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 Financial Analytics and Research, 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 1995.

Background…..

Premium and Risk Subsidies

Premiums (costs of insurance products) are federally subsidized. Subsidy rates are set in the Agricultural Risk Protection Act of 2000. Subsidy rates vary by coverage level and type of insurance.

Risk Subsidies as a Percent of Total Premium

Coverage Farm GroupLevel 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: www.rma.usda.gov/data/sob.html

Total Premiums, U.S., 1995 to 2005

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

4.5

95 96 97 98 99 00 01 02 03 04 05

Year

$ (

bill

ion

)

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

0

5

10

15

20

25

30

35

40

95 96 97 98 99 00 01 02 03 04 05

Year

Pe

rce

nt

Corn

Soybeans

Total Premiums, U.S., 2005Crop Total Premiums PercentCorn 1,266,003,668 32%Soybeans 873,110,128 22%Wheat 576,970,245 15%Cotton 329,547,491 8%Fruits and vegetables 325,154,705 8%Other grains 142,446,688 4%Other 106,124,408 3%Potatoes 69,957,018 2%Nursery 68,839,802 2%Grain sorghum 67,280,532 2%Peanuts 41,323,094 1%Sugar Beets 39,870,013 1%Tobacco 30,586,571 1%AGR 11,420,788 0%Total 3,948,635,151 100%

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.

Crop $ per Acre

Soybeans 2.76Corn 3.03Other 3.70Wheat 5.35Other grains 6.38Grain sorghum 8.99Sugar Beets 14.18Cotton 17.92Fruits and vegetables 22.81Peanuts 25.71Potatoes 30.36Tobacco 204.54

Source data unless otherwise indicated: www.rma.usda.gov/data/sob.html

* Excludes Nursery and AGR policies

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

Payments MinusTotal Farmer-Paid Loss

Crop Premium Premium Ratio

Corn $8,663,068,283 $1,868,752,682 0.68Soybeans 5,346,885,430 1,574,312,770 0.74Fruits and vegetables 2,363,727,988 1,260,696,951 0.85Potatoes 579,603,620 298,487,944 0.90Nursery 397,721,162 296,313,435 0.90Other 623,116,677 422,581,615 1.02Sugar Beets 327,746,499 183,133,449 1.02Wheat 4,332,281,302 2,862,620,024 1.10Cotton 3,615,786,256 2,606,177,757 1.11Other grains 1,169,217,061 847,677,316 1.14AGR 51,628,184 42,224,905 1.25Peanuts 440,911,913 373,437,276 1.32Grain sorghum 709,136,368 678,471,495 1.38Tobacco 397,367,562 660,806,811 2.14

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

Payments MinusTotal Farmer-Paid Loss

Crop Premium Premium Ratio

Iowa $1,448,224,763 -$237,339,250 0.35Illinois 1,112,582,499 39,438,013 0.54Nebraska 1,041,003,003 251,353,058 0.72Minnesota 956,678,670 -156,600,667 0.30South Dakota 647,838,398 310,133,430 0.93Indiana 571,216,269 98,977,828 0.69Kansas 376,994,307 234,847,588 1.08Missouri 355,437,717 123,974,556 0.75Wisconsin 322,198,732 115,862,611 0.78Ohio 280,030,309 160,756,829 1.05Texas 258,957,963 224,916,098 1.27North Dakota 205,455,384 140,497,352 1.09Other States 1,086,450,269 561,935,236 0.77

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

Payments MinusTotal Farmer-Paid Loss

Crop Premium Premium Ratio

Iowa $734,129,900 $90,818,490 0.63Minnesota 692,727,222 173,977,222 0.75Illinois 544,945,252 13,107,933 0.48South Dakota 425,908,028 173,291,222 0.59Nebraska 398,055,628 64,627,926 0.65Missouri 360,987,432 88,904,932 0.62Indiana 342,122,391 28,819,289 0.58North Dakota 252,966,927 152,304,945 1.04Ohio 251,105,969 80,294,133 0.79Kansas 238,957,882 137,042,756 1.02Arkansas 197,656,695 66,884,917 0.57Other States 907,322,104 504,239,005 1.05

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

Payments MinusTotal Farmer-Paid Loss

State Premium Premium Ratio

Iowa 2,325,009,452 -189,660,612 0.44Hawaii 11,419,346 1,587,513 0.45Illinois 1,753,472,247 72,908,130 0.52Rhode Island 547,753 195,039 0.59Minnesota 2,234,286,431 330,891,172 0.62Washington 327,675,063 85,639,176 0.63New Jersey 24,596,004 12,066,670 0.63Idaho 274,238,219 58,740,520 0.64Arkansas 491,397,111 200,522,251 0.64Indiana 972,379,336 141,513,060 0.65California 1,417,778,958 509,339,542 0.66Missouri 819,199,650 244,750,257 0.67Nebraska 1,797,487,026 428,877,848 0.73

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 120 0.75 90

APH 10 104 0.75 78

APH 4 113 0.75 85

Trend = 3

Current Rules: Sample Variability

APH Sampling Dist by length

0

10

20

30

40

50

60

70

80

75 95 115 135 155 175 195

Mean

St.

