Commercial Poultry Compensation Stephen L. Ott, Ph.D. Appraisal-Indemnity-Compensation Specialist USDA:APHIS:VS:CEAH July, 2011

Presentation Overview Why Compensation Compensation & Biosecurity How Appraisals Are Done Indemnity Payments Valuation Methodology Appraisal Calculators Data Sources

What Compensation is Not Not necessarily required by U.S. Constitution, taking clause 5th Amendment Diseased animals can be considered a public nuisance and thus be ordered destroyed by government through its police powers Based upon conversation with DOJ lawyer Currently required by Animal Health Protection Act of 2002 What Congress gives, it can take away USDA isn’t required to pay for plants it orders destroyed for disease control purposes

What Compensation is Not Not to provide income subsidies to producers. Not to put producers back into business It is a secondary benefit Business interruption insurance is a financial tool producers should consider if they are concerned about their ability to survive a depopulation

What Compensation Is Compensation recognizes there is a disconnect (externality) between producers’ incentive not to report disease and industry and governmental desire for quick reporting to limit the spread of disease Thus, the economic reason for paying indemnity for diseased animals is to encourage rapid reporting to animal health officials

Compensation Law & Regulations Animal Health Protection Act 2002 Part of 2002 Farm Bill Pay fair market value Indemnity is for assets destroyed Lost income not covered Federal indemnity plus any other indemnity received must not exceed fair market value Values not subject to judicial review Title 9 Code of Federal Regulations Part 53: Foreign Animal Diseases Part 56: Avian Influenza

Compensation and Biosecurity

Does On-Farm Biosecurity Increase or Decrease Profits? Function of costs and benefits Costs Capital, e.g. truck tire bath Labor, e.g. time spent cleaning and disinfection between each load or pen of livestock These costs are real and affect farm profitability

Biosecurity Benefits Benefits function of Effectiveness of biosecurity measures to prevent disease Greater effectiveness, more biosecurity Amount of potential losses Value per head Greater value, more biosecurity Number of head Greater numbers, more biosecurity

Optimal Biosecurity Optimal biosecurity occurs where costs and benefits are equal If benefits > costs, then increase level of biosecurity If costs > benefits, then reduce level of biosecurity costs D o l a r s benefits low high Biosecurity

Government Compensation & Farm Biosecurity Expenditures Q. What is the impact of government compensation on optimal on-farm biosecurity expenditures? A. Compensation reduces losses realized Which reduces benefit of biosecurity Which reduces optimal on-farm biosecurity expenditures

Government Compensation & Farm Biosecurity Expenditures Conclusion: government compensation reduces private incentive to practice good biosecurity Which works against Veterinary Services’ Goal of Safeguarding Animal Health through Disease Prevention Thus the tension between disease control and disease prevention in terms of compensation policy

Compensation Conflict Summarized “One of the most difficult challenges in designing mechanisms that address the risks posed by contagious livestock disease is the potential conflict between encouraging producer herd health management and biosecurity measures while maintaining incentives for early disclosure of health problems.” – Gramig, Barnett, Skees & Black, 2006

Poultry Appraisal

Poultry Appraisal Use price lists developed from appraisal calculators Broilers: Meat & Breeders Turkeys: Meat: Hens & Toms Breeders: Hens & Toms Table Egg Layers: Layers & Breeders Value by age Meat: day-of-age Breeders / Layers: week-of-age

Poultry Appraisal Obtain bird count and age from owner or contract grower Look up per bird value from APHIS’ price list Maintained by the Appraisal-Indemnity-Compensation Specialist Total flock appraisal value = count x value per bird

Poultry Indemnity Total indemnity = appraisal value x indemnity percentage Indemnity percentage may be less than 100% for large scale producers who do not participate in the National Poultry Improvement Program (NPIP) Indemnity payment may be split between owner and contract grower Contract grower indemnity payment = (expected earnings (based upon previous flocks) prorated by actual production length – any company payments already received) x indemnity rate Company indemnity = total indemnity – any indemnity payments to contract grower

Appraisal Valuation Methods Two Basic Appraisal Methods Revenue Minus Start with value of final product and work backwards subtracting costs and share of retained earnings for each downstream production/processing phase Cost Plus Appraisal value is equal to cost of production plus accumulated shares of retained earning for each upstream production/processing phase Both methods produce the same exact value, thus provide internal check that spreadsheet equations are correct Cost Plus will be discussed

Cost Plus Appraisal Value Valuation based upon cost of production and allocated retained earnings Retained earnings = net margin (gross profit) – income taxes – return to owner equity (dividends) Assumed to be 1/3 of net margin Approximate U.S. corporation average (US Bureau of Economic Analysis) If net margin is negative then retained earnings are set to zero This method guarantees companies at minimum will be compensated for their unrecouped costs Retained earnings are allocated across the various production/processing phases based upon each phase’s share of total cost

