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Crop insurance jitters

After drought, crop insurance indemnity payments could be one-sixth of a record $122 billion in 2012 U.S. net farm income. But this success makes it a political target – just one concern farmers have about the program.

Government costs will rise as it pays part of what Kansas State University economist Art Barnaby estimates to be $24 billion in loss claims from farmers for 2012.

Bruce Babcock, an Iowa State University economist who has criticized the size of federal payments to insurers, questions whether insurance is making crop production nearly risk-free for farmers. “The payouts are going to be so large. It's not the crop insurance companies that are going to be paying them out – it's the taxpayers,” he says “One would think that some in Congress would look at that amount and ask, ‘Are we really getting a good deal for our money?’ ”

Babcock believes that one way to cut crop insurance costs for taxpayers would be to offer slightly lower levels of coverage. “The whole idea that you take all of the risk out of crop production would go away,” he says.

“This drought has made me aware of how much risk is being taken out at 85% revenue protection,” says Babcock, who owns a farm in Iowa that he leases on a crop-share basis.

Kansas State's Barnaby is trying to estimate how much the government will actually pay this year on crop insurance losses. It's not easy. USDA's Risk Management Agency (RMA) signs a standard reinsurance agreement with each of 16 companies approved to sell crop insurance. The agreement can vary in each state where a company sells insurance. If a company has an underwriting loss in a state (it pays out more for crop losses than it took in as premiums), then the federal government pays part of the losses. The bigger the loss, the more the federal government kicks in. This fall, state loss numbers by company weren't public. Barnaby could use only nationwide estimates.

Premium subsidies have grown

Crop insurance critics tend to focus on farmers' loss claims like this year's $24 billion. But that overstates government exposure. Last year, for example, insurance companies and USDA made $10.8 billion in indemnity payments for crop losses, a record then. Yet, “2011 was also a record premium year: $11.9 billion,” Barnaby says. “As a result, there was about a $1.1 billion underwriting gain, not a loss.” USDA does subsidize those farmer premiums and part of insurance company costs, as well as pick up a share of the losses. In 2011, the government's share of losses was about $500 million, Barnaby says.

Losses from 2012 will cost more. RMA expects farmer claims to approach $24 billion. Subtracting more than $10.3 billion in premiums leaves an underwriting loss of almost $14 billion.

Another indicator is the loss ratio: total crop loss indemnity payments divided by total premiums. For 2012, it's 2.35, meaning the crop insurance program is paying out 2.35 times more than premiums it took in. It's the second highest in 25 years, topped by a loss ratio of 2.7 in 1988. Most years, the loss ratio is smaller than 1; the program takes in more than it pays out. Some surplus goes into the federal treasury, Barnaby says.

Critics might call those ratios misleading. They lump together farmers' insurance premiums and government premium subsidies ($6.5 billion for 2012). Farmer share of premiums has been dropping, from 75% in 1988 to under 38% in 2012. The loss ratio for just the farmer share of premiums was 3.52 in 1988. This year it's 6.28 – the program pays out over six times what farmers paid in.

If budget cutters target crop insurance, Barnaby has his own ideas. Like many insurance experts, he believes capping premium subsidies based on income could weaken crop insurance. A better way to save costs might be to increase all farmers' share of the premium by 5 percentage points, from 38% to 43% (including 5% of catastrophic coverage), Barnaby says. “That cuts the cost by $2 billion over 10 years. I don't think many would drop coverage. They'd complain.”

Such changes aren't on tap for 2013.

“Rates will automatically increase on farmers with losses, but premiums may be higher next year because of higher volatility or higher market prices,” Barnaby says. “But RMA won't change rates for a given level of APH by county for next year. In fact, I expect RMA to wait several years before making large changes to rates.”

Steve Griffin, an economist and consultant who developed crop-hail insurance for several companies, believes that a recent RMA rule on add-on policies could make heavily discounted crop-hail insurance more expensive in 2013.

“This is a real game changer if RMA actually does enforce it or even if the companies just believe RMA will enforce it,” says Griffin. The rule “removes an entire class of weapons used by companies and agents to compete for farmers' business.” (Griffin shares his views below.)

Barnaby isn't certain of big hail premium increases. “Companies can still underprice their hail and other private products, but they cannot require a farmer to buy their multi-peril policy as a condition to buy hail from them,” he says.

Rule May Hike Hail Premiums

A new rule from USDA's Risk Management Agency (RMA) says, “An AIP (approved insurance provider) or agent cannot require that a producer purchase an MPCI (multi-peril crop insurance) policy from the AIP or agent in order to be eligible to purchase a private crop insurance policy or endorsement offered by that AIP or agent.” Until now, crop insurers and agents have offered private insurance at rates less than expected losses to entice farmers to buy their MPCI from them.

The new rule takes effect for all MPCI policies with sales closing dates or cancellation dates starting in 2013.

Farmers could see crop-hail and other MPCI-related endorsements premiums skyrocket in 2013. Some products or endorsements may not be offered at all.

The unparalleled underwriting losses sustained in 2012 due to the widespread drought were already going to put upward pricing pressure on MPCI loss leaders and reduce underwriting capacity.

RMA doesn't regulate private crop insurance products, a duty left to state regulators. However, the standard reinsurance agreement requires AIPs to file their supplemental products that aren't reinsured with RMA for approval so they don't create greater risk for MPCI policies. In addition, under the Federal Crop Insurance Act, RMA has the authority to prohibit any rebate or inducement for any producer to buy federal crop insurance from a particular crop insurance company or agent.

MPCI is different from other insurance. There is no price competition. All companies have the same RMA-set premium rates. So as states have allowed price competition among companies with other policies, they have quickly learned to market crop-hail and other supplemental coverages as loss leaders. This entices farmers and agents to place their profitable MPCI policies with those companies.

In 2011, an average hail loss season, insurers suffered crop-hail underwriting losses in excess of $350 million, mainly due to inadequate rates (rates with expected loss ratios above 100). The losses ate into MPCI underwriting profits, causing some companies to raise crop-hail rates in 2012. They lost market share to those who didn't.

The new rule hits independent agents hard and hampers their ability to compete.

The competitive advantage may shift toward noninsurance delivery partners. Synergistic agribusinesses are displacing traditional pure retail insurance agents. Farm lenders have encouraged farmers to secure insurance from them. Agents tied to seed providers allow greater access to the latest technology. Agents with grain marketers provide free marketing services, exotic contracts, and improved grain basis bids. Yet, traditional retail insurance agents are competitive and innovative. They will find a way to compete.

- By Steve Griffin

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