The US Federal Crop Insurance Program: A Case Study in Rent Seeking

Vincent H. Smith

February 2016

Montana State University Initiative for Regulation and Applied Economic Analysis

Working Paper # 2

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Abstract

Rent seeking is endemic to the process through which any policy or regulatory initiative is developed in the United States and farm lobbies have become some of the finest artists in seeking benefits from the public purse. In doing so they have become especially effective in developing alliances with other interest groups to protect and expand their rents. This study illustrates the process by which coalitions have been formed by farm groups with other lobbies by focusing on the legislative history of a major farm subsidy program over the past four decades, the federal crop insurance program. The study examines how, in the context of three major crop insurance legislative initiatives, regulatory and program innovations for the most part have been designed to jointly benefit farm interest groups and the agricultural insurance industry, at considerable and generally increasing expense to taxpayers. The three major initiatives are the 1980 Crop Insurance Act, through which private agricultural insurance companies gained a foothold in the federal crop insurance program, the 1994 Crop Insurance Reform Act, and the 2000 Agricultural Risk Protection Act.

The major findings of the analysis are as follows. The federal crop insurance legislation and the way in which the USDA Risk Management Agency manages federal crop insurance program are replete with complex and subtle policy initiatives. Nevertheless several major features of the program have been especially important. They include the requirement that RMA compute actuarially fair premium rates and the methods by which RMA requires that those rates be established and a mandate incorporated in the 1994 Crop Insurance Act that a catastrophic loading factor be added to that rate to establish the total premium rate for insurance coverage. In addition, since 1980, in successive legislative initiatives, congress has required that tax payers provide an increasingly large share of the total premium rate through a premium rate subsidy, which now averages 62 percent of the total premiums paid into the federal crop insurance pools. A further administration and operations subsidy is also paid directly to crop insurance companies by tax payers. The companies obtain revenues from the A&O subsiding and underwriting gains, which through a complex reinsurance agreement with the federal government are biased towards companies through a complex set of stop loss provisions.

The central conclusion is that the simultaneous changes in the provisions of the 1980 Crop Insurance, the 1994 Crop Insurance Reform Act, and the 2000 Agricultural Risk Protection Act with respect to how premium rates are set, premium subsidy rates, and the A&O subsidy rate have been designed to benefit both farmers and the crop insurance industry, and almost always at the expense of taxpayers. Even though some policy adjustments, when considered in isolation, may have benefitted farmers and adversely affected the insurance industry, or vice versa, the joint effects of the multiple adjustments included in each legislative initiative have generated net benefits for both sets of interest groups. Thus the evidence indicates that, at least implicitly, coalitions have been formed between the farm lobby and the insurance lobby to obtain policy changes that in the aggregate benefit both groups, as well as banks with substantial agricultural lending portfolios. The upshot has been a thirty five year evolution of the crop insurance

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program into a large, costly (over $8 billion a year) subsidy program that mainly redistributes tax revenues to relatively wealthy farm operators and landowners and to a crop insurance industry that in all likelihood would not exist absent the federal subsidy program.

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Introduction

Rent seeking is endemic in the process through which any policy or regulatory initiative,

including agricultural policy, is developed in the United States and, for that matter almost all

other countries. The process has been well understood by economists for many years (see, for

example, Olsen, 1971; Buchanan and Tullock, 1962; Becker, 1982 and 1985; Peltzman, 1976).

However, farm lobbies seem to have become some of the finest artists in seeking benefits from

the public purse and especially in developing effective alliances with other interest groups to

protect and expand their rents (Babcock, 2015a; Carter et al, 1998; Constantine et al, 1994;

Goodwin and Smith, 2015; Orden and Zulauf, 2015; Rausser and Foster, 1990; Rausser et al,

2011; Smith and Glauber, 2012). Over the past eight decades, those coalitions have involved

downstream and up-stream agricultural businesses (for example, food processors and chemical

companies), environmental lobbies (especially in relation to the current smorgasbord of

conservation programs offered under the 1985 and subsequent farm bills), agricultural insurance

companies and urban and rural groups concerned with the food security and nutritional status of

the poor (but perhaps especially urban groups in the context of farm bill coalitions).

The focus here, however, is on a specific farm subsidy program and how, in the context of three

major legislative initiatives, regulatory and program innovations for the most part were designed

to jointly benefit farm interest groups and the agricultural insurance industry, at considerable and

generally increasing expense to taxpayers. The three major initiatives are the 1980 Crop

Insurance Act, through which private agricultural insurance companies gained a foothold in the

federal crop insurance program, the 1994 Crop Insurance Reform Act, and the 2000 Agricultural

Risk Protection Act. The historical evidence indicates that many key aspects of those legislative

initiatives jointly served to benefit farm interests and the interests of the crop insurance industry.

The approach is as follows. A brief history of the federally subsidized agricultural insurance is

provide in the next section1 in which the core provisions of the three major congressional

initiatives (the 1980, 1994 and 200 Acts) are described and the general structure of the federal

crop insurance program is discussed. A theoretical model of the impacts of the crop insurance

program on the economic well-being of farmers and the crop insurance industry is then presented

1 More detailed discussions of the program’s history are presented by, among others, Kramer (1983), Goodwin and Smith (1995) and Glauber (2013).

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in the third section. The fourth section then presents an assessment of the most important

changes in the federal crop insurance program in each of the three Acts, the extent to which those

changes reflected the joint and separate interests of the farm sector and the crop insurance

industry, and the impacts on federal budget expenditures.

The central conclusion is that for the most part, implicitly or explicitly, the changes in policy

embedded in, especially, the 1994 Crop Insurance Reform Act and the 2000 Agricultural Risk

Protection Act, indicates that, at least implicitly, coalitions have been formed between the farm

lobby and the insurance lobby to obtain policy changes that in total benefit both groups, as well

as many banks with substantial agricultural lending portfolios. The upshot has been a thirty five

year evolution of the crop insurance program into a large, costly (over $8 billion a year) subsidy

program that mainly redistributes tax revenues to relatively wealthy farm operators and

landowners and a crop insurance industry that would in all likelihood not exist absent the federal

subsidy program.2

Economic Efficiency of the US Federal Crop Insurance Subsidy Program

At the outset it is useful to ask whether there is any economic efficiency argument to justify the

existence of US federal crop insurance subsidy program or whether it is simply an income

transfer program. The answer is that the program is almost certainly economically inefficient

because there is no evidence of any substantive market failure. Wright (2014), Goodwin and

Smith (1995, 2010), Smith and Glauber (2012) and many other analysts have consistently

pointed out that, absent substantial government subsidies, at commercially viable prices farmers

do not purchase either index insurance products or farm specific insurance products that protect

farmers against yield shortfalls on their operations and/or low prices. The authors emphasize

that by itself the absence of a product in the market place does not imply a market failure; it just

means that the cost of providing the commodity to the private seller exceeds the price the buyer

is willing to pay. No company offers pet rocks or insurance products that guarantee restaurant

owners their estimated monthly gross incomes from sales for the same reason. The empirical

2 Smith and Glauber (2012) provide a summary of the (then) extant analysis of farmers’ willingness to pay for crop insurance. Those studies uniformly reported that almost no farmers were willing to purchase commercially offered crop insurance if loading factors for administrative and operations costs exceeded nine percent of the actuarially fair premium required to cover indemnities. Loading factors required by companies for even the least costly forms of crop insurance are likely to exceed 20% to 25% of the actuarial fair premium (Smith and Glauber, 2012; Goodwin and Smith, 2013).

