Crop Insurance and 2012 Drought

7/28/2019 Crop Insurance and 2012 Drought

1/19

www.ewg.og

1436 U Street. NW, Suite 100

Wasington, DC 20009

environmental

working group

April 2013

Taxpayers,

Crop InsuranCe,

and The droughT

of 2012


2/19

Taxpayers, Crop Insurance, and te Drougt of 20122 EWG.og

CAuthos

Bruce Babcock P.D.

Professor of Econoics

Iowa State University

peface

Craig Cox

Vice President for Agricuture

and Natura Resources

EWG

Edto

Nis Bruzeius

Executive Editor and VP for

Pubications

EWG

Desgnes

Aan Anderson

Ty Yaniz

3 Preface

4 Fu Report

5 Crop Insurance in 2012

7 Preius and Subsidies

10 Crop Insurance Progra Costs

14 2012 Payouts witout Revenue Protection

14 Wat Constitutes an Adequate Safety Net?

19 Notes

Acnowedgements:

EWG tanks te Waton Faiy Foundation for its

support for tis researc.

Te autor tanks Xiaoong Zu for er data

assistance.HEADQUArTErS1436 U Street. NW, Suite 100

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Aout EWG

Te ission of te Environenta Working Group

(EWG) is to use te power of pubic inforation to

protect pubic eat and te environent. EWG is a

501(c)(3) non-prot organization, founded in 1993 by

Ken Cook and Ricard Wies.

rent pemsson

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3/193Environenta Working Group

prEFACE

by CrAiG COx

ViCE prESiDENT FOr AGriCUlTUrE AND NATUrAl rESOUrCES, EWG

ThERE WERE TWO REASONS ThAT

ENVIRONmENTAl WORKING

GROUP (EWG) COmmISSIONED

AGRICUlTURAl ECONOmIST BRUCE

BABCOCK OF IOWA STATE UNIVERSITY TO

ANAlYZE hOW ThE hEAVIlY SUBSIDIZED

FEDERAl CROP INSURANCE PROGRAmPERFORmED DURING ThE CORN BElT

DROUGhT OF 2012.

First, te 2012 drougt drasticay cut crop yieds

across severa states just te kind of event tat

many economists agree justies a role for taxpayers

in providing farers wit a safety net. Second,

Congress is about to take up te far bi again under

serious pressure to cut spending. Te taxpayer cost

of crop insurance as grown steadiy since 2000 and

now is te ost expensive governent progra

supporting far incoe. EWG tougt te 2012

drougt woud be te perfect case to test weter

its possibe to save federa tax doars wie sti

providing an eective safety net for farmers facing

potentiay cripping osses.

Dr. Babcocks concusions soud be a wake-up ca

for taxpayers and te senators and representatives

in Congress charged with creating a more scally

responsible safety net. His key ndings:

Over-generous subsidies ave turned crop

insurance into ore of a far incoe support

progra tan a risk-anageent progra.

Taxpayers coud provide farers wit a secure

oor under their nances for less than half of

wat te current progra costs.

Atoug avoiding ad hocdisaster reief

expenses as been one of te ost-often cited

justications for subsidized crop insurance, the

current insurance progra cost taxpayers far

ore in 2012 tan traditiona disaster reief

woud ave.

Taxpayers wi bear te burden of aost 75

percent of te 2012 insurance payouts; and

since 2001, insurance copanies ave enjoyed

$10.3 biion in underwriting gains wie

taxpayers ave ost $276 iion.

Tis atest report fro Bruce Babcock adds to te

growing evidence tat coon sense refors to

crop insurance woud save biions of doars wie

still providing a solid safety net, cutting the decit and

investing in progras tat iprove uan eatand te environent. So far, owever, te subsidy

obby as anaged to pus Congress in te opposite

direction. If eiter te faied Senate or house

Agricuture Coittee far bi proposas fro ast

year were to becoe aw, taxpayers woud be asked

to pay even ore for crop insurance wie funding fo

conservation and nutrition progras went under te

budget knife.

Congress soud and coud do far better as it takes upte far bi again tis year.


4/19


FUll rEpOrT

Taxpayers, Crop Insurance and te Drougt of 2012

by brUCE bAbCOCk pH.D.

prOFESSOr OF ECONOMiCS, iOWA STATE UNiVErSiTy

lOW FARm YIElDS IN CORN BElT

STATES DUE TO ThE 2012 DROUGhT

hAVE lED TO ThE hIGhEST CROP

INSURANCE PAYOUTS IN hISTORY.

PAYOUTS (INDEmNITIES) FOR ThE YEAR

WIll EXCEED $16 BIllION, AN AlmOST 50

PERCENT jUmP FROm ThE ThEN-RECORD

$10.8 BIllION PAID OUT ThE YEAR BEFORE.

