Revenue programs and crop insurance: What works?

WASHINGTON, April 11, 2012 -One of the most consistent themes heard during grower meetings and farm bill hearings over the last year has been the need to protect federal crop insurance as a viable part of the safety net in the 2012 Farm Bill. The crop insurance industry made this point in a backgrounder circulated on Capitol Hill in which they quoted John Williams, an Illinois farmer, who recently testified before a House Agriculture Committee field hearing. “I firmly believe the number one goal for the next farm bill should be: Do no harm to federal crop insurance,” Williams noted.

Support for crop insurance is a message that’s been echoed in various forms by both the chairs and ranking members of the House and Senate Agriculture Committees. That’s despite criticism from some non-farm groups who want to reduce reimbursement for crop insurance companies delivering the product or cut the level of premium subsidies provided for farmers.

And, of course, some Farm Service Agency officials want the private sector out of the delivery business, claiming that they alone can handle all of the risk management responsibilities.

But as staff members try to develop consensus on what the new commodity title should look like, there is growing concern about the interaction with crop insurance, which is subsidized by the federal government and new supplemental revenue assistance provisions ‑ available at no direct cost to farmers. University of Illinois Ag Economist Gary Schnittkey recently outlined some potential roles for crop insurance versus commodity programs in providing a farm safety net.

“Lost revenue due to low prices during the mid-1980s and late 1990s would not have been covered by crop insurance, because projected prices would have adjusted downward. Not covering these losses suggests a role for Farm Bill commodity programs,” Schnittkey wrote. “Farm Bill commodity programs can cover revenue declines of a multi-year nature due to declining prices or other factors. These have been labeled “shallow losses” because they occur before crop insurance pays, but these shallow losses are what have caused financial stress in the agricultural sector in the past.”

“One design of a commodity program that provides multi-year protection is to have the guarantee based on historical revenue. Many of the current program proposals base their guarantees on multi-year revenue. The Aggregate Risk and Revenue Program (ARRM) sponsored by Sens. Sherrod Brown, D-Ohio, John Thune, R-S.D., Richard Durbin, D-Ill., and Richard Lugar, R-Ind., uses a five-year Olympic average of revenue where revenue equals harvest price times Crop Reporting District (CRD) yields. The Ag Risk Coverage (ARC) program that was put forward to the Super Committee based its guarantee on an Olympic average of revenue, where revenue is based on the national season average price and farm yield. The Revenue Loss Assistance Program (RLAP) proposed by Sens. Kent Conrad, D.N.D., Max Baucus, D-Mont., and Hoeven, R-N.D., bases its guarantee on the Olympic average of five-years of national season average price times a farm’s historical yield,” Schnitkey pointed out.

Others are looking more closely at the impact shallow loss proposals might have on crop insurance. For example, Ruth Gerdes, a crop insurance agent with the Auburn Agency in Nebraska, says she “appreciates the “strong leadership” offered by Conrad, Baucus, and Hoeven with their RLAP proposal, but is concerned there will be “unintended damage” to crop insurance.

“As I understand RLAP, it is a free FSA-delivered revenue program payment to a producer,” she said. “This free payment would be reduced by any crop insurance indemnity the producer may have received under a crop insurance policy he purchased. In real life this will only encourage farmers to roll the dice and reduce the level of coverage they buy.” She called that a “step backward” from progress agriculture has made since a landmark 2000 crop insurance bill.

“Farmers should not be penalized by Washington policy for buying the level of crop insurance they need,” Gerdes said. She doubts that was the authors’ purpose, but given the unintended consequences of recent years, “I am not certain the crop insurance program can survive another.”

Conrad, Baucus and Hoeven have recently been talking about their RLAP proposal in their home states and, have taken great pains to point out that they are trying to “strengthen” crop insurance in their commodity title proposal. However, Kansas State University Ag Economist and Risk Management specialist Art Barnaby, found some interesting interactions when he took a closer look and compared the RLAP with crop insurance revenue protection at the highest, 85% level.

“Revenue risk has only two variables, price and yield,” Barnaby points out in his analysis. “Puts cover price risk and insurance covers yield risk. Combining puts and insurance in to a revenue derivative is a more efficient method for insuring revenue than independently insuring price and yield risk.” Barnaby says that the Supplemental Revenue Assistance Program (SURE) and its proposed replacement, RLAP, is “a derivative of puts and insurance with USDA paying 100% of the premium costs.” Below is Barnaby’s side by side comparison of RLAP and 85% Revenue Protection (RP), with some footnotes from the author for clarification.

²Crop insurance’s APH likely lower if growers have a historical loss. However if the grower has a significant trend adjusted APH, then likely their RLAP's APH will be lower.

³There are two ways to ration any good or service: create eligibility requirements as is the case for RLAP, or ration by price as is the case for crop insurance that requires farmer paid premiums. Few farmers buy the maximum coverage because of the premium cost but nearly all farmers will want the maximum “free” RLAP coverage.

⁴RP could provide a co-pay for losses covered from 85% to 75% for a reduced farmer paid premium. If RMA continued to pay the same dollars of subsidies, farmer paid premium would decline from 62% to 27% of the premium for the coverage from 85% to 80% and 52% to 17% of the premium for the coverage from 80% to 75%. Farmers would collect the full indemnity payment for losses 75% to zero (total loss) and they would pay the current full farmer paid premium cost for 75% RP.

⁵Allowing “GRIP” with a 25% deductible at the county level to be added to crop insurance will likely provide effective protection in high risk areas only, but requires farmer-paid premiums that include a 70% subsidy will reflect the low expected payouts. Any payments will be deducted from the free RLAP payments.

⁶Policy makers requiring premium reductions (it states premium but I am sure they mean rate) on a specific contract creates a precedence for future rate cuts dictated by policy. If the national book is to achieve actuarially soundness then premium rate increases will be needed on other contracts and types of insurance.

⁷Rather than policy makers requiring a premium reduction to save funds, an alternate would be cut the premium subsidy on CAT from the current effective rate of 100% to a subsidy rate of 67%, or the same as any 50% buyup coverage level. Farmer paid premiums and reduced CAT participation will reduce taxpayer cost.

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Original story printed in April 11th, 2012 Agri-Pulse Newsletter.

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