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Economist: Senate's Durbin-Brown bill would change current farm safety net

10/18/2007 @ 7:22am

Senators Dick Durbin (D-IL) and Sherrod Brown (D-OH) have introduced legislation that would change the current farm safety net. The Durbin-Brown plan is a Group Risk Income Protection (GRIP) with no Harvest Revenue Option but based on state expected yields rather than county yields.

Durbin-Brown is effectively a "put option" on expected state revenue. The Durbin-Brown revenue guarantee is based on a trend adjusted yield using linear regression based on the state yields for the 27 years from 1980-2006. Once the trend yield is calculated then USDA would forecast off of the trend line to generate the expected state yields for future years of the farm program based on this selected set of state yields.

The Durbin-Brown revenue guarantee is the expected state yield based on the Durbin-Brown formula times the Durbin-Brown strike price times 90%. The state payment is then allocated to the farm level through a formula but if there is no state payment to allocate then there are no farm payments. The Durbin-Brown strike price is the three year average Crop Revenue Coverage (CRC)/Revenue Assurance (RA) price subject to a 15% price cap and cup.

The revenue to count against the Durbin-Brown guarantee is the observed state yield times the CRC/RA harvest price. The legislation does not specify using CRC or the RA price but it could make a difference. The CRC price is capped at $2 for wheat. Therefore if prices increase beyond the $2 limit then the CRC harvest price will be lower than the RA harvest price.

The CRC lower price would reduce the number of dollars to count against the guarantee and increase the Durbin-Brown payment. However, only Portland wheat has hit the CRC price limit but it could happen on other crops in the future with a short crop. All of the analysis in this paper used CRC prices.

Many policy observers believe there will be some type of revenue guarantee similar to Durbin-Brown in the farm bill as an option. It will be presented as a choice but with current strike prices in Durbin-Brown that are much higher than the effective target prices and loan rates, economics will cause farmers to select the Durbin-Brown option. Durbin-Brown would replace the counter-cyclical and marketing loan payments.

It clearly makes a difference in the expected yield depending on the crop years selected to calculate the expected trend yield. Just eliminating one year and using 26 years to set the state expected yield would reduce Kansas corn yield by about 3.5% while increasing Iowa corn yield by about 0.5% and Kansas wheat yield by 0.9%. Kansas wheat would prefer the 18 years 1989-2006 be used to set the Durbin-Brown expected yield. That change would increase the expected Kansas wheat yield by more than five percent while reducing the Kansas corn yield by more than 10%.

The longer data set provides more observations and reduces the effects of recent weather problems. Also it is better to prorate the payment than increase the deductible for budget reasons. If one were to set the deductible high enough there would be no claims.

The argument for deducting Durbin-Brown payments from crop insurance indemnity payments is to prevent farmers from being paid twice for the same loss, but is that true? Let's assume a revenue insured corn farm with a 133 bushel APH times a $4 planting price times 75% coverage would generate a revenue guarantee of $400. The farmer's expected revenue is the average yield of 133 bushels (if there have been recent weather problems, the farmer's expected yield would be higher than the aph) times $4 new crop price equals $532.

Let's assume the farmer has a yield loss and produces 100 bushels and the price falls to $3. This farmer has $300 of sales to count against the $400 guarantee and the indemnity payment is $100 (less premium paid). The farmer's total revenue is the sum of the $300 of sales and a $100 crop insurance indemnity payment for a total of $400 and he is short $132 from the expected revenue of $532.

Let's assume the state revenue was also low and this farmer received a Durbin-Brown payment of $50. Under the proposal the $50 Durbin-Brown payment would be deducted from the crop insurance indemnity payment and the farmer would be paid the net indemnity payment of $50. The farmer's total revenue is the sum of the $300 of sales, $50 Durbin-Brown payment and a $50 crop insurance indemnity payment for a total of $400 and he is short $132 from the expected revenue of $532.

Durbin-Brown is not a perfect safety net. Durbin-Brown will have reduced payments in states with "high" negative price-yield correlation because when low yields occur they cause higher prices, especially at the state and national level. The negative price-yield correlations are greater in the core growing states, i.e. Kansas wheat, Iowa corn. Because of a near record 24% increase in wheat prices combined with a state yield that was more than 25% below the expected 2007 yield, the Durbin-Brown plan would not have triggered payments based on 2007 Kansas wheat losses.

The expected state revenue for 2007 Kansas wheat based on the Durbin-Brown formula would have been 36.7 bushels times 90% times $3.87 Durbin-Brown planting price equals $127.83 revenue guarantee. The revenue to count was the observed 2007 state yield of 27.3 bushels times the Durbin-Brown harvest price of $5.62 equals $153.43.

Because the revenue to count exceeds the guarantee, the 2007 Kansas wheat Durbin-Brown payment is zero. It would have required a Kansas yield that is below 22.7 bushels to trigger payments. The 2007 Kansas yield was 35.6% below the expected but it would require a yield loss greater than 38.1% to trigger 2007 Durbin-Brown payments on Kansas wheat.

The 2007 Kansas wheat yields ranged between zero in Central Kansas to a bumper crop in Northwest Kansas. Crop insurance will provided indemnity payments based on either farm level or county level yields. If there had been a Durbin-Brown payment this year, farmers with a bumper wheat crop would also have received the payment while crop insurance targets payments to farmers with losses.

The proposed permanent disaster program would also provide little help this year because Kansas' fall crop yields will likely offset the wheat losses, unless the farm was a single enterprise wheat farm with losses.

Is the real issue overrating of crop insurance for corn or are policy makers buying the argument by some economists that government can provide crop insurance services cheaper than the private sector? Clearly many people would find the argument that government can provide the same level of service as the private sector for a lower cost to be very unconvincing. However, the argument of overrating of crop insurance in the Corn Belt has some supporting evidence.

If the issue is rating then policy makers need a thorough review of RMA rating methods by a consulting actuary. It has been several years since Milliman & Robinson completed its review of RMA rating methods. Coverage levels of 80% and 85%, CRC, RA, RA-HPO, GRP, GRIP, GRIP-HRO, dollar plans AGR and livestock products have been added to the RMA product list.

A complete review of RMA rating methods on all of these new products and there interaction by a consulting actuary would be helpful in a report to Congress before major changes are made to rates.

Why would one believe tying crop insurance and Durbin-Brown together will fix any crop insurance rating problems? There is some evidence to support the idea that corn is overrated but probably not as overrated as assumed by many corn farmers. How much the rates are "excessive" is not so simple and clearly cannot be based on a short number of years when droughts are infrequent but severe in the Corn Belt.

While the recent losses have been low, one needs to base rates on at least 20 years of expected indemnities. The base rate on corn and the rate relativity may not be correct, but any changes in rates should be based on loss cost estimates.

Perhaps it would make more sense to deduct any permanent disaster aid payments from the Durbin-Brown payment. This would reduce the cost of Durbin-Brown and the permanent disaster aid payments are funded from a different budget source.

Tying Durbin-Brown with permanent disaster aid payments rather than crop insurance would reduce any administrative problems caused by payment limits because both programs will likely include payment limits, while there is no limit on crop insurance payments that have significant funding from farmer paid premiums.

Senators Dick Durbin (D-IL) and Sherrod Brown (D-OH) have introduced legislation that would change the current farm safety net. The Durbin-Brown plan is a Group Risk Income Protection (GRIP) with no Harvest Revenue Option but based on state expected yields rather than county yields.