Thursday, June 17, 2010
Dennis A. Shields
Specialist in Agricultural Policy
Under the federal crop insurance program, farmers can purchase crop insurance policies to manage financial risks associated with declines in crop yields and/or revenue. The program covers more than 100 crops and is administered by the U.S. Department of Agriculture's (USDA's) Risk Management Agency (RMA), which acts as both regulator and reinsurer. To encourage farmer participation and reduce the need for ad hoc disaster assistance, the federal government subsidizes the purchase of crop insurance policies, which are sold and serviced through 15 approved private insurance companies. Insurance company losses are reinsured by USDA, and their administrative and operating (A&O) costs are reimbursed by the government.
A Standard Reinsurance Agreement (SRA) between USDA and the private companies spells out expense reimbursements and risk-sharing by the government, including the terms under which the government provides subsidies and reinsurance (i.e., insurance for insurance companies) on eligible crop insurance contracts sold or reinsured by insurance companies. As a result, the SRA plays a central role in determining program costs. The SRA does not affect policy premiums paid by farmers, which are based on RMA's estimates of risk and on subsides set in statute.
RMA is in the process of renegotiating the SRA that has been in effect since 2004. Some have criticized it as being too generous for insurance companies following a significant increase in government costs in recent years. Although Congress does not directly approve any new agreement, Congress has been interested in its oversight capacity, particularly with respect to cost-effectiveness and effects on farmer participation, the industry's selling and servicing of crop insurance products to farmers, and baseline funding levels for the next farm bill.
Since A&O reimbursements under the current SRA are based on a percentage of premiums, their dollar amount has risen sharply in recent years as premiums have risen to reflect higher crop prices. The A&O reimbursement increased from an average of $881 million during FY2004- FY2006 to $1.6 billion in 2009. Some observers argue that reimbursements should be pegged to something other than premiums, such as a flat fee per policy sold, to better reflect actual costs and to help reduce federal expenditures. The insurance industry contends that reimbursements are currently less than actual delivery expenses.
Similarly, company underwriting gains (the amount by which a company's share of retained premiums exceeds its indemnities) have increased substantially in recent years, as weather has been generally favorable for growing crops. Some have argued that if the government share of gains is increased in exchange for a larger government share of losses, average taxpayer costs would decline. The insurance industry contends that a certain provision of the current SRA ("net book quota share") is a tax on underwriting income and crowds out private reinsurance.
RMA released its first draft of the 2011 SRA on December 4, 2009, a second draft in mid- February 2010, and a "final" draft on June 10, 2010. The most recent draft places a cap on A&O reimbursements to control costs, and limits a company's expenditures on agent commissions. Among the proposed changes to underwriting provisions, the final draft improves profit potential and reduces company risk in higher-risk states. The draft also directs proceeds from an increase in the net book quota share to companies operating in "underserved states." Throughout the negotiations, the industry has been concerned that overall funding reductions are excessive. RMA expects that most companies will sign the agreement in time for it to take effect in July 2010. The new SRA will cover crops with policy closing dates after July 1, 2010 (e.g., 2011-crop corn).
Date of Report: June 10, 2010
Number of Pages: 19
Order Number: R40966
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