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Thursday, August 26, 2010

Renegotiation of the Standard Reinsurance Agreement (SRA) for Federal Crop Insurance

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 16 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. 

As provided under the 2008 farm bill, USDA in late 2009 began renegotiating the SRA established in 2004. On July 13, 2010, USDA announced that all of the approved crop insurance companies had signed the new SRA, which covers crops with policy closing dates after July 1, 2010 (e.g., 2011-crop corn). Prior to and during the negotiations, some had criticized the previous SRA 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 previous SRA were based on a percentage of premiums, their dollar amount had risen sharply in recent years as premiums rose 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. 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 has contended that a certain SRA provision ("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 final SRA places a cap on A&O reimbursements to control costs, and limits a company's expenditures on agent commissions. Among the changes to underwriting provisions, the final SRA improves profit potential and reduces company risk in higher-risk and underserved states. Overall, USDA expects the changes to save $6 billion over 10 years. The industry remains concerned that funding reductions are excessive, potentially jeopardizing program delivery to farmers.

Date of Report: August 12, 2010
Number of Pages: 20
Order Number: R40966
Price: $29.95

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