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evidence with respect to farm level and index based crop insurance products is simply that

insurance companies require larger premiums than most, if not all farmers are willing to pay for

multiple peril or index insurance (Smith and Watts, 2009; Miranda and Farrin, 2012; Smith and

Glauber, 2012; Goodwin and Smith, 2013(a)).

Given that the absence of a market for a product is no evidence of market failure, the question is

whether there are market failures that prohibit or impede the provision of crop insurance

products and especially multiple peril crop insurance (MPCI), the type of product that in value

terms accounts for 94 percent of all federal subsidized insurance. MPCI products pay farmers

indemnities when their farms’ yields or farm revenues from a specific crop fall below their

expected levels, almost regardless of the reason for the loss (other than poor management or

clear evidence of fraud). The claim made by some advocates for the US agricultural insurance

program, however, is that insurance companies are unwilling to offer multiple peril insurance

because of what they call systemic risk.

Systemic risk, in this context, is defined as the following phenomenon. Frequently, and mainly

because of droughts or other weather events that typically affect large regions, when one farmer

experiences a crop loss so do many other farmers. As a result, it has been argued, insurance

companies engaged in offering coverage for crops cannot hold enough reserves to meet their

indemnity obligations in the event of a major drought or other extensive sources of crop losses.

This analysis, however reflects a misunderstanding of how the insurance industry is organized

because it ignores the existence of reinsurance markets.

For a fee, any primary insurance company can effectively pass on much or even all of the risk

associated with its crop insurance portfolio to a reinsurance company. The reinsurance

company’s portfolio will include many different forms of liability – for example, hurricane

insurance, auto insurance, property and casualty insurance, etc. – with which agricultural

insurance losses are essentially uncorrelated or only weakly correlated. Thus, other things being

equal, agricultural insurance policies are in fact relatively attractive to reinsurers (Wright, 2014).

The major “market failure” justification for why multiple peril and index based crop insurance

are not offered by the private sector, the systemic risk proposition, is therefore an argument

based on a flawed understanding of the role of reinsurance markets and not an example of a

market failure (Goodwin and Smith, 1995; Goodwin and Smith, 2013(a); Wright, 2015).

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A related claim has been that the reinsurance companies do not have the financial depth to cope

with the excessively large losses associated with systemic risk related crop insurance events. As

Goodwin and Smith (2013(a)) note, however, the worst adverse outcome for reinsurance

companies who took on all the risks associated with the current heavily subsidized US federal

crop insurance program book of business would not require them to pay more than $25 billion

dollars in indemnifiable losses in excess of premium revenues. In 2012, for example, the worst

year for the federal crop insurance program in the past quarter of a century, total indemnities

amounted to about 18 billion dollars, and net indemnities to about 12 billion dollars. Over the

past fifteen years, major hurricanes have resulted in net outlays in indemnity payments over

current year premiums that have been in excess of $60 billion by the companies who have

reinsured much of the federally subsidized US crop insurance book of business (for example,

Munich Re and Zurich Re).

Thus the “financial depth” argument is also fundamentally a “red herring” justification for what

is in fact an income transfer program from taxpayers to farmers and a corresponding risk transfer

program from farmers to taxpayers, rather than a genuine risk management program that reduces

the amount of aggregate risk taken by farmers. In fact, as Goodwin and Smith (2013(b)) point

out, there is a substantial body of evidence that the US subsidized crop insurance program

encourages farmers take on more risk by reducing their use of risk reducing inputs such as

pesticides and herbicides and planting crops on highly erodible land where crop loss risks are

higher.

A Brief Legislative History of the US Federal Crop Insurance Program

The federal crop insurance program was initiated through landmark new deal era legislation

proposed by President Franklin Roosevelt in 1937 and signed into law in 1938 (Kramer, 1983).

Multiple peril yield insurance, which no private sector company had successfully offered prior to

1938 (Goodwin and Smith, 1995) and which paid a farmer an indemnity when actual yields fell

sufficiently below their estimated expected yields, was then offered in 1939 by the newly

established Federal Crop Insurance Corporation (FCIC), but only for wheat. Coverage for a

second crop, cotton, was made available in 1941 partly because of intensive lobbying by then

president of the American Farm Bureau, Edward O’Neal, a cotton producer from Alabama

(Kramer, 1983). Subsequently, coverage for additional crops such as corn, barley and potatoes

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was introduced and by 1980 federal crop insurance policies were available for 27 different crops

in at least some counties (Goodwin and Smith, 1995).

Between 1938 and 1980, for the most part congress expected the federal crop insurance program

to be managed by the USDA Federal Crop Insurance so that farmer paid premiums covered

expenditures on indemnities but the federal government covered all administrative and operating

expenses. While that objective was often not achieved, when the ratio of indemnities to farmer

paid premium payments, defined as the program’s loss ratio, seemed likely to persistently exceed

one, congress tended to step in with legislation that required changes to return the program to

“solvency” (Goodwin and Smith, 1995).

In 1980, however, congress, strongly supported by President Carter’s administration, radically

altered the direction of the federal crop insurance program. The 1980 Federal Crop Insurance

Act (FCIA) ushered in an era replete with efforts by Congress, consistently responding to the

pressures and campaign contributions from a plethora of agricultural and crop insurance

lobbying groups, to expand the size and scope of the program and the level of federal subsidies

for insurance premiums. These pressures were successful in generating substantial growth in

both the size and scope of the federal crop insurance program over the next thirty five years.

The core provisions of the 1980 legislation were as follows.

First, and in terms of the long term impacts of the legislation on subsidy costs, perhaps

most substantively, the 1980 FCIA explicitly authorized subsidies at the rate of 30% of

the actuarial fair premium, reducing farmer paid premiums to an average of 70% of the

total premium paid into the insurance pool. The 30% premium rate subsidy was to be

paid for coverage levels of up to 65% of a farm’s expected yields. Farmers selecting the

higher coverage levels of 70% or 75% would only receive the dollar amount of subsidy

associated with the 65% coverage policy. The principle of reduced subsidy rates for

higher coverage levels and zero or smaller proportional additional subsidies for the

highest coverage levels would be included in subsequent legislative initiatives.

Second, the 1980 Act provided a mandate for FCIC to expand access to yield based crop

insurance as rapidly as possible. The expansion was to be spatial, involving offering

coverage for crops such as corn, rice and wheat, for which coverage was already

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available in some counties, to all counties in which the crops were grown. It also

involved scope, requiring FCIC to develop contracts for new crops.