Te big payouts are ardy surprising. A arge

proportion of US crop acreage is now insured, and

farers experienced record-breaking drougts and

proonged periods of ot teperatures during te

growing season in bot years. Furterore, ig

coodity prices ade te insured crops orevauabe, driving up te size of te payouts.

Supporters of te current crop insurance progra

argue tat te record-setting payouts sow tat te

program is working exactly as it should: by covering

farmers losses, the insurance provided the nancial

safety net tat tey need to be abe to pay teir bis

and survive to pant anoter crop.

But the truth is very dierent. A close analysis reveals

tat crop insurance as it is currenty structured and

arketed is a boated, taxpayer-funded incoe

support progra tat in any cases aows growers,

particuary te industria-scae operations tat ave

been enjoying record prots, to make more money

fro insurance payouts tan tey woud fro a

eaty arvest.

Teres no question tat farers, wo ust cope wit

the vagaries of weather and other dicult-to-predict

risks, deserve a safety net. And a propery structured

insurance progra tat worked ike oter types of

insurance woud provide tat safety net.

But crop insurance is not ike te auto, eat

and property poicies sod by private copanies

to custoers wo vaue te coverage and pay a

preiu tat is adequate to cover teir possibeosses and te insurers processing costs, as we as to

generate a prot for the agents and the companies.

Tose copanies, in turn, contro teir risk exposure

by buying private reinsurance wen needed and by

anaging teir portfoio of poicies.

In contrast, te preius paid by farers for crop

insurance cover ony 40 percent of te anticipated

payouts. It is taxpayers wo foot te bi for te

oter 60 percent, aong wit deivery costs, agent

commissions and company prots. Taxpayers alsosouder a arge sare of te osses wen payouts

exceed preius, as tey did in 2012. Because

tax dollars nance such a large share of the costs,

farers decisions about ow uc and wat type of

insurance to buy do not reect their true valuation

of te insurance. And because taxpayers take uc

of te it for excess osses, insurance copanies

decisions on wat types of poicies to se ikey do

not reect prudent risk management. In addition, the

abiity of insurance copanies to anage teir risk

is restricted by te governents requireent tat

copanies ust se crop insurance to a farers

wo want it.

Overa, taxpayers outsized support akes crop

insurance ore of a far incoe support progra

tan an insurance pan. And because it is te

governents costiest far progra, it is iportant

to assess weter taxpayers are getting good vaue



for teir doars. Te answer is no. Taxpayer subsidies

distort farmers insurance choices and inate the

progras costs.

Te detaied anaysis tat foows sows tat because

of te taxpayer subsidies, farers ave powerfu

incentives to buy Cadiac insurance poicies tat

draaticay drive up te cost of te progra.Witout tose subsidies, for exape, corn and

soybean crop insurance payouts woud ave been

ust over $6 biion in 2012 ess tan af of te

actua aounts. And farers woud sti ave ad a

solid oor under their revenues a far more cost-

eective farm safety net.

Crop InsuranCe In 2012

Tere is no better pace to begin tis anaysis tan

by reviewing ow crop insurance perfored in te

drougt year of 2012.

Figure 1 sows te nuber of acres insured and

panted in 2012 for te 11 crops wit te ost

insured acreage. Fuy 84 percent of panted acreage

for tese 11 crops was insured. Overa, tey

represent about 95 percent of tota insured crop

acreage. The top ve crops clearly dominate the crop

insurance progra, accounting for 90 percent of

tota insured acreage, 87 percent of tota preius

paid and 82 percent of te tota aount of insurance

purcased in 2012.

Fi 1. I pl C ac,ui s

Source: USDA: Risk Management Agency Summary of Business Reports and National Agricultural Statistics Service

Con so

yWhe

at

Cotto

n

soghu

m

Bale

yric

e

Sunf

ower

Cano

laBe

an

pean

ut

I

plt

millionacres

100

90

80

70

60

50

40

30

20

10

0


6/19


Tere are tree aor insurance products avaiabe

for growers of these ve crops. Yield Protection (YP)

poicies cover osses due to ow yieds. Revenue

Protection-harvest Price Excusion (RP-hPE) protects

against ow revenue. Revenue Protection (RP)

cobines te two, protecting against osses due to

ow prices wen prices drop and against ow yieds

wen prices rise.

A farers crop insurance guarantee is set before

panting. It is deterined by te proected arvest

tie price of te crop and te farers istory, wic

is used to estiate te expected yied. Te foowing

example of how the dierent products work is based

on te case of a corn farer wit an expected yied of

200 buses per acre and a springtie-proected 2012

arvest tie price of $5.68 per buse.

