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Dairy industry wants broken safety net fixed

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Most dairymen are dissatisfied with the performance of the Margin Protection Program and have lost faith in the program’s ability to provide an effective safety net.

But they found out the hard way that their faith was misplaced when global dairy markets collapsed again in 2015 and 2016.

“I had some hope that it would work at some point. … It was a miserable failure,” said Contente, who milks 800 cows in Hanford, Calif.

The Margin Protection Program, established in the 2014 Farm Bill, was designed to guarantee that dairies had some income even when the U.S. all-milk price dropped below the national average feed costs. Margins on 90 percent of a producer’s established production would be covered when milk prices dropped, feed prices increased, or both.

MPP was designed to provide free catastrophic coverage, insuring a $4 per hundredweight margin when producers signed up and paid a $100 administrative fee.

Here’s how MPP is supposed to work. If USDA calculates the difference between the national all-milk price and a formula that determines the national average feed cost is less than $4, the MPP would make up the difference.

For example, if the average milk price is only $3 more per hundredweight than the national price of feed during one of the six, two-month program periods in a year, the program will pay $1 per hundredweight of milk to those farmers who signed up.

The intended strength of the program, however, was that farmers could buy coverage for a larger margin, up to $8 per hundredweight. Producers can insure up to 90 percent of their milk production at a higher margin.

For the most part, that hasn’t panned out. Producers say they have avoided buy-up coverage because USDA’s MPP margin calculations don’t reflect actual milk prices and feed costs and overstate the margins dairymen actually see.

With the U.S. House and Senate ag committees starting work on the 2018 Farm Bill, fixing MPP is the top priority for many in the dairy industry — particularly the National Milk Producers Federation, which originally developed the program when the current farm bill was written.

All told, dairymen paid almost $95.7 million into the program in 2015 an 2016 and received only $12.2 million in indemnity payments — despite depressed milk prices well below the cost of production.

Contente purchased buy-up coverage in 2015 to insure a $7.50 margin on 4 million pounds of milk, which represents a little more than two months of his production. Premiums to cover production above 4 million pounds are significantly higher, making it unaffordable to cover a higher margin on more of his milk, he said.

His milk price sank to a low of $12.60 per cwt. in May of that year, while his cost of production was about $17 per cwt.

But USDA computed a national margin that was higher than $7.50 all year, and he didn’t receive one cent from the insurance program.

“It should have triggered some kind of a safety net. I put several thousand dollars in the program and got no benefit,” he said.

The following year, he didn’t buy any additional coverage — and he wasn’t alone. The program’s performance “soured a lot of people,” he said.

Producers who signed up are locked into the program for the life of the farm bill. But the majority of them are now just paying the required $100 annual fee, shrugging their shoulders and forgetting about it because they believe they won’t get anything out of it, he said.

Coverage falters

The program is “certainly not up to expectations,” said John Newton, director of market intelligence for the American Farm Bureau Federation.

In 2015, about half of U.S. dairy farmers signed up, representing about 80 percent of U.S. milk production, and 56 percent purchased buy-up coverage, he said. Producers paid $73 million in premiums and fees.

When milk prices collapsed, USDA calculated that margins only fell below insured levels at the highest coverage of $8 per hundredweight. The program paid a total of $727,000 to the 264 producers who had elected that level of coverage. The other dairy operations received nothing.

Producers who signed up are locked in but can make annual changes to their level of coverage. The program’s poor performance had many backing away from higher coverage and instead opting to participate only at the $4 margin level, he said.

“They voted with their feet,” Newton said.

By last year, only 23 percent of participating farms paid for buy-up coverage, representing 12 percent of insured milk production.

“While producers can’t walk away, they weren’t actively participating above the catastrophic level,” he said.

Milk prices fell further in 2016, but USDA’s program margins fell below $8 in only two periods — $7.14 in March-April and $5.76 in May-June. The program paid out only about $11.5 million after taking in $22.8 million in premiums and fees.

“Performance again was well below expectations, and producers rolled back coverage,” he said.

For 2017, only 8 percent of participating producers bought buy-up coverage on only 2 percent of the insured milk.

“People look at premiums paid in and dollars paid out as a measuring stick,” Newton said.

Nonetheless, “I think it’s working exactly how Congress designed it to work, it just hasn’t delivered program payments. It can definitely be improved,” he said.

Origin and outcome

In 2009, dairymen faced crippling losses that revealed a gaping hole in the USDA safety net. Mending that hole with antiquated dairy policy developed in simpler times was not a viable option.

