Crop insurance: Private benefit, yet public impact

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Crop insurance may be part of the permanent U.S. agricultural law that Congress will not delete in re-writing the farm bill, so plan for premium costs in your crop budget for next year.  However, some of those premium costs could eventually climb higher if Congress directs the USDA’s Risk Management Agency to have farmers pay a larger share of the cost for the Harvest Price Option. 

The HPO was an automatic part of crop insurance in 2012, unless a farmer decided to opt out of it for a lower premium cost.  But the use of the Harvest Price Option raised the price guarantee on corn from $5.68 to $7.50 and on soybeans from $12.55 to $13.59 per bushel.  As a result some of the higher coverage levels will return substantial indemnity payments to producers.

First, do you know what you will be getting for an indemnity payment, if you carried crop insurance through the 2012 drought?  If you had revenue protection, Iowa State University ag economist Steven Johnson says multiply your APH yield by your coverage level to get your guarantee.  Subtract your actual yield from the guarantee, and if it is lower, the remainder will be your loss per acre.  If you had Revenue Protection, multiply the $7.50 Harvest Price by the loss to determine the amount of your indemnity payment per acre. 

In his example, Johnson used a 175 APH, a 75 percent coverage level, and ended up with a 31.3 bushel per acre loss after deducting the 100 bushel per acre actual yield.  By multiplying the 31.3 by the $7.50 price of corn, the net indemnity is $234.75 per acre.  While 75 percent coverage is lower than many policies, it had a lesser premium cost.  For producers willing to move toward an 85 percent coverage level, the producer in Johnson’s example would have received a $365.62 indemnity per acre.  However, a producer which opted for only the spring guarantee at the 85 percent coverage level reduced his indemnity check to $276.90 per acre, a revenue reduction of $88.72 per acre.

While the Harvest Price Option returns more indemnity payment, it also costs more in premium payments.  But the squawk about the harvest price option is coming from federal budget hawks who say the premium for the HPO should not be subsidized by the taxpayer, and should be borne by the producer.

Ohio State University ag economist Carl Zulauf says critics complain about the increased cost resulting from the HPO for 2012, particularly about the common coverage levels which allowed the insurance payment to exceed that for a farm only expecting to get the spring guarantee, and Zulauf should be asking the question of whether the principles behind the farm safety net is being violated, since a loss is shared between the farm and public, but now greater profitability is being guaranteed to the farm. 

Zulauf makes the case that 85 percent coverage at the harvest price returned 112 percent of what was expected in the spring for corn, and 104 percent of what was expected in the spring for soybeans.  His research report is focused on farmers who used the spring guarantee to forward contract their production.  He demonstrates that pre-harvest sales usually occurred between 1974 and 2006, when farmers could be guaranteed of their crop insurance to cover any financial penalty for over-selling their production.

Zulauf observes that:  “The harvest price option can result in a situation where a farm has more revenue at harvest than the revenue that was expected prior to planting, even after experiencing a decline in yield. This situation has occurred in 2012. Critics are asking whether this situation is fair and whether the definition of loss is appropriate.”   He follows that up with another observation:  “While underscoring the simplicity of this analysis, it suggests that offering the harvest price option on all insured production may lead farmers to sell more than is consistent with appropriate risk management.”  In other words, Zulauf says critics are wondering if their tax money is subsidizing crop insurance that will allow farmers to sell more grain than they normally would, because they have the fall guarantee.

But how much is the public really underwriting the cost of crop insurance?  Kansas State University ag economist Art Barnaby  says the total amount is declining substantially, following the better than expected yields for soybeans that are being reported. 

While one of his colleagues, Iowa State’s ag economist Bruce Babcock had predicted a $30-$40 billion dollar crop insurance payout earlier in the summer, Barnaby now estimates the underwriting loss to be in the $5-$6 billion range.  The Standard Reinsurance Agreement between USDA and the crop insurance providers calls for different participation ratios between each one.  While many of the companies will have a loss, he says some companies will actually have a gain in income this year, depending on the states they serve.

But Barnaby also reminds crop insurance critics of the money that crop insurance has generated for many years.  While insurance companies can roll that into retained earnings and bolster their reserves, the government cannot claim a profit, even though it may not have paid out more than its premium income for many years.  Although the crop insurance system is supposed to be set up to pay out the same amount it takes in, Barnaby uses Illinois as an example.  He says, “For the 23 years prior to 2012, farmer paid premiums in Illinois on all crops and insurance contract types exceeded the claims, meaning in the aggregate, Illinois farmers netted none of the subsidy.

That was also nearly true for Iowa, but it is possible the 2012 underwriting losses may wipe out all of the underwriting gains (includes farmer paid and FCIC paid premiums) for the past 23 years in Illinois, i.e. Illinois farmers may net all 23 years of subsidy in 2012. This would require an Illinois loss ratio of 400 percent.”


Crop insurance indemnity payments will soon be distributed based on crop yield loss and coverage level, with some farmers at high coverage levels receiving more than they expected at the level of the spring guarantees.  The expectation of harvest price coverage may have caused more farmers to forward contract more grain than normal, had they not had the harvest price option.  While the higher cost of the harvest price option may be shifted to farmers from the government during the next Farm Bill consideration, the actual amount of USDA payments to crop insurance policy holders may be lower than previously expected.

