Crop Insurance: Continuing Efforts Are Needed to Improve Program 
Integrity and Ensure Program Costs Are Reasonable (03-MAY-07,	 
GAO-07-819T).							 
                                                                 
The U.S. Dept. of Agriculture's (USDA) Risk Management Agency	 
(RMA) administers the federal crop insurance program in 	 
partnership with private insurers. In 2006, the program cost $3.5
billion, including millions in losses from fraud, waste, and	 
abuse, according to USDA. The Agricultural Risk Protection Act of
2000 granted RMA authority to renegotiate the terms of RMA's	 
standard reinsurance agreement with companies once over 5 years. 
This testimony is based on GAO's 2005 report, Crop Insurance:	 
Actions Needed to Reduce Program's Vulnerability to Fraud, Waste,
and Abuse, as well as new analyses this Committee requested on	 
underwriting gains and administrative and operating expenses USDA
paid companies. GAO discusses (1) USDA's processes to address	 
fraud, waste, and abuse; (2) extent the program's design makes it
vulnerable to abuse; and (3) reasonableness of underwriting gains
and other expenses. USDA agreed with most of GAO's 2005 	 
recommendations to improve program integrity. RMA agreed that	 
GAO's new analyses were technically accurate.			 
-------------------------Indexing Terms------------------------- 
REPORTNUM:   GAO-07-819T					        
    ACCNO:   A69067						        
  TITLE:     Crop Insurance: Continuing Efforts Are Needed to Improve 
Program Integrity and Ensure Program Costs Are Reasonable	 
     DATE:   05/03/2007 
  SUBJECT:   Agricultural policies				 
	     Agricultural programs				 
	     Crop insurance					 
	     Fraud						 
	     Insurance						 
	     Insurance claims					 
	     Insurance losses					 
	     Insurance premiums 				 
	     Internal controls					 
	     Monitoring 					 
	     Program abuses					 
	     Program evaluation 				 
	     Risk management					 
	     Waste, fraud, and abuse				 
	     Federal Crop Insurance Program			 

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GAO-07-819T

   

     * [1]Background
     * [2]RMA Has Strengthened Procedures for Preventing Questionable
     * [3]RMA's Regulations and Some Statutory Requirements Hinder Eff
     * [4]Compensation to Insurance Companies Has Been Excessive
     * [5]Conclusion
     * [6]Contact and Staff Acknowledgments
     * [7]GAO's Mission
     * [8]Obtaining Copies of GAO Reports and Testimony

          * [9]Order by Mail or Phone

     * [10]To Report Fraud, Waste, and Abuse in Federal Programs
     * [11]Congressional Relations
     * [12]Public Affairs

Testimony

Before the Committee on Oversight and Government Reform, House of
Representatives

United States Government Accountability Office

GAO

For Release on Delivery
Expected at 10:00 a.m. EDT
Thursday, May 3, 2007

CROP INSURANCE

Continuing Efforts Are Needed to Improve Program Integrity and Ensure
Program Costs Are Reasonable

Statement of Lisa Shames, Acting Director Natural Resources and
Environment

GAO-07-819T

Mr. Chairman and Members of the Committee:

I am pleased to be here today to discuss the U.S. Department of
Agriculture's (USDA) efforts to address fraud, waste, and abuse in the
federal crop insurance program. As you know, federal crop insurance is
part of the overall safety net of programs for American farmers. It
provides protection against financial losses caused by droughts, floods,
or other natural disasters. USDA's Risk Management Agency (RMA) supervises
the Federal Crop Insurance Corporation's (FCIC) operations and has overall
responsibility for administering the crop insurance program, including
controlling costs and protecting against fraud, waste, and abuse. RMA also
partners with private insurance companies that sell and service the
insurance policies and share a percentage of the risk of loss and
opportunity for gain associated with each policy.

In November 2006, we identified the federal crop insurance program as a
program in need of better oversight to ensure program funds are spent as
economically, efficiently, and effectively as possible.^1 In 2006, the
crop insurance program provided $50 billion in insurance coverage for 242
million acres of farmland, at a cost of $3.5 billion to the federal
government, of which a total of $1.8 billion was paid to insurance
companies for their participation in the crop insurance program.^2 USDA
reports that an estimated $62 million in indemnity payments were made in
2006 as a result of waste, such as incorrect payments or payments based on
incomplete or missing paperwork.^3

To improve the integrity of the crop insurance program, among other
things, Congress enacted the Agricultural Risk Protection Act of 2000
(known as ARPA). ARPA provided RMA and USDA's Farm Service Agency (FSA)
with new tools for monitoring and controlling program abuses.^4 ARPA
required the Secretary of Agriculture to develop and implement a
coordinated plan for FSA to assist RMA in the ongoing monitoring of the
crop insurance program and to use information technologies, such as data
mining--the analysis of data to establish relationships and identify
patterns--to administer and enforce the program. Furthermore, ARPA
provided USDA with the authority to renegotiate the financial terms of its
contractual agreement--known as the standard reinsurance agreement
(SRA)--with the private insurance companies once during 2001 through 2005.
USDA renegotiated the terms of the SRA in 2004 and implemented the new
agreement in 2005. In its recent Farm Bill proposal, USDA recommended that
Congress provide the agency with authority to renegotiate the financial
terms and conditions once every 3 years. RMA officials also told us they
sought legislative remedies to address excessive underwriting gains in
their budget proposals for fiscal years 2006 and 2007. The SRA between
USDA and the insurance companies includes (1) a cost allowance that is
tied to the value of the policy and that is intended to cover
administrative and operating expenses incurred by the companies for
program delivery, and (2) risk-sharing formulas that establish
underwriting gains and losses.