The dairy safety net included the Dairy Price Support Program, which indirectly supported minimum milk prices through government purchases of dairy products such as cheese and milk powder. It also included Milk Income Loss Contract payments, which paid 45 percent of the difference between a set price for fluid milk — called Class I — in Boston and the actual market price on a limited amount of production.

Both proved woefully inadequate in the 2009 devastation, which saw dairymen burning through equity to borrow money to try to stay in business.

The National Milk Producers Federation set about to develop a 21st century risk-management tool that would be more flexible, comprehensive and equitable than any previous federal program.

The result was the Margin Protection Program, but significant changes to the program during congressional deliberations on the 2014 Farm Bill rendered it ineffective, according to NMPF leaders.

As originally designed, the MPP program “would work fine for us right now,” said Jim Mulhern, NMPF president and CEO.

The problem is the changes made by Congress — principally the feed cost calculation in the margin formula, which was reduced by 10 percent, he said.

The resulting formula underestimates true feed costs by about $1 per hundredweight. That might not seem like a lot, but it is, he said.

“That’s the major fix we have proposed for the program going forward,” he said.

Changes to NMPF’s original proposal were based on Congressional Budget Office cost projections, which turned out to be inaccurate, he said.

CBO’s numbers continue to be dramatically off base, said John Hollay, NMPF vice president of government affairs.

The original scoring was that the program would cost about $1 billion over 10 years and could be too expensive in some years. That led to the reduction in the feed calculation, he said.

“But what we’ve seen is the exact opposite,” with the government making money on the program, he said.

Going forward, CBO is acting under the same assumptions, projecting significant government outlays. Particularly disconcerting, he said, is that in January CBO reported actual government payments for MPP in 2016 were $194 million, when it was only about $11.5 million.

“Obviously there is some confusion at CBO on what it actually costs,” he said.

While CBO scoring will challenge changes to the program, it won’t preclude NMPF from trying to get the policy right first and working on the budget issues after a policy is in place for a fundamentally sound safety net, he said.

NMPF is recommending other changes as well, including using more precise data to calculate feed costs, lowering premiums, greater sign-up flexibility and expanding the use of other risk-management tools in conjunction with MPP.

“The real point of all these changes is that together they will provide the safety net envisioned when MPP was first formulated,” Mulhern said.

Another route

Rick Onaindia, CFO of Bettencourt Dairy in Wendell, Idaho, said he doesn’t see why dairymen wouldn’t sign up at the catastrophic $4 level and pay the $100 fee. By anyone’s calculations, he said, it would pay off in a disastrous year like 2009.

But most dairymen he knows didn’t see a benefit in purchasing additional coverage, and he can’t think of anyone who did, he said.

He went back and compared historical national milk prices and feed costs with Bettencourt’s numbers, and the program just didn’t pencil out for the operation.

“The correlation was really poor, under 60 percent,” he said.

The income-over-feed margin is so different around the country that using a national average is probably an inherent problem in the program, he said.

Besides, the average dairyman today has plenty of ability to hedge his feed cost and milk price, and most in Idaho — who haven’t operated under a federal milk marketing order in quite some time — are active in hedging income over feed, he said.

“I don’t know anybody that hasn’t got a variety of options at minimal cost,” he said.

Dairymen can lock in their feed prices with grain brokers for an extended period, and milk processors offer a wide variety of options to mitigate revenue risks, such as forward contracting. In addition, producers can work with brokerage firms, such as Rice Dairy or FCStone, to hedge their risks through futures trading.

“Most dairymen will look at those opportunities rather than paying for buy-up coverage for a $6 or $7 margin. So you get to the same place arguably easier,” he said.

NMPF’s recommendation to change the feed calculation in MPP is a step in the right direction, but it still won’t be adequate, Contente, the California dairyman, said.

At this point, most dairymen have no trust or faith in the program, he said.

“I think we chose to go down the wrong path in the last farm bill,” he said.

Supply management was stripped out of the original proposal, the calculations and triggers were tweaked and the budget baseline for dairy was reduced to a ridiculously low level, he said.

“We wound up with a program that leaves us with no safety net,” he said.

In addition, there are a lot of issues with the milk-pricing system, he said.

“I don’t have too much faith in National Milk coming up with some strong policy for a safety net,” he said.

The organization pushed MPP, saying it was going to be “the cat’s meow, a new safety net better than before … but in the end, we wound up with basically nothing out of it,” he said.

Mulhern said he understands producers’ frustration.

“There is no question the producers have diminished confidence in MPP because of the way the program has performed the last two years,” he said.

But the program in its original form would have been effective, and restoring key provisions that Congress removed is the goal.

“Once people see the changes and how the program operates under the changes, I have no doubt that they’ll see it is the effective safety net program that our industry needs,” he said.

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