Dev

4 year

7 year

10 year

(APH 4,7, and 10-year samples from same sim-farm)

Yield distributions for various APH base periods and “true”

0

0.002

0.004

0.006

0.008

0.01

0.012

0.014

0.016

0.018

0.02

1 51 101 151 201

Yield

Pro

bTRUE

True - 0.85

4 Y APH

Idem4Y-APH -0.85

7 Y APH

Idem 7Y APH -0.85

10 Y APH

Idem 10Y APH -0.85

Probabilities

Coverage Level 0.55 0.6 0.65 0.7 0.75 0.8 0.85

10 Y APH * Coverage Level 75 82 89 96 102 109 116

10 Y 1% 2% 3% 6% 9% 13% 19%

7 Y 1% 2% 3% 5% 7% 11% 17%

4 Y 1% 1% 2% 4% 6% 10% 14%

TRUE 0% 1% 1% 3% 4% 7% 10%

Yield distributions for various APH base periods and “true”

0

0.002

0.004

0.006

0.008

0.01

0.012

0.014

0.016

0.018

0.02

1 51 101 151 201

Yield

Pro

bTRUE

True - 0.85

4 Y APH

Idem4Y-APH -0.85

7 Y APH

Idem 7Y APH -0.85

10 Y APH

Idem 10Y APH -0.85

Bushels

Coverage Level 0.55 0.6 0.65 0.7 0.75 0.8 0.85

Probability under True 0% 1% 1% 3% 4% 7% 10%

10 Y 66 72 79 85 92 98 105

7 Y 68 74 81 88 94 101 108

4 Y 70 77 83 90 97 103 110

TRUE 75 82 89 96 102 109 116

Illinois

Alexander

CookDu Page

HardinJohnson

Pope

Schuyler-16.30Adams

-15.00

McDonough-13.00

Peoria-12.70

Pike-12.30

Knox-11.80

Putnam-11.40

Carroll-11.20

Fulton-11.20

Woodford-11.10

Hancock-10.50

Stark-9.40 Marshall

-9.10

Mason-8.40

Iroquois-7.80

Rock Island-7.80

Tazewell-7.70

Warren-7.30

Brown-7.10

Ford-6.80

Logan-6.10

Bureau-5.90

Cass-5.60

Macoupin-5.50

McLean-5.50

Macon-5.40

Menard-5.30

Henry-5.20

Mercer-5.20

De Witt-5.00

Greene-4.50

Madison-4.10

Livingston-3.60

Scott-3.60

Jersey-3.20

Kankakee-2.90

Grundy-2.70

Sangamon-2.70

Montgomery-2.10

Morgan-2.10

Coles-2.00

Christian-1.60

Lee-1.60

White-1.00

Whiteside-0.80

Henderson-0.60

Fayette-0.40

Stephenson-0.30

Ogle-0.20

Piatt0.10

Bond0.80

Clark0.90

Clay1.10Marion

1.40

Edgar1.60

Saint Clair1.60

Wayne1.60

Will1.70

Champaign2.00

Douglas2.00

Pulaski2.70

Calhoun2.90

La Salle2.90

Jo Daviess3.10

Clinton3.20

Effingham3.40

Kendall3.60

Vermilion3.60

Lawrence3.80

Cumberland4.30

Wabash4.40Washington

4.70

Gallatin5.20

Union5.30

Hamilton5.80

Boone5.90

Jasper6.40

Richland6.40

Moultrie6.60

Saline6.70

Shelby6.90

De Kalb7.10

Crawford7.30

Monroe7.60

Jackson7.80

Edwards8.00

Kane8.80

Winnebago9.40

Jefferson11.10

Massac11.30

McHenry12.80

Franklin12.90

Randolph13.80

Williamson19.50

Perry19.70

Lake20.60

iFarm Trend minus RMA -17.00 to -11.00, 10 10.4%-11.00 to -5.00, 19 19.8%-5.00 to 1.00, 23 24.0%1.00 to 7.00, 29 30.2%7.00 to 13.00, 11 11.5%13.00 to 19.00, 1 1.0%19.00 to 25.00, 3 3.1%25.00 to 31.00, 0 0.0%No data