The Federal Crop Insurance Program

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The United States Senate has recently passed its proposed version of the periodic update of the federal law that most people in production agriculture refer to as the Farm Bill. The House of Representatives Agriculture Committee has passed a different version of the same. It is likely that the Farm Bill will be debated for quite some time, even into 2013, because of major philosophical differences over the subsidy size and the terms of the crop insurance coverage provisions of the Farm Bill. Prairie Fire believes that a background on the current crop insurance program will be very beneficial to anyone following this contentious debate. We will endeavor in future issues to encourage essayists to put forth papers on House and Senate versions as the debate merging them continues.

By Brad Redlin

The farming sector has changed drastically since the first Farm Bills of the 1930s, when about a quarter of all Americans lived on a farm. Today, only 2 percent reside on farms. The American farm in the first half of the 20th century was a relatively small and diversified operation. For instance, a single farm could easily have raised cattle, hogs, chickens and sheep, producing beef, pork, dairy, wool, eggs and poultry. These products, combined with the grain, fruit and vegetable growing capabilities of a farm, made many farms self-sufficient operations.

The typically smaller, diversified and labor-intensive farms of the mid-20th century also functioned to an extent as their own insurance providers. A farm that produced corn and cattle, eggs and eggplants, wheat and wool had the added advantage of an increased opportunity to access a rising market for some products in hopes of mitigating a dropping market for others. If pork and milk were up, but corn and wheat were down, a farm ideally could use its grain for feed and sell the meat and dairy. While certainly not a foolproof model, diversified small farms were, and increasingly are again, more an economically driven model than a pastoral philosophy.

However, as influenced by advanced agronomy, plant science and other trends toward specialization in agriculture production, farms have become larger and less diversified in production. With farms primarily focused on high output of a few select crops, but still subject to the whims of weather, crop insurance has evolved for greater applicability.

In the 1930s Congress created the Federal Crop Insurance Corporation (FCIC), which is now administered by the USDA’s Risk Management Agency (RMA). The RMA develops and provides the federal crop insurance program’s risk management tools to producers that are sold and serviced through private insurance companies. The agency has established agreements with 15 private insurance companies and reimburses those companies administrative and operating costs in addition to reinsuring the companies’ losses.1

Crop Insurance Policy: How It Works

Producers participating in the federal crop insurance program purchase insurance policies on insurable crops, paying a portion of the premium with the remainder paid by the federal government.2 The amount of the premium paid by the producer varies by the type and level of insurance coverage. For the lowest level of coverage—catastrophic coverage, which covers losses in yield of 50 percent or greater—the federal government covers the entire premium (producers must pay an administrative fee of $300 per crop covered within a county). Catastrophic insurance pays 55 percent of the estimated market price of the crop. This places a coverage “floor” in federal crop insurance of 50 percent loss and 55 percent estimated price.

For higher coverage options, the portion paid by the producer increases as the level of coverage increases. Known as “buying-up,” producers may increase the 50/55 level provided by catastrophic coverage for both the yield and estimated price, with 75 percent of yield and 100 percent of estimated price generally being the highest possible coverage available (though in some circumstances an 85/100 buy-up is available). On average, the federal government pays the majority of premiums. As an example, the subsidized portion for all corn policy premiums in 2010 equaled 61 percent, and the Congressional Research Service documented an average total premium subsidy for all policies of 60 percent.3

As demonstrated above, the elements of yield and price are integral to delivering federal crop insurance. Those two elements even define the two primary types of federal crop insurance policies, yield based or revenue based. In either case, the yield and price factors must be established.

The yield element is determined by “Actual Production History,” or APH. An approved APH yield is determined by recording consecutive years of actual yields produced (total crop production divided by total acreage planted), with the minimum requirement of four years of actual recorded yields and a maximum of 10 years. For example, a Midwestern corn grower may have recorded annual bushels/acre yields of 180, 178, 196, 184, 190, 148, 181, 183, 186 and 184. That producer’s APH for purpose of a federal crop insurance policy would be the average yield for the 10 years of production, or 181 bu/ac.