Third, the 1980 Crop Insurance Act required FCIC to establish procedures through which

private insurance companies could sell and service federally subsidized crop insurance

policies. Under the legislative provisions, FCIC would (i) pay insurance companies an

amount to cover their operating and administrative costs for handling FCIC policies, (ii)

pay the premium rate subsidy for each policy into the insurance pools, and (iii) provide

reinsurance to the companies for the policies they sold. The FCIC was also required to

have a test plan for the sale of federal crop insurance policies by private insurance

companies in place for the 1982 crop year. Prior to passage of the 1980 Act, independent

agents called master marketers had sold federal crop insurance but the policies had been

serviced (in terms of loss adjustment, payment of indemnities, etc.) by the Federal Crop

Insurance Corporation.

Figure 1 shows how the federal crop insurance program expanded over the period 1981 to 2014

in terms of total acres insured by farmers among all crops and the estimated rate at which

farmers participated in the program. Over the period 1981 to 1993, the consequences of the 1980

legislation for farmer participation in the federal crop insurance program were relatively modest.

In 1981, farmers insured approximately 48 million acres of crops through the federal program,

but by 1989 that number had changed very little.

However, in 1990 and 1991 the number of insured acres effectively doubled in response to a

1989 congressional mandate that farmers would only be eligible for ad hoc disaster aid payments

if they also carried insurance.3 After 1991 when, as a result of substantial lobbying by farm

interest groups, the mandate no longer applied participation fell. In 1992, the insured area

declined from just over 100 million acres to 82 million acres (Goodwin and Smith, 1995) and

over the period 1992 to 1994, insured acres remained in the 80 to 83 million acre range. The

participation rate was correspondingly relatively low. Between 1980 and 1989, participation

remained below 15 percent of planted acres and even by 1993 was still well below 30%.

3 In 1988 and to some extent in 1989, major drought in the northern and southern great plains states and parts of the corn belt led congress to pass substantial disaster aid bills. Farmers with crop insurance also collected substantial indemnity payments.

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What had changed was the delivery system for crop insurance policies. The companies had

lobbied vigorously for the 1980 FCIA mandate that the companies replace the FCIC as the

entities that would sell and service crop insurance programs. Despite General Accountability

Office (GAO) reports that indicated the companies were a more costly vehicle for delivering the

program (GAO, 1986 and 1988), FCIC provided the companies with a substantial administrative

and operations (A&O) subsidy equal to 33% of total premium paid into the insurance pools to

encourage the expansion of the “private public partnership.” Thus, by 1989, effectively all crop

insurance policies were being sold and serviced by crop insurance companies.

The federal crop insurance program’s persistently low participation rates were a cause for

concern among the congressional house and senate agricultural committees, in large part because

various farm interest groups continued to lobby for and receive substantial ad hoc disaster aid

(Goodwin and Smith, 1995; Zulauf and Hedges, 1988). In addition, by 1994 farmers were

arguing that the yield insurance policies then currently available neither provided sufficient

indemnities to guarantee that they could cover their costs of production nor provided them with

protection against unexpected declines in crop prices.4

At the same time, there was a push within congress for the crop insurance companies to take on

more of the underwriting risks associated with the insurance policies they marketed. One

argument for the shift was that if the companies were more fiscally liable for on-farm losses,

they would be more diligent in ensuring loss adjustments were carried out accurately and in

preventing fraud.5 Thus, in 1992, FCIC and the companies negotiated a new Standard

Reinsurance Agreement in which the companies took on more risk but were given a relatively

large of any underwriting gains while accepting some responsibility for any underwriting losses.

4 For example, a 1993 GAO study (GAO, 1993) reported that 25% of farmers included in a USDA national survey stated that they did not participate in the federal program because available coverage levels were to low and 37% stated that the availability of disaster aid programs influenced their decision not to participate. In a March 3, 1994, New York Times article, reflecting on the proposed reforms in the 1994 CIRA, then Representative Tim Johnson (Dem-South Dakota) was quoted as saying "the idea is to get out of crop disaster spending altogether and use some of that money to enhance the crop insurance program," by which he presumably meant that the funds would be used to increase premium subsidies and other initiatives to increase incentives for farmers’ participation in the crop insurance program.5 A 1993 GAO study of the federal crop insurance program reported that a substantial number of farmers were overstating yield losses (GAO, 1993a). A subsequent 1994 Senate Agricultural Committee inquiry limited to eight crops in nine states reported that questionable payments to farmers for losses in the amount of $92.5 million had been identified over the period 1988 to 1993 (New York Times, October 3, 1994).

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However, the companies’ shares of any underwriting losses would be substantially smaller than

their shares in any underwriting gains.

The above concerns contributed to initiatives for congress to debate and pass the 1994 Crop

Insurance Reform Act. The major provisions of the 1994 legislation were as follows:

Premium subsidies were to be increased to an average of 50% of total premium

payments.

The Federal Crop Insurance Corporation was given a mandate to develop revenue crop

insurance products where feasible and explore innovative products that might cover

farmers’ costs of production rather than their crop yields or revenues. Subsequently, the

FCIC, through its administrative agency (the Risk Management Agency which was

established in 1996) determined that revenue insurance would be viable only for crops for

which futures markets were well established or crops whose prices were closely

correlated with those of the crops for which futures markets did exist.

Participation in the federal crop insurance program became mandatory for farmers to be

eligible for deficiency payments under other government subsidy programs such as price

support programs, loan programs and other benefits. However, this requirement was

vitiated on year later in 1995.

A catastrophic coverage option was created to allow farms to obtain minimal coverage in

which farmers were compensated for losses exceeding 50% of their expected yields at

60% of the expected price for the crop. The coverage would allow farmers to meet the

mandatory participation requirement. However, farmers had only to pay a $50

administrative fee to obtain catastrophic (CAT) coverage for each crop, up to a maximum

of $150 per farm. While the mandate was terminated in 1995, CAT coverage was

retained and remains available to this day.

The 1994 CIRA also required FCIC to add a catastrophic loading factor to every

estimated actuarial fair premium rate, essentially guaranteeing that, over the long run,

insurance pools would experience positive underwriting gains. In response, FCIC

required that a loading factor of 13.64% be added to all estimated actuarially fair

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premium rates.6 It is worth noting that the A&O subsidy rate had been lowered from

33% to 31% under the terms of a new SRA negotiated in 1993.

The latter provision has had important long run effects on underwriting gains and was actively

lobbied for by the insurance companies. The argument was that a catastrophic event risk

surcharge on actuarially fair premium rates was required to account for potential catastrophic

losses not reflected in the data used by FCIC or its contractors to establish the actuarially fair

premium rates for each crop in each county (as premium rates were, and are for the most part

still established at the county level).

