ABOUT CROP INSURANCE
JUST THE FACTS
U.S. farm policy has been under the microscope recently as Congress has tried, so far unsuccessfully, to enact a successor to the 2008 Farm Bill. As part of that process, the purpose, justification, effectiveness and cost of farm policies, including crop insurance, have been thoroughly examined.
Below are some of the most common questions about crop insurance, which farmers have called their most important risk management tool. The answers to each, including useful links to additional information, are just a click away. If you still cannot find what you are looking for, feel free to contact Laurie Langstraat at (913) 685-2767 or contact here.
An improper payment occurs when funds go to the wrong recipient, the right recipient receives the incorrect amount of funds (including overpayments and underpayments), documentation is not available to support a payment, or the recipient uses funds in an improper manner.
The government reporting website states the following: “Not all improper payments are fraud (an intentional misuse of funds). The vast majority of improper payments are due to unintentional errors. For example, an error may occur because a program does not have documentation to support a beneficiary’s eligibility for a benefit, or an eligible beneficiary receives a payment that is too high—or too low—due to a data entry mistake. . . . Also, many of the overpayments are payments that may have been proper, but were labeled improper due to a lack of documentation confirming payment accuracy. We believe that if agencies had this documentation, it would show that many of these overpayments were actually proper…”
The Risk Management Agency (RMA) estimates and reports improper payment rates for the Federal Crop Insurance Corporation Program. RMA reported an improper payment rate of 4.08 percent for FY 2012. This is less than the FY 2012 reduction target of 4.40 percent and the 4.72 percent improper payment rate reported for FY 2011. RMA reported that for FY 2012, the primary cause of improper payments was “producer certification.”
It should be noted that improper payments associated with the crop insurance program are below the government-wide improper payment rate of 4.35 percent.
RMA and the crop insurance industry are working to reduce improper payments. RMA states they have “initiated discussions with insurance companies that would result in a historical production database for policy holders and acreage with the first phase scheduled for completion in 2015.” In conjunction with this corrective action, RMA plans to switch land identification to “common land units” for all farm programs. This collaboration could potentially reduce the number of certification errors by producers and ease program.
Read more on the background and issues pertaining to improper payments here.
The U.S. multi-peril crop insurance (MPCI) program is a risk management tool that producers purchase to protect against the loss of their crops due to natural disasters such as hail, drought, freezes, floods, fire, insects, disease and wildlife, or the loss of revenue due to a decline in price. Crop insurance is Federally supported and regulated and is sold and serviced by private-sector crop insurance companies and agents. In 2012, 1.17 million polices were sold protecting more than 120 different crops covering 282 million acres, an area larger than Texas and California combined, with an insured value of $117 billion.
Crop-Hail policies are not part of the Federal Crop Insurance Program and are provided directly to farmers by private insurers. Many farmers purchase Crop-Hail coverage because hail has the unique ability to totally destroy a significant part of a planted field while leaving the rest undamaged. In areas of the country where hail is a frequent event, farmers often purchase a Crop-Hail policy to protect high-yielding crops. In 2012, Crop-Hail liability was approximately $39 billion, and premium was approximately $950 million.
The Federal program came to prominence following years of costly, inefficient ad hoc disaster bills as a way to speed assistance to farmers when they need it most while reducing taxpayer risk exposure. To read more about the history of crop insurance, click here.
See a video overview of crop insurance here.
Read more about crop insurance in general here.
It is in the public interest to have a financially stable agricultural sector that produces the nation’s food and fiber and supports the rural economy. That requires the presence of some form of publicly-funded safety net for farmers, who increasingly face variable weather patterns that challenge the food production system. The need for a sound crop insurance program is most easily demonstrated by the three-year drought, which began in 2011 and is extending into 2013.
Crop insurance is the primary risk management tool farmers use to financially recover from natural disasters and volatile market fluctuations; pay their banks, fertilizer suppliers, equipment providers and landlords; and purchase their production inputs for the next season. Without an effective and affordable crop insurance program, catastrophic production losses would sap the rural economy by setting in motion a series of harmful events: farm failures and consolidation, job losses, farm-related small business failures and financial stress on rural banks. A financially healthy rural economy requires a financially healthy farm production sector.
By 2050, the UN projects a 34 percent increase in global population and a 70 percent increase in demand for food (see this.)
As the number of consumers expands globally and the climate continues to exhibit more intense weather events there will be increasing pressure on the global food production system. In the U.S., the ability for farmers to purchase crop insurance is this nation’s ” insurance policy” against disruption and instability in the food production sector. Crop insurance is also be critical in helping new and beginning farmers obtain credit, enter farming and become the next generation of producers that meet the growing global food and energy needs.
