging from $4.00 to $9.50 per hundredweight in $0.50 increments.
  • select a coverage percentage of the dairy operation’s production history ranging from 5% to 95%, in 5%increments.

DMC participants can also participate in crop insurance risk management options including Livestock Gross Margin – Dairy program (LGM), as well as the Dairy Revenue Protection program (DRP), subject to certain limitations.

“Catastrophic” coverage is available at no cost (other than the $100 administrative fee), which protects an income-over-feed-cost (IOFC) margin of $4.00/cwt. Many producers will want to purchase greater coverage, which is available in $0.50 /cwt increments, up to $9.50/cwt.

One notable aspect of the program is that there are two tiers of premiums: Tier one for the first 5 million pounds of production, and tier two for production over 5 million pounds. The tier one premiums are much lower than tier two premiums.

How has the program performed?

It’s important to remember that the DMC program should be viewed as part of a risk management strategy, and that premiums are paid to manage the risk of unfavorable and unforeseen moves in milk prices, feed costs, or both. However, a look back at the past performance of the program is instructive. The program has a large number of coverage options, and the choices a producer makes greatly affect the programs payout levels. However, here are a few possible scenarios:

Maxing out Tier 1

If a producer with historic production of 5 million pounds, covered 95% of their production at the maximum level of $9.50/cwt, since the first year the program was offered in 2019, the indemnities that they received would have exceeded their premiums paid by $156,082. Each of the three years of the program, 2019, 2020 and 2021, had a net benefit, with the program paying out a net of $0.48/cwt in 2019, $0.63/cwt. in 2020, and $2.41/cwt. in 2021.

A Mid-scale, Strong Risk Management Strategy

If a producer with a historic production of 10 million pounds, somewhere around 400 cows, covered 95% of their production, with the first 5 million at $9.50 and the second 5 million at $8.00, they would have had a modest net cost for their participation in the program, or -$14,323 for the three-year period. For the first two years of the program, there would be a net expense, but in 2021, the indemnities paid would nearly cancel the costs incurred in 2019 and 2020. The net result for the three-year period would be a cost of only -$0.05/cwt., a pretty reasonable expense for insuring against margin risk.

A Bigger Risk Appetite

If the same 10 million pound-producer, still covering 95% of production and $9.50 for the tier 1 production, opted to assume more risk and only buy up their tier 2 production to the $6.00 level, they would have a substantial net gain over the three-year period, and would come out ahead each year. The program would have paid out $0.10/cwt in 2019, $0.21/cwt in 2020, and $1.18/cwt. in 2021.

In general, the tighter the margins get, the more the DMC program will pay out, and the more those who bought up coverage would benefit. In a “good year” with strong milk prices such as 2022, the program would not pay out at lower coverage levels. But even in 2022, the DMC program is forecast to pay net indemnities at the $9.50 coverage level for tier 1 for the months of August, September, November and December due to higher feed costs.

What’s your appetite for risk?

As previously mentioned, the best way to look at DMC and programs like it, is the same way we look at insurance and other risk management strategies we employ in business. The ideal scenario is to have strong markets, good milk prices, and to not need the program. In this case, the program would represent a net cost, but for that price, it would provide a backstop and security against unfavorable market moves. In a more challenging year, the program would pay indemnities – possibly at a substantial level, and would help your farm weather the market “storm,” so to speak.

Buying risk management coverage at a modest cost may make a great deal of sense for your business. The fact that the DMC program indemnities have generally exceeded premium costs for most producers, in most years, means that it’s probably worth serious consideration for the average producer. The tier 1 / tier 2 premiums mean that the coverage is generally more favorable for smaller producers, but producers of all sizes should consider it as an option.

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Editor: Chris Laughton
Contributors: Tom Cosgrove and Chris Laughton

View previous editions of the KEP

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