People often ask why Washington has to involve itself at all in providing crop insurance to American farmers. After all, homeowners across the country buy fire insurance, individuals buy life insurance, business owners buy casualty and liability insurance, all without taxpayers having to kick in subsidies. So why are farmers any different? Why the special treatment?
It’s a fair question, and the answer can be seen in two maps recently published by USDA’s Risk Management Agency (RMA), which operates the Federal crop insurance program on behalf of the Federal Crop Insurance Corporation (FCIC). What they demonstrate is a phenomenon economists call “systemic risk,” and that makes all the difference.
The two maps show, county by county, the amount of money FCIC and its partner insurance companies paid farmers for crop losses during two recent years, 2012 (top) and 2015 (bottom). The darkest areas show the worst damage.
2015, the lighter map, was a better-than-average crop year, with losses limited and scattered about the country. Notice the very few dark-brown splotches across the Midwest, where the biggest concentrations of insured crops are raised. Payments to farmers for crop losses that year have reached only $5.7 billion, far less than the $9.6 billion collected in premium (of which about 60 percent is taxpayer-subsidized). As a result, the system showed a profit, shared between taxpayers and private insurers.
By contrast, 2012 was a bad-weather year when severe drought hit much of the Midwest. Notice the extended dark-brown areas. Losses were massive, totaling over $17 billion in indemnities, far outstripping premiums. The system ended the year in the red by almost $6 billion, including almost $2 billion in losses for private insurers.
Herein lies the basic difference between agriculture – with high “systemic risk” – and other forms of coverage. Take home-owners insurance, for instance. Here, insurers know, based on years of experience, that a certain number of houses will catch fire or be hit by falling trees any given year, but the likelihood of every house in California or Illinois catching fire all at once is severely low. As a result, insurers can set premium rates and plan payouts in a predictable way, with financing in place. The same is true for life insurance. Demographic data show that a certain percentage of people at each age group will die in any given year. Each death is a unique tragedy, but the national levels remain stable year after year.
For an unusual event like a San Francisco earthquake or an East Coast tsunami, this predictability allows insurers to plan ahead by tapping global “reinsurance” markets that spread the risk worldwide.
Agriculture, though, is the opposite. A major drought or flood can wipe out all the farms in a large production area all at once, as we saw with 2012. A disaster this bad may occur only once every ten years or so, but that can be enough to bankrupt the system and preclude private investment.
This is why, prior to Washington’s getting involved in the 1930s, insurance for farm crop production barely existed in the United States, limited to isolated risks like hail. Even there, sky-high premiums make it unaffordable to all but the most affluent growers. Even the original bare-bones Federal crop insurance system created in the 1930s left participation low. As recently as the 1990s, when disaster struck (like the historic 1988 drought and 1993 flood in the Midwest), Congress stepped in with expensive, often-wasteful, after-the-fact ad hoc farm disaster relief programs. Taxpayers paid the tab, and farmers had no chance to manage their coverage.
But beginning with the 1990s, a succession of Congresses and Administrations began investing in Federal crop insurance, increasing fiscal supports and developing better products in partnership with private providers. Crop insurance became affordable, and farmers since then have voted with their checkbooks to make it the principal safety net for American agriculture, replacing the old ad hoc disaster bailouts.
The key was recognizing that phenomenon of “systemic risk.” It made Federal support essential. In a blow-out year like 2012, the Federal government, through FCIC, cushions the system by absorbing the deepest blows, allowing the system to weather the storm. That’s the difference. It’s real, and you can see it in those shades of yellow and brown. Just look at the maps.
Ken Ackerman, a former administrator of USDA's Risk Management Agency, and Elliot Belilos represent farmers and crop insurance AIPs (approved insurance providers) in crop insurance disputes.