[Federal Register Volume 59, Number 66 (Wednesday, April 6, 1994)]
[Unknown Section]
[Page 0]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 94-8244]


[[Page Unknown]]

[Federal Register: April 6, 1994]


                                                    VOL. 59, NO. 66

                                           Wednesday, April 6, 1994
      

DEPARTMENT OF AGRICULTURE

Federal Crop Insurance Corporation

 

Program Changes Improving the Actuarial USDA. Soundness of the 
Federal Crop Insurance Program

AGENCY: Federal Crop Insurance Corporation.

ACTION: Notice.

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SUMMARY: The Omnibus Budget Reconciliation Act of 1993 (OBRA) directed 
the Federal Crop Insurance Corporation (FCIC) to make program changes 
as necessary to improve actuarial soundness of the Federal crop 
insurance program and to achieve, by the fiscal year beginning October 
1, 1995, a projected overall loss ratio not to exceed 1.10 (110 
percent) (section 1501(a)). Section 1501(c)(2) further directed the 
Department to issue for public comment a comprehensive plan or 
``blueprint'' that identifies, among other things:

     Steps FCIC intends to take to achieve a projected overall 
loss ratio of no greater than 1.10 on and after October 1, 1995.
     Additional steps if further action is required, based upon 
actual program experience or unforeseen external circumstances.
     Modifications to be considered if initial actions to 
improve actuarial soundness work better than anticipated.
     Projections, assumptions, and analyses which underlie the 
FCIC conclusions that the above actions will achieve the required loss 
ratio within the stated deadline while maintaining fairness and 
effective coverage to agricultural producers, and which thereby 
demonstrate FCIC's compliance with the performance standard identified 
in section 1501(a).
    The following notice outlines such a plan. Readers are requested to 
identify additional issues other than those outlined herein that they 
believe are relevant and important in assisting FCIC in its actions to 
manage the program to achieve the target loss ratio. This notice 
encourages comment and participation from the affected public. Comments 
and inquiries should be sent to the address listed below.

FOR FURTHER INFORMATION CONTACT:
Mari Dunleavy, Regulatory and Procedural Development Staff, Federal 
Crop Insurance Corporation, Washington, DC 20250, telephone (202) 254-
8314.

NOTICE: The Federal Crop Insurance Corporation's ``Blueprint for 
Financial Soundness'' reads as follows:

Blueprint for Financial Soundness

Scope and Purpose

    Actions identified herein result from internal analysis by FCIC and 
information previously provided to FCIC by numerous interested parties. 
These include the Commission for the Improvement of Crop Insurance (a 
Congressionally established work group in 1989 and 1990), various crop 
insurance industry organizations, members of Congress, agricultural 
producers, crop insurance agents and insurance companies, the General 
Accounting Office, and others. Information was not solicited 
specifically for this draft but was compiled from previous 
recommendations. Not all of the specific recommendations made by any or 
all of these groups are included herein. This document establishes 
initiatives to achieve the above actions.
    Estimates of the financial impact of an action, based on available 
data and professional judgment, are provided whenever possible. Readers 
should recognize that these estimates are fluid due to the nature of 
the data and the ever-changing program. In particular, since FCIC does 
not have a single aggregate mathematical or statistical model that 
describes its programs, estimates of financial impact are based on 
partial analysis which considers the effect of one particular action in 
the absence of any other action or initiative. Also, the exact steps to 
be taken under this Blueprint depend in part upon the public comment 
and recommendations received before investing resources in detailed 
studies of potential impacts. Readers are encouraged to provide 
information, rationale, and where possible, estimates of costs or 
potential savings.
    In some cases the financial impact of an action may not be 
quantified. This does not mean the action is not important or that it 
cannot contribute to achievement of the goal. For example, enhanced 
management reporting systems do not produce a measurable financial 
impact. However, such systems can enhance FCIC's ability to estimate 
the potential impacts of program changes and assure that ongoing 
management decisions recognize the impact of the decision on future 
actions.
    This document is divided into four main sections, which describe:
    (1) Crop insurance program to provide context and background;
    (2) Actions FCIC proposes as part of this plan to achieve the 
target loss ratio;
    (3) Additional actions that FCIC may take if those described in 
section II are not effective or that cannot be implemented due to 
unforeseen circumstances; and
    (4) Changes FCIC will consider once the projected loss ratio 
achieves the targeted level of 1.10.