The price element is called the “projected price” and is determined through a price discovery process for any insured crop. As an example, for the spring-planted corn crop, RMA tracks the corn futures market during the month of February to set the projected price for corn producers. In 2011 the projected price for corn was a record-high $6.01 per bushel. Price discovery periods vary by crop and season.4

With an established Actual Production History and RMA’s recorded projected price, a producer may chose between the two primary types of insurance coverage: Yield Protection or Revenue Protection (see sidebar). It is important to note that Revenue Protection has an additional price element where a “harvest price” is also determined by RMA through a price discovery process initiated at the end of a crop season. For instance, once more using the example of corn, RMA tracks the corn futures market during the month of October to set the harvest price for corn producers.

Yield Protection policies will make payments when yields fall below a yield guarantee. Payment will occur when a producer’s actual production is less than the APH multiplied by the level of coverage. The difference is then multiplied by the projected price to determine the amount of payment, known as the indemnity: ((APH * coverage) - actual production) * projected price.

Revenue Protection will make payments when revenue falls below a revenue guarantee. Payment will occur when a producer’s actual production multiplied by the harvest price is less than APH multiplied by the projected price multiplied by the level of coverage: ((APH * coverage) * projected price) - (actual production * harvest price). The difference between the insured projected price revenue and the harvest revenue will constitute the indemnity. In addition, and unless specifically excluded by the producer when obtaining a Revenue Protection policy, Revenue Protection will automatically increase the revenue guarantee if the harvest price is greater than the projected price: ((APH * coverage) * harvest price) - (actual production * harvest price).

Revenue policies provide coverage in the event of poor yields, like Yield Protection will, but also provide coverage should harvest prices drop compared to projected prices at planting (not an unusual occurrence if given a rational supply/demand market realization that crop availability should increase at harvest time). And, even in the case of a higher harvest price than the projected price at planting, Revenue Protection policies can still result in payments.

As the examples demonstrate, producers have done the math and Revenue Protection has become the most popular type of crop insurance policy purchased.

Crop Insurance Policy: Evolving Consequences

A further aspect of the Federal Crop Insurance program is the increasingly consistent positive return on the investment achieved by producers. To improve their odds, program participants naturally choose to “buy-up” coverage using the most advantageous structures RMA provides for obtaining insurance (see Table 1). As described previously, the average subsidized portion of the total premium is 60 percent, leaving an out-of-pocket expense to producers of 40 percent. However, with available options such as enterprise units—insuring all the land of a single crop for a producer in a county—government subsidies pay 80 percent of a producer’s premium at a 70 percent coverage level and 68 percent at an 80 percent coverage level. Using such options, combined with the greater opportunity for indemnities provided by Revenue Protection compared with Yield Protection, the rapidly expanding use of Revenue Protection policies means the existing trend of consistently greater indemnities received than premiums paid will increase at even larger ratios.

The Federal Crop Insurance program also provides a specific means for insuring a crop that is planted in newly converted land that has not previously been in production, or new breakings. Contained within a set of provisions for “New Breaking,” the RMA Written Agreement handbook enables a producer to obtain insurance without prior production.5 As detailed previously, a minimum four years of production is otherwise necessary to establish Actual Production History.

For land that has not been in production previously, federal regulations contained in 7 CFR Ch. IV §400.55(b) establishes qualification requirements for establishing an APH based most commonly on a “Transitional Yield” or T-Yield. The T-Yield is an estimated yield derived from USDA records for yields for a specific crop in a county. If insufficient records are available for a specific crop in a given county, a “Determined Yield” or D-Yield derived from national data may be used.

The APH qualification requirements stipulate that the obligatory minimum four years of production are to be determined by applying an “Adjusted Yield” that is equal to 65 percent of the established T or D-Yield. Further, as established by RMA Manager’s Bulletin MGR-11-006, any Written Agreement providing insurance for land that cannot be shown to have ever previously been in production must also stipulate a maximum yield of the Adjusted Yield, or 65 percent of the T- or D-Yield.6

Crop Insurance Conclusion

As a logical support system for farmers, subsidized crop insurance has exploded in popularity. Most of the acreage devoted to major field crops is enrolled in the crop insurance program. Program participation rates exceed 80 percent for corn, soybeans, wheat, cotton and peanuts. Insurance premium subsidies to producers grew from $951 million in the 2000 crop year to $2.3 billion in 2005 and $4.7 billion in 2010. The 2011 crop year saw more than 264 million acres insured, with premium subsidies exceeding $7.4 billion.7 The total cost for the Federal Crop Insurance program is further projected to continue surpassing all Commodity Program spending, making crop insurance the primary means by which taxpayer support is provided to agricultural producers (see Figure 1).