YP: Insuring Against Low Yields

Under a yied protection poicy, a farers buys

insurance against ow yieds. Te yied guarantee

equas te product of a fars expected yied eve

and te coverage eve te farer seects. Coverage

eves range fro 50 to 85 percent in 5 percent

increents. Wit an expected 200-buse yied, te

farer in tis exape can seect a yied guarantee of

fro 100 to 170 buses per acre.

In te fa, te farers arvested yied per acre

is copared to te yied guarantee to deterine

weter an insurance payent is due. If te

arvested yied is ess tan te guaranteed yied,

tere is a payout equa to te yied guarantee inus

actua arvested yied (te yied oss) utipied by

te projected arvest price.

Wen defenders of crop insurance cite crop disasters

brought about by drought, ood, wind or pestilence

to argue tat crop insurance is necessary to protect

farers fro te vicissitudes of nature, teyre

taking about YP poicies, te type tat protects

against tese disasters. But very few farers actuay

buy YP. Instead, tey buy protection against revenue

decines, not just yied decines. Te two products tat

protect revenue are RP-hPE and RP.

RP-HPE: Pure revenue insurance

Wit an RP-hPE poicy, a farer cooses to protect

doars per acre, rater tan buses per acre.

Avaiabe poicies guarantee fro 50 to 85 percent of

projected revenue, wic equas springtie projected

crop price ties expected yied. Tus te corn farer

in our exape coud seect revenue guaranteesranging fro $568 to $965 per acre.

Coe fa, te arvested yied per acre is utipied

by te actua (not te projected) arvest price to

deterine arvest revenue. Tis arvest revenue is

copared to te revenue guarantee to deterine

weter tere soud be a payout. If te arvest

revenue is ower tan te guarantee, te poicy

payout makes up the dierence.

Soe farers ay prefer a revenue guarantee to a

yied guarantee because tey typicay pay production

expenses in doars, not buses. Even a buper crop

igt not generate adequate revenue to pay te bis

if te arvest price turns out to be uc ower tan

anticipated.

Advocates of crop insurance seldom tout the benets

of protection against ower-tan-expected arket

prices, peraps because a grower as ore ways to

protect against ow prices tan against ow yieds. A

farer can use forward contracts to ock in a price

we before a crop is panted, or, if e or se doesnt

want give away upside price potentia, use put

options on futures contracts as price insurance.

RP-hPE provides pure revenue insurance, since any

cobination of yied and arvest price tat generates

revenue beow a farers revenue guarantee triggers

a payout. If te cobination of price and yied

generates revenue tat exceeds te guarantee, tereis no payout. In 2012, for exape, ow corn yieds

increased te arvest price to $7.50 per buse.

Our 200-buse corn farer wo purcased an 80

percent revenue guarantee under RP-hPE (at $908.80

per acre) woud not ave received a payout if is

arvested yied exceeded 121.2 buses per acre

(908.80/7.5 = 121.2). In contrast, te farer woud



ave received a YP payout for any yied ower tan

160 buses per acre. Tats because te iger

harvest-time price is reected in the calculation of a

farers oss under pure revenue insurance, but not

under yied insurance. Tis feature of RP-hPE akes

for ecient insurance, because it appropriately

reduces payouts wen prices rise. But te very

features that make RP-HPE ecient for taxpayersake it unpopuar wit farers.

RP: The Cadillac Crop Insurance Policy

Fro a farers perspective, te probe wit

Yied Protection is tat it does not protect against

ow prices, and te probe wit RP-hPE is tat its

coverage against ow yieds is reduced if arvest

prices are iger tan projected. RP does awaywit tese perceived probes by cobining te

coverages provided by YP and RP-hPE. RP provides

pure revenue insurance wen te arvest price fas

and pure yied insurance wen it rises. Furterore,

wen te arvest price increases, yied osses are

vaued at te iger actua arket price rater tan

te projected price.

If te farer wit te expected 200-buse-per-acre

yied ad purcased 80 percent RP and arvested

just 125 buses per acre, te yied oss woud ave

been 35 buses (0.8 X 200 125 = 35) and te RP

payout woud ave been $262.50 per acre (35 X 7.50 =

262.50). Te Cadiac nature of tis coverage becoes

obvious wen you copare wat te payouts woud

ave been under YP and RP-hPE. If te farer ad

purcased 80 percent YP, ten te payout woud ave

been $198.80 per acre. If te farer ad purcased

80 percent RP-hPE, tere woud ave been no payout

at a, because te price increase generated enoug

extra revenue to copensate for te yied oss.

