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Premium Payments Why Crop Insurance Costs Too Much Premium Payments Why Crop Insurance Costs Too Much by Vincent H. Smith Premium Payments Why Crop Insurance Costs Too Much by Vincent H. Smith Introduction Agricultural insurance has become an increasingly important component of the farm program over the past decade. Since 2007, government subsidies for crop insurance have averaged about $5.6 billion per year, representing over one-third of total expenditures on income transfers and other government payments for programs targeted directly to farmers. However, about 58 per- cent of those expenditures have ended up in the hands of agricultural insurance companies and agricultural insurance agents. In fact, since 2005, on average, the agricultural insurance indus- try has received $1.44 for every dollar farmers have received in crop insurance subsidies. Vincent H. Smith ([email protected]) is a professor of agricultural economics in the Department of Agricultural Economics and Economics at Montana State University. 1 Thus, the US federal crop insurance program has offer multiple-peril crop insurance (MPCI), one in become one of the most expensive ways of trans- 1919 and the other in 1922, collapsed almost ferring income to farmers while, at the same time, immediately. In the 1920s, several congressmen and supplying products that most farmers would Henry Wallace, a future secretary of agriculture, never buy absent subsidies. Further, the program expressed support for the concept of a federally involves many products that generate moral- managed program. However, no federal action was hazard behavior by farmers and waste resources. taken until, in the aftermath of the Dust Bowl drought Nevertheless, the program is likely to continue for years of 1934 and 1935, and in the maelstrom of a the foreseeable future, and to expand even further vigorous presidential campaign, Franklin Roosevelt as livestock operations seek to benefit from a sub- promised farmers in the Midwest and southern sidy pool that until recently has been the domain plains that his administration would establish a of crop producers. Aside from substantial support commission to create such a program; the commis- for the program from agricultural organizations sion delivered on Roosevelt’s promise in 1938.1 and insurance industry lobbies, it has broader The initial program, managed by the newly estab- political appeal as a Good Samaritan program that lished Federal Crop Insurance Corporation (FCIC),2 helps people when they appear to be in trouble. was offered for a limited number of crops (wheat and In this context, this paper begins by examining corn) in a limited number of counties, and farmer- the origins and evolution of the US crop insurance paid premiums were intended to cover indemnity program and provides an overview of its complexity payments. However, several management follies and diversity with respect to individual insurance (including allowing local farmer-based committees to products. The program’s growth in terms of subsidies determine expected yields) and an inherent adverse- and overall actuarial performance is then described. selection problem resulted in what were then viewed Next, the economic issues surrounding the program as substantial losses and the discontinuation of the are examined, including concerns about delivery program in 1941. The program’s apparent demise was costs and the supply side. The paper ends with con- relatively, and perhaps regrettably, brief, and by 1944 clusions and recommendations for policy change. the FCIC was back in the business of offering MPCI The major recommendations are as follows. Ideally, yield contracts to some farmers in some counties for the entire crop insurance program should be aban- wheat, corn, and cotton. The program remained a doned. However, given that subsidized crop insur- relatively modest exercise in government support ance is here to stay—at least for a while—first, the until the early 1980s. At that point, tired of providing subsidized insurance products should be designed to what was described as free insurance through a minimize incentives for moral-hazard behavior, standing disaster aid program that operated during which almost always results in wasted resources. the 1970s, President Jimmy Carter proposed and Second, the program should be structured to mini- Congress passed the 1980 Crop Insurance Act.3 The mize delivery costs. Third, insurance subsidies should 1980 act mandated the rapid expansion of MPCI to as be capped on a per-farmer basis to minimize adverse many counties and crops as possible, but only income redistribution (taking from the relatively poor envisioned offering yield insurance. to disproportionately benefit the relatively rich). Between 1980 and 2010, the federal crop insur- ance program grew like a weed, both in scope (num- bers of crops and geographic regions covered) and A Brief History of Crop Insurance complexity (array of different products), mainly because of substantial increases in subsidies and con- Multiple-peril agricultural insurance