However, subsidized insurance can provide an inherent incentive for risky production. The major form of crop insurance now pays out often independently of crop failure or weather disasters and instead is based on insuring price, so producers regularly average returns far greater than the premiums they invest. Furthermore, it creates an incentive for producers to plant as much land as they can, resulting in the conversion of remaining parcels of native land. Predictably, these parcels have often been left undisturbed due to a low likelihood of high yields—but current federal policies for transitional yields and guaranteeing revenue make protecting resources and keeping sensitive land out of production look like a bad business choice.

The Federal Crop Insurance program is not in and of itself bad policy, but any Farm Bill policy that reduces risk must be accompanied by policies that protect against reckless and destructive reactions to the resulting artificially low-risk conditions for program participants.

Endnotes

1. See www3.rma.usda.gov/tools/agents/companies/indexCI.cfm

2. See www.rma.usda.gov/policies/2011policy.html

3. Policy and crop data available at www3.rma.usda.gov/apps/sob/current_week/crop2010.pdf

4. See www3.rma.usda.gov/apps/pricediscoveryweb/ActiveDiscoveryPeriods.aspx

5. See www.rma.usda.gov/handbooks/24000/2011/24020.pdf

6. See www.rma.usda.gov/bulletins/managers/2011/mgr-11-006.pdf

7. See www3.rma.usda.gov/apps/sob/current_week/sobrpt1999-2008.pdf and www3.rma.usda.gov/apps/sob/current_week/sobrpt2009-2012.pdf

Examples comparing the USDA-Risk Management Agency’s federal crop insurance Yield Protection (YP) and Revenue Protection (RP) policies support the statistical move of the current majority of producers to Revenue Protection. In a low-yield scenario both YP and RP result in insurance payments. However, in a low-yield and low-harvest-price environment, the RP payment on the example farm would be $135,000 higher than the YP payment. In addition, in a low-yield and high-harvest-price environment the RP payment would still be slightly greater than the YP payment. Finally, in a high-yield environment, YP would provide no payment, but RP would provide a significant payment (more than $47,000 in our example) in a low-harvest-price environment.

Corn Producer A: low yield

APH: 181 bushels
Projected price: $6.01
Coverage: 75 percent
Acreage insured: 500

Actual Production: 135 bushels
Harvest Price (a): $4.00
Harvest Price (b): $7.00

Yield Protection
Example:
((APH * coverage) - actual production) * projected price
181 * 75% = 135.75
135.75 - 135 = 0.75 * 6.01
$4.51 payment per insured acre
$2,255.00 total gross

Revenue Protection
Example Harvest Price (a):
((APH * coverage) * projected price) - (actual production * harvest price)
181 * 75% = 135.75
135.75 * $6.01 = $815.86
135 * $4.00 = $540.00
$815.86 - $540.00 = $275.86 payment per insured acre
$137,930.00 total gross

Revenue Protection
Example Harvest Price (b):
((APH * coverage) * harvest price) - (actual production * harvest price)
181 * 75% = 135.75
135.75 * $7.00 = $950.25
135 * 7.00 = $945
$950.25 - 945 = $5.25 payment per insured acre
$2,625.00 total gross

Corn Producer A: high yield

APH: 181 bushels
Projected price: $6.01
Coverage: 75 percent
Acreage insured: 500
Actual Production: 180 bushels
Harvest Price (a): $4.00
Harvest Price (b): $7.00

Yield Protection
Example:
((APH * coverage) - actual production) * projected price
181 * 75% = 135.75
180 > 135.75 = no insurance payment

Revenue Protection
Example Harvest Price (a):
((APH * coverage) * projected price) - (actual production * harvest price)
181 * 75% = 135.75
135.75 * $6.01 = $815.86
180 * $4.00 = $720.00
$815.86 - $720.00 = $95.86 payment per insured acre
$47,930.00 total gross

Revenue Protection
Example Harvest Price (b):
((APH * coverage) * harvest price) - (actual production * harvest price)
181 * 75% = 135.75
135.75 * $7.00 = $950.25
180 * 7.00 = $1,260.00
$1,260.00 > $950.25 = no insurance payment

 

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