Of course, Cadiac coverage coes wit a Cadiac

price. A simple analysis of costs and benets easily

expains wy farers overweingy coose tis

type of coverage.

premIums and subsIdIes

Figure 2 sows te per-acre insurance preius in

2012 for a corn farer in Capaign County, I. a

county ard-it by te 2012 drougt wo ad an

expected yied of 200 buses per acre. RP preius

averaged 80 percent iger tan RP-hPE and 90

percent iger tan YP across te coverage eves

sown.1 If crop insurance were ike oter insurance

arkets, one woud expect tat farers wo paid

iger preius for te Cadiac poicies did so

because tey vaued te additiona coverage ore

tan te cost of te preius tey paid. If tey

didnt, tey woud not buy it. But crop insurance is not

ike oter insurance arkets, because farers can

get te Cadiac coverage witout paying te Cadiac

preius.

Figure 3 sows te preiu subsidy doars avaiabe

for te tree types of crop insurance. Because te

subsidies are proportiona to te coverage aounts,

RP subsidies are 80 percent iger per acre tan

RP-hPEs and 90 percent iger tan YPs. Figure 3

sows ceary tat farers wo want to axiize

teir subsidies can do so by buying 85 percent RP

coverage a coice tat substantiay increases te

cost to taxpayers. most farers, owever, ake ore

sopisticated cacuations tan just axiizing tesubsidies.

Suppose tat preiu subsidies were equaized

on a doar-per-acre basis across a products and

coverage eves. Farers considering iger coverage

eves woud copare te increenta cost to te

additional benet. Similarly, farmers considering

weter to ove fro RP-hPE to RP woud copare

the incremental cost of RP with its additional benets

Te increenta cost of coosing a iger coverage

level or RP is reected in the dierence in premiums

sown in Figure 2. As wit any oter insurance,

the incremental benet of the additional coverage

depends on a farers abiity and wiingness to

absorb risk. When the incremental benets of higher

coverage or RP are greater tan additiona costs,

farers wi coose te ore expensive insurance.


8/19


But as sown in Figure 3, preiu subsidies are not

equa. Farers wo buy RP and ig coverage eves

benet from higher premium subsidies. Farmers

considering iger coverage eves or RP do not ave

to pay te fu increenta costs. And tat eans

that many more will nd that the benets of higher

coverage eves and RP exceed teir subsidized cost.

Weter farers decide to increase coverage or buy

RP because of preiu subsidies depends on ow

uc of te increenta cost tey are asked to pay.

If tey dont ave to pay any of te increenta cost,

they will all nd the additional insurance attractive. If

tey ave to pay 100 percent of te increenta cost,

on the other hand, premium subsidies dont inuence

teir coices.

Figure 4 sows te proportion of increenta cost

tat te Capaign County corn farer ust pay for

iger coverage eves for a tree types of insurance

Te farer pays ony 40 percent of te additiona cos

of oving fro 65 percent to 70 percent coverage.

The costs are so low that almost all would nd that

this move generates benets that exceed their costs.

In contrast, a saer proportion of farers woud

nd that moving from 80 percent to 85 percent

coverage generates sucient benets to make it

wortwie because tey ave to pay 88 percent of

te increenta cost.

Te actua coverage eves cosen by Capaign

County corn farers are sown in Figure 5. Aost 89

Fi 2. 2012 p-ac C Ic pif Chi Cy C F

Source: Calculated from premium calculator located on USDAs Risk Management Agencys website.

rp

rp-hpe

yp

$eracre

0

85% 80% 75%

Cv Lvl

70% 65%

10

20

30

40

50

60



percent calculated that the articially low incremental

benets of moving to the 80 percent and 85 percent

eves exceeded te increenta costs. Tat so any

farmers found that the incremental benets of 85

percent coverage to exceed te increenta costs

is soewat surprising, since tey ad to pay 88

percent of te additiona costs. One expanation istat any farers wo bougt 85 percent coverage

insured teir acreage under an enterprise unit tat

qualied them for even higher subsidies and lower

increenta cost requireents tan sown in Figure 4.

Te sae type of cacuation can be ade for te

coice of insurance product. Figure 6 sows te

proportion of increenta cost tat te Capaign

County corn farer ust pay for oving to RP

fro eiter RP-hPE or YP at various coverage eves.

Farers are ony asked to pay 41-to-62 percent of te

cost of oving to RP at te sae coverage eve. For

exape, farers insured at te 85 percent eve pay

62 percent of te cost of oving up to RP. Farers

insured at te 80 percent eve pay just over 50percent of te cost of securing te Cadiac coverage.

