Are you among the many farmers who think forgetting the March 15 crop insurance deadline is equal to forgetting to plant in the spring? Or, are you among the others who think it is a waste of money, since you rarely collect any indemnity payments? USDA’s financial support of the crop insurance program could have been a contentious issue in the WTO negotiations, but that is a moot point now. However, as the clock ticks down toward the 2007 Farm Bill debate, agriculture is faced with decisions about renovating a program that may have to pass WTO muster in future years, unless another country soon files a complaint against it, as Brazil did against the US cotton program. Such a lightning rod program is not only an expensive security blanket, but potentially lucrative.

Bruce Babcock probably knows the federally subsidized crop insurance program as well as anyone. He’s not only studied it for decades, but also designed crop insurance programs that are only the books with records of success. So his analysis, published in the summer 2006 issue of the Iowa Ag Review, published by the Iowa State University Center for Agriculture and Rural Development is a good place to start.

In a multi-billion dollar taxpayer-funded program, most of the money can be traced. Babcock and collaborator Chad Hart provide some simple math:
1) The 2005 crop insurance program cost taxpayers about $2.5 billion.
2) Farmers received $746 million in net payments for claims.
3) For each $1 paid in, $3.31 was paid out.
4) Since 2001, taxpayers have paid $15.1 billion to pay $8.82 billion in claims.

And you thought the crop insurance premiums you paid in covered all the indemnity payments and expenses for the program! The taxpayer would LOVE to have a USDA program with a zero balance at the end of the year.

Let’s have a brief lesson about crop insurance, with emphasis on brief. A private insurance company will establish a premium, knowing that it will have to pay a specific amount in indemnity payments (that’s what an actuary does), and still have enough to pay its operating costs and provide a profit. If the risk is too large (Gulf Coast hurricanes) then insurance companies will back away from writing policies that create excessive financial exposure. Babcock and Hart say private insurance companies believe that farming creates excessive financial exposure, consequently, USDA’s taxpayer funds are used to cushion the financial blow, as well as keep premiums low enough to entice producers to sign up. (It is ironic that a farmer will enter a season without any crop insurance, yet a risk management company will not go anywhere near farming without someone else covering their risk.)

With recent renovations to the crop insurance program, which include expansion to nearly all crops, and the ability of a farmer to cover up to 80% of his risk, the program has seen significant money flow through it. For example, in 2001 farmers paid in $2.9 bil. in premiums and were paid $2.9 bil. in indemnity payments. However, the USDA invested $1.8 bil. in the program, which paid $626 mil. to insurance companies for administering the program and paying commissions to their agents. Their profit (underwriting gain) was $342 mil. which came from premiums they collected. Because of crop losses in 2002, about $1 bil. more in indemnities were paid out than farmer premiums paid in. The USDA still invested $1.7 bil, to help insurance companies pay operating costs of $743 mil. As a result of the heavy indemnities paid out, insurance companies lost $52 mil. which had to be returned to the USDA. 2003 was more of a wash in premiums and indemnities, but the USDA subsidized the program by nearly $2.5 bil. to help the insurance companies cover their $869 million in administration costs and have an $848 underwriting gain. While the 2005 figures are not yet complete, farmers paid in nearly $4 bil. in premiums, but collected only $2.3 bil. in indemnity payments. Even with that difference, USDA contributed $2.3 bil.

Babcock and Hart say the program is good for farmers, just because of the cost/benefit ratio, “Currently, farmers pay about 41 percent of the amount needed to cover insured losses. This large subsidy means that most farmers will get substantially more back from the program than they pay into it….This premium subsidy is now so large that the average farmer in the program can expect a rate of return on the producer paid premium of 143 percent.“

So, farmers as a whole are doing well from the program. But what about the insurance companies? Their operating costs are consider “A & O,” administration and operating, and that is covered by a percentage of the premiums they collect, which was 31% in 1997, but has fallen to 21.5% this year. Keep in mind acres have grown from 211 million in 2001 to 246 million in 2005, and premiums have increased from $2.9 bil. to $3.9 bil. in 2005.

Guiding the relationship between the USDA and the insurance companies is the “Standard Reinsurance Agreement,” which requires the companies to share the benefits of low risk they have with some of their clients with the USDA, but also requires the companies to take any and all clients whom the USDA deems as eligible.

One of the expensive aspects of the program is the option for farmers to obtain insurance on a crop that may be well within the range of year to year yield variability. With the option of insuring against a yield that may fall below an average, exposure is increased and indemnity payments become expensive. Such 80 and 90% coverage options may be discarded if the World Trade Organization upholds a complaint filed by another country about US agriculture subsidies.

Babcock and Hart suggest program savings could be achieved by reducing the commissions to agents, since farmers are currently familiar with the program and there is less of a need to “sell” it. Also, they suggest the government bear the entire underwriting risk, because USDA is paying out a large underwriting gain, in exchange for companies assuming a small amount of the actual risk.

Summary:
With the rewrite of the Farm Bill next year, there will be opportunities to make significant changes in the crop insurance program. Currently, taxpayers are senior partners in the program, which not only helps farmers manage risk, but also pays insurance companies to do the legwork in program administration. While the companies also share some of the risk of loss, the USDA subsidizes those companies larger amount for them to cover administration and operations, including agent commissions. The crop insurance program also could be a target for an international trade complaint because of the fact farmers get back more in indemnity payments than in premiums they pay.