I. Background of the Crop Insurance Program

A. Overview of Program Operations

    Crop insurance is delivered primarily by commercial insurance 
companies that have entered into a cooperative financial arrangement 
[the Standard Reinsurance Agreement (SRA)] with FCIC. Under this 
arrangement, the company agrees to deliver an FCIC designed and priced 
product to eligible buyers. The company is responsible for all aspects 
of customer service, and guarantees payment of the insured person's 
share of the premium to FCIC. In return, FCIC reimburses the company 
for administrative expenses and requires the company (on a state basis) 
to share in insurance experience whether favorable or unfavorable. FCIC 
also provides stop loss reinsurance that limits the maximum loss the 
company can sustain.
    A small and decreasing portion of the total sales is managed 
directly by FCIC through sales and service contractors. These 
contractors agree to sell an FCIC designed and priced product and to 
perform certain servicing functions related to the sale (such as 
determining the average yields). FCIC reimburses the contractor for 
administrative expenses associated with selling and servicing the 
product; however, FCIC is directly responsible for premium collection, 
loss adjustment, and payment of losses. These latter functions are the 
responsibility of the reinsured company under that delivery system. 
FCIC intends to eliminate direct sales after the 1994 crop year because 
this system now delivers less than 10 percent of the total business, 
and maintaining a nationwide capability for delivery at an acceptable 
cost is difficult.
    The crop insurance plan for most crops indemnifies insured persons 
for losses in yield exceeding a predetermined threshold amount. To 
establish this threshold an average yield is determined based on the 
individual's production history. The first portion of the loss 
(deductible of the insurance), equal to 25, 35, 50, or 65 percent of 
the average yield, must be sustained by the insured person. These are 
the choices of deductibles now offered by FCIC, and typically are 
described by the maximum loss in yield covered by the insurance; e.g., 
75 percent coverage, 65 percent, etc. The 50 and 75 percent coverage 
levels are required by the Act to be available to all persons. The 
level of coverage is chosen by the insured individual.
    The insured person also must choose a price at which the yield is 
valued for the purposes of computing the amount of premium and any 
applicable amount of loss; this variable is called the price election. 
FCIC must offer a price election that is not less than the anticipated 
market price at time of harvest. This determination is made well before 
the possibility of loss is known during the crop year. Otherwise, 
insured persons would choose low price elections if no loss is 
sustained (minimizes premium payments) the highest possible price 
election if a loss occurs (maximizes indemnities).
    FCIC establishes premium rates for the various coverage levels, 
yields, crop types and farming practices (e.g., irrigated) for each 
county. All planted acres of the crop are covered by the insurance 
policy unless for some reason the acreage is uninsurable. The premium 
owed by the insured person is determined by multiplying the average 
yield per acre by the coverage level, multiplied by the number of acres 
planted, the price election, and the premium rate. For example, if the 
average yield is 100 bushels per acre, the coverage level is 65 
percent, planted acres are 50, the price election is $2.25, and the 
premium rate is 5.2 percent, the premium is equal to 100  x  0.65  x  
50  x  $2.25  x  0.052, or $380.25. The potential indemnity in the 
event of a total loss is $7,312.50 (determined by multiplying the 
average yield, coverage level, planted acres, and price election).
    A portion of the total premium is subsidized to encourage 
participation in the program. The subsidy is 30 percent of the total 
premium for coverage levels up to and including the 65 percent level. 
The subsidy for 75 percent level of coverage is equal to the dollar 
amount that would be paid at the 65 percent level of coverage. The 
premium subsidy for the above example would be $114.08; thus, the 
insured person would pay $266.17. The same $114.08 subsidy would be 
paid if the insured person chose the 75 percent coverage level.
    In the event of a loss, the amount of production that was 
harvested, or that was determined should have been harvested, is 
measured by the insurer. An indemnity payment is made if the determined 
production is less than the total guarantee for the acreage (yield 
multiplied by coverage level and acres planted). For example, if the 
insured person harvests 1,000 bushels from 25 acres and does not 
harvest a potential yield of 10 bushels per acre from the remaining 25 
acres, the total of the production to count is 1,250 bushels (1,000 
bushels harvested plus 25 acres multiplied by 10 bushels). This is 
subtracted from the total bushel guarantee for the acreage (100  x  
0.65  x  50, or 3,250 bushels), resulting in a loss of 2,000 bushels. 
The indemnity is equal to the number of lost bushels multiplied by the 
price election. For this example, the indemnity would be 2,000 bushels 
x  $2.25, or $4,500.
    Crop insurance does not guarantee revenue. As the above example 
illustrates, it provides an insurance indemnity only if production is 
less than the established guarantee. No protection is provided if the 
market price is less than the price election.

B. Legislative Background and Issues

    Federal crop insurance was established as a pilot program in the 
1930's. Prior to 1980, crop insurance was available only on major crops 
in major producing areas. The coverage level often was limited to 60 
percent or less of a long-term average yield for an area. Congress 
amended the Act in 1980 to expand the scope and coverage of the program 
with the intent that it be the sole means of providing public disaster 
assistance to U.S. farmers. Participation in the program increased 
after the 1980 amendments, but remains below levels deemed necessary to 
be regarded as the principal vehicle for disaster assistance. Insured 
acreage peaked at about 40-45 percent of the total acreage planted to 
insurable crops in 1988-89, but more commonly has been in the 30-35 
percent range. Losses also increased with the expansion of the program. 
The loss ratio has exceeded the break-even amount of 1.00 in every year 
since 1980. Cumulative losses for the years 1980-1992 were 
approximately $2.9 billion, with a cumulative loss ratio of about 1.45 
for the 13 years.
    Program participation is an issue influencing the Federal crop 
insurance program. Full participation (i.e., 100 percent of eligible 
acres insured) is the measure of program success that is accepted (at 
least implicitly) by some persons. This measure may not be the most 
appropriate. A rational decision to buy insurance of any kind must be 
based on the magnitude of the financial difficulties that accompany a 
loss. For example, buying collision coverage on a 15-year old 
automobile makes little financial sense. Similarly, buying insurance on 
a crop that contributes only a small portion of the expected income of 
the insured person may not make financial sense. Full participation in 
the crop insurance program may not represent an efficient use of the 
taxpayer's resources. However, participation must be high enough to 
minimize or eliminate perceived needs to legislate disaster assistance 
funded under dire emergency provisions of the Budget Enforcement Act. 
The level of participation in the crop insurance program that maximizes 
returns to the public is not known, and is an area needing further 
definition.
    Many losses paid in the 1980's and early 1990's were due to 
widespread disasters, the adverse financial effects of which Congress 
intended to mitigate under the Act. However, continuing loss ratios 
exceeding 100 percent, enactment of disaster assistance in nearly every 
year since 1988, and lower than desirable participation indicate that 
the public policy goals of the program have not been fully realized. 
The Secretary of Agriculture has proposed a reform of the crop 
insurance program to:
     Achieve actuarial soundness.
     Increase participation to levels that render ad hoc 
disaster legislation.
     Eliminate incentives to enact ad hoc disaster assistance 
legislation.
    The proposals contained in this Blueprint focus on these three 
areas that directly relate to the goal of achieving the targeted loss 
ratio. They are:
    (1) Actuarial matters such as premium rates and yield guarantees,
    (2) Underwriting matters such as terms and conditions of insurance 
policies, and
    (3) Management issues such as compliance and risk-sharing 
arrangements with commercial insurers.

