1. LGM-Dairy: A Refresher Webinar
Brian W. Gould
University of Wisconsin-Madison
Ron Mortensen
Dairy Gross Margin, LLC
March 28, 2018

2. Overview of Today’s Presentations
Overview of how to protect your milk Income Over Feed Cost (IOFC) margin
Via a traditional options based strategy
Use of USDA’s Livestock Gross Margin for Dairy Cattle (LGM-Dairy)
Use of the LGM-Dairy Analyzer software for contract cost estimation and evaluation
On-the-ground logistics of purchasing an LGM-Dairy contract
Preparing for contract offering 2 2

3. of Program Fundamentals
LGM-Dairy: A Review
of Program Fundamentals
Brian W. Gould
Renk Professor of Agribusiness
Department of Agricultural and Applied Economics
University of Wisconsin-Madison
University of Wisconsin Extension
March 28, 2018

4. Margin Risk Management: Options Based
How can dairy producers establish a floor on their IOFC using feed and Class III options?
Class III put options: Creates milk revenue floor
Feed call option: Establishes feed cost ceiling
When designing your strategy:
What are your total costs of production?
Will the IOFC cover variable production costs?
Milk revenue floor
IOFC ($/cwt)
$P* Put
Strike Price
Min.
IOFC
IOFC*
$C* Call
Strike Price
IOFC**
Feed cost ceiling
IOFC** > IOFC < IOFC*
Market Prices C* P* 4 4

5. Margin Risk Management: LGM-Dairy
An alternative method for managing margin volatility: Livestock Gross Margin Insurance for Dairy (LGM-Dairy)
Objective: Establish minimum IOFC
Similar to above put/call options strategy except:
No options actually purchased
No minimum size limit
Upper limit: 240,000 cwt over 10 mo./insurance yr
Premium not due until after 11-month insurance period regardless of number of insured months
Subsidized premiums
Purchased from authorized crop insurance agents

6. Historical Use of LGM-Dairy
Insur. Year
No. of Policies
% Indem-nified
CWT Insured (000)
$1,000
% Prem. Sub.
Loss Ratio
Sold
Indem-nified
Total
Per Policy
Min. Gross Margin
Total Prem.
Prem. Subsidy
Indem-nities.
Sub. Prem
08/09 45 34
75.6
402
8.9
4,716
287
-----
718
2.50
09/10
153 56
36.6
1,872
12.2
24,915
782
281
0.36
10/11
1,412 24
1.7
46,173
32.7
769,644
25,013
10,736 65
42.9
0.00
0.01
11/12
1,769
124
7.0
40,474
22.9
704,864
19,144
8,871
1,395
46.3
0.07
0.14
12/13
1,697
221
13.0
34,179
20.1
664,078
16,873
7,656
2,666
45.4
0.16
0.29
13/14
1,626
123
7.6
27,739
17.1
546,366
11,592
4,967
3,653
42.8
0.32
0.55
14/15
2,090
445
21.3
48,738
23.3
889,332
22,338
10,178
16,717
45.6
0.75
1.38
15/16
1,638
236
14.4
20,064
300,854
7,184
3,142
8,719
43.7
1.21
2.16
16/17
1,618
168
10.4
18,577
11.5
305,266
6,750
2,952
2,114
0.31
0.56
12048
1,431
11.9
238,218
19.8
4,210,035
109,963
48,502
36,328
44.1
0.33
0.59
Note: % Premium Subsidy is defined as Premium Subsidy/Total Premium.
Prior to 10/11 there were no direct premium subsidies. The Loss Ratio is defined as Indemnity Value/Total (Subsidized) Premiums. There are additional subsidies paid to crop insurance providers in the neighborhood of 20% of unsubsidized premiums.

7. State Use of LGM-Dairy: 2016/17 Ins. Year
Note: TGMG is defined as the Total Gross Margin Guarantee = Total milk revenue − Total declared feed costs − (Chosen deductible × CWT Insured) = IOFC minimum 7

8. LGM-Dairy: An Overview
LGM-Dairy can be customized:
No. of months insured per contract: 1−10
% of monthly milk production insured
0 – 100% of certified marketings
% coverage can vary across insured months within the same contract
Other farm specific insurance characteristics
Declared feed use: Only protect market-based risk?
IOFC deductible → extremely large impact on premium subsidy but less impact on min. IOFC
→ Farm specific premium depends on your insurance contract design 8