As Pearcy and Smith (2015) point out, while that may make sense in the context of a single

county-based insurance product, in the aggregate it does not. Extreme loss events are included in

the data used by RMA and the agency’s contractors to establish many “actuarially fair” premium

rates. For example, the 1983 and 1988 extreme “one hundred year” drought years in the

Northern Great Plains are used to compute premium rates for many wheat insurance products

and the “two hundred year” 1993 catastrophic flood and 2012 extreme drought years are

included in the data used to calculate premium rates for corn and soybean insurance products in

the cornbelt states. Effectively, the 1994 mandate for adding a 13.64 percent catastrophic risk

loading factor to estimated actuarially fair premiums amounted to guaranteeing on average a

substantial positive underwriting gain for crop insurance companies. Between 1981 and 1994,

net underwriting gains accruing to the companies (the sum of all underwriting gains and losses

on all policies sold) averaged 1.7% per year. Subsequently, between 1995 and 2014, annual net

underwriting gains accruing to the insurance companies averaged in 13.4 percent of total

premiums paid into the federal crop insurance pools.7

The impacts of the 1994 legislation on program participation and program size are illustrated in

figure1 and figures 2 and 3, which respectively show the growth of the federal program

6 The language mandating this approach in the 1994 CIRA formally required that a loss ratio of 1.075 be achieved where the loss ratio was defined as “the ratio of all sums paid by the Corporation as indemnities under any eligible crop insurance policy to that portion of the premium designated for anticipated losses and a reasonable reserve, other than that portion of the premium designated for operating and administrative expenses.” (Federal Crop Insurance Reform and Department of Agriculture Reorganization Act of 1994, Section 102 (a)). 7 These estimates were calculated by the author using publicly available annual data on company underwriting gains and losses and total premiums published by the USDA Risk Management Agency on line from 1997 to date, and for data prior to 1997, previous RMA and FCIC annual reports on the federal crop insurance program’s book of business.

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measured in terms of dollars of coverage or liability (figure 2), total premium payments,

premium subsidies, and farmer paid premiums (figure 3).

Between 1994 and 2000, as illustrated in figure 1, the area of crops insured more than doubled to

just over 200 million acres and participation increased from a little less than 30% to 63% of the

area planted to crops. The dollar value of total coverage or total liability also increased at a

commensurate rate from $13.6 billion in 1994 to $36.7 billion in 2000 (figure 2). Similarly

premiums and premium subsidies grew rapidly over the same period. Also, between 1994 and

2000, premiums paid into the insurance pools increased from just under $1 billion to $2.5 billion

and premium subsidies paid to farmers more than tripled from $255 million to $941 million

(figure 3). The more rapid rate of increase in premium subsidies was a direct result of the

increase in the average subsidy rate from 30% to 50% of total premiums mandated by the 1994

legislation. Program growth was directly linked to the increase in the subsidy rate and also to the

introduction of revenue insurance.

In 1995 and 1996, prices for major crops such as corn and wheat were relatively high. However,

by 1998 prices for many of those crops had substantially moderated. As is their wont, farm

interest groups took advantage of the low price environment to argue that agriculture producers

were in dire financial straits, and sought further protections from congress against fluctuations in

their incomes. Congress responded to those pressures in 1998 by effectively doubling payments

to farmer through what became known as the direct payments program from about $2.5 billion a

year in 1997 to over $5 billion a year in 1999 and 2000.8 In 2000, with the support of the

Clinton Administration, farm lobbies and the crop insurance industry, congress also made major

changes to the federal crop insurance through the 2000 Agricultural Risk Protection Act

(ARPA).

The 2000 legislation involved many initiatives but the key elements of the legislation were as

follows:

Premium subsidy levels were substantially increased, with average subsidy levels

increasing from approximately 50% between 1995 and 2000 to 62% from 2001 to 2014.

8 See table 35 of various fiscal year President’s Budget publications available at http://www.fsa.usda.gov/about-fsa/budget-and-performance-management/budget/commodity-estimates-book-and-reports/index.

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Extended subsidies to include premiums paid by farmers for the Harvest Price Option

(HPO), an endorsement to revenue insurance contracts for which farmers were required

to pay the additional actuarially fair premium prior to passage of ARPA.

Authorized pilot insurance programs for livestock that were not served by crop insurance.

Established the 508(h) process by which private sector and other entities could propose

new products for various commodities, for which they would receive compensation for

development costs if the product were approved for development by the FCIC Board.

The 508(h) process was proposed by the USDA Risk Management Agency as a vehicle for

addressing requests for crop insurance coverage for a wide range of crops not previously covered

by federal crop insurance policies. There is a case to be made that the 508(h) program has been a

comprehensive waste of taxpayer funds. The program created incentives for special interest

crops and their consultants to propose policies for very small acreage crops (for example, citrus

trees in a small number of Texas counties or North Carolina strawberries).9 Goodwin and Smith

(2013) note that many of the policies approved by FCIC under the 508(h) process generate very

small volumes of premiums, and in some cases almost surely fewer premiums than the

administrative costs of reviewing and maintaining the policies.

Expanding subsidies to the Harvest Price Option also had a substantial impact, recently estimated

by the Congressional Budget Office to have increased total subsidies to farmers by about $1.8

billion.10 Under a standard crop revenue insurance contract, the futures contract for a crop like

corn that expires at harvest time is used at planting time to establish the expected price of the

crop. Coupled with the farmer’s expected yield, that price provides the estimate of the revenue

the farmer is expected to obtain from the crop. The farmer chooses a coverage option, say 80%

of the expected revenue. At harvest time, the farmer’s actual yield is multiplied by the average

price of the crop in the futures contract over the month before the contract expires to estimate the

farm’s revenue. If that amount is less than the farm’s coverage level (say 80% of the expected

9 Descriptions of the products proposed and approved by FCIC under the 508(h) process can be gleaned from the agendas and minutes of the quarterly meetings of the FCIC Board of Directors since passage of ARPA. Many of those agendas are available on line at http://www.rma.usda.gov/fcic/archive.html. For example, the August 2016 agenda included consideration of privately developed submissions for insuring Louisiana Sweet Potatoes and Apiculture.10 The CBO estimates for ending HPO premium subsidies were provided to congress in October 2015 with respect to the provisions of the proposed Assisting Family Farmers through Insurance Reform Measures Act introduced by Senators Flake (R-Arizona) and Shaheen (D-New Hampshire). The estimates are reported at https://www.shaheen.senate.gov/news/press/release/?id=023FAC3B-1A56-4DD4-8AD6-6ED8BDBD274F.

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revenue) the farm receives an indemnity equal to the difference between the coverage level and

the farm’s estimated actual revenue.

The HPO works as follows. It allows a farmer to revalue his expected revenues at the harvest

time price if that price is higher than the price that was expected at planting time. The effect is to

increase the amount of the indemnity a farmer receives when crop revenues are relatively low

because of poor yields. By subsidizing the HPO, the 2000 ARPA essentially provided farmers

with a heavily subsidized put option. The result was that many producers of crops eligible for

revenue insurance switched into HPO revenue contracts, substantially increasing coverage and

also, because HPO contracts are more expensive than standard contract, total premium subsidy

payments to farmers and taxpayer expenditures on the federal crop insurance program.

In terms of affecting program growth – as measured by participation, premium subsidies, and

insurance company revenues - the two most important innovations were the substantial increase

in premium subsidies from about 50% to over 60 percent of total premiums and the extension of

subsidies to the Harvest Price Option component of revenue insurance contracts. Between 2000

and 2015, at the national level the area of insured crops expanded from about 200 million to 294

million acres, from just over 60% to 90% of the area estimated to be eligible for insurance

coverage.

Total liability, total premiums and premiums subsidies also increased rapidly over the period.