II. Management Actions To Achieve a Loss Ratio of 1.10

A. Develop More Accurate Insurance Yields

    The insurance yield may be the single most important factor in 
determining the success or failure of the crop insurance program. A 
yield that is too high compared to the productive potential of the 
person or land will increase the number of years that a loss is paid. 
An excessively high yield also increases the amount paid when a loss 
occurs. A yield that is too low will not effectively protect farmers 
from loss and, because it is regarded as insufficient, will not induce 
desired levels of participation.
    From the 1985 through 1993 crop years, insured yields were based on 
a program called the Actual Production History (APH) Plan. The goal of 
this program was to obtain 10 previous yields to establish the insured 
yield for the next crop year. Proxy yields largely based on ASCS farm 
program payment yields or county averages were allowed whenever farmers 
would not or could not provide 10 years of history. Analysis by FCIC 
and others determined the proxy yields were benefiting farmers whose 
yields tended to be lower than average and discouraging farmers whose 
yields tended to be above average. Consequently, a modified-APH program 
that reduced the influence of the proxy yields was introduced beginning 
with the 1994 crop year; thus, a ``ladder'' was introduced into the 
proxy yields. Only 65 percent credit is given to the proxy yield if no 
actual yields are reported, 80 percent credit is given if one actual 
yield is reported, 90 percent if two actual yields are reported, and 
100 percent if three actual yields are reported. The proxy yields are 
not used after four actual yields are available. The insured yield is a 
simple average of the 4 years of actual and modified proxy yields for 
the first 4 years, and then (after 4 years) is the simple average of 
the actual yields reported. Acquiring 10 years of production history 
remains the goal of the program. These revised procedures are the core 
of the initiatives to comply with the mandate of OBRA 93 to institute 
rules to demonstrate actual production histories.
    The revised rules are expected to substantially reduce losses of 
the Federal crop insurance program. Analysis performed by FCIC 
indicates the new rules would reduce losses by 15 percent for corn, 22 
percent for soybeans, and 18 percent for wheat. These analyses were 
based on simulations of loss histories using the rules for the two 
computational methods--the previous APH and the proposed modified-APH 
plans. The analyses encompassed nine states each for corn and soybeans 
and three states for wheat. These states and crops represented nearly 
60 percent of the total premiums earned in 1990. The results indicated 
that the modified-APH rules would reduce losses by a weighted average 
of 19 percent and are believed to be representative for most crops.
    The actual loss ratio for the 1990 crop year was 1.23. If the 
modified-APH rules did reduce losses by an average of 19 percent, the 
loss ratio would have been 0.996. This would achieve significant 
compliance with the loss ratio target of 1.10.
    Based on these results, FCIC implemented modified-APH for the 1994 
crop year by:
     Promulgating regulations for the program during calendar 
year 1994.
     Measuring the impact of the modifications upon net program 
losses by calculating insured yields, premiums, and indemnities of 
policyholders under 1993 and 1994 rules.
     Where possible, determining whether the modified-APH rules 
had the intended effect of providing a more accurate offer for farmers 
who previously elected not to purchase crop insurance.
     Determining whether the average number of yields reported 
for prior years has changed under the modified-APH rules compared with 
APH rules for 1990 through 1993.
     Implementing a tracking system to assure that insurance 
experience remains associated with a person in future years (see item D 
below).
     Developing reporting processes to assure that the accuracy 
of yield determinations is continuously monitored and improved.
     Actions requiring analysis of the effects of the modified-
APH rules upon the accuracy of insured yields cannot be completed until 
losses from the 1994 crop year are processed. For wheat and other fall 
planted crops, such availability will occur by about the fourth 
calendar quarter of 1994. For spring planted crops, this does not occur 
until about the middle of the first calendar quarter of 1995.
    FCIC believes that these actions to implement modified-APH will 
reduce the average loss ratio over time by 10-15 percentage points 
(e.g., from an average of 1.40 for several years to 1.25 to 1.30). This 
estimate is based on a conservative expectation of the actual results 
of the simulations described above.

B. Catastrophic Yield Adjustment

    FCIC recognizes that the average of a series of observations as 
short as 4 years is subject to significant variations due to abnormally 
large or small yields during that time. For example, if a major 
disaster year such as 1993 is included in the 4 years, the procedure 
implicitly states that a similar year will occur once every 4 years. 
This is not likely. Thus, FCIC will examine certain adjustments to the 
modified-APH rules with a goal to assign more appropriate probabilities 
to the individual observations. These adjustments commonly are called 
catastrophic yield adjustments. However, just as the yields for 1 year 
may be abnormally low, they also may be abnormally high. Capping the 
abnormally high years may also be appropriate so that average yields 
are not excessively high due solely to a few observations.
    FCIC will evaluate alternative methods to recognize catastrophic 
and unusually good crop years, and consider implementing appropriate 
adjustments to the modified-APH plan effective for the 1995 crop year.