9. LGM-Dairy: An Overview
Class III, corn, and soybean meal futures markets source of Expected and Actual prices
Expected: Forward looking at time of LGM-Dairy contract purchase
Previous 3 days’ futures contract settlement prices
Actual: As LGM-Dairy contract matures
3 days prior to last futures contract trading day
No futures market transactions for either
Actual farm prices are not used
No local basis added to Expected/Actual prices 9 9

10. LGM-Dairy: An Overview
At time of LGM-Dairy contract purchase you know
All Expected contract milk prices and feed costs; and
The IOFC margin floor established for insured milk production 10 10

11. LGM-Dairy: Expected Feed Use
Declared feed use converted to Corn (energy) and SBM (protein) equiv.
Allowable range of feed equiv.:
Corn equiv.: – 1.36 bu/cwt of milk
SBM equiv.: – lb/cwt of milk
No required conversion method
No auditing of declared feed use
→Need not match feed
By declaring minimum feed amounts → create a contract average put option
Establishes a minimum revenue target 11 11

12. LGM-Dairy: An Overview
Total Expected Gross Margin:
TEGM = Total contract Expected value of milk – Total contract Expected feed costs
Single TEGM value/contract regardless of months insured
→ One month’s low margin can offset another’s relatively high value as only total contract sum matters 12 12

13. LGM-Dairy: Determining Expected Prices
All 10 months of Expected Prices known at sign-up
Insurance sign-up period 4:30 pm Central and 8 pm Saturday
Expected Prices = Average of futures settle prices on these days
March Contract Offering→ May 18 – Feb 19 production eligible
Source of May ʹ18 – Feb ʹ19 Expected Prices 13 13

14. LGM-Dairy: Producer Deductible
Producer chooses insurance deductible
Deductible = the portion of insured milk’s TEGM not protected
Program allows $0 - $2.00/cwt TEGM to be excluded from coverage
Higher deductible → Lower premium
Producer assumes more risk (−)
Increased premium subsidy (−) 14 14

15. LGM-Dairy: Direct Premium Subsidies
Deductible ($/cwt)
Subsidy (%)
0.00 18
0.60 31
0.10 19
0.70 34
0.20 21
0.80 38
0.30 23
0.90 43
0.40 25
1.00 48
0.50 28
1.10 – 2.00 50
Avg. Premium Subsidy
Total Gross Margin Guarantee:
TGMG = TEGM – Deductible 15 15

16. LGM-Dairy: UW’s LGM-Dairy Analyzer
As noted above, prior to purchase producer knows all expected prices
Contract sold with futures markets closed
Can use UW’s LGM-Dairy Analyzer to evaluate TGMG 1-2 weeks in advance of purchase to examine impacts on costs and performance of alternative contracts:
Deductible rates
% of production covered each month
Declared feed rations 16 16

17. LGM-Dairy: Determining Actual Prices
As insurance contract matures RMA determines actual monthly Class III milk value and feed cost
Use the same production and feeding regimes as established when contract purchased
→ Need actual Class III, corn and SBM prices 17 17

18. LGM-Dairy: Determining Actual Prices
Actual prices based on futures settlement prices at futures contract expiration
Actual price = Average futures contracts’ settlement prices for the 3 days prior to that futures contract’s last trading day
For all months in which some production is insured 18 18

19. LGM-Dairy: Determining Actual Prices
Settle prices used to calculate
Actual July 2018 Corn/SBM prices
Last Corn & SBM
trading day
Settle prices used to calculate
Actual July 2018 Class III price
Last July Class III trading day 19 19

20. LGM-Dairy: Determining Actual Gross Margin
Total Actual Gross Margin (TAGM) = Total contract actual milk value – Total actual feed cost values
Using above actual prices
No monthly determination of actual monthly gross margins
→ Only 1 TAGM regardless of months insured
→ A month with a low IOFC can offset a month with a relatively high IOFC value 20 20

21. LGM-Dairy: Indemnity Determination
If TGMG > TAGM → An insurance indemnity will be generated
Payout amount = TGMG–TAGM if TGMG > TAGM
→ Market did not live up to expectations
Again: Only 1 indemnity calculation per contract
When are indemnity determinations made?
After last actual price is available from RMA
May be 1 – 2 months after last covered month
Corn: Sept/Dec futures contracts vs. Oct/Nov LGM coverage months 21 21