Congress created and provides funding for the modern-day crop insurance system — administered by the Risk Management Agency — as a way to help farmers manage the risks of natural disasters and market fluctuations. Lawmakers intended for the system to largely replace the need for ad hoc disaster legislation, thereby helping to shelter taxpayers from the full costs of agricultural disasters and avoiding the need to enact new disaster assistance following every major disaster, such as was recently experienced with Hurricane Sandy in 2012.
To this end, the Federal government sets program standards, approves new products, sets premium rates and reduces farmer premiums. The Federal government further reduces the cost that farmers would otherwise pay for crop insurance by reimbursing the Administrative and Operating (A&O) delivery costs of the program. However, those reimbursements do not fully cover the companies’ delivery costs. The crop insurance companies (known as approved insurance providers, or AIPs) share in the underwriting gains and losses with the government, thus reducing taxpayer risk exposure.
Thanks to the success and popularity of crop insurance, there have not been any widespread calls for ad hoc crop disaster bills over the past several years, despite 2011 and 2012 being two of the worst weather years on record. By comparison, 42 emergency disaster bills in agriculture have cost taxpayers $70 billion since 1989, according to the Congressional Research Service.
The private sector companies employ agents and loss adjusters who sell policies to farmers and determine the extent of losses, collect premiums, pay claims and bear underwriting risk. The companies employ more than 20,000 licensed agents, certified loss adjusters, and company staff. For more information on the role agents play, click here.
Farmers benefit from private-sector efficiency, which speeds payments when needed most, and taxpayers benefit from reduced overhead costs and aggressive procedures to combat waste, fraud and abuse. View a video on private sector efficiency here.
Why does the Federal government reinsure private-sector companies and should the Federal government share in insurance losses?
Under today’s risk-sharing arrangement, the companies bear a substantial portion of the risk and the government is viewed as providing partial reinsurance — or insurance sold to insurers — to the companies for the program’s underwriting losses. In return, the government takes a share of the companies’ underwriting gains. The terms of the arrangement are spelled out in the Standard Reinsurance Agreement (SRA), the contract between the government and the companies that deliver the program.
In short, as a reinsurer the government will help shoulder excessive losses in bad years like 2012, but will receive underwriting gains from farmer premiums in good years. That was the case from 2001-2010 when the government saw $3.99 billion in underwriting gains.
The government shares in the risk of loss for two reasons. The first reason is the requirement for universal availability of crop insurance. Companies must sell a policy to any farmer who wants one – including high-risk farmers – at the premium rate set in advance by the Federal government. Companies cannot refuse to provide protection, raise the premium rate, or impose special underwriting standards on any individual producer, regardless of risk. Due to these prohibitions against normal underwriting practices, insurers would consider this to be a textbook example of uninsurable risk. The SRA mitigates this problem by allowing companies to transfer a portion of the risk of policies to the Federal government.
Without Federal reinsurance, private-sector companies would have to rely solely on private-sector reinsurance. With the potential for widespread correlated losses, private-sector reinsurance alone would be very costly and would likely lead to crop insurance companies being unwilling to write policies in high-risk regions or leaving the crop insurance business.
The second reason is that agriculture is inherently risky and the potential for large-scale losses may exceed the capacity of the private sector. Natural disasters can cover wide areas with many individual farms simultaneously incurring large losses, which could bankrupt a private-sector company. The losses in this instance are said to be correlated, unlike automobile accidents, which occur randomly across a state or region.
Because of the magnitude of risk inherent in U.S. agriculture, combined with the large volume of commodities produced, even with Federal reinsurance, companies that participate in the crop insurance program are required to have access to adequate capital to meet their obligations if disaster strikes the farming sector. These requirements dictate that companies must have capital sufficient to pay out losses equal to roughly the value of the premiums on the policies they sell (technically, at least twice the maximum possible underwriting loss, as specified in the Federal regulations). To help meet these capital requirements, crop insurance companies buy additional insurance from the private market.
No. In fact, in 2012, crop insurance companies lost money, as well as in 1983, 1984,1988,1993 and 2002. That is in sharp contrast to providers of everyday property and casualty insurance, which have only lost money once over the past 50 years in 2001 —the year of the 9-11 attacks.
