NCIS Comments on RMA's Second Draft of the 2011 SRA And
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Response to the Risk Management Agency’s Second Draft of the Standard Reinsurance Agreement and Appendices Issued on February 23, 2010 Submitted by National Crop Insurance Services, Inc. On April 9, 2010 National Crop Insurance Services, Inc. 8900 Indian Creek Parkway, Suite 600 Overland Park, KS 66210-1567 National Crop Insurance Services, Inc. April 9, 2010 Contents Part Page 1. Overview……………………………………………………….. 3 2. Concerns with the Financial Provisions of the Second Draft.. 3 3. SRA Provisions………………………………………………… 26 National Crop Insurance Services, Inc. 2 April 9, 2010 1. Overview NCIS appreciates the ongoing efforts of USDA’s Risk Management Agency (RMA) to meet and discuss its second draft of the 2011 Standard Reinsurance Agreement (SRA) and the appendices. The industry continues to have serious problems with the second draft. With these comments, which include a new proposal for reinsurance terms of the SRA, and the negotiating meetings scheduled to take place soon, NCIS believes that a workable and mutually acceptable SRA and appendices can be developed. On February 17, 2010, RMA officials presented the key features of the financial provisions of the second draft of the SRA at the crop insurance industry’s annual meeting. On February 23, 2010, RMA released the text of the second draft, including the texts of draft Appendices I-IV, and requested comments by March 22, 2010 (Manager’s Bulletin No. MGR-10-002). On March 19, 2010, RMA extended the comment period to April 9, 2010 (Manager’s Bulletin No. MGR- 10-002.1). These comments are being provided in response to the April 9 call for comments on April 9. While NCIS values RMA’s efforts to respond to industry concerns with the first draft, there has been insufficient progress toward an acceptable SRA. These comments present the industry’s primary concerns with the second draft and again provide a proposal to address these issues. Some of these comments have been provided informally to RMA in recent weeks. The industry remains concerned with the insufficient data and analysis provided by RMA and whether RMA has appropriately addressed the many factors that will determine industry performance under the second draft SRA. Consequently, these comments include questions regarding RMA’s data, methods, and analyses that are either unknown to the industry or are unresolved. The next section addresses the financial provisions, while all other major issues are identified in Section 3 of this document, headed “SRA Provisions.” Included with these comments are red-lined edits to the draft SRA prepared by RMA and the four accompanying appendices. Those attachments contain all revisions to the contract documents which NCIS and its work groups propose. 2. Concerns with the Financial Provisions of the Draft SRA This portion of the response presents the industry’s financial concerns with the second draft 2011 SRA and proposes alternatives. Key financial concerns continue to be the excessive funding reductions and program structural changes that will not achieve the intended objectives. The draft’s excessive, open-ended, and unnecessary administrative and informational requirements also have financial implications, and these concerns are addressed in the section on SRA Provisions. A&O Provisions of the Second Draft SRA Conceptual Problems with the Use of RMA Reference Prices At present, RMA establishes the prices of all insurable commodities using recent crop prices, including information from commodity futures markets reflecting the market value of the National Crop Insurance Services, Inc. 3 April 9, 2010 commodities insured. These prices are then used to determine premium, and ultimately used to calculate A&O payments as a percentage of the premium. A&O payments are intended to cover the delivery costs of the program. Basing A&O payments as a percentage of premium is consistent with the long-standing business practices of the insurance industry. RMA’s SRA proposal would establish A&O payments based on two categories: (1) reference crops: corn, soybeans, wheat, upland cotton, barley, rice, and grain sorghum, and (2) non- reference price commodities: essentially all other crops. This proposal decouples the linkage between the prices used to establish premium and the prices used to determine A&O payments. In RMA’s proposal, the reference price crops are segregated into a separate group for the purpose of computing A&O payments. Instead of using the current prices of the insurable commodities, which reflect the market value of these crops, RMA uses an historic average of season-average prices received by famers, as reported by the National Agricultural Statistics Service. These reference prices are decoupled from the current market value of these crops. The reference prices are an average of farm priced during the period 1999-2008 and would be