C. Implement Group Risk Plan

    FCIC is implementing a program of insurance that is based on the 
average yield of an area, not upon individual yield coverage as is 
offered under the traditional APH program. The area coverage is called 
the Group Risk Plan (GRP) by FCIC. GRP was introduced as a pilot 
program for the 1993 crop year for soybeans in 96 counties. It was 
expanded for the 1994 crop year to include seven additional crops 
encompassing, 1,872 county crop programs (one crop in one county) in 27 
states. Crops now included under GRP are barley (three states), corn 
(17 states), cotton (seven states), forage (two states), grain sorghum 
(four states), peanuts (four states), soybeans (24 states), and wheat 
(eight states).
    The GRP is intended to protect the insured person against the 
financial consequences of a disaster that strikes all or nearly all 
farmers in an area. It sets an expected county yield for each year 
based on historical yields, adjusted for any trends. Whenever the 
actual county average yield for the year is less than the expected 
county yield by a predetermined amount, an indemnity is paid. The 
principal differences of the GRP compared to traditional individual 
coverage area:
     Coverage is based on a trend projected yield, which 
probably will exceed the average yield of all farmers insured under 
individual yield coverage is there is a positive trend in yields for 
the area.
     Higher coverage levels (deductibles are as low as 10 
percent) at affordable premium rates can be sold.
    Thus, in the proper circumstances, GRP will offer risk protection 
that may be better than the individual coverage, and may do so at a 
lower cost.
    GRP has characteristics that make it unsuitable for managing the 
adverse financial consequences of crop loss in certain circumstances. A 
farmer's yield each year must change in the same direction and by about 
the same amount as the county yield if it is to be fully effective 
coverage for the individual. For example, if the county's yield 
decreases by 25 percent from the expected yield for that year, the 
farmer's yield also should decline by about 25 percent from the yield 
he or she would have expected. In financial market terms, the ``beta'' 
or the farmer's yields and the county yields should be near 1.00.
    Adequate data are a limitation to further significant expansion of 
GRP. The concept as presently developed uses many years (30 or more) of 
county yields. These data are routinely available only for counties in 
which the crop has been grown in commercially significant quantities. 
Weather data and crop growth models may permit expansion into counties 
in which the historical yield data are not available, but research is 
needed to develop and test these approaches. Further, acceptance of GRP 
by bankers as collateral for loans is yet to be determined.
    Significant expansion of GRP is not anticipated until its 
contributions to agricultural risk management can be measured. No 
estimates of savings can be attributed to GRP because customer 
acceptance is not known. Customer acceptance of the soybean GRP for the 
1993 crop year was limited. Fewer than 500 policies (of nearly 700,000 
total for the crop insurance program) were sold. Even if the plan 
improves the actuarial soundness of crop insurance, the present volume 
of business is not sufficient to make any noticeable difference in 
program results.

D. Implement Data Base of Taxpayer Identification Numbers

    Amendments to the Federal Crop Insurance Act enacted in 1990 
authorize FCIC to collect and use social security numbers and employer 
identification numbers to administer its programs. These regulations 
were appropriately approved and were published in the Federal Register 
in late 1992. OBRA 93 further directed FCIC to implement a database of 
these numbers for certain uses not later than the 1995 crop year.
    FCIC implemented the database described above in January 1994, 
effective for the 1994 crop year. This database is used to locate 
production history that is not reported by a person to assure that 
classifications assigned under the nonstandard classification system 
(NCS--see paragraph E below) are used for both the individual who 
accumulated the adverse history and any person having a significant 
beneficial interest in a crop produced by that person, and for other 
related purposes. In particular, further efforts will be made to 
accumulate information about persons involved in sales and servicing of 
crop insurance--agents, loss adjusters, and other insurance providers--
so that their contributions to achieving the target loss ratio can be 
measured.
    Implementing this database will make both modified-APH and the NCS 
more effective by permitting FCIC and reinsured companies to assure 
that all appropriate experience and premium rating factors are used. 
Incremental improvement in the loss ratio due to modified-APH and NCS 
is difficult to quantify. The database will enhance those programs as 
well as permit FCIC to systematically measure the performance of 
insurance providers for the first time.
    FCIC will also use the social security numbers and employer 
identification numbers for the implementation of an Ineligible File 
Tracking System. This system will be used to restrict (through an 
automated environment) producers who have been declared ineligible to 
obtain benefits provided by the Federal crop insurance program. The 
FCIC expects to implement the Ineligible File Tracking System beginning 
with the 1995 fiscal year.

E. Expand the Nonstandard Classification System (NCS)

    FCIC instituted the NCS for the 1990 crop year because evidence 
indicated that a small percentage of insured persons had losses in 
nearly every year. The losses paid to these persons far exceeded paid 
premiums. For various reasons, the insured yields for these individuals 
exceeded their apparent capabilities, and the premium rates were not 
representative of the risks posed by these persons. NCS was intended to 
reduce the insurance guarantee and increase the premium rate for such 
individuals. Modified-APH eliminates the need to reduce insured yields 
because the insured yield will be based solely on actual yields when a 
person is selected for NCS. However, NCS will continue to increase the 
premium rates as appropriate for those individuals who persistently 
have losses.
    The Agriculture, Rural Development, Food and Drug, and Related 
Agencies Appropriation Act for the 1994 fiscal year prohibited FCIC 
from using any funds appropriated to insure crops in certain counties 
unless an NCS program had been implemented in those counties. Counties 
were affected if the loss ratio, after applying the 1993 premium rates, 
was greater than 1.10 more than 70 percent of the years that the crop 
had been insured in that county. Approximately 2,100 county crop 
programs were affected by this provision.
    For the 1994 crop year, NCS has been extended to 11 crops 
encompassing over 90 percent of the total value of insurance in force. 
Additionally, all of the county crop programs affected by the 
Appropriations language have been included under the NCS. Over 25,000 
individuals (about 3.6 percent of all active policies for the 1993 crop 
year) were included under this program. Not all of these persons had 
been insured during the base period. NCS also extends to persons who 
participated in growing the crop in some way but who may not have been 
insured. These persons also are classified under NCS so that the 
acreage cannot simply be insured under a different name to avoid the 
NCS classification.
    In 1993, FCIC commissioned a study of the NCS to determine its 
effectiveness. A draft report of that study indicates that the NCS 
reduced the loss ratio by 5 to 10 points. This report is undergoing 
final preparation as this Blueprint for Financial Soundness is 
finalized.
    FCIC will expand the NCS program for the 1995 crop year. All 
eligible crops will be included, although greater flexibility in 
selections may be authorized whenever program factors that led to poor 
experience have been identified. NCS is not suited to certain insured 
crops (e.g., Texas citrus trees) that are subject to infrequent losses 
of great severity. The additional savings from NCS are likely to be 
small in terms of the total business because the crops that constitute 
the majority of premiums and losses already are included.