As a resut, youd expect tat ost farers woud

nd that the benet exceeds the costs. And you

woud be correct. Ony 11 percent of corn farers

in Capaign County wo bougt crop insurance

cose to buy RP-hPE or YP. Wen you can get Cadiac

coverage at a fraction of te actua cost, ost opt to

buy it.

Fi 3. 2012 p-ac pi sii f Chi Cy C F

Source: Calculated from premium calculator located on USDAs Risk Management Agencys website.

rp

rp-hpe

yp

$eracre

0

85% 80% 75%

Cv Lvl

70% 65%

5

10

15

20

25


10/19


Giving farers incentives to buy RP poicies and

increase teir coverage eves increases taxpayers

costs because te aount te progra costs

taxpayers is argey proportionate to te cost of

subsidizing te preius. An exaination of

progra costs in 2012 deonstrates tat wen

preius go up, so too do progra costs.

Crop InsuranCe programCosts

Tabe 1 suarizes progra data tat can be used

to cacuate ow uc te crop insurance progra

cost taxpayers in 2010, 2011 and 2012. Tree years

of data are sown to iustrate ow uc tese costs

can vary fro year to year.

Row 1 sows te tota preiu te preiu paid

by farers pus te preiu paid by taxpayers. Row

2 is te tota payout to farers wo ade cais

against teir insurance. Gross underwriting gain

(Row 3) is cacuated by subtracting payouts (Row

2) fro preiu (Row 1). In bot 2010 and 2011

tere were gross underwriting gains, but in 2012

tere was a arge gross oss. Gross underwriting

gains are sared between taxpayers and te crop

insurance copanies. Te saring rues for osses are

copicated, but in genera, te arger te oss (cais

exceeding preius), te greater te taxpayers

sare.

Fi 4. pi f Icl C f HihCv pi y F

Source: Calculated from Figures 2 and 3.

pe

rcentage

100%

90%

80%

70%

60%

50%

40%

30%

85% m 80% 80% m 75%

Cv Lvl

75% m 70% 70% m 65%

20%

10%

0



Row 4 sows te preiu subsidy. Tis is te

aount of tota preiu paid by taxpayers, not

farers. Te aount of te preiu paid by farers

sown in Row 5 is cacuated by subtracting te

preiu subsidy (Row 4) fro tota preiu (Row

1). In 2012, farers paid $2.882 biion in preius,

wie taxpayers paid $4.126 biion.

The net cash benet farmers gained from the crop

insurance progra (Row 6) is found by subtracting

te farer-paid preiu (Row 5) fro te payouts to

farers (Row 2). In 2010, farers netted $1.37 biion.

In 2012, farers netted aost $12 biion.

Payents to insurance copanies for teir

anageent and deivery (adinistrative and

operating costs, or A&O) of te progra in 2012

totaed $1.4 biion (Row 7). Row 8 sows te

copanies underwriting gain. In 2012 tis gain was

negative, eaning crop insurance copanies ost

$1.3 biion. Taxpayers ost ore tan twice as uc,

$3.7 biion (Row 9). Te net cas paid to copanies

in 2012 was $105 iion (Row 7 pus Row 8). Tenet cost to taxpayers was $12.1 biion (Row 11),

cacuated by adding te net cas paid to farers to

te net cas paid to insurance copanies.

Tabe 1 sows soe of te pecuiarities of te crop

insurance progra. First, note tat in 2010, taxpayers

paid insurance copanies ore tan farers

Fi 5. pi f rp, Yp rp-Hpeac I Vi Cv Lvl iChi Cy, Ill.

Source: Summary of Business Reports. USDA-RMA.

pe

rcentage

50%

45%

40%

35%

30%

25%

20%

15%

85% 80%

Cv Lvl

75% 70% 65%

10%

5%

0


12/19


received in net payouts. In fact, taxpayers paid

copanies ore tan farers in six of te ast 12

years. Tis iustrates bot te ig cost of deivering

te progra and te arge year-to-year swings in

payouts. Tese are a direct resut of so uc of te

progra being concentrated on corn and soybeans.

Wen tose two crops do we, te progras costs

are doinated by payents to te copanies.

Second, wen tere are underwriting gains, insurance

companies benet more than taxpayers. In 2010,

57 percent of te gross underwriting gain went to

te copanies. Taxpayers got 43 percent. In 2011,

copanies gained $1.7 biion wie taxpayers ost

$550 iion, even toug te progra as a woe

ad a gain of $1.1 biion.

In 2012, taxpayers wi absorb aost 75 percent

of te gross underwriting oss. Tis is because te

copicated forua for saring gross underwriting

gains ensures tat taxpayers send ots of oney to

copanies wen osses are sa and greaty iits

te oss to copanies wen overa osses are ig.

