Federal Crop Insurance Programs: Historic Performance, Contemporary Issues prepared by: Gary Schnitkey, Bruce Sherrick, Bob Hauser, Paul Ellinger Agricultural and Consumer Economics University of Illinois at Urbana-Champaign August 2006 ● iFAR ● integrated F inancial A nalytics and R esearch, LLP

Outline:  Executive summary: Corn and Soybeans have experienced lower per acre payments than other major crops Loss ratios below targets Significant geographic concentrations Non-uniform effective subsidization by crop, region.  Background: iFarm and farmdoc crop insurance evaluation tools (online) Subsidy structure, pool structure, SRA, etc. Operating elements of Federal crop insurance programs  Loss ratio data and distribution: Premiums and payments by crop and region  Summary and implications: What does it mean and where to from here

Loss Ratios  Loss Ratio = Insurance Payment / Total Premium  A loss ratio of 1.00 indicates that payments to farmers equal total premiums. A loss ratio less than 1.0 indicates that payments are less than total premiums. A loss ratio of greater than 1.0 indicates that payments are greater than total premiums.  Crop insurance companies share gain/losses with Federal government depending on loss ratio and fund selection by company for assignment of risk.  Overall, loss ratios have averaged.92 since Background…..

Premium and Risk Subsidies Premiums (costs of insurance products) are federally subsidized. Subsidy rates are set in the Agricultural Risk Protection Act of Subsidy rates vary by coverage level and type of insurance. Risk Subsidies as a Percent of Total Premium Coverage Farm Group Level Products Products CAT 100% 50%67% 55%64% 60%64% 65% 59% 70% 59% 64% 75% 55% 64% 80% 48% 59% 85%48% 59% 90% 55% Farm products include APH, CRC, IP and RA. Group are GRP and GRIP

Farmers’ positions  Farmers should make money on crop insurance given a 1.0 total loss ratio.  Example, Total premium is $1 and insurance payment is $1, giving a loss ratio of 1 ($1 payment / $1 premium). If the risk subsidy is 59%. The farmer pays $.41. In this case, farmer makes $.59.  Farmers will not make money when loss ratios are around.6 or less. The.6 benchmark depends on the risk subsidy.

Mythbusters  Often suggested that the Midwest is subsidizing other areas.  A better explanation may be that crop insurance companies make higher profits in the Midwest than in other areas.  Corn, soybeans are key to crop insurance companies’ profitability

Loss Ratios and Related Data Source data unless otherwise indicated:

Total Premiums, U.S., 1995 to 2005

Corn and Soybeans Premiums as Percent of Total Premiums, 1995 to 2005 Corn Soybeans

Total Premiums, U.S., 2005

Per Year Insurance Payments less Farmer-Paid Premiums, Crops, 1995 – 2005 Note: “Payments less farmer-paid premiums” expressed in dollars and may not reflect similar shares of the value of the crop produced. Source data unless otherwise indicated: * Excludes Nursery and AGR policies

Premiums, Payments, Loss Ratios by Crop, 1995 to 2005 by Crop

Premiums, Payments, Loss Ratios for Corn, 1995 to 2005 by State State

Loss Ratios, Corn, 1995 to 2005

Per Acre Payments Minus Farmer Paid Premiums, Corn,1995 to 2005

Premiums, Payments, Loss Ratios for Soybeans, 1995 to 2005 by State State

Loss Ratios, Soybeans, 1995 to 2005

Per Acre Payments Minus Farmer Paid Premiums, Soybeans,1995 to 2005

Premiums, Payments, and Loss Ratios, 1995 to 2005, Lowest Loss Ratio States

Loss Ratios, All Policies, 1995 to 2005

Per Acre Payments Minus Farmer Paid Premiums, All Crops, 1995 to 2005

Some Preliminary Summaries and Implications

Summary and Implications  Corn and soybeans have lower loss ratios than other crops - lower effective subsidization rates as a result.  There is upward bias in premium rates for corn relative to those that are consistent with intended loss ratios. Geography also plays a role.  The bias has not mitigated through time.

Where to from here?  Seek to determine why corn has a low loss ratio.  Likely due to actuarial methods, not politics.  Changing insurance product shares (i.e., movement toward group policies) also important to consider

Where to from here?  Possible factors for analysis: Good weather in corn producing areas Bias in methods for crops with increasing trend-yields or “Trend Acceleration” (would require re-rating at some level) Bias in methods for crops with lower variability Bias in methods due to low participation in early years, changing products

Impacts of the Rules for Calculating APH on the Performance of APH Insurance Seek to determine why corn has a low loss ratio….

Current Rules and Extreme values:  Small sample statistics sensitive to extremes (could be several consecutive years of poor yields, or one or more years of good yields)  RMA noted that it is “the most frequent and consistent concern heard from producers”  There is an incentive to selectively report yields, alter participation patterns  Sample moments are dependent in small samples

Current Rules and Trend issues:  RMA rules ignore trend  Example:  Skees and Reed argue that “either RMA must attempt to adjust APH yields for trends or they must reduce their rates to reflect actual level of coverage provided when trends are not adjusted.”  Average bias = trend*(n+1)/2 Cov. Level Guarantee Expected Yield APH APH Trend = 3

Current Rules: Sample Variability (APH 4,7, and 10-year samples from same sim-farm)

Yield distributions for various APH base periods and “true” Probabilities Coverage Level Y APH * Coverage Level Y1%2%3%6%9%13%19% 7 Y1%2%3%5%7%11%17% 4 Y1% 2%4%6%10%14% TRUE0%1% 3%4%7%10%

Yield distributions for various APH base periods and “true” Bushels Coverage Level Probability under True0%1% 3%4%7%10% 10 Y Y Y TRUE