Insurance Basics: The Risk Pool

March 2016

Corn Crop Destroyed By Drought

All insurance, from auto to life, health, and crop insurance, works best when it expands the number of people it covers. That’s because the broader the participation, the more widely risk can be spread. And by spreading the chance of loss among a diverse group of insureds, premiums become more affordable for everyone involved.

This concept is known as the “risk pool.”

Think of it like this: Car insurance would not work if only a handful of drivers participated – especially if those drivers were accident-prone or heavily ticketed. Insurance companies would be hesitant to offer coverage and premiums would be astronomically high. A deep bench of experienced drivers with safe driving records is needed in the risk pool to balance out the equation and help offset losses.

The same can be said for health insurance. Why else do you think there was so much discussion on enrolling young, healthy people during the Affordable Care Act debate?

Crop insurance is no different, except crop insurance is about acres covered, not the number of farmers participating. If 1,000 acres is farmed by one farmer or three smaller operations is of little to no consequence. Getting the 1,000 acres covered is the key to expanding the size of the risk pool.

Widening the risk pool is so important that many forms of insurance encourage participation through incentives or mandates. If you have a mortgage, for example, you are obligated to carry insurance. State laws require auto coverage. Health insurance is aided when employers and the government help cover a portion of the premium.

In the case of crop insurance, these incentives didn’t always exist. As a result, coverage was expensive, policies were unavailable for many crops, and few people were insured. And when disaster struck, farmers looked to Congress to help them rebound through expensive, unbudgeted disaster legislation.

In fact, in the early 1990s, less than 30% of farm acreage was insured and farmers were vulnerable to risk. Having been stung by $70 billion worth of disaster bills since 1989, lawmakers needed to find a way to boost crop insurance participation.

Congress expanded the size of the risk pool through a three-pronged strategy.

First, it said crop insurance must be available to all – farmers couldn’t be excluded because they grew canola instead of corn or because they farmed in California instead of Connecticut. Then, the government invested in the development of new policies for crops, regions, and farmers that were traditionally underserved. Finally, it incentivized participation by discounting farmers’ premiums.

And the results speak for themselves. Today, 90% of acres are covered, taxpayer-funded bailout packages are a thing of the past, and farmers get assistance quickly when they need it thanks to private-sector efficiency.

Yet, despite these advances in modern risk management, some of agriculture’s political opponents have demanded that these investments be unraveled and that we return to the old inefficient and expensive model.

These farm policy critics want to exclude farmers with large operations from the system and cap benefits for all growers. Doing so would remove large swaths of acres from the risk pool, alienate experienced farmers with lower risk profiles, and ultimately make it harder for smaller, beginning farmers to get insurance coverage.

Just like removing all the safe drivers from auto insurance, that would be a wreck for everyone involved – including taxpayers.