Archive for May, 2007
For crop insurance companies, A&O reimbursements and underwriting gains are determined in large measure by the terms and conditions of the Standard Reinsurance Agreement (SRA), a legally binding “cooperative financial assistance agreement” between the Federal Crop Insurance Corporation (FCIC) and approved insurance providers (AIPs) as developed more or less unilaterally by USDA. Traditional negotiations were not permitted by RMA in developing the current SRA in 2005. Crop insurance companies have been in a “take it or leave it” situation with respect to the SRA and its terms and conditions.
The increased cost of operating a successful, nationwide crop insurance program should not be viewed as a large “piggy bank” from which to take money to fund other programs. Crop insurance cost is driven largely by the level of success of the program in meeting Congress’ public policy objectives for the program to be an efficient and effective risk management tool that is fairly and equitably available to all farmers regardless of size, location or enterprise. Keith Collins, Chief Economist at USDA, testified in March, 2006, before a House Agriculture Subcommittee, that program liability or coverage is up about one-third and program acres is up about one-fifth since the passage of ARPA in 2000. In that testimony, Collins also stated, “Recent increases in the administrative and operating expense reimbursement and underwriting gains have strengthened the financial performance of the companies and encouraged new entrants and we believe that will help increase service to producers.”
Any raids on the crop insurance funds will result in higher premium costs and less service for farmers. They would signal a retreat from all the gains in building the best crop insurance program in the world. It would be a retreat from ARPA and all the efforts made in previous legislation and program changes to provide essential risk management for America’s farmers, ranchers and growers that would also be readily accepted by lending institutions and commodity markets.
Reimbursement of delivery expenses and the potential for underwriting gain does not overcompensate for the risk taken by crop insurance companies. Crop insurance is a risky business, especially when compared to other lines of insurance and taking into consideration the nature of the risk associated with production agriculture enterprises relative to the risk in other insured ventures. Multiple studies have shown that crop insurance profitability is lower and more volatile than other lines of property and casualty insurance (Deloitte and Touché 2004, Price Waterhouse Coopers 1999 and 1997, Milliman and Roberts 2002). Indeed any analysis of Best’s Aggregates and Averages will demonstrate this fact. The Deloitte and Touché study reported a 10 year profitability measure of 7.9 percent for the crop insurance program with a standard deviation of 12.9 percent while other lines of property and casualty insurance ran a 12.7 percent return with an 8.9 percent standard deviation (1992 – 2002).
Administrative and operating (A&O) reimbursements and underwriting gain opportunities are the elements for attracting and keeping private companies, agencies and capital in the business. To the extent that A&O reimbursements are insufficient for the sale and servicing of crop insurance, these expenses must be met through underwriting gains.
The press often makes the mistake of reporting underwritings gain as profits, thus conveying the false impression that the industry is making huge profits. Both A&O reimbursements and underwriting gains are gross revenue earned by approved crop insurance providers (crop insurance companies) under the terms and conditions of the USDA developed and approved SRA that each company must agree to and sign in order to be an eligible program participant. They are not profits. All businesses, including approved crop insurance companies and affiliated agencies, must subtract all expenses from their gross revenue in order to determine their profits. These expenses include unreimbursed delivery expenses, reinsurance premiums, the building of reserves for loss years, and other expenses.
Federal reimbursements for delivering the crop insurance program do not cover the costs of the private sector. Normally, insurance premiums are expense loaded, which means the administrative costs of selling, servicing and delivering the coverage are loaded into and are a part of the premium. This is not the case with crop insurance. Rather, the government pays these costs on behalf of policyholders. This policyholder subsidy, known as administrative and operating (A&O) subsidy, is paid to private sector companies that deliver the program to offset the costs of selling and servicing of policies. However, the A&O amounts paid fall short of covering companies’ expenses for delivering the program. Currently, the average percentage A&O reimbursement rate is approximately 20 percent of premium, which is down from an average high of more than 32 percent in the early 1990s. Companies indicate that the current A&O reimbursement rate does not cover all policy selling and servicing expenses.
Company statements regarding their total selling and servicing cost are consistent with the conclusion of an April 1997 GAO Report to Congressional Committees in which the analysis indicated that the reimbursement rate would need to be 26.5 percent of premium to “adequately reimburse companies for their reasonable expenses of selling and servicing crop insurance.”
Some reports raise questions about certain aspects of the cost of the modern federal crop insurance program. Federal cost of the program includes funds to pay a portion of the farmers’ premium amount for each policy and funds to pay approved insurance providers’ (AIPs) total expenses for selling and servicing policies. Therefore, in general, increased federal cost of the program reflects implementation of congressional intent to expand and enhance coverage of farmers across the nation.
The congressional objective has been to have a federal crop insurance program that is an efficient and effective production agriculture risk management tool equally and universally available to all farmers across the nation. Therefore, premium support cost will always be consistent with the level of farmer participation in the program. To the degree that the congressional objective is more fully satisfied, meaning more farmers participating and purchasing more protection, premium support cost increases.
A study released in September, 1989, by Arthur Andersen & Company concluded that USDA experienced delivery costs twice the amount of the private sector participants, on average. Specifically, the study reported that for 1987 total delivery cost by private sector companies equaled 43.17 percent of premium while for master marketers the total was 85.30 percent. This finding and other factors supported a move by Congress to transition to sole delivery of the federal crop insurance program by private sector insurance companies and agents