Since 2001, taxpayers have paid companies signicant

underwriting gains in every year except 2002 and2012. Over te 12 years, copanies ave enjoyed

$10.3 biion in underwriting gains at taxpayers

expense. Taxpayers have suered a net loss of $276

iion over te sae period.

Te structure of te crop insurance progra ensures

tat taxpayer costs are argey proportionate to te

tota preiu paid by farers and taxpayers. Te

Fi 6. pi f Icl C pi yF mvi rp f ih rp-Hpe Yp

Source: Calculated.

perc

entage

60%

50%

40%

30%

20%

85% 80%

Cv Lvl

75% 70% 65%

10%

0



cost of preiu subsidies increases as te tota

aount of preius goes up, and te net cas paidto farers goes up and-in-and wit preiu

subsidies.

Average underwriting gains paid to copanies are

also proportionate to total premiums. And nally,

adinistrative and operating reiburseents (A&O)

aso go up as preius rise, atoug tey ave been

capped since te Standard Reinsurance Agreeent

was renegotiated in 2011 as ong as tota preiusdont fa beow about $8 biion.

Figure 7 iustrates te strong positive reationsip

between taxpayer costs and tota preius, wic

is te ain reason taxpayers costs for te crop

insurance progra ave expoded.

tl 1. C Ic p C

a Nationa Suary of Business Reports, USDA- RmA as of Apri 1, 2013.

bRow 1 inus Row 2.

cRow 1 inus Row 4.dRow 2 inus Row 5.

eCost and outlay estimates http://www.rma.usda.gov/aboutrma/budget/cycost2003-12.pdf

fFor 2010 and 2011, Reinsurance Reports, USDA-RmA. Cacuated for 2012.

g Row 3 inus Row 8.

Row 7 pus Row 8.

i Row 6 pus Row 9.

Co yea

2010 2011 2012

row # $ mons1 Tota Preiusa 7,593 11,968 11,083

2 Payoutsa 4,250 10,855 16,089

3 Gross Underwriting Gainsb 3,343 1,113 -5,006

4 Preiu Subsidiesa 4,711 7,461 6,957

5 Farer-Paid Preiusc 2,882 4,507 4,126

6 Net Cas to Farersd 1,368 6,348 11,963

7 A&O Reiburseentse 1,371 1,383 1,411

8 Copany Underwriting Gainsf 1,915 1,666 -1,306

9 Governent UnderwritingGainsg

1,428 -553 -3,700

10 Cas to Copanies 3,286 3,049 105

11 Taxpayer Costi 4,654 9,397 12,068


14/19


Premiums have risen for two reasons. The rst is

tat ig prices ave ade crops ore vauabe,

aking te ore expensive to insure. Te second

is tat te powerfu incentives farers ave to buy

iger eves of te far ore expensive RP poicies. To

understand the magnitude of these eects and the

resuting escaation in costs, it is usefu to cacuate

wat te progra woud ave cost in 2012 if farerswo bougt RP poicies ad instead purcased YP or

RP-hPE.

2012 paYouts wItHout rp

Preius for RP coverage are iger tan for YP and

RP-hPE because farers ave a iger cance of a

payout and typica payouts are iger. If te arvest

price is ower tan te springtie price, ten RP andRP-hPE payouts wi be te sae and bot wi be

iger tan YP payouts. If, owever, te arvest price

is iger tan projected, payouts for RP coverage wi

be iger soeties far iger tan for YP. And

YP payouts in turn wi be iger tan for RP-hPE .

Te drougt year of 2012 provides a good case study

to understand wy payouts fro RP are so uc

iger tan fro YP or RP-hPE wen disaster strikes.

Wen farers ocked in teir insurance yied or

revenue guarantees for 2012, projected prices were

$5.68 per buse for corn and $12.55 per buse

for soybeans. As it turned out, te actua prices at

arvest were $7.50 and $15.39 per buse as te

drougt owered yieds and drove up crop prices. A

straigtforward cacuation sows ow uc ower

payouts woud ave been if every corn and soybean

farer ad purcased a YP poicy instead of an RP

poicy at te sae coverage eve. Wen te arvest

price is iger tan te projected price, RP poicies

pay for any yied oss at te iger vaue, wie a YP

poicy woud pay out at te ower projected price. Te

percent dierence between an RP and a YP payout is

equa to te ratio of te projected price to te arvest

price.

Witout knowing eac farers actua yied, it isnt

possibe to deterine exacty wat payouts woud

ave been if every farer wo purcased an RP

poicy ad instead purcased RP-hPE. however, its

possibe to estiate te payouts by using te actua

per-acre payouts for RP-hPE at eac coverage eve

for eac state and aking te assuption tat te

per-acre payouts woud ave reained constant if a

RP poicies been RP-hPE instead. Its a sipe atter

of utipying te per-acre payouts by te nuber ofacres insured under RP at eac coverage eve..