Liability more than tripled, from $34.4 billion in 2000 to $109.8 billion in 2014, while, over the

same period, total premium increased fourfold from $2.5 billion to $10.1 billion and premium

subsidies increased by over 500 percent from $1.6 billion to $9.1 billion. Total revenues

received by crop insurance companies also increased substantially, from $0.8 billion in 2000 to a

peak of $4.7 billion in 2008.

In fact the companies enjoyed exceptional earning between 2007 and 2010, which averaged $3.4

billion a year over the four year period, in large part because of high crop prices that led to

substantial increases in premiums and A&O subsidy payments. Those earnings attracted

considerable criticism from congress and the media. In response, under a new SRA negotiated

between RMA and the companies in 2010, A&O subsidies were capped at approximately $1.4

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billion a year, a provision which has reduced company revenues.11 However, under that SRA, as

Smith et al (2016) show, effectively RMA enabled the companies to lower their costs by capping

the commissions they could pay to insurance agents for selling policies.

A Model of the Market for Federal Crop Insurance Products

The market for federally-subsidized crop insurance policies has an unusual feature. In effect, the

products are designed by the USDA Risk Management Agency (RMA) which sets the price and

all other terms of the crop insurance policy a farmer purchases. Further, none of the private

companies that sell and service a federally subsidized crop insurance product can alter the price

paid for coverage by a farmer or the terms of the farmer’s contract. There is no price or product

competition among the companies.

In addition, under the terms of the 1994 Crop Insurance Reform Act, RMA is explicitly

mandated by Congress to use the following procedures in setting prices for each insurance

product. First, to the best of its ability, the RMA is required to estimate the actuarially fair

premium rate for a policy, which is defined as the premium rate required to cover the expected

indemnity payment associated with a policy. A mandatory loading factor of 13.64% of the

estimated expected indemnity is then added to the actuarial fair premium rate, notionally to

account for potential catastrophic events not accounted for in data used to compute the

actuarially fair premium rate.12 The government then pays a subsidy equal to a predefined

proportion of that amount and the farmer pays the rest.

Formally, let r be the actuarially fair price of one dollar of coverage for crop loss (r is also called

the actuarially fair premium rate) and let l be the amount of coverage purchased by a

representative farmer. Then rl equals the actuarially fair premium for a contract that provides l

dollars of coverage, where l, the coverage purchased by the farmer, is measured as the maximum

indemnity that can be paid to the farmer in the event of a complete crop loss. Note that l is also

11 After 2010, company revenues declined, in large part because of the new cap on A&O payments but also because of a substantial underwriting loss in 2012 (when the cornbelt experienced an exceptionally severe drought) and lower underwriting gains in other years. 12 The 1994 legislation mandates that each estimated actuarially fair premium rate be dived by 0.88 to account for catastrophic risks not represented in the data used to compute the initial premium rate, which is equivalent to a 13.64 catastrophic risk loading factor.

16

widely described in the insurance literature as the company’s liability under the contract. Let β

denote the proportional premium rate catastrophic loading factor required by Congressional

mandate (that is, β = 0.1364 under the current legislative mandate). The total premium rate, p, is

then defined as p = (1 + β) r.

The premium rate paid by the farmer, however, is equal the difference between p and the subsidy

provided by the federal government. That subsidy is equal to the premium subsidy rate, s,

multiplied by the total premium rate p or sp. As a result, the price paid by the farmer for a dollar

of coverage, pf, is defined as:

1. pf = (1 – s)p = (1 – s)(1 + β)r.

The Standard Reinsurance Agreement (SRA) is the agreement between the federal government

(in the form of the Federal Crop Insurance Corporation) and the insurance companies that are

approved to sell federally subsidized insurance policies (the approved insurance providers or

AIPs) that governs those companies’ actions. Under the SRA, in the states in which an AIP

operate, the AIP must sell policies to any farmer that wants to purchase coverage at the terms

established by RMA. Thus pf is the price paid for coverage by each farmer. Hence, in the

context of a simple supply and demand model, the supply curve for coverage or liability can be

viewed as perfectly elastic at any given value for pf.

The market demand curve for coverage by farmers can be viewed as downward sloping with

respect with the price paid by farmers; that is, L = L(pf) where ∂ L∂ p f =L'<0. This assumption has

consistently been supported by numerous studies of crop insurance demand over the past thirty

years (for example, Gardner and Kramer, 1987; Goodwin, 1993; Smith and Goodwin, 1996;

Knight and Coble, 1997). Thus, when the price paid by farmers is lower, farmers’ expected

benefits are higher, as measured by the analog of consumer surplus in an input market.

Figure 4 provides a graphical representation of the market for federally subsidized crop

insurance. In figure 4, the supply curve of total coverage or liability, defined as L, where L is the

sum of the amount of liability purchased by each farmer (L=∑i

❑

li) is perfectly elastic at pf0 and

17

the farmer demand curve is downward sloping. As defined in equation 1 above, the values for r

(the actuarially fair premium rate), β (the catastrophic loading factor), and s (the premium

subsidy rate), determine pf0. In figure 4, given that the farmers’ price for coverage is pf

0, the

market clears at L0 and farmers’ total out of pocket expenditures on crop insurance coverage are

pf0 L0, represented by area 0L0Bpf

0 in figure 4.

The revenues paid into the crop insurance pool, however, are equal to the sum of farmer paid

premiums and the government premium rate subsidy, or equivalently, the total premium rate, p,

multiplied by the total liability purchased by farmers. Given that p = (1 + β)r, where r and β are

determined the federal government, there is a predetermined value of p, p0, for any given value

of r and β , r0 and β0. Thus total revenues paid into the insurance pool are p0 L0, as illustrated by

area 0L0Ap0 in figure 4. In figure 4, premium subsidy payments received by farmers therefore

equal the difference between p0 L0 and pf0 L0 or area pf

0 BA p0.

As discussed in the previous section, insurance companies have two sources of revenue from the

federal crop insurance program; underwriting gains and direct subsidies from the government for

their administration and operations (A&O) expenses. The government pays each company a

predetermined proportion, α, of the total premiums paid into the insurance pool for the policies

they sell to cover A&O expenses. Thus, as a group, the companies receive A&O subsidies equal

to α p L.

The companies also receive a share of any underwriting gains and, as discussed in the previous

section, pay a smaller share of any underwriting losses associated with the insurance pool. Let

the expected loss ratio for the insurance pool, k, be defined as the ratio of the expected amount of

indemnities to total premium paid into the insurance pool. Underwriting gains are expected to

be positive for two reasons. First, as discussed above, applying a catastrophic loading factor to

all estimated actuarially fair premium rates introduces an effective guarantee on average over

time that underwriting gains will be positive. Second, as also discussed above, the SRA

guarantees that insurance companies receive a larger share of any underwriting gains than the

share they pay of any underwriting losses. The value of k is therefore expected to be less than

one and the companies can expect to receive positive underwriting gains. Those expected gains

equal to the difference between total premiums, p L, and total expected indemnities to be paid

18

out of the insurance pool. Those expected indemnities are defined as the expected loss ratio

multiplied by total premium, k p L.

