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posted on 06 January 2018

Options To Reduce The Budgetary Costs Of The Federal Crop Insurance Program

from the Congressional Budget Office

The federal crop insurance program, which helps protect agricultural producers from losses due to low crop yields or lower-than-expected crop prices, is one of the largest support programs for those producers. It cost the federal government $5 billion in 2016 and an average of nearly $9 billion annually over the past five years. Policymakers have faced questions about how to reduce those costs while maintaining appropriate support for agricultural producers.

This CBO report describes the structure of the crop insurance program, focusing on factors that influence its cost; discusses the government’s role in providing crop insurance; assesses how the program benefits various groups; and examines several policy options that would decrease spending on the program over the 2018 - 2027 period.

What Kinds of Costs Does the Federal Government Incur for the Crop Insurance Program?

Agricultural producers pay only a portion of the price for crop insurance policies, known as the premium. The federal government pays the majority of the cost through subsidies. Premium subsidies are set by law as a percentage of premiums, and premiums are set annually by the government to match expected claims. Most of the government’s spending on the crop insurance program over the past five years - about four-fifths of the total - has gone toward premium subsidies.

The federal government also pays for the delivery costs of insurance by reimbursing the private insurance companies that sell and service the policies for their administrative and operating (A&O) costs. Those costs are the second-largest component of the government’s spending on crop insurance, accounting for about one-fifth of the total. Like premium subsidies, A&O reimbursements are calculated as a percentage of premiums.

Remaining federal spending on the program goes toward risk sharing between the government and private insurers. In years when the amount of money insurers spend on claims exceeds the amount collected through premiums, those underwriting losses increase the federal cost of the program. In other years, underwriting gains decrease its cost. Those losses and gains can be substantial in a given year - having increased the government’s cost of the program by as much as 60 percent and decreased it by as much as 40 percent - but they tend to cancel each other out over time. (Because the federal government shares in underwriting gains as well as underwriting losses, discussions of federal costs and federal spending throughout this report refer to net costs and net spending.)

The government’s total costs for crop insurance were higher in the past decade than in the previous decade: They averaged $8 billion a year from 2007 to 2016 but $3 billion a year from 1997 to 2006. Increases in crop prices, which began in 2006 and peaked for many crops in 2012, largely explain the higher spending. Increased crop prices prompted the government to set higher premiums for crop insurance policies in order to match expected claims for the increased value of the crops. The higher premiums then resulted in larger premium subsidies and A&O reimbursements, because both are calculated as a percentage of premiums.

Why Does the Federal Government Play a Role in Crop Insurance, and What Are the Alternatives?

Historically, when agricultural producers have suffered significant losses, the government has usually provided them with supplemental financial assistance. A key goal of the federal crop insurance program is to reduce that assistance. From 1994 through 2010, supplemental assistance for agricultural losses continued to be provided despite the growing participation in the program that followed increases in subsidies. Natural disasters in more recent years have not prompted comparable supplemental assistance, which suggests that federal crop insurance can substitute for it.

However, it is unclear whether current subsidies for the crop insurance program represent a more effective or economical means of protecting producers from agricultural losses than supplemental assistance. It is not possible to know how much supplemental assistance would have been provided in the absence of the crop insurance program. Nor are data available to assess how much increased spending on the crop insurance program has reduced spending on supplemental assistance.

Agricultural producers’ risks might be managed in ways that do not involve the government. For example, producers can diversify their crops to reduce the likelihood of overall low yields; use financial tools, such as futures contracts, to mitigate the risk of declines in crop prices; or rely on nonfarm income as a resource in the event of losses. Also, producers could conceivably obtain crop insurance in a fully private market, but insurers might have difficulty providing coverage at prices that could compete with such alternative risk management strategies (for reasons discussed later). Nonetheless, crop insurers could arrange to share risk more widely by purchasing reinsurance - that is, insurance coverage for insurers - through the private market, rather than relying on the government to assume responsibility for a portion of losses. Even if producers could manage their risks privately, however, the expectation that they would receive supplemental assistance for significant losses might discourage them from doing so.

Who Benefits From the Federal Crop Insurance Program?

Agricultural producers, as a group, obtain a sizable benefit from the program. Considered together, producers received about $65 billion more in claim payments than they paid in premiums between 2000 and 2016. In total, producers’ receipts from claims exceeded their premium payments in all but one year during that period. (Of course, the outcomes for individual policyholders for any kind of insurance vary; accordingly, many individual agricultural producers receive less in claims than they spend on crop insurance premiums.)

Consumers derive a small benefit from the program. Analysts have shown that the higher participation in the crop insurance program that followed increases in subsidies boosted the cultivated acreage of crops (corn, soybeans, and wheat in particular) by up to 1 percent, which probably lowered the prices of those commodities by a small amount. Ultimately, for consumers, the effect of that small change is limited because the prices of commodities account for only about 10 percent of the retail prices for domestically produced food.

There is some evidence that crop insurance companies earn a greater profit than similar insurers earn in the private market. However, data limitations make that comparison uncertain. CBO could compare the groups’ rates of return on equity only on a book-value basis (which reflects financial accounting measures), not a market-value basis (which directly reflects companies’ worth from the perspective of investors). Moreover, because crop insurers’ rate of return on equity is not reported in publicly available statements, it must be estimated, and several factors make CBO’s estimate uncertain. Although any single factor would be unlikely to bring the estimated rate of return for crop insurers in line with that of other property and casualty insurers, the combined effect of multiple factors could conceivably do so.

Taxpayers incur costs for the program. However, it is difficult to gauge whether those costs are larger or smaller than the costs of supplemental assistance might be if the program did not exist or provided less assistance to producers.

How Might Lawmakers Change the Federal Crop Insurance Program?

This report examines four types of options that would reduce the costs of the program over the next 10 years: restrictions on how losses are quantified, which would reduce claim payments; reductions in premium subsidies for crop insurance; reductions in reimbursements to private insurance companies for A&O costs; and changes to the terms of risk sharing between the government and private insurers. Those options would result in cost savings ranging from less than half a billion dollars to $19 billion.

This report also discusses two broader approaches for restructuring the crop insurance program, whereby the government might provide subsidies only for policies that specifically protected against widespread losses or might set premium subsidies independently of premium levels, as a percentage of expected gross revenue per acre of the insured crop (rather than as a percentage of premiums).

Data and Supplemental Information

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