Tabe 2 sows te resuts for corn and soybeans,

wic accounted for aost 80 percent of a payouts

for insured crops in 2012.

In reaity, ore tan 94 percent of corn and soybean

payouts in 2012 resuted fro crop osses covered

by RP poicies. If tey ad been YP poicies instead,

payouts woud ave been cut by 22 percent, fro$12.7 biion to $9.9 biion. Because RP vaues crop

osses at te iger of te arvest price or te

projected price, payouts were $2.8 biion iger.

Wit RP-hPE poicies, te cost to taxpayers woud

ave been even ess. Corn and soybean payouts

woud ave been cut by ore tan af to just over

$6 biion. Tis cacuation sows te iportance

of a proper denition of what constitutes a loss. If

the eects of drought-induced higher prices are

appropriatey accounted for, te ipact of te

drougt is substantiay saer tan if te iger

prices are ignored. RP-HPE policies eectively account

for drougt-induced iger prices. RP poicies do not.

wHat ConstItutes anadequate saFetY net?

It is cear tat current preiu subsidies give farers

incentives to buy RP poicies, greaty increasing te

progras costs. Te two questions poicyakers

should ask are:

1. Given te iits on agricuture subsidy doars,

does it ake sense to spend te on RP

coverage?



2. Woud farers ave an adequate safety net if

tey purcased YP or RP-hPE poicies? It woud

be easy to answer tis question if we knew wat

kind of safety net farers woud purcase if

taxpayers were not subsidizing soe of teir

coices. Unfortunatey, teres no way to know

ow farers woud spend teir own oney if

their decisions were not heavily inuenced bysubsidies. A usefu aternative, owever, is to

examine the dierent degrees of safety provided

by te ain tree insurance products.

Return now to te corn farer wit an expected

yied of 200 buses per acre. Suppose tat before

panting corn in 2012, tis farer anticipated getting

a price of $5.68 per buse and a yied of 200 buses.

Tat is, tis farer expected revenues of $1,136 per

acre ($5.68 x 200 buses). Suppose furter tat tis

farer purcased crop insurance at te 85 percent

coverage eve. At tis eve RP and RP-hPE provide an

insurance guarantee of $965.60 per acre. Under YP

te guarantee is set at 170 buses per acre. Beow

tis yied eve te ost buses woud be vaued at$5.68 eac. Tabe 3 sows payouts, arket revenues

and tota revenues for tis farer if is 2012 yied

was 0, 50, 100 or 150 buses per acre, assuing tat

the farmer sells the corn at the 2012 ocial harvest

price of $7.50 per buse.

Because te arvest price of $7.50 per buse was

Fi 7. C Ic p C tlpi sic 2001

Taxayer

costs($million)

14,000

12,000

10,000

8,000

6,000

4,000

2,000 4,000

Ttl pmim ($ milli)

6,000 8,000 12,00010,000 14,000

2,000

0

Source: Calculated by author.


16/19


iger tan te projected price of $5.68, RP payouts

are iger tan YP and RP-hPE payouts at a treeyied eves. YP payouts occur wenever RP payouts

occur but are ower because YP poicies pay out at

te ower projected price. Tere is no RP-hPE payout

wen yied is 150 buses per acre because revenue

fro seing te saer crop at te drougt-induced

iger price is above te guaranteed eve.

Tota revenue equas te arket revenue pus te

insurance payout. RP tota revenue is constant at

$1,275 per acre because te RP payout copensatesfor ost buses at te sae price tat te farer ses

arvested buses. Note tat tota revenue under RP

is $139 per acre iger tan anticipated revenue. Tis

sows tat wen prices increase and tere is a yied

oss, farers wo buy RP actuay net ore revenue

tan if tere ad been no drougt.

Te sae situation can occur wit YP coverage if te

yied oss is not too great, but wit YP te reasonwy tota revenue is iger tan anticipated revenue

is tat arvested buses are sod at a iger price.

Wen yied is ow enoug, tota revenue wi fa beow

anticipated revenue, but it wi never fa beow te

insurance guarantee of $965.60.2

Because RP-hPE provides pure revenue insurance,

te farer can never coect an insurance payout

tat produces ore revenue tan te insurance

guarantee. If tota revenues rise above teguaranteed eve, it is because te farer as

beneted from the drought-induced higher prices,

which oset part or all of any loss from lower yields.

