Federal Crop Insurance AIPs: Some Misconceptions about Underwriting Gains

Debate over the 2018 Farm Bill, likely to start in earnest this week with House consideration of H.R. 2, may focus sharp attention on the question of whether taxpayer costs for Federal Crop Insurance are reasonable and supportable.  At least five amendments filed for floor consideration are intended to limit these costs in different ways.

No one questions that Federal crop insurance has been broadly successful, delivering effective risk management services to farmers across America using a business model that encourages good management by individual producers and good service by industry professionals.  It has evolved to become the most prominent element of the Federal safety net for farm producers, and widely supported by growers and their organizations.  At the program’s heart is a partnership between the government, through FCIC (USDA’s Federal Crop Insurance Corporation), and a group of about 16 participating insurance companies, referred to as AIPs (Approved Insurance Providers).  The AIPs sell and service FCIC policies through private agents, all under the rubric of a Standard Reinsurance Agreement (SRA) setting out the legal, administrative, and financial terms of the relationship.  It is generally believed that the AIPs, agencies, and agents have helped create the world’s best crop insurance system.

Do AIPs profit too much under the agreement, or is the opposite true, are they squeezed too tightly by SRA terms and FCIC regulations?  One proposed House amendment, for instance, would reduce the ”target rate” for AIP underwriting gains from 14.5 down to 12 percent. 

Our long-time client and friend, the economic research firm of Watts and Associates, Inc. (W&A), has analyzed this question and found some surprises.  Here is a quick summary--

  • W&A reviewed the analytics of CBO and other parties and identified a logical flaw in the approach they used to determine expected AIP returns. Most of these analyses have looked at AIP underwriting gains going back five to ten years, in some cases up to 20 years, and assumed this history can predict the future.  This is flawed.  Beyond normal uncertainties based on annual weather changes, the program quite simply has changed dramatically in the past few years.  As two examples among many: (a) SRA changes in 2011 and (b) massive cuts to premium rates for corn and soybeans starting around the same time as the SRA changes, have worked together to change the basic math underlying the calculation of underwriting gains, making prior history highly misleading.  The past simply does not predict the future, in this instance. 
  • AIPs earn revenue from two main sources: (a) A&O from the government and (b) underwriting gains. Experience has shown that virtually the entirety of A&O goes to pay commissions for agents.  This is expected.  Agents in crop insurance bring value to the table because of the specialized expertise they apply in servicing clients using the complex FCIC program, and the SRA itself anticipates these levels of compensation in its applicable agent compensation caps in years of positive underwriting experience.   Therefore, underwriting gains become the primary contributor to pay both operating expense and profit. (In years of underwriting losses in a state, the SRA caps revert to 80% of A&O.)
  • As a result, any estimates of the expected underwriting gains for AIPs based on mandated changes in the SRA are speculative at best. Even existing estimates of gains under the post-2011 SRA are based on far too few years’ experience to draw conclusions.  Subtract from this the impact of operating expenses not covered by A&O, and the result is that many projections of underwriting gains for AIPs may be highly suspect.
  • Based on this analysis, lawmakers and policymakers are urged to proceed with caution in trying to mandate financial outcomes in a highly complex system subject to substantial recent change. Analyses which do not explicitly address changes to the SRA and premium rates as well as the more recent actual uses of A&O will produce results that cannot be relied on. The result of decisions based on flawed data could be to damage a program that currently works well both for farmers and for taxpayers, setting the stage for future costs that far outweigh any short-term gain.

We will track closely the debates on Capitol Hill this week and in coming months on the Farm Bill with a special eye on how House and Senate members address these important issues affecting federal crop insurance. Please let us know if you have any questions or if we can provide any further information on the issues as they unfold.

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