F. Institute Premium Rate Adjustments

    Premium rates are essential to the success of the crop insurance 
program. Rates that are too low will not produce adequate income and 
will lead to persistent losses. High rates will, paradoxically, likely 
lead to the same outcome. Excessive premium rates discourage 
participation by a broadly based cross-section of the farming 
community. Instead, persons who are most likely to collect indemnities 
will buy, and it is not likely that rates can be increased as rapidly 
as the relative risk of the pool of insured persons increases.
    FCIC has increased premium rates for all crops in a systematic 
fashion beginning with the 1991 crop year. Rates have increased as much 
as 70 percent for some crops in some counties from the 1991 to the 1994 
crop years. Decreases of up to 20 percent have been made for some crops 
in counties with histories of low losses. By an amendment to the Act in 
1990, Congress limited general premium rate increases to 20 percent 
annually.
    The above statistics indicate the amounts that FCIC has increased 
the base premium rates. The average premium rate actually earned 
(actual premium paid divided by actual liability) may not have 
increased by the same magnitude for various reasons. Most importantly, 
insured persons may choose a lower coverage level when the rate 
increases. By doing so, they accept a lesser degree of protection but 
also pay a lower premium rate.
    FCIC proposes to continue premium rate increases as needed to help 
achieve the required loss ratio. The rate increases made during 1991-
1994 have done much to enhance the actuarial soundness of the program. 
However, the premium rates for some crops and areas of the country 
remain below the levels needed to achieve the overall 1.10 loss ratio 
target.
    The impact of premium rate adjustments has been evaluated by using 
data for the 20 years from 1973-1992. The effectiveness of the 
adjustments was measured by applying the current 1993 premium rate 
levels to the historical period from 1973 and all subsequent years. The 
loss ratios were recalculated by using the revised premium amounts.
    This method does not include any change in sales that may occur due 
to a higher or lower cost of insurance. It assumes the 20-year base 
period is adequate to measure actuarial performance, an assumption that 
may not be the most appropriate definition of actuarial soundness. 
Events such as a 1993 Midwestern flood may or may not be appropriate to 
include in the 20-year base period for a particular area of the 
country.
    In 1993, seven crops (barley, corn, cotton, grain sorghum, oats, 
soybeans, and wheat) constituted 75 percent of total premiums. The loss 
ratio for 1980-1992 for these seven crops was 1.45, identical to the 
loss ratio for all insured crops for this same period. Thus, changes in 
premium rates for these crops should be representative of the changes 
that have been made for all crops in recent years. The premium rate 
changes for the seven crops through the 1994 crop year are estimated to 
have been adequate to reduce the 1980-1992 loss ratio from 1.45 to 
1.08. This aggregate result meets the 1.10 standard required by OBRA 
93, but only two of the seven crops individually meet this standard. 
Within each of these crops, many parts of the country will meet the 
standard but others will not. Hence, additional rate changes in 1995 
and later years are appropriate.
    FCIC recognizes that premium rate increases are an important 
component of a viable crop insurance program. It is also recognized 
that increasing premium rates to the levels suggested by the most 
recent 20 year experience may not be good public policy. Extremely high 
premium rates will preclude realization of the social benefits and 
public policy goals of the program because participation will be 
discouraged. If this happens, experience indicates that ad hoc disaster 
assistance will be enacted. Such assistance is less likely to satisfy 
social objectives with regard to maintaining rural communities and 
adequate supplies of food and fiber because it is uncertain for any 
particular year or region of the country. Thus, a catastrophic 
adjustment process may be needed to temper the influence of a year such 
as 1993. If the weather of 1993 truly is a 1 in 100 year event (or, as 
some have suggested, a 1 in 500 year event), its influence should be 
tempered in terms of the premium rates charged to insured persons.
    In addition to changing premium rates as needed, FCIC proposes to 
take a number of additional actions to enhance the accuracy and 
adequacy of its actuarial activities. These include:
     Develop computer software and other tools to enhance the 
quality of the data used to establish premium rates and perform 
actuarial analyses (``STATPLAN'' database, due for completion in 
October 1994).
     Plans to contract with a major actuarial consulting firm 
to review all aspects of FCIC's actuarial methods.
     Enhance staff skills by additional training in analytical 
methods for existing personnel and more emphasis on recruitment of 
actuarial trainees (ongoing) for appropriate functional units.
     Continue to contract with external specialists such as the 
Economic Research Service, land grant universities, the Cooperative 
Extension Service, and others (ongoing).
     Develop models to measure sources of change in premium 
volumes and track the effects of premium rate changes as isolated from 
changes induced by factors such as price elections, coverage level 
choices, insured crops, and other factors that are not controllable by 
the rate-making function (development to begin immediately).

G. Improve Underwriting of Crop Insurance Contracts.

    Underwriting begins by establishing the basic terms and conditions 
of the coverage. These include defining conditions that result in a 
covered loss, measuring the amount of that loss, and defining the 
responsibilities of the insured and the insurer. Underwriting continues 
with proper classification of an insured risk. For example, planting 
crop B the year after crop A was grown on the same acreage may be 
riskier that if other crops were grown the previous year. Some land, 
such as flood plains, is more prone to losses. Quality of management 
also is important. A farmer who is organized, plans, performs 
preventive maintenance on equipment, and performs field operations in a 
timely manner may minimize losses.
    A comprehensive underwriting system requires effective risk 
management strategies and goals, standards, and documentation. 
Initiatives to improve underwriting that began in the early 1990's will 
be continued as part of the strategy detailed in this Blueprint. The 
following specific actions will be pursued:
     Fully automate the actuarial documents to facilitate more 
comprehensive underwriting at the point of sale and to verify the 
classification of risk in an automated environment (completed by the 
1996 crop year).
     Develop standards and classification systems to assess and 
classify individual risk, including completion of research intended to 
develop a ``scoring model'' for risk that is based on measurable 
attributes of a person or situation similar to a credit rating model 
(for implementation by crop year 1996 if this model is feasible).
     Continue to rewrite crop insurance policies to better 
describe the insurance coverage and limitations and to reduce 
vulnerabilities to actuarial soundness that exist due to imprecise, 
unclear, or omitted terms and conditions (ongoing, with major crops 
scheduled for the 1995 crop year).
     Encourage development of supplemental or alternative 
insurance coverages authorized by section 508(b) of the Act so that 
coverage may be improved with most of the risk remaining in the 
commercial sector.
    Improved underwriting will improve program performance. However, 
meaningful measures to quantify possible benefits are not readily 
available. For this reason, FCIC cannot attribute a specific dollar 
amount to the benefits of improved actuarial systems and crop insurance 
policies.