Supporters of te crop insurance industry cai

tat te 2012 Corn Bet drougt was devastating

to farers.3 But Tabes 2 and 3 sow tat ow

tl 2. Ic f rp 2012 C sypy ($ illi)

Source: Summary of business reports, USDA-RMA and author calculations.

Actua paouts Con Soean Totarp $10,064 $1,899 $11,962

yp $378 $105 $328

rp-HpE $223 $20 $398

Tota $10,665 $2,024 $12,688

paouts f yp eaced rp

yp $8,000 $1,631 $9,631

rp-HpE $223 $20 $243

Tota $8,223 $1,651 $9,874

paouts f rp-HpE eaced rp

yp $378 $105 $483

rp-HpE $4,775 $764 $5,539

Tota $5,153 $869 $6,022



devastating te drougt was depends on your

denition of devastation. Given the high proportion

of acres insured in 2012, te size of te payouts is

one easure of devastation. Actua payouts to corn

and soybean farers totaed $12.7 biion. Wen cropinsurance contracts were signed before panting tie

in 2012, corn and soybean farers expected to earn

a tota of $116 biion in arket revenue. Insurance

payouts, ten, wi account for about 11 percent of

tota anticipated revenues. But RP poicies accounted

for aost a of tese payouts, and RP payouts

overstate actua econoic osses because tey do not

account for te iger revenues farers captured

because of drougt-induced iger prices.

Tabe 1 provides a better easure of te degree

of devastation. Payouts woud ave been just over

$6 biion if farers wo bougt RP coverage ad

instead bougt RP-hPE poicies ess tan af of

te actua payouts. As sown in Tabe 3, farers

with RP-HPE coverage would have had a solid oor

under teir revenues. By te RP-hPE easure of

devastation, osses due to te drougt aounted to

about 5 percent of anticipated revenues.

Te point is not to argue tat te drougt did not

seriously aect crop yields. Clearly it did. But givente ig cost of te crop insurance progra, it is

reasonabe to ask weter it akes any sense to

entice farers to buy Cadiac coverage wit taxpayer

doars wen a basic revenue guarantee is possibe at

uc ower cost.

It is no ystery wy farers want to buy RP

coverage: it is more heavily subsidized and it pays out

more, hence farm prots are higher. There is only one

possible risk management benet for farmers who

buy RP. Farers wo forward se teir crop face te

risk tat tey wi not ave enoug yied to deiver on

te contract. If te price of te contracted coodity

rises, producers wit a sort crop wi ose oney

because tey ust purcase ore expensive grain to

onor teir contract. Farers wo forward contract

te exact sae proportion of teir crop tat tey

insure with RP will nd that the additional payout

tl 3. oc f Ic py f dh-sick C F

Source: Calculated.

Havested yed (u/ace)

0 50 100 150Maet revenue ($/ace) $0 $375.00 $750.00 $1,125.00

paout ($/ace)

rp $1,275.00 $900.00 $525.00 $150.00

rp-HpE $965.60 $590.60 $215.60 $0.00

yp $965.60 $681.60 $397.60 $113.60

Tota revenue

rp $1,275.00 $1,275.00 $1,275.00 $1,275.00

rp-HpE $965.60 $965.60 $965.60 $1,125.00

yp $965.60 $1,056.60 $1,147.60 $1,238.60


18/19


under RP copensates te exacty for tis edging

oss. Tus purcasing RP owers te risk to farers of

forward seing teir crop.

Given te pressure to cut funding for a agricutura

progras, it is a stretc to argue tat every doar

currenty being used to encourage farers to buy RP

and ig coverage eves is needed, wen te onypossible risk management benet is to reduce some

farers edging risks. If farers ad to pay te fu

increenta costs of RP, ony tose wo igy vaue

te additiona edging risk protection woud buy

it. Te rest woud opt for RP-hPE or YP. Tis woud

draaticay ower te cost of te crop insurance

progra wie sti providing a generous safety net.

Te considerabe savings coud be sared between

decit reduction and other programs in which bothtaxpayers and farers ave a fundaenta stake

in te outcoe, suc as conservation and researc.

making farers pay a arger sare of te increenta

cost of Cadiac insurance coverage woud be a good

pace to start.


19/19

notes

1. Te preius sown in Figure 2 are designed to be actuariay fair in tat tey woud generate enoug revenue to pay

out expected indenities over tie.

2. If te arvest price is ower tan te projected price, ten tota revenue for te farer wo buys YP can fa beow te

insurance guarantee if yied is positive because arvested buses wi be sod at a price tat is ess tan te price at

wic any yied oss is vaued.

3. See, for exape, To Zacarias, Farers Rey on Crop Insurance wen Nature Turns Against Te. Te hi, marc 1,

2013.

Documents

Crop Insurance and 2012 Drought