NCIS Response to Chris Clayton

November 2010

Farmers buying crop insurance as enterprise units get increased federal subsidy
Chris Clayton, AgFax — November 3, 2010

Tom Zacharias, newly-named president of National Crop Insurance Services, said enterprise units have expanded the opportunity for farmers to manage their risk. “I would say, in general, it has been very well-received,” Zacharias said. “There is evidence enterprise units have moved producers from CAT (catastrophic) to buy-up coverage,” Zacharias said. Zacharias said he has heard insurance representatives say that about 40 percent of their business is enterprise units. In the Corn Belt, it looks as if there is more uptake for enterprise units on single-crop ground. There have even been increased sales in other regions of the country, such as the Mississippi Delta. More acres and more diversification reduce the likelihood of a payout, so it reduces the premium substantially, while it increases the premium subsidy. “It provides a pretty good discount,” Zacharias said. “The benefit to the producer is reduced premium.” The benefit to the insurer is reduced risk….

NCIS Response to Chris Clayton
Thank you for the recent discussion we had regarding the status of the crop insurance program which focused on the recent experience with the new enterprise unit pilot program authorized by the 2008 Farm Bill. I appreciate the article you released on November 3 calling attention to this new and popular feature of crop insurance.

I do, however, have a concern regarding the final portion of the piece, and apologize for not contacting you sooner. Your article ended with the following statement attributable to Professor Bruce Babcock: “Of the $13 billion in support for crop insurance, more than $7 billion went to the companies. Farmers received $6 billion in net indemnities,” Babcock testified. “Crop insurance failed the cost-effectiveness test, because it simply makes no sense for taxpayers to spend $13 billion to deliver $6 billion in net payments to farmers.” I take exception with these statements for two reasons: (1) the supposed “efficiency/effectiveness” metric does not accurately measure either efficiency or program benefits and costs and (2) the numbers reported are for 2008 and 2009; they look backward at only two selected years and do not reflect recent program changes and future expectations.

Issue (1). The metric — $7 billion “to the companies” compared with farmers receiving “$6 billion in net indemnities”— does not accurately portray the underlying economics of crop insurance. Let me explain why it is misleading and not a useful comparison.

Farmers’ net income (indemnities less farmer premium) is being compared to company gross income (A&O payments plus underwriting gains). A&O is a producer subsidy paid to the companies on behalf of the producer. The appropriate comparison would be net income to net income. That comparison shows farmer net income for 2008 and 2009 of $6 billion and company net income of, at most, $3.4 billion (assuming A&O payments equal delivery expenses), not $7 billion. In fact, company income would be less than $3.4 billion, as actual delivery expenses for 2008 exceeded A&O payments (this can be found in the Grant Thornton analysis on company profitability). Final expense data for 2009 is not yet available, so company net income cannot yet be determined exactly.
Benefits of crop insurance should not be inappropriately measured as net indemnities to farmers. Farmers buy and benefit from insurance even when indemnities are zero. As you are aware, crop insurance provides farmers with the opportunity to better manage their marketing plans and obtain financing from year to year. Although these types of benefits are difficult to measure explicitly, they are of value and Babcock fails to acknowledge them.

Issue 2. Using only two years, 2008 and 2009, to judge the program is also inappropriate. Because prices and yields vary greatly from year to year, crop insurance premiums and performance are better judged on long-term experience. Moreover, while 2008 may have been a typical year, 2009 had the third lowest level of losses relative to premium in the 29 year history of the program. It was a rare year, which distorts Babcock’s metric. The metric also does not reflect the changes in the new Standard Reinsurance Agreement (SRA), which reduced company funding by $6 billion over 10 years as compared to expected funding prior to the new SRA, nor does his data fully reflect the cuts made in the 2008 Farm Bill. If premiums remain at this year’s level of less than $8 billion, and RMA’s estimates of the expected company rate of return on retained premium for 2011-2015 are used, then future expected net income (net underwriting gains) of the companies would range from $1.0 to $1.2 billion per year, about 30% less than the level used by Babcock. In addition, A&O payments are capped in the new SRA at about $1.3 billion per year, again about 30% less than the level used by Babcock.

I certainly have no issue with articles that comment on crop insurance program costs. My only hope is that such articles make meaningful comparisons and use relevant data.

Thanks again for the recent interview, and please feel free to contact me if I can answer any questions you may have in the future.


Tom Zacharias
National Crop Insurance Services