H. Emphasize Program Compliance

    The FCIC Compliance function is designed to confirm that the 
Federal crop insurance program is operated and delivered as intended. 
Through internal reviews based on generally accepted auditing 
principles, it assures that program controls are in place against 
excess losses due to waste, fraud and abuse. Compliance emphasis will 
focus on:
1. Program Delivery
    Beginning in 1987, the Compliance staff conducted reviews of 
program delivery to assess compliance with regulations, policy, and 
procedure. That year, according to GAO and OIG audits, errors in claims 
payment represented an estimated 15 percent of all losses paid equaling 
$55 million of taxpayer dollars. Since that time, Compliance efforts 
have reduced these errors to approximately 5 percent of indemnities but 
still need continued improvement. Losses due to claim payment errors 
are not included in underwriting calculations of risk, so this 
reduction in excess losses has a direct and immediate impact of 
lowering the program loss ratio without increasing program cost or 
premium rates.
    To further reduce claims overpayment the Compliance Staff will 
review the entire operations of each delivery company in coordinated 
nationwide reviews. The review methodology was recently revised to 
reflect generally accepted auditing principles and statistically 
projectable sampling techniques.
    Beginning with the 1995 crop year, Compliance requirements will be 
expanded to define specific quality control and performance measurement 
processes for each delivery company. Policy service error rates will be 
monitored. The performance of each company will then be compared to an 
established national standard.
2. Program Performance
    Compliance reviews for several years have shown that a proportion 
of the excess losses are attributable to features in program 
construction that produce unintended results. The Compliance Staff will 
conduct program performance reviews that assess regulations, policies 
and procedures designed to prevent waste, fraud, and abuse and that the 
program, policies, and procedures perform as intended.
    As an example, in 1989 GAO claims that construction of policy 
language in the California Safflower program alone resulted in 
approximately $20 million in excess losses. It is not possible to 
determine how much of FCIC losses may be attributable to unintended 
features of program construction. However, recent program performance 
pilot reviews of the peanut program and regional irrigated practices 
resulted in an estimated 4 to 10 percent reduction in losses for those 
areas that may otherwise have gone undetected.
    For the past several years Compliance has conducted ad hoc program 
reviews on topical issues. These reviews will be expanded to identify 
and target reviews for crop insurance programs with the greatest 
potential vulnerability.
3. Fraud Prevention
    The risk of fraud is particularly acute in the insurance industry. 
Estimates for property-casualty insurance indicate insurance fraud may 
represent as much as 15 percent of all losses paid. Recent efforts at 
crop insurance fraud detection and subsequent prosecution have been 
increasingly successful. However, after-the-fact controls on program 
abuse are not fully effective. Compliance will work with the delivery 
companies to focus on practical, cost efficient fraud prevention. 
Compliance operations, program performance, and complaint reviews will 
emphasize identifying systemic vulnerabilities and assessing program 
safeguards. Discrepancies noted in review findings will be evaluated to 
determine the underlying causes.
    Emphasis also will be placed on measures to control program abuse 
that include strict contract enforcement and pro-active policy analyses 
that identifies potential abuse and targets additional claims review. 
These measures will be coupled with the aggressive implementation of 
civil sanctions, agent/loss adjuster debarment, and designating 
producer ineligibility in finding related to program abuse.

I. Assure that Adequate Risk is Borne by the Commercial Insurance 
Industry

    Amendments to the Act in 1990 directed FCIC to assure that adequate 
risk is borne by the commercial insurance companies reinsured by FCIC, 
consistent with their ability to bear risk and the availability of 
commercial reinsurance. For the 1992 reinsurance year (a 12 month 
period that began on July 1, 1991 and ended on June 30, 1992), FCIC 
substantially modified its Standard Reinsurance Agreement (SRA) with 
the commercial insurers which participate in the program. Both the 
amount and the probability of losses on the part of the commercial 
insurers were increased in this agreement. Additional incremental 
changes in the amount of potential gains and losses were made for both 
the 1993 and 1994 SRA's.
    The GAO suggests in a report entitled Crop Insurance Program Has 
Not Fostered Significant Risk Sharing by Insurance Companies (GAO/RCED 
92-25, January 13, 1992) that the changes in the 1992 SRA are not 
significant enough in the area of risk bearing by the commercial 
insurance companies. Still, the 1992 SRA fundamentally changed the 
manner in which gains and losses are calculated, a subtle but effective 
measure to increase risk. The amount of potential loss increased, but 
the change in the formula increased the chances that the company would 
lose in years of poor experience. As a comparison, the commercial 
industry lost approximately $8 million in 1988 when the crop insurance 
program sustained a loss ratio of 2.45 primarily due to drought in the 
Midwest. If that experience is restated to the larger 1993 premium 
amounts, the loss still would have amounted to only about $10-$15 
million. Results from the 1993 crop year are not yet complete, but 
current estimates indicate that commercial insurers will sustain losses 
of $80-$85 million although the loss ratio will be less than in 1988. 
The difference is caused by the SRA changes.
    Some will argue that industry-wide losses of $80-$85 million are 
not significant compared to overall program losses that may be near 
$900 million in 1993. Two factors bear on this issue:
    (1) The ability of the insurance companies to earn reserves under 
the SRA, and
    (2) The effect of losses upon an insurance company's operations in 
future years.
    The commercial industry can bear a greater share of the losses only 
if there is corresponding opportunity to achieve comparable earnings in 
favorable years. Over the long term, the industry must achieve a 
satisfactory rate of return on invested capital, or it would make 
economic sense for participants to invest in other endeavors. The SRA 
must allow adequate opportunity to earn this satisfactory rate of 
return. It also must permit accumulation of reserves to pay losses in 
years that disasters strike. Under the present SRA and the conditions 
of actuarial soundness of the program, there is no opportunity to 
accumulate the reserves needed to bear a large portion of a $900 
million loss.
    Losses directly impact the capital structure of the companies. An 
insurance company leverages its capital (the term ``surplus'' is used 
by the industry) to support the volume of business that it writes. As a 
general rule, an insurance company is permitted by regulators to bear 
the risk associated with $2 to $3 of premium per $1 of surplus. The 
ratio of premiums to surplus may be lower for risky lines of insurance 
such as multiple peril crop insurance. Thus, whenever an insurance 
company loses a portion of its capital, its ability to accept premiums 
in future years is reduced by a greater amount, which in turn reduces 
its ability to earn profits and reserves. These factors must be 
considered when the ability of the industry to bear risk is evaluated, 
as is mandated by the Act.
    As appropriate, given the factors discussed above, FCIC will 
evaluate (1) the need to increase risk sharing with the commercial 
insurance industry as the program achieves greater actuarial soundness, 
(2) reducing cessions to the assigned risk fund by requiring the 
industry to share in losses for loss ratios that exceed 5.00, (3) 
changing the stop loss provisions of the SRA, and (4) recruiting 
additional commercial insurers to participate in the crop insurance 
business. These changes will be made incrementally beginning with the 
1995 SRA that takes effect on July 1, 1994.