did not exist gressional mandates. In 1994, the Crop Insurance until the late 1930s. Two commercial attempts to Reform Act increased subsidies and expanded the 2 American Boondoggle: Fixing the 2012 Farm Bill Table 1: A Taxonomy of Multiple-Peril and Index-Based Agricultural Insurance Products MPCI: Individual Farm Plans Index Insurance: Area Plans Yield and Revenue Insurance Offered for single crops, multiple crops, Offered for area yield and revenue crop quality, and whole-farm revenues, (typically on a county basis for yields sometimes with riders covering quality using national prices) losses (for example, malt barley and tobacco) Weather Insurance Not offered on a farm-by-farm basis Offered using single and multiple indicators for forage and hay (weather and temperature) Vegetation Insurance Offered (at least in the United States) Offered for forage and hay (using for hay satellite-based vegetation indexes) Commodity Price Insurance Not offered on the basis of individual Offered using national and futures price farm prices information (for example, Livestock Risk Protection and Livestock Gross Margin products for cattle, dairy, and hogs) allowable scope of insurance products; in 2000, the federal agricultural insurance is now available for over Agricultural Risk Protection Act (ARPA) further 130 different crops and livestock nationwide, and increased subsidies, further expanded the potential over 80 percent of the planted area eligible for federal array of products, and required that the Risk crop insurance is currently insured. Management Agency (RMA) introduce a crop cost-of- The evolution of the federal crop insurance pro- production product and products that cover live- gram since 1980 is reflected in figure 1 with the stock.4 In addition, the 2008 Farm Bill required number of crop acres insured and participation rates farmers who wanted to be eligible for the new (measured as the ratio of insured acres to total Supplemental Revenue (SURE) standing disaster planted crop acres) and in figure 2 with total liabil- aid program for crops to purchase subsidized federal ity and total premiums (the sum of farmer-paid pre- crop insurance. The 2008 Farm Bill also expanded miums and government-premium rate subsidies). a “508h” process (introduced in the 2002 Farm Bill) Between 1981 and 1988, participation fluctuated that, through private initiatives, now allows farm between 9 and 17 percent but jumped to 31 percent groups and insurance companies to seek funding for in 1989 and 1990, years when recipients of disaster developing other new agricultural insurance policies payments in 1988 were required to purchase cover- for which premium subsidies may be provided. age to remain eligible for other federal commodity Currently, farmers pay about 46 percent of the esti- program benefits. Subsequently, between 1991 and mated actuarially fair premium for the most widely 1993, participation rates fell to about 25 percent used federally subsidized insurance instruments (rev- but increased substantially after passage of the enue and yield products based on a farm’s actual pro- 1994 act as direct premium subsidies to farmers duction histories), and about one-third of the total increased to between 40 and 50 percent of estimated cost of the products. The federal government picks actuarially fair premiums. The introduction of even up the other two-thirds of the outlays.5 As a result, larger subsidies in 2001, as a result of the 2000 Premium Payments: Why Crop Insurance Costs Too Much Vincent H. Smith 3 Figure 1: Total Insured Acres, 1981–2010 300 products, covering over 130 crops and Total Acres Insured Percentage of Planted Acres Insured 120% forages as well as beef cattle, dairy cattle, P 250 e r ) c e s 100% and hogs. Table 1 provides a taxonomic n n t o a i l l g i overview of the products that the RMA 200 e M ( 80% o f d P currently manages. The most widely used e r l a u n s 150 t n e products are based on a farm’s actual I 60% d s e A r c c production yield history (APH) and its r A e l 100 40% s a I t n current yields. The APH products come in o s T u r e two general forms. The first is pure yield 50 20% d insurance, under which farmers receive a 0 0% payment when their actual yield is less 1981 1983 1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 Year than the yield that triggers losses. The SOURCE: Data on insured acres were obtained from the US Department of Agriculture (USDA) Risk Management Agency (RMA); trigger yield is established by multiplying data on annual acres planted to crops were obtained from the USDA National Agricultural Statistical Service. the average of the farm’s APH yield7 by a coverage level selected by the farmer. Losses are valued at a predetermined Figure 2: Total Liability and Total Premiums, 1981–2009 price also selected by the farmer. Revenue $100,000 $12,000 insurance uses futures-market contracts Total Liability Total Premiums $90,000 to establish expected harvest-time prices $10,000 $80,000 when the insurance is obtained (at plant- T o ) t s ing and program sign-up time).
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