22. LGM-Dairy: When Purchased?
LGM-Dairy can be purchased monthly
Each contract can cover up to 10 months
Purchase period starts no earlier than 4:30 pm CDT on month’s last business Friday
March ′18 contract: 4:30 pm CDT, Mar 23rd
Sales will start on the half hour if data not available at 4:30 (e.g. 5:00 pm, 5:30 pm, etc.)
Purchase period ends at 8:00 pm CDT the next day (e.g., Saturday March 24th)
Why planning by both agent and producer is needed well in advance of contract purchase 22 22

23. LGM-Dairy: Coverage Calendar Example
Hypothetical insurance strategy
Purchase insurance on March 23– 24, 2018
By rule: No coverage the month after purchase
March
′18
April ′18
May ′18
June
July ′18
Aug ′18
Sep ′18
Oct ′18
Nov ′18
Dec ′18
Jan ′19
Feb ′119 1 2 3 4 5 6 7 8 9 10
Purchase Mar 23rd – 24th No
Cover-age
Potential Insurance Coverage Period
Production Coverage
75%
50%
25%
20%
15%
Hypothetical LGM Contract 23 23

24. LGM-Dairy: Summary LGM-Dairy a flexible insurance program
Need not insure all months or production in a month
Could make sense to overlap covered months under different contracts
Substantial premium subsidies ↑ w/deductible
Similar to combined use of Class III puts and corn/SBM calls
Premiums are very sensitive to elected deductible 24 24

25. LGM-Dairy: Summary Major Drawbacks Short sign-up window once a month
Unlimited number of contract designs
→ Advanced planning is needed
A positive characteristic?
Actual price of last insured month known before indemnity evaluation
Could be multiple months delay
Cannot participate in both USDA’s MPP and LGM-Dairy programs
Even though no double coverage 25 25

26. LGM-Dairy: Use of LGM-Dairy
The following is an example of the use of the LGM-Dairy Analyzer software
WI 2017 Production Per Cow (lbs) ←
WI 2017 Total Milk Prod. Assuming 250 Cow Herd (cwt) ← 26 26

27. Wisconsin Example 27

28. 28

29. Wisconsin Example 29

30. Wisconsin Example
TGMG
= $100,125 w/$1 deductible
TAGM
= $98,764

31. Wisconsin Example
TAGM = $98,764

32. Contact Information
Livestock Gross Margin Insurance:
LGM-Dairy Analyzer Software:
Download PPT File:
Download MP4 Recording:
Brian W. Gould
(608)
website: 32

33. Nuts and Bolts of LGM-Dairy Applications & Strategies Dairy Gross Margin, LLC started in 2007 and sold first LGM- Dairy policy in Licensed in 22 states. Have direct clients and affiliated agents. Personally have been registered Commodity Trading Advisor since Dairy Gross Margin, LCC 33 33

34. Working with Clients Newsletter via 2-5 days before sales date Discusses changes in margins from prior months Reviews charts 34 34

35. Long Term Chart www.dairygrossmargin.com35 35

36. 36 36

37. 37 37

38. Working with Clients Call customers to remind them of Sales Date Send estimated premiums from Dr. Gould’s website and application forms Discuss with customers the issues and application 38 38

39. Applications Name, address & contact info 2. Make sure applicant is same as milk check 2. Entity type & tax id or SS# 3. SBI – same info as above - if own greater than 10% 4. Conservation Compliance AD Signature 39 39

40. Paper Flow Get signed application by Thursday or Friday morning via email. www.dairygrossmargin.com40 40

41. Paper Flow Friday afternoon--enter data. After 4:30 pm--submit
Paper Flow Friday afternoon--enter data. After 4:30 pm--submit. customer Schedule of Insurance and billing. Put applications in electronic files. Get hard copy from Insurance Company. 41 41

42. Marketing Strategies Cover 2-3months. Cover in middle of range
Marketing Strategies Cover 2-3months. Cover in middle of range. Cover last 2-3 months 42 42

43. Marketing Strategies Next month—repeat. Cover 2-3months
Marketing Strategies Next month—repeat. Cover 2-3months. Do percentages of production. Build a portfolio. 43 43

44. Marketing Strategies Cover 1/3 with LGM-Dairy Cover 1/3 with forward contracts Leave 1/3 open. Do different percentage Could be 50% LGM-Dairy 25% forward contracts 25%open 44 44

45. Marketing Strategies Do something every month to average the portfolio www.dairygrossmargin.com45 45

46. Marketing Strategies Integrate with other option strategies
Marketing Strategies Integrate with other option strategies. Buy LGM-Dairy Sell CME Call higher 46 46

47. DAIRY GROSS MARGIN, LLC Ron Mortensen Marv Carlson Jean Lynch 47