The companies’ expected underwriting gains are therefore (1 – k) p L and their expected total

revenues, TR, are therefore the sum of their expected underwriting gains and the A&O subsidies

they receive from the government

2. TR=(1– k ) pL+α p L .

Using the fact that p = (1 + β) r to substitute for p, the companies’ total revenues can be defined

in term of the actuarially fair premium rate, the catastrophic loading factor, and the expected loss

ratio, k, all of which are policy related variables determined by federal legislation and regulation;

that is,

3. TR=(1– k+α ) (1+β ) rL .

It should be noted that the role of adverse selection may be important in determining the

expected loss ratio, k. As L increases, participation in the program increases reducing adverse

selection and lowering the expected loss ratio (Smith and Goodwin, 1995; Smith and Glauber,

2012; Glauber, 2013; Wright, 2014). Thus k is an inverse function of L, k (L), where dkdL

=k '<0.

Using the fact that pf = (1 – s)(1 + β)r and substituting for L in equation (3) using equation (4),

the companies’ total revenues are:Type equation here .

4. TR=(1– k (L)+α ) (1+β ) Lr .

Equation 4 is helpful in examining the effects of policy and regulatory innovations on the

insurance companies’ revenues and illuminating their incentives for lobbying for regulatory

changes.

The Impacts of Policy Initiatives on Farmers and Crop Insurance Companies

Farmers’ benefits are directly affected by policy initiatives through the out of pocket price they

pay for coverage, pf. A lower out of pocket price increases their benefits from the program by

increasing their economic surplus, as measured by the analog of consumer surplus for their

demand for crop insurance. Given that pf = (1 – s)(1 + β)r, the following four policy related

results immediately follow:

19

1. An increase in the subsidy rate, s, increases benefits for farmers as ∂ p f

∂ s=−(1+β ) r<0.

2. Assuming that s < 1 (the subsidy rate is less than 100%), an increase in the catastrophic

loading rate, β, reduces farmers’ benefits as ∂ p f

∂ β=(1−s )r>0. Holding the subsidy rate

constant, an increase in the catastrophic loading factor increases the total premium rate, p,

and, therefore, pf.

3. Assuming that there is no impact on the budget available for premium subsidies if a

change in the A&O subsidy rate α is mandated, an increase or decrease in that subsidy

rate has no effect on the price paid by farmers for crop insurance coverage.

4. An increase or decrease in the estimated actuarially fair premium rate r does affect

farmers’ benefits as ∂ p f

∂r=(1−s ) (1+β )>0. So, for example, if a new rate setting

procedure is approved by RMA that systematically reduces r, as occurred for two major

crops (corn and soybeans) in many mid-western counties in 2013 (Coble et al, 2015),

then farmers will benefit through lower farmer paid premiums.

The effects of changes in the four policy variables – α, β, s and r – on crop insurance company

total revenues in some cases are somewhat more complex. From equation 4,

TR=(1– k (L)+α ) (1+β ) Lr . The effects of changes in each of the four policy variables on crop

insurance revenues are therefore as follows.

1. The effect of a change in the A&O rate on TR is positive as ∂TR∂ α

=pL>0. The reason is

straightforward. A change in α has no impact on pf and therefore no effect on L.

Insurance companies are therefore always likely to lobby for increases and against any

cuts in the A&O subsidy rate, a practice in which they have consistently been engaged

over the past thirty years. Only if the companies are offered offsetting or more favorable

benefits through another aspect of the program – for example, the introduction of a

catastrophic loading factor that increases premiums and expected underwriting gains or a

more favorable distribution of underwriting gains and losses (through stop loss

arrangements), as in the 1994 Crop Insurance Reform Act, are they likely to accede to a

lower A&O rate without too much fuss.

20

2. The impact of a change in the premium subsidy rate s is as follows:

∂TR∂ s

=¿)[k ' L' (1+β )rL¿−(1 – k+α )r L'¿ > 0.

Given that L'<0 , the expression is strictly positive. An increase in the subsidy rate

lowers the premium rate paid by farmers or their coverage and, therefore, increases the

amount of liability L that they purchase. The increase in the amount of liability reduces

adverse selection and therefore also reduces the loss ratio for the insurance pool. Both

shifts lead to an increase in total revenues for the companies because increases in sales

increase the amount of A&O subsidy the companies obtain, although increased sales

would involve increased operating cots

3. A change in the catastrophic loading factor, β, has the following effects:

∂TR∂ β

=(1−s) ¿¿

The first term in the derivative, (1−k ( L )+α ) rL ' , is strictly negative as long as the loss

ratio, k, remains less than one, reflecting the adverse effect of an increase in premium

rates on the amount of liability purchased. An increase in β, by raising the total premium

rate p, will unambiguously increase revenues if L is constant because there is no impact

on the loss ratio or the A&O subsidy. The second term, k ' L' (1−s )rpL¿ is strictly

positive, reflecting the direct impact of an increase in the loading factor on premium

earned by the companies on each policy.

However, if the marginal effect on quantity of coverage purchased of a change in the

price paid by farmers is small then almost surely the direct impact on the total premium

rate will exceed any revenue losses associated with a decline in liability and the

associated potential increase in the loss ratio.

If an increase in, or introduction of a positive catastrophic loading factor is accompanied

by an increase in premium subsidy rates then the net effect of the joint changes in β and s

on the price paid by farmers for coverage can be negative. Such was the case under the

terms of the 1994 Crop Insurance Reform Act when the 13.64% catastrophic loading

21

factor was introduced but, at the same time, the average premium subsidy rate was

increased from 30% to 50%.

Prior to the 1994 CIRA, as s = 0.3 and β = 0, pf = (1 – s)(1 + β)r = (1 -0.3)r = 0.7r.

After the reform, s = 0.5 and β = 0.1364, pf = (1 – 0.5)(1 + 0.1364)r = 0.5682 r. Thus

the joint changes in s and β substantially reduced pf, thereby increasing program

participation, L, and lowering loss ratios. The combined effects of these policy changes

increased the revenues of the crop insurance companies while also increasing farmers’

economic well-being. Thus the 1994 Crop Insurance Reform Act is perhaps a classic

example of two interest groups lobbying for program changes that had positive effects on

each group’s economic welfare.13

4. The effect of a change in the estimated actuarially fair premium on crop insurance

companies’ total revenues is simply:

∂TR∂ r

=(1−s) (1−β ) ¿).

As with the effect of a change in β, an increase in r increases the price paid by farmers for

insurance coverage and reduces L, the amount of coverage they purchase. Therefore the

impact on crop insurance companies’ revenues is ambiguous. However, the effect on

crop insurance companies’ total revenues will be positive as long as the term

(1−k+α ) L'−k ' L ' pL is positive. An increase in r increases revenues per dollar of

liability but also increases pf, reducing L and therefore may increase adverse selection and

loss ratios. Hence the ambiguity with respect to the impact of an increase in r on

company revenues. Effects on the companies’ A&O total subsidy revenues are

themselves ambiguous because, while a ceteris paribus reduction in L would lower those

payments, a ceteris paribus increase in the total premium rate would increase (assuming

no effective cap on those payments was in place)

13 Other provisions of the 1994 CIRA also benefitted both farmers and the crop insurance companies, including a mandate to develop a range of new crop insurance products, including revenue insurance and area yield insurance policies. In the context of this model, those initiatives can be viewed as causing an outward shift in the demand for crop insurance; that is, an increase in G. It is straightforward to show that an increase in G increases farmers’ economic surplus and total expected revenues for the crop insurance companies as long as the expected loss ratio, k, is not affected or also declines.