Source: FarmGate blog

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Steve Griffin    
West Des Moines, IA  |  November, 17, 2012 at 12:47 PM

The HPO, harvest price option, is similar to replacement cost coverage on a home or farmstead. You may have built the structure at a cost, but when it is destroyed by fire, windstorm, etc. you want to be compensated for the full cost of replacement. If a homeowner builds a $100,000 home and it is destroyed a couple of years later when it would take $110,000 to build it again - replacement cost coverage provides the extra $10,000. The storm itself might have caused construction material prices to have risen. HPO does the same. Initially the crop price is set at the beginning of the year, then if the crop is lost and its value has risen, the HPO kicks in. Bottomline, this is not a special benefit, but an ordinary and usual part of a comprehensive insurance plan for good risk managment.

Robert Smith    
Ames, Iowa  |  November, 19, 2012 at 11:59 AM

Dr. Griffin: While you certainly make a compelling plea in defense of the HPO and it's apparent similarities to replacement cost coverage, you fail to mention the obvious fact that American taxpayers don't subsidize replacement cost coverage on personal homes or autos. Today, American taxpayers pick up, on average, about 62% of crop insurance premiums (of which nearly 80% are revenue, not yield coverage policies), whereas producers pay only about a 1/3rd of the total premium costs. Meanwhile, the Approved Crop Insurance Providers (APIs) also recieve a negotiated annual payment of $1.3 B (yes, billion) from the fed. gov't (taxpayers) to sell and administer these policies. Many of the assigned high risk policies are pooled and reinsured by the gov't, whereas the private APIs assume a much lower risk by pooling lower risk commercial coverage. That's a much different system than today's free-market, private auto or home owners insurance policies. Furthermore, another fundamental flaw with today's highly subsidized HPO is the fact that when supplies are down (due to widespread drought, floods, disease, etc.) prices are likely to go up. Therefore, one can expect high indeminities payouts and increased risk to taxpayers during periods of widespread yield/revenue losses. Like you suggest, HPO would be like replacement cost coverage, if producers actually picked up the entire cost.

Michael Hunt    
Correctionville, Iowa  |  November, 19, 2012 at 01:12 PM

I don't think the analogy to homeowners insurance is a valid one, but is perhaps a favorite of the crop insurance insiders - as it strikes a sympathetic chord with the public while glossing over the many dissimilarities. From a purely legal standpoint, authorities differ on whether crops, Fructus industriales, constitute real or personal property and further legal complications are illustrated when the landowner is not the crop owner. Another glaring difference has already been highlighted in these comments: crop insurance is heavily subsidized at multiple levels by the federal government while home and other property owners go it alone. This fundamentally alters the risk to, and therefore decision making of, both the insurer and insured, such that contemporary crop insurance is insurance in name only and should more accurately be called a revenue guarantee.

SD  |  November, 30, 2012 at 07:41 PM

A couple of thoughts, but first a disclaimer: I am not a field crop producer, but a cattle producer for which there is no such program. A point missed or ignored in all criticisms of 'farm programs' is that they are designed more to protect consumers by keeping food prices artificially low, not necessarily to protect farmers' income, but to assure they have the means to continut producing that low cost food. Further, isn't do "home and other property owners" TRULY "go it alone"? As we write and read here, FEMA and many other government groups/programs are picking up the pieces after the Hurricane Sandy destruction. Granted no one will 'be made whole', but some will benefit significantly from government programs there, and all will benefit in one degree or another. Further, there is also an 'income protection' program for 'city folk', aka various forms of welfare benefits, even Social Security and similar programs where govt' and worker both pay, but the worker CAN get far more out of it than both parties together in nursing home care for the destitute, as just one example.

Michael Hunt    
Correctionville, Iowa  |  December, 04, 2012 at 11:26 AM

Maxine, you are incorrect as to the intentions of Farm Bill program. They are not intended to keep food cheap for Americans - given our vast exports, this would constitute market manipulation and therefore go against international trade agreements. Farm Bill programs are meant to ensure long-term viability for farmers, such that total crop loss wouldn't drive them out of business and leave the nation wanting for farmers when it is all said and done. That said, even the true intentions may be lost today. The Hurricane Sandy example is also misleading - this a case of cherry picking a very unique situation and applying it to the whole. Perfect storms aside, the insurance market doesn't work like this. Go burn your house down with your BBQ grill and give FEMA a call. I do like the idea suggested though, treat farm subsidies like welfare and social security. All farmers involuntarily pay in annually and then the funds are there when needed, supplemented as needed with general funds. It does beg the question though, we pay a factory worker if his knees are shot and he can no longer work. As a corollary, should we also continue to pay if a farm is eroded such that the land is no longer fertile?

SD  |  December, 15, 2012 at 05:48 PM

Isn't it splitting hairs as to whether farm subsidies are to keep food prices low, or to allow farmers to keep producing when their income from crops can't cover cost of producing them, in that the EFFECT is about the same....lowest cost food in the world for consumers in the USA??? Re. 'Sandy', again, the effect is similar.....AND there is the non-emergency situation where so many community services are federally funded to a greater or lesser degree, seemingly due to 'pull' of a particular community for things such as water and sewer systems, roads, etc. Granted, farmers do benefit from roads and other transport systems, but do have to fund their own sewer systems, tho recently some have benefitted in part from rural water systems. Farmers already do pay social security taxes, and certainly do pay taxes which fund welfare of all sorts. People all to often like to criticize people whom they envy, due to believing the envied person or group is getting a break or is 'wealthy'. Often farmers are that groups envied and believed to be getting 'rich off the government'. A problem brought home to some of us when a 'city lady' complained that farmers had it easy because "the grass is free, the water is free, and your cows just eat and drink and make money for you", when complaining that we do not pay enough land taxes. It SD, at least, farmer/ranchers pay a disproportionate 'share' of property taxes, as probably is true in other states as well.

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