Guest editorial/opinion:
Securing producers

John Umhoefer is executive director of the Wisconsin Cheese Makers Association. He contributes a monthly column for Cheese Market News®.

Producer security, that egalitarian concept of protecting dairy producers from the risks of the marketplace, varies widely across America. A handful of traditional dairy states host programs to support dairy producers when milk buyers default on payment, while several top 10 dairy states such as Idaho, New Mexico, Washington and Texas have no programs at all.
What’s right and wrong with the patchwork of state security programs? Read on.

• Why security?

Government-backed security is a rare concept in business. Through complicated programs that include assessments, fund pools, bonding and review of financial data, several dairy states regulate dairy processors in an attempt to protect dairy producers’ interests. But the very concept of producer security deserves critical scrutiny.

Outside of producers, no industry is protected by government against the risk of a buyer’s default. Certainly dairy processors are not protected when they sell cheese, butter or fluid milk to retail chains, distributors or marketers.

States that require security build significant bureaucratic staffs and add paperwork and significant costs to dairy processors. In Wisconsin, the security program impacts processors’ decisions to borrow money or increase milk intake.

Producer security in Wisconsin is extended to all dairy producers and to farmers that grow vegetables and ship to grain dealers. This year, the program saw its first defection: potato growers that sell to large potato chip manufacturers convinced the state legislature to drop them from the program. Their buyers wanted no part of the assessments levied by Wisconsin to build its security fund. The potato growers asked to be dropped from the program, and the state approved.

• Cooperative coverage

In Wisconsin, small dairy cooperatives were added to the state program when it was retooled in 2000. Exempt from the previous program, these small cooperatives are now in, unless they remain tiny enough to opt out. Every milk buyer (or “milk contractor” in state lingo) must submit annual financial statements if they buy more than $1.5 million worth of milk per year.

Wisconsin’s treatment of cooperatives is unique. Every dairy producer that ships milk to their cooperative or to a private milk buyer is secured in Wisconsin. Cooperatives operating across several states find that they must uniquely secure their Wisconsin members.

New York, California, Pennsylvania and Minnesota all operate producer security programs, but none of these state programs will pay a producer if their cooperative defaults on payment. California documents note: “Since its member-producers control the cooperative, the fund is not accountable for internal decisions that may have led to the failure to pay.”

Should Wisconsin secure dairy producers from risk if the producers’ cooperative does not want this cost? Should a cooperative pay to be secured against itself?

• Back-up coverage

When Wisconsin reinvented its producer security program in 2000, it created complex assessments to build a fund pool for dairy, vegetable and grain farmers. The state also promised to buy back-up bonds for each industry and a giant “blanket bond” of up to $40 million to cover a major default. These layers of bonds proved impossible to secure.

In 2003, the state reduced these requirements to a single back-up bond or line of credit not to exceed $17 million. This smaller requirement also has failed. Banks and bonding companies will not secure this broad-based, hard-to-define risk.

Other states have taken a more practical approach to the coverage their programs provide. California’s security program is only a fund pool, now bloated to $45 million. Giant buyers purchasing more than $45 million worth of milk in a single month add a bond to cover the amount over the fund balance.
Last month, California legislation took effect that will cap this fund at $30 million, and add state cheese plants to the list of milk buyers that will pay assessments into the pool. However, no one will be paying into this fund pool for quite some time. The state has suspended assessments until defaults reduce the fund from $45 million to below $30 million. The fund has only seen about $5 million in payouts during the past 20 years.

New York currently has $5.5 million in its fund for dairy producers and the state recently lifted its cap on this fund to $7.5 million. In addition, the agriculture department has a $6.5 million appropriation authority granted by the state legislature. This loan from the state would have to be paid back. Interestingly, New York allows milk buyers to post a private bond or letter of credit instead of paying into the state fund.

Pennsylvania asks for a bond or letter of credit to cover purchases from dairy farms. Like New York, the state operates an optional fund, but a court ruling has defeated the ability of this fund to work as a shared “pool” of dollars. In Pennsylvania, each buyer’s contributions to the state fund are accounted for separately and only a buyer’s portion of the fund can be paid in a default case. Most buyers opt for private bonding and not the fund.

Minnesota and Michigan do not have fund pools for dairy farmers. These dairy states require milk buyers to purchase a bond, letter of credit or other financial security.

Today, Wisconsin’s producer fund has amassed $7.3 million, and based on a rule limiting a payout to 60 percent of the fund, about $4.4 million is available for a default.

Due to its failure to secure back-up bonds, Wisconsin’s agriculture department has drafted legislation requiring private bonds for any milk buyer with a monthly milk payroll greater than the fund can pay out. This means each milk buyer in the security program with a monthly payroll over $4.4 million would need to add a private bond.

Before 2000, Wisconsin’s producer security program was entirely based on private bonds or letters of credit. Now, after building a fund pool, the state is suggesting a return to private bonds to support its program. State milk buyers are resisting this proposal to require assessment payments and bond charges.

• Pool assessments

Among the top 10 dairy states, New York, California and Wisconsin are the three states operating a fund pool shared by the state’s dairy producers. But these states built their pools of money in different ways.

New York assesses “milk dealers” a flat rate of $0.001 per hundredweight to build its fund pool. A milk dealer is someone that buys milk from a producer or cooperative, thus cooperatives are not assessed when buying their producers’ milk.

California built its pool on a flat rate of $0.04 to $0.05 per hundredweight charged to handlers buying milk used in Class 1, 2, and 3 (that is, fluid milk, soft products and ice cream/frozen products). The new state law passed in September lowers this assessment rate to $0.014 to $0.022 beginning in January (but the assessments are suspended). Interestingly, California handlers buying milk for Class 4a and 4b use (cheese, butter, nonfat dry milk) were exempt from this assessment program during the past 20 years.

Wisconsin’s assessments are more complex. Instead of a flat rate, Wisconsin customizes each milk buyer’s rate based on the strength of their current ratio and their debt-to-equity ratio. These rates are then reduced with each year the contractor remains in the program.

Including the debt-to-equity ratio in the program has had the effect of “punishing” dairy processors that have borrowed money to expand their operations or introduce new products.

• Conclusions

Producer security is a fringe benefit offered to producers in some states and not others. In 2000, Wisconsin built a program with broader producer coverage, higher promised bonding, and more complex and costly compliance (certainly for cheesemakers) than any other state. Faced with a promise, in state law, to provide up to $17 million in back-up security, Wisconsin has pursued new language to add private bonds to the state’s largest milk buyers.
Other solutions would be more practical. Taking a page from New York and California, Wisconsin could drop its promised back-up bonds and simply operate its fund pool. Like New York, Wisconsin could ask its state legislature to appropriate back-up dollars to support the fund.

Like New York and Pennsylvania, Wisconsin could change its program to allow milk buyers that require security to participate in the fund pool or purchase a private bond (or letter of credit). This would provide security for producers while allowing milk buyers to select the least costly option.

Wisconsin could revisit its assessment system and consider removing or replacing the debt-to-equity ratio.

In short, Wisconsin could shift its focus from “limitless” payment coverage for dairy producers to coverage limited by reality. The reality is that states may be able to build some dollars in a fund while remaining competitive, but may not be able to entirely remove the risk of doing business in the greatest free market economy in the world.

CMN

The views expressed by CMN’s guest columnists are their own opinions and do not necessarily reflect those of Cheese Market News®.