J. Improve Loss Adjustment

    Any actuarial and underwriting system can be affected by errors in 
adjustment of losses. These errors include both overpayment and 
underpayment of claims. Underpayment would not seem to be a factor 
influencing actuarial soundness, but failure to pay a loss when due 
will cause insured persons to question the value of the insurance and 
potentially reduce participation. The insurance experience also will 
not accurately depict the nature of the risk insured, leading to 
inaccuracies in future premium rates.
    Some problems in loss adjustment are directly related to 
deficiencies in underwriting. For example, if the crop insurance policy 
is not clear on a particular point, the loss adjuster may find it 
necessary to make a determination in favor of the insured person.
    FCIC will undertake the following initiatives to assure high 
quality of loss adjustment determinations so that results are fair to 
insured persons and taxpayers:
     Develop uniform loss adjustment standards that clearly 
specify the requirements for accurate determinations.
     Continue research to improve loss adjustment methods, such 
as yield appraisal methods and techniques for unharvested crops, and 
measurement techniques for stored production.
     Strengthen the quality adjustment provisions of crop 
insurance contracts and develop standards to prevent abuse of 
production determinations when quality losses are claimed.
    The contributions of these factors to achieve the 1.10 target loss 
ratio will be measured by a reduction in improper amounts paid on 
claims and a reduced error rate. The potential impact of these actions 
is difficult to quantify since the initiatives to improve underwriting 
also affect this area. These actions are ongoing. Loss adjustment 
standards for major crops and changes to the quality adjustment 
provisions are targeted for the 1995 crop year.

K. Marketing Crop Insurance

    FCIC marketing efforts for 1994 will be directed by a strategic 
marketing plan based on information and data received from market 
research compiled across the country. The plan's main objectives will 
be to inform members of the farming community about changes in the 
program and to educate farmers about risk management, emphasizing the 
value of crop insurance to farming operations.
    FCIC will conduct a year-long media campaign targeted at 
publications and broadcast markets with an agricultural audience.
    Also, emphasis on outreach to minority farmers, traditionally 
under-represented in the program, will be coordinated through a 
Minority Outreach Marketing Plan that specifically identifies minority 
farmers in each of the 10 FCIC Regional Service Offices.

L. Expand Participation by Introducing New Products

    Numerous ideas for products that will enhance the quality and 
acceptance of the crop insurance program have been suggested. These 
include cost of production coverage (several different concepts), 
dollar denominated coverage, revenue insurance, replacement cost 
insurance, and others. FCIC currently has contracts with the Economic 
Research Service to evaluate several alternatives in the context of 
public policy contributions, availability of data to support the 
concepts, assessments of producer acceptance, and other factors. FCIC 
proposes to continue such research and seeks comments about additional 
concepts that may be appropriate. Implementation of a pilot test of the 
best alternatives will be pursued.