First, it is crucial to realize that underwriting gains for crop insurers are not profits; they are one component of a company’s revenue. Second, the Administrative and Operating (A&O) payments received from the government have consistently fallen short of actual delivery costs for loss adjustment, commissions, information technology, salaries and benefits, rent and other expenses. This shortfall reduces the net income earned by participating companies. Third, companies can have underwriting gains and still have operating losses whenever their shortfalls in A&O payments exceed their underwriting gains.
Read more about the rate of return here.
A recent report prepared by Bruce Babcock and funded by the Environmental Working Group calls crop insurance “a bloated, taxpayer-funded income support program” and that farmers are profiting from the 2012 drought because of crop insurance. Is this true?
Absolutely not. It should come as no great surprise that the recent EWG report prepared by Bruce Babcock is highly critical of the crop insurance program. Once again, the public is being led to believe by the EWG that farmers are somehow profiting from the drought of 2012 and crop insurance indemnities. This is simply not true. In 2012, indemnities paid to farmers for losses will total approximately $17 billion.
The report states that crop insurance has ‘turned more into a farm income support program than a crop insurance program…’ Unfortunately, EWG fails to acknowledge that before farmers received a single dime in crop insurance indemnity payments, they shouldered $12.7 billion in losses as part of their crop insurance policy deductibles, and an additional $4.1 billion was paid out by farmers to purchase their policies. Thus, farmers absorbed approximately $17 billion in uninsured losses and premium expenditures out of their own pockets before insurance.”
Compared to ad hoc disaster relief, the private sector delivery system allows for indemnity payments to be made on a timely basis. With crop insurance, farmers are able to plant their crops for 2013 and stay in business. Contrast this to the experience of victims of Hurricane Sandy who struggled to get relief and then have waited for its distribution.
This report also ignores the fact that crop insurance companies will suffer losses due to the 2012 drought, and that the federal government made nearly $4 billion in underwriting gains from 2001-2010. The report focuses primarily on the unusual, 1-in-25-year drought of 2012 and not the long term performance and improvements that have been made to the crop insurance.
The report ignores the fact that farmers may pay premiums for many years and suffer no losses, or losses within their deductibles, in order to have sufficient protection for the years like 2012. The report ignores the substantial funding reductions in the safety net for farmers that will be part of the new farm bill.
The report is also highly critical of a type of insurance that farmers can purchase known as the Harvest Price Option. Without the harvest price option, the producer’s loss would be indemnified at the lower price projected at the start of the season. Unfortunately, such an indemnity would place many farmers in financial jeopardy. Many farmers enter a forward contract to sell a portion of their production before harvest. Usually these contracts pay the producer for the production they deliver after harvest based on harvest prices.
If the producer loses the crop, the producer is still obligated to deliver under the forward contract. But since the producer has lost the crop, the producer would have to buy the commodity at the harvest price and deliver that or financially settle the buyer’s contract at the harvest price. The purpose of the harvest price option is to provide the producer with sufficient funds to settle the forward contract.
Farmers utilize crop insurance because it enables them to manage their own risk, be it weather or market related. Congress supports crop insurance because it shifts the risk of natural disaster from taxpayers and takes the politics out of natural disasters.
No. The Federal government takes a share of underwriting gains, so the government earns a net gain in low loss years. One study (here) found that after accounting for gains and losses across all states from 2001-2010, the government realized $3.99 billion on its reinsurance operations.
The gains have helped offset the government’s underwriting losses in 2011 and 2012.
Critics say that foreign-owned companies profit from crop insurance. So, why are foreign companies involved in providing crop insurance to U.S. farmers?
There are currently 18 companies authorized to sell crop insurance to U.S. farmers. Because of the amount of risk present in writing policies for the U.S. agricultural sector, represented by an insured value of $117 billion in 2012, there are only a limited number of corporations, both domestic and multi-national, that have sufficient liquid assets available, and are willing to risk them, to pay the required indemnities in a timely manner. Read more about the need for companies to have strong financial underpinnings here.
In fact, Federal regulations mandates that insurers have access to enough capital to offset twice the maximum possible underwriting loss (about $11 billion in 2012).
Most lines of property and casualty insurance in the United States involve foreign insurance and reinsurance companies as global diversification is necessary in insurance to counterbalance risks across industries and countries around the world. This is especially the case for crop insurance due to the high potential for catastrophic loss. Put another way: Without foreign capital, the U.S. crop insurance business would be less diversified.
Regardless of where a parent company or reinsurer is based, it is important to note that crop insurance businesses operate in the United States, invest in American assets, employ American workers and provide assistance to American farmers when those farmers and their neighboring communities need help the most.