22

The effects of the higher premium rate, only part of which will be paid by farmers as long

as the premium subsidy rate remains constant, seem likely to dominate unless the

increase is relatively substantial and/or the demand for crop insurance is relatively price

elastic. Certainly, the insurance companies, and reinsurance companies such as Zurich,

Munich and Alliance, have viewed recent changes in the way in which RMA calculates

the actuarially fair premium rate for corn and soybeans in cornbelt states with some

concern. The new methodologies, by accounting for upward trends in yields, resulted in

lower estimates for actuarially fair premium rates for crops such as corn and soybeans,

potentially reducing both expected underwriting gains and A&O payments for policies

sold Perhaps not surprisingly, shortly after the reductions in premium rates for corn and

soybeans in major corn producing states in 2013, some larger companies with crop

insurance subsidiaries announced they were considering divesting those subsidiaries.14

The above analytical results, including effects on tax payer costs not formally examined, can be

heuristically summarized as follows:

An increase in the A&O subsidy rate increases insurance company revenues but has no

effect on farmers. However, taxpayers lose because subsidies paid directly to the

insurance companies increase while subsidies paid to farmers remain constant (as total

coverage purchased remains constant.

An increase in premium subsidy rates increases the economic benefits farmers obtain

from the program and increase the total revenues obtained by crop insurance companies

from the program. Taxpayers, of course, lose because each dollar of coverage receives a

larger premium subsidy and coverage increases (L increases).

An increase in the catastrophic loading factor almost certainly increases the total

revenues obtained by the crop insurance companies but lowers the economic benefits to

farmers by increasing the out of pocket price they pay for coverage. Taxpayers almost

certainly lose because an increase in the catastrophic loading factor increases the total

14 For example, in 2015 Wells Fargo announced it was selling its Rural Community Insurance Agency (RCIA) and its subsidiary Rural Community Insurance Company to Zurich for $700 million, which it obtained through a takeover in the mid 2000s. See http://www.bloomberg.com/Research/stocks/private/snapshot.asp?privcapId=4476557.

23

premium rate and, given a constant subsidy rate, the amount of subsidy per dollar of

coverage increases.

An increase in the actuarially fair premium rate almost certainly increases company total

revenues, and by reducing coverage through higher farmer paid prices, lowers their costs.

Farmers receive fewer benefits as they now face higher out of pocket costs for coverage.

Tax payers almost surely lose because the increase in the actuarially fair premium rate

increases the total premium rate for each dollar of coverage and, therefore, the amount of

subsidy for each dollar of coverage.

The Effects of the Joint Provisions of the 1980, 1994 and 2000 Crop Insurance Legislative

Initiatives on Farmers and Crop Insurance Companies

The 1980 Federal Crop Insurance Act (FCIA), the 1994 Crop Insurance Reform Act (CIRA) and

the 2000 Agricultural Risk Protection Act (ARPA) all included important provisions that

affected both farmers and crop insurance companies. Those provisions also provided benefits to

agricultural lenders, many of which are small rural banks. By effectively guaranteeing farmers a

revenue floor for many of their crops through substantial tax payer subsidies, as well as

increasing their expected revenues, crop insurance reduces the risk of non-repayment of loans,

either through default or delay of repayment of principal or interest (see, for example, Atwood et

al, 1996). The expansion of participation in the federal crop insurance program engendered by

those legislative initiatives has therefore generated substantial benefits for private lenders to the

agricultural sector. Thus the banking sector has also become an advocate for expanding and

sustaining the federal crop insurance program. However, the main focus of this study concerns

the relationship of the provisions of those legislative initiatives to the coalition between farmers

and insurance companies as lobbyists for the program.

The case with respect to the 1980 FCIA is straightforward. First, the FCIA introduced a mandate

for private companies to enter the federal crop insurance market and effectively to eventually

become the sole providers of federally subsidized crop insurance products to farmers. The

incentive was a substantial A&O subsidy rate (α = 0.33 or 33%) that had no implications for any

premium subsidies that would benefit farmers. However, one potential benefit for farmers was

that the companies would perhaps be more eager to provide service such as loss adjustments and

24

indemnity payments more rapidly than would the FCIC. The reason, as Smith, Glauber and

Dismukes (2016) note, was that companies and insurance agents could only compete on service

dimensions and not on price or other aspects of the insurance policies.

A second issue was that, until the 1992 Standard Reinsurance Agreement, the companies bore

minimal risks associated with underwriting gains. Further, as noted above, annual underwriting

gains averaged less than 2% of total premiums over the period 1981 to 1994. In addition, prior

to 1992 net underwriting gains never exceeded 6.3% and, in the three years where underwriting

gains were negative, the losses were less than 1.9% of total premiums. Hence farmers may have

believed that the companies would be relatively generous in assessing underwriting losses, as

was indicated by GAO reports in 1986, 1988, and 1993, and by the findings of the 1994 Senate

inquiry into the performance of the federal crop insurance program (discussed above).

In addition, the 1980 Act introduced a 30% premium subsidy for most federal crop insurance

policies (s increased from close to zero to 0.3). As discussed above, an increase in premium

subsidy rates increases the economic benefits farmers obtain from the program and increase the

total revenues obtained by crop insurance companies from the program. Both groups, therefore

expected to benefit from the subsidy provision. Further, the 1980 Act required FCIC to expand

the availability of crop insurance as rapidly as possible and between 1980 and 1992 the number

of crops covered increased from 27 to 51, and for major crops coverage had become available in

almost all counties in which the crops were grown. Both farmers and the insurance companies

benefited from the expansion which increased access to and the demand for crop insurance

coverage at the national level.

The provisions of the 1994 CIRA seem to be more complicated when considered in isolation

from one another. The companies were disadvantaged by a reduction in the A&O subsidy rate

from 33% to 31%. In addition, though not an explicit part of the 1994 act, congress gave the

FCIC signals that further cuts in the A&O rate would be appropriate and subsequently, in 1997,

the A&O subsidy rate was further reduced to 27%. However, as discussed above, the 1994

CIRA also included two important additional provisions. The first was a substantial increase in

the premium subsidy rate, from an average of 30% of total premium to 50% of total premium.

The second was the introduction of a mandatory 13.64% catastrophic loading factor on all

estimated actuarially fair premium rates.

25

As discussed above, by itself the catastrophic loading factor almost surely was likely to benefit

the insurance companies at the expense of raising farmer paid premiums and increasing tax payer

subsidies, effectively resulting in an income transfer from farmers and tax payers to the

companies. However, the joint impact of the catastrophic loading factor and the increase in the

premium subsidy was to benefit both the companies and farmers.

