Are You Adequately Covered?

As the cost of buildings on your operation continue to rise each year, you certainly wouldn’t think of not covering their replacement with adequate insurance. Yet, have you done the same thing with the primary source of revenue in your business?

For most dairymen, Milk Sales represent 85-90% of their total revenue streams. This would seem completely prudent, given the increased levels of volatility in the dairy markets… It’s been almost two years since the introduction of the Dairy Revenue Protection (DRP) Program, but are you using it?

If you study the program, it is a fairly straightforward method for placing a floor under the milk price you receive at your dairy. You can choose to protect your Class 3 price, your Class 4 price or you can use your components as the basis for protecting your milk price, assuming that fits your operation better. The key question here is – Have you looked into DRP yet? If not, please do so soon.

I believe you can go ahead up to five calendar quarters. Of course, since the price protection is based upon the use of “Put Options,” which place a floor under your prices received, the longer into the future you contract, the greater the cost of those Put Options will likely be. Their cost can also increase when markets are more volatile (such as this year…) and if you select higher price coverage levels (e.g. $18/cwt vs. $16/cwt.)

However, there is some good news on the cost front. Currently, the federal government is subsidizing the cost of the DRP options by about 40-45%, so if an option costs $0.60/cwt in the open market, your net cost through DRP will likely be about $0.36/cwt. So, how do they pay out?

At the end of each quarter, if the market prices have been higher than those you had set as a floor in the DRP program, these Put Options will expire unused, and, unfortunately, you will receive a bill for the cost of that quarter’s Puts. That’s the bad news. The good news is that since the market was stronger than the level you had set for coverage, you should have been receiving higher milk prices & thus be able to pay this premium. And, please remember that you can do less than all of your milk; I believe you can also set this up with multiple tiers of coverage, e.g. 25% of your milk one week and then another 25% the following week. The costs of the two 25% coverages may be different, but as long as you contract before the required deadline (around the 15^th of the month before the next quarter begins), you’ll be covered for the level you select. You can also go into your DRP account every day, if you wish, to monitor your progress/potential payout levels.

Is this DRP program perfect? Probably not. I’m certain that if we study it long enough, we can likely find some characteristic we don’t like… However, it can put a “floor” under your overall milk price received, the premiums are government subsidized, you have numerous different input factors that you can use (e.g. Class 3, Class 4 or Components), and you don’t even pay the premiums until the month following the quarter for which you were covered. As a result, you can pay the “premiums” out of the DRP coverage you received or out of the higher milk prices you collected if your DRP coverage didn’t kick in.

Yes, you will be out the cost of the Put Options, but do you call your insurance agent at the end of the year if your house doesn’t burn down, despite having it insured? I didn’t think so…

Given the higher levels of volatility due to market conditions, unforeseen events such as COVID-19, or disdain for some variables in our trade agreements, don’t you owe it to yourself to be covered? Take action now! I wish you the best of success!

If I can assist you in any way, please let me know at john@success-strategies.com or 209-988-8960.