APHIS’ Appraisal Calculators Spreadsheets used to determine value Broilers: Meat Breeders (Parents) Turkeys Meat: Hens & Toms Breeders: Hens & Toms Table Egg: Layers Uses national numbers so as not to identify any one company Updated Monthly Meat & egg prices Feed price index

Customized Values A poultry company has the option of basing appraisal value on their own cost of production data where value equals unrecouped cost Meat birds value = cost of production Breeder/layers value = capitalization cost - depreciation Documentation Computerized Records Productivity data Cost of production data

Grandparent Valuation Grandparents and parent layers are generally produced by a few poultry companies Valuation will have to be customized Use same valuation approach as for parent/layers Data requirements Productivity data Cost of production data Revenue data If unwilling to provide this data, then valuation will equal that of parent/layers

Appraisal Calculators For each species Over 100 input parameters Prices, Costs & Productivity data Over 200 equations With feed costs feedback loops Broilers 3 sizes of meat birds Breeder birds Turkeys Meat: 2 sizes each for hens and toms Breeders: hens and toms Layers 3 laying periods

Meat Bird Valuation Slaughter Value = cost of production + allocated retained earnings of any upstream production phases, e.g. breeder birds & hatchery in an integrated broiler company Initial value: day-old chick cost + (slaughter value – final production cost) x livability %

Mid-Age Meat Bird Valuation Linear interpolation between beginning value and ending (slaughter) value Beginning value + beginning age ÷ slaughter age * (slaughter value – beginning value) Age expressed in days in barn

Breeder & Layer Valuation Three valuation points Initial (Day-old chick) Maximum (Beginning of Lay) Final (Salvage) = Spent hen price

Breeder & Layer Valuation Beginning of lay valuation Value = capitalization cost + allocated retained earnings from future egg production Retained earnings based upon 12 month rolling average price Value declines linearly to salvage (spent hen) value Day-old chick value Value = day-old chick cost + (beginning of lay value – capitalization cost) * livability % Linear interpolation between day-old value and beginning of lay value

Breeder & Layer Valuation Broiler & Layer Breeders all valuation is in the hen, therefore, don’t count roosters in bird inventory Assume a single lay Value at beginning of lay when molted Capitalization cost (value at molting age plus costs during molting) plus allocated retained earnings of expected egg production

Brown & Organic Table Egg Layers Brown Egg Layers Value determine using brown egg price and brown egg layer productivity Brown egg layer productivity determined by comparing breeding companies production guides for white & brown table egg layers Organic: Value at capitalization assumed to be 50% greater than that of brown egg layers

Turkey Breeder Valuation Turkey hens & toms valued separately Allocated retained earnings divided evenly between hens and toms Since one tom services several hens allocated retained earnings per tom is greater than that of hens Thus toms have greater value than hens

Cost Data National productivity and cost data from 2009 Updating with 2010 data is planned Monthly adjustments for feed costs based on changes in feed costs used by USDA-NASS to calculate its broiler-feed, turkey-feed, and market egg-feed ratios. June ‘11 feed cost indexes (2009 = 100): broilers, 148; turkeys, 150; layers, 156 Changes in feed costs not only impact the cost of feeding a meat bird or producing an egg, but also the costs to produce a breeder/layer which impact bird depreciation cost in egg production. The change in egg production costs in turn impacts the cost of a day-old chick which changes total production cost of a meat bird. Base day-old chick cost: NASS’ Agricultural Prices

Broiler Price Data Meat: USDA-ERS’ monthly composite wholesale price for broiler meat Jun ‘11: current, $0.718/lb 12-month avg., $0.719/lb Spent Hens: average of USDA-AMS’ Monthly Heavy Hens Jun ‘11: $0.1369/lb

Turkey Price Data Meat: Light Hens & Toms (up to 98 days old): USDA-AMS’ Monthly Frozen Whole Body, FOB Shipper’s Dock Jun ‘11 current 12-month avg. Hens $1.0314/lb $0.9790/lb Toms $1.0506/lb $0.9802/lb Heavy Hens & Toms: Monthly composite price based upon AMS’ National Young Turkey Parts and Bulk Meat & AMS’ percent carcass breakout Hens $1.1588/lb $1.1424/lb Toms $1.1707/lb $1.1488/lb

Layer Price Data Table Eggs White & Brown Egg prices calculated from AMS’ Monthly Trailer Load Egg Sales May ‘11 12 month avg.: white, $0.6882/doz; brown, $0.9934/doz USDA-NASS market egg price, $0.685/doz Spent Hens: normally a cost to remove spent layers, assume minimum layer value of $0.01/bird

Data Needs Layers Broilers Turkeys Better brown egg layer cost & productivity data Organic eggs: prices, costs & productivity data Breeders: revenues, costs & productivity data Broilers Grandparent breeder information Colored bird: meat & breeder information Turkeys Light tom productivity information More breeder tom information