fixed for the life of the SRA. As noted in Table 1, compared with current commodity prices, this approach results in an A&O reduction of approximately 30 to 40%: Table 1. Field crop base and reference prices Crop 2010 CRC base 2013 reference price Reduction prices (Group 1) Corn $3.99 per bu. $2.57 per bu. 36% Soybeans $9.23 per bu. $6.43 per bu. 30% Upland cotton $0.72 per lb. $0.52 per lb. 28% Wheat $5.43 per bu. $3.92 per bu. 28% Barley $3.70 per bu. $2.93 per bu. 21% Rice $0.14 per lb. $0.083 per lb. 41% Sorghum $3.90 per bu. $2.43 per bu. 38% In addition to segregating the principal field crops into a separate group, RMA’s proposal also separates the states into three groups, without explicit justification. Group 1 is Cornbelt states: Illinois, Indiana, Iowa, Minnesota, and Nebraska. Group 3 is defined as the “underserved/low participation” states, including Maine, New Hampshire, Vermont, Massachusetts, Rhode Island, Connecticut, New York, Pennsylvania, New Jersey, Maryland, Delaware, West Virginia, Nevada, Utah, Wyoming, Hawaii, and Alaska. Group 2 is all other states. The Group 1 category is simply the most profitable states in the Cornbelt. Group 3 “underserved/low participation” states, with the addition of Alaska, were defined in Sections 522 and 524 of the Federal Crop Insurance Act. By default, Group 2 is everything else and primarily represents the Plains and Western states and the southeast region of the United States. A&O payment and reinsurance provisions vary by state Group, as described below. The rigidities and discriminatory effects by crop and state of the fixed reference price formula. Determining A&O payments using fixed reference prices has a number of conceptual problems and would have adverse impacts on the crop insurance program. Using an imputed premium (“adjusted net book premium”) to determine A&O payments is simply an artifice designed to cut National Crop Insurance Services, Inc. 4 April 9, 2010 A&O payments to a predetermined level—a budget target—and keep payments close to that level over time regardless of program changes. There is no methodological basis for use of the 1999-2008 period. It does not reflect any long- term projections of market prices (e.g., projections of CBO, USDA, or FAPRI), and it reflects a recent, but arbitrary, period of history. By fixing the imputed premium for the purposes of calculating A&O payments, the reference price method ignores all the program and market factors that are likely to increase (or possibly decrease) future delivery costs in a dynamic and growing program. RMA’s reference price procedure discriminates against the insurers of major field crops as defined by RMA, namely, corn, soybeans, wheat, cotton, grain sorghum, barley, and rice. This means that states that have a high proportion of the seven field crops will face much sharper A&O reductions than other states. Many of these states are also facing the sharpest underwriting gain reductions under the proposed SRA. Insurable crops outside the set of reference commodities receive no reduction in A&O payments. RMA does not explain its justification for its delineation of reference crops versus non-reference crops in its SRA proposal. The discriminatory effect of RMA’s reference price procedure is detrimental to the underserved/low participation Group 3 states where the seven crops are important. RMA proposes to reduce this adverse effect compared with the first draft of the SRA by providing a 5% price increase for Group 2 and 3 states. In 2013 and beyond, the corn reference price is $2.57 per bushel in Group 1 and $2.70 in Groups 2 and 3. This price bump fails to address the problems introduced by the use of reference prices and introduces yet another discriminatory effect—different prices for the same crop in different states. USDA’s baseline season-average corn farm price averages $3.71 per bushel during 2011-2015, which means the cut in A&O for corn in Group 3 states is from $3.71 to $2.70 or a still very large 27%. Compared with policy base prices, which are futures prices and normally exceed farm prices, the cuts would be even larger. Consider some of the Group 3 states: corn and soybeans are the number 1 and 2 crops in production value in Delaware; corn and soybeans are the ranked number 2 and 3 in Maryland; wheat and feed grains are ranked number 3 and 5 in New York and number 2 and 4 in Pennsylvania. The proposed A&O cuts would reduce the incentives for companies to participate in the underserved states, in conflict with RMA’s stated objectives for these negotiations. The reference price procedure also discriminates against states in Group 2 which predominantly grow the reference crops and have poor actuarial experience. In these states, A&O is critical to the insurance provider. Since poor actuarial performance is a strong disincentive to write insurance in a state, A&O payments become even more important in ensuring good service in low return states.