^1GAO, Suggested Areas for Oversight for the 110th Congress,
[13]GAO-07-235R (Washington, D.C.: Nov. 17, 2006).

^2Cost data in this testimony are reported on a fiscal year basis. Program
data are reported on a crop year basis.

^3See U.S. Department of Agriculture, FY 2006 Performance and
Accountability Report (Washington, D.C.: Nov. 15, 2006). RMA officials
indicated that they have not developed an estimate of losses attributable
to fraud and abuse.

^4FSA is generally responsible for helping producers enroll in agriculture
support programs, overseeing these programs, and issuing program payments.

GAO has issued reports on the federal crop insurance program that have
raised a number of concerns. (See Related GAO Products.) Most recently, in
June 2006, we reported that some farmers may have abused the crop
insurance program by allowing crops to fail through neglect or deliberate
actions in order to collect insurance, and some insurance companies have
not exercised due diligence in investigating losses and paying claims.^5
In addition, the effects of climate change, including rising temperatures
and increasingly frequent and intense droughts, storms, and flooding, may
be potentially significant in coming decades and affect the program's
financial costs to the government. As we recently reported,^6 major
private and federal insurers are both exposed to the effects of climate
change over the coming decades, but are responding differently. Many large
private insurers are incorporating climate change into their annual risk
management practices, and some are addressing it strategically by
assessing its potential long-term, industrywide impacts. However, the
major federal insurance programs, including the crop insurance program,
have done little to develop comparable information.

^5GAO, Crop Insurance: More Needs to Be Done to Reduce Program's
Vulnerability to Fraud, Waste, and Abuse, [14]GAO-06-878T (Washington,
D.C.: June 15, 2006), and Crop Insurance: Actions Needed to Reduce
Program's Vulnerability to Fraud, Waste, and Abuse, GAO-05-528
(Washington, D.C.: September 30, 2005).

^6GAO, Climate Change: Financial Risks to Federal and Private Insurers in
Coming Decades Are Potentially Significant, [15]GAO-07-285 (Washington,
D.C.: March 16, 2007).

My testimony today focuses on the (1) effectiveness of USDA's procedures
to prevent and detect fraud, waste, and abuse in selling and servicing
crop insurance policies; (2) extent to which program design issues may
make the program more vulnerable to fraud, waste, and abuse; and (3)
reasonableness of underwriting gains and administrative and operating
expenses USDA pays to the companies for program delivery. My testimony is
primarily based on published GAO products. In addition, at the request of
this Committee, we analyzed underwriting gains and losses and
administrative and operating expenses. RMA reviewed these analyses and
told us they were technically accurate. We performed our work in
accordance with generally accepted government auditing standards.

In summary, since the enactment of ARPA, RMA has taken a number of steps
to improve its procedures to prevent and detect fraud, waste, and abuse in
the crop insurance program. Most notably, RMA reports that data mining
analyses and subsequent communication to farmers resulted in a decline of
at least $300 million in questionable claims payments from 2001 to 2004.
However, we found that, at the time our review, RMA was not effectively
using all of the tools it had available and that some farmers and others
continued to abuse the program. We identified weaknesses in four key
areas: (1) field inspections, (2) data mining processes that exclude many
large farming operations when farmers do not report their interest in
them, (3) quality assurance reviews conducted by insurance companies, and
(4) imposition of sanctions. Weaknesses in these areas left the program
vulnerable to questionable claims, and the insurance companies and RMA
could not always determine the validity of a claim to minimize fraud,
waste, and abuse. RMA has taken steps on some of the recommendations we
made. For example, RMA amended its crop insurance policy manual to provide
information more frequently to FSA on suspect claims so that FSA is able
to conduct timelier field inspections to detect potential abuse. In
another case, we recommended that RMA promulgate regulations needed to
fully utilize its expanded sanction authority provided under ARPA. In
response, RMA developed draft regulations that, when final, will allow the
agency to fully use this authority to sanction program violators.

We also found that the program's design, as laid out in RMA's regulations
or as required by statute, can impede the efforts of RMA officials to
prevent and detect fraud, waste, and abuse in a number of ways. In terms
of RMA's regulations, farmers can insure their fields individually instead
of insuring all fields combined, which makes it easier for them to switch
production among fields, either to make false insurance claims or to build
up a higher yield history on a particular field in order to increase its
eligibility for higher future insurance guarantees. RMA disagreed with our
recommendation to reduce the insurance guarantee or eliminate optional
unit coverage for producers who consistently have claims that are
irregular in comparison with other producers growing the same crop in the
same location. RMA stated that our recommendation represents a
disproportionate response, considering the small number of producers who
switch the yield on a field each year. Nevertheless, we continue to
believe that RMA could tailor an underwriting rule to target those
relatively few farmers who file anomalous claims related to yield