Risk management tools required to address dairy income volatility
A new report addressing the issue of income volatility on Irish dairy farms evaluates the effectiveness of existing and proposed risk management tools. The report by economists from Teagasc, Cork Institute of Technology and University College Cork concludes that dairy farmers in Ireland may require multiple risk management tools to address income volatility.
The new report, entitled ‘An evaluation of suitable tools to manage price/income volatility at dairy farm level in Ireland’, funded by Dairy Research Ireland, assesses the different forms of risk faced by Irish dairy farmers, including, output and input price, production, weather and animal disease risks. The research highlights the large increase in the volatility of milk and input prices over the last decade, the consequences for farm income volatility and the limited range of tools available to manage the associated risks.
The report contains an assessment of currently available risk management tools, including forward contracting agreements and the taxation based income averaging system, as well as a number of other possible risk management tools, including revenue insurance and gross margin insurance schemes and a taxation related deposit scheme known as the ‘5-5-5 income stability tool’, which has been proposed by a number of Irish dairy industry stakeholders.
The research highlights a key limitation of the current income averaging system in the context of dairy farming. Scheme eligibility rules relating to whether farm household have off-farm employment income mean that approximately 55% of all specialist dairy farms in Ireland are automatically excluded from participation due to the presence of non-farm employment income.
The report finds that, when managed appropriately, the proposed 5-5-5 income stability tool looks promising. However, the report cautions that farmers would ideally take advice from a professional, such as their accountant, so as to understand how best to effectively use the tool for their farm.
Dr. Jason Loughrey, Research Officer, Teagasc said that “the 5-5-5 tool can reduce income volatility, while encouraging a proactive and long term approach to risk management.” However, he also cautioned that “used in isolation, the 5-5-5 tool would not fully address income volatility and therefore, were it to become available, dairy farmers would need to consider using the 5-5-5 tool in combination with other available risk management tools”.
The research examines the use of milk forward contracting agreements in 2016, and finds that farmers using milk forward contracts were typically younger, operated larger herds and had a lower share of CAP support in their family farm income, than dairy farmers that did not engage in a forward contract for their milk.
The report contains analysis of the gross margin scheme in the United States, which has been relatively unsuccessful to date, due to low levels of farmer participation. The research concludes that in a grass based dairy system, such as Ireland’s, creating this type of insurance product would be challenging, as the estimation of a dairy farm’s gross margin is less straight forward in Ireland than in the predominantly feed based system in the United States. In an Irish context, the report also notes that gross margin insurance could be costly and that tiered levels of cover with different associated premia would be required. Public support, to at least cover part of the farmer’s premium payment, would also be necessary, in order to persuade private insurers to offer such insurance products.
The research also utilises Teagasc National Farm Survey data to show the important role of direct payments in providing farmers with a buffer from price volatility. However, the report also cautions that the effectiveness of this support buffer is likely to be watered down as dairy farm output increases and the nature of the direct payment supports could change in the context of Brexit and the impending CAP Reform.
Ultimately, dairy farmers need a suite of risk management tools. Usage of any of these tools by farmers is, and should remain, a voluntary undertaking. Farmers will require support in the form of education with respect to these tools in order to develop a risk management strategy that is favourable to their individual circumstances.
Overall, the report concludes that without a higher rate of take up of risk management tools, Irish dairy farmers will face an even greater challenge in managing farm income variability, with potentially negative consequences for the development of the wider agri-food sector through the curtailment of investment at both the farm and processor level.