As shown above, prior to the 1994 CIRA, when the subsidy rate was 30% and the catastrophic

loading factor was zero, farmers on average were paying about 70% of the estimated actuarially

fair premium for their coverage. Subsequently, when the subsidy rate was 50% percent and the

catastrophic loading factor was 13.64%, farmers on average were paying about 57% of the

actuarially fair premium. Thus the net effect of the reduction in the premium subsidy rate and

the introduction of the catastrophic loading factor was to substantially reduce farmers’

premiums. The result was a substantial increase in program participation and farmers’ benefits

from the program over the next five years, much lower loss ratios, and substantially higher

underwriting gains for the companies. The expansion of the federal crop insurance program, in

terms of participation, also expanded the benefits derived from the program by agricultural

lenders because more of their potential customers now obtained crop insurance and, as such,

became less risky borrowers.

The 1994 CIRA also required FCIC to introduce new revenue crop insurance products, cost of

production related products, and a catastrophic coverage option for which no premiums were

charged to enable farms that would not otherwise buy insurance to comply with a subsequently

short lived mandate to have insurance coverage in order to be eligible for other subsidies. The

act also required FCIC to continue to expand the national program in terms of crops eligible for

insurance. As noted above, effectively these initiatives can be viewed as increasing the demand

for federally subsidized crop insurance, to the benefit of both the farmers and the companies.15

Finally, in relation to the 1994 legislation, two additional observations are noteworthy. First,

while the CIRA reduced the companies’ A&O subsidy rate from 33% to 31% and shortly

thereafter in effect to 27% of total premiums, the introduction of a 13.64% catastrophic loading

factor generated subsequent annual average underwriting gains for the companies of over 13%.

Almost surely the crop insurance companies, and behind them reinsurance companies like Zurich

15 While the companies received no premiums from CAT coverage policies, they did receive the administrative fees.

26

Re and Munich Re who took on much of the risk the companies now faced, were well aware that

1994 legislation would substantially increase their revenues. Second, it is worth noting that since

1994, no subsequent actions by either congress or the USDA FCIC and the RMA (FCIC’s

administrative arm) have been taken to alter the catastrophic loading factor even though, as

Pearcy and Smith note, the original statistically based rationale for that initiative was flawed.

Finally, the major provisions of the 2000 ARPA were also designed to benefit both farmers and

the companies. Most obviously, the mandated increase in premium subsidy rates, which

subsequently averaged 62% of total premiums, was intended to increase participation. The

extension of such subsidies to the additional premiums associated with the Harvest Price Option

(HPO) endorsement to revenue products was also designed to increase the total amount of crop

insurance coverage purchased by farmers. Prior to 2000 relatively few farmers purchased

revenue insurance coverage that included the HPO. However, in 2015 in cornbelt states like

Iowa, Illinois, Indiana and eastern Nebraska, for corn, which is the most heavily insured crop in

the federal crop insurance program, over 90% of the insurance contracts purchased by farmers

were revenue insurance contracts, most of which included the HPO (Smith, 2016).

Summary

This study has provided a case study of how the provisions of three major congressional

legislative initiatives – the 1980 Federal Crop Insurance Act, the 1994 Crop Insurance Reform

Act, and the 2000 Agricultural Risk Protection Act – were designed to benefit both farmers and

the private sector crop insurance industry. These three initiatives form the basis of the current

federal crop insurance program that in 2015, at about $8.5 billion a year, the Congressional

Budget Office estimated would be the most expensive farm subsidy program over the next

decade.

Using a formal model of the market for crop insurance, this study has illustrated how each of the

three acts included provisions that, when taken as a whole, were very likely to benefit both the

insurance companies and agricultural producers in terms of industry revenues and economic

rents. The study has also indicated that banks with substantial amounts of agricultural loans are

a third group that has also benefitted relatively substantially from these legislative initiatives by

improving the credit worthiness of farm enterprises (at the very least in terms of default risk).

27

Thus, the US federal crop insurance program provides a clear example of legislative change that,

most of the time, benefits multiple special interest groups who form coalitions to increase both

the probability that program will be maintained and the size of the program’s income transfers

that accrue to those special interest groups will increase, or at least not be diminished.

In the case of the federal crop insurance program, an important and politically sensitive question

concerns where the income transfers built into the program flow. Given there are no caps on the

subsidies that accrue to individual farms, and that premium subsidies are paid on a per acre basis,

it is clear in absolute terms that larger farms receive much larger benefits than small farms, as

illustrated by studies by the General Accounting Office (GAO 2012) and Smith (2016). Further,

as discussed by Goodwin et al (2004) and Smith and Goodwin (2013), the federal crop insurance

program engenders complex environmental impacts many of which are adverse.

As always, the limits of this study should be acknowledged. The analysis has focused on the

three major legislative initiatives associated with the federal crop insurance program. Thus it is

not a comprehensive assessment of all the policy actions that have affected the economic rents

obtained by farmers from the program or the revenues and profits obtained by the crop insurance

industry. Examples that have not been so carefully considered include the 2011 cap on A&O

payments to companies associated with the 2011 SRA and the 2013 shift in the methodology

used to compute actuarially fair premium rates for crops where over time average yields were

increasing. The latter tended to reduce those rates, lowering total premiums and farmer paid

premiums to the economic benefit of farmers and the detriment of the insurance industry.

Finally, as Babcock and Hart (2006), Babcock (2015b), and Smith et al (2016) have

demonstrated, the crop insurance industry is complex, involving the companies, independent

insurance agents and multinational reinsurance companies. The potential for policy changes to

have different impacts among the subsectors of the crop insurance industry has also not been

considered in any detail in this study.16

16 In addition, this study has not considered a set of issues that are important to the companies with respect to the management of the insurance pool. These specifically concern changes in the rules governing risk sharing and the use of Assigned Risk pool and, prior to the 2011 SRA, the Development Pool, into which the companies could assign individual farm policies that were assessed to be at high risk of experiencing losses. More detailed discussions of these issues are provided by Smith et al (2016) and Pearcy and Smith (2015).

28

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32

19811983

19851987

19891991

19931995

19971999

20012003

20052007

20092011

20130

50000

100000

150000

200000

250000

300000

0.00%

10.00%

20.00%

30.00%

40.00%

50.00%

60.00%

70.00%

80.00%

90.00%

100.00%

Figure 1. Total Acres Insured and Estimated Program Participation Rates: 1981-2014

Net Acres InsuredParticipation rate

Acre

s (in

Tho

usan

ds)

33

19811983

19851987

19891991

19931995

19971999

20012003

20052007

20092011

2013$0

$20,000

$40,000

$60,000

$80,000

$100,000

$120,000

$140,000

Figure 2. U.S. Crop Insurance Program: Total Liability, 1981-2014 ($ mil-lions)

34

19811983

19851987

19891991

19931995

19971999

20012003

20052007

20092011

2013$0

$2,000

$4,000

$6,000

$8,000

$10,000

$12,000

$14,000

Figure 3. U.S. Crop Insurance Program: Total Premiums, Premium Sub-sdiy Payments, and Farmer Paid Premiums, 1981-2014 ($ millions)

Total Premiums Premium Subsidies Farmer Paid Prmeiums

35

Figure 4. The Market for Crop insurance Coverage

36

Lo

pf0

p 0

O

A

B

DD