M. Improve Accuracy of Other Program Variables

    This section includes items that impact the program but are not 
easily categorized under a previous heading. These are:
     Unit division. A unit is a tract of land used to establish 
the amount of insurance and any indemnity. For example, the crop 
insurance policy defines a unit as all land in a county that is owned 
by the farmer or rented for cash and planted to the insured crop. This 
unit may be subdivided under certain conditions, including payment of 
additional premium. Generally, insured persons favor a program that 
gives them great flexibility and freedom for establishing a unit. Some 
research indicates that size of a unit may affect losses, i.e., a unit 
consisting of 10 acres may have a great loss (in relative terms) than a 
unit consisting of 100 acres. This research, if verified, suggests that 
a surcharge may be needed for small acreage units regardless of how 
these are formed (by dividing larger units or because this is all the 
land planted to the crop). FCIC will examine the research and determine 
if this surcharge is appropriate, both actuarially and as a public 
policy initiative. FCIC also will explore the potential to provide 
greater flexibility of unit determinations as a tool to enhance program 
acceptance by customers. The pricing needed to support greater 
flexibility must be determined before it can be implemented. 
Implementation of changes will be targeted for the 1996 crop year.
     Program dates. Program dates include sales closing, 
acreage reporting, cancellation, and others. Several of these dates may 
directly affect the actuarial soundness of the program. For example, 
neither the farmer nor the insurer should be able to predict the 
potential for loss on the sales closing date. However, a study by one 
university indicates that farmers may achieve better than a 50-50 
probability of predicting a loss with the current sales closing date of 
April 15 in the Midwest. Arguments in favor of having a sales closing 
date as late as possible generally focus on the need to maximize sales 
opportunities; i.e., that interest in purchasing crop insurance is 
greatest as planting time approaches. In a draft report, the GAO has 
encouraged FCIC to close sales earlier. FCIC proposes to close sales 
for the 1995 crop year by 15-30 days earlier than the present dates. 
FCIC requests comments regarding other actions with regard to program 
dates that will facilitate achievement of the targeted 1.10 loss ratio.
     Staged guarantees. Staged guarantees reduce the amount of 
insurance when a crop is lost before harvest. For example, a farmer who 
abandons a crop within 30 days of planting might be paid only 40 
percent of the amount of insurance. The concept underlying staged 
guarantees is investment costs; the farmer's investment is less than 
the total needed to produce and harvest the crop. Some believe this 
approach will reduce outlays for indemnities and help achieve actuarial 
soundness. However, in the long run its efforts could be to reduce 
premium rates from levels otherwise needed. The impact of staged 
guarantees upon customer acceptance of crop insurance may be the valid 
measure of this concept. FCIC specifically requests comments on this 
feature and assessments of its potential contribution to achieving the 
targeted 1.10 loss ratio.
     De minimis yields. This term denotes a yield below which 
any production is disregarded for the purpose of determining the amount 
of indemnity. The concept is advanced by interested parties as an 
equity issue--that it costs the farmer more to harvest the crop than it 
is worth in the market. If allowed by the program, indemnities will 
increase compared to the present provisions of the crop policies, 
which, in turn, requires higher premium rates to achieve the goal. 
Readers are encouraged to comment on the desirability of increasing 
premium rates by an amount needed to permit this feature to be included 
in crop insurance policies.
     Suspension and debarment. Inappropriate determinations and 
poor administration of the crop insurance program is alleged about 
agents, loss adjusters, and others who are involved with delivery of 
crop insurance. The SSN/EIN database is intended to help FCIC monitor 
the conduct of these persons. However, monitoring in and of itself is 
insufficient if there are no penalties for violations of program rules. 
FCIC proposes to develop clear and concise suspension and debarment 
procedures for agents, loss adjusters, reinsured companies and others 
who fail to observe the highest standards of performance in program 
delivery and administration.
     Price Elections. The GAO recommended in a 1991 report that 
for the major crops, FCIC set its price elections equal to the 
forecasts issued by the World Agricultural Outlook Board in its semi-
annual estimates. These estimates correspond to the cycle used to 
prepare the annual budget of the United States Government. These 
estimates are available only twice each year. Based on a sampling of a 
few years, GAO stated that overall losses would be reduced if this 
recommendation were adopted. FCIC is committed to offering a price 
election that complies fully with the requirements of the law. In 
addition, the offer must be meaningful to farmers. FCIC requests 
comments regarding this recommendation and assessments by readers of 
its likelihood of contributing to reduced loss ratios and improved 
participation.
    Readers are requested to identify additional issues that they 
believe are relevant and important to assist FCIC in its actions to 
manage the program to achieve the target loss ratio while maintaining 
or increasing participation levels.

III. Management Actions If Section II Are Not Successful

    The actions identified in Section II of this document represent a 
continuation of current management initiatives that have been and 
continue to be important for the effective administration of a public 
program. FCIC believes that successful completion of these actions will 
meet the objective of achieving actuarial soundness as required by OBRA 
93. Several years must elapse before it will be possible to observe 
FCIC's achievement of the objective. In the interim, attainment must be 
measured by realistic models of risk that adequately represent the crop 
insurance program. Flexibility in managing the program to attain the 
objective while simultaneously achieving other important policy 
objectives must be stressed.
    Few options that do not adversely affect participation in a 
material manner are available in the event the actions described in 
this blueprint are determined to be inadequate. One option is to focus 
better on defining the risk that is included in the premium rates 
charged to current insureds. Extreme crop disasters (such as the 1993 
flooding and cold, wet growing season) tend to be widespread and occur 
infrequently. Crop insurance is not actuarially sound in a commercial 
sense because the private sector cannot manage the magnitude of these 
risks or arrange the financing over the long periods of time needed to 
accumulate reserves for a major disaster. This characteristic of crop 
disasters argues that actuarial soundness perhaps should be measured on 
a basis that separates normally expected conditions from the extreme 
disasters. This would serve to more precisely define the risk included 
in the premium rates for current insureds, and the risk that should be 
amortized over longer time periods.
    If the above is not acceptable, another action would be to limit 
the liability of crop insurance to specific areas and crops. This 
limitation could take the form of complete withdrawal of insurance in 
some cases, or limitations on the volume of business that would be 
accepted in a year for a crop or area. Commercial insurers use this 
process to manage their exposure to avoid concentrations geographically 
or by product line. Crop insurance may need the same management of its 
exposures rather than accepting any and all risk whenever farmers 
decide to enter and exit the program. This extreme action would 
indicate that the program was unable to completely fulfill its social 
and public policy responsibilities, and must be regarded as an 
initiative of last resort.

IV. Management Actions If Actions in Section II Are More Successful 
Than Needed

    The greatest impediment to increased program participation will be 
high premium rates that might result from the actions defined in this 
plan. Moderation of premium rate increases will be a priority if more 
stringent program administration reduces the loss ratio below the 
target. If this occurs, experience should be examined to identify 
losses paid that no longer should be expected. Once the impact of those 
losses is eliminated from the experience, some improvement in premium 
rates would be anticipated. FCIC believes that the remaining management 
actions that have improved administration of the program or that have 
better defined the coverage provided to U.S. agriculture should not be 
relaxed because these generally represent good administration of public 
policy.

    Done in Washington, DC on April 1, 1994.
Kenneth D. Ackerman,
Manager, Federal Crop Insurance Corporation.
[FR Doc. 94-8244 Filed 4-5-94; 8:45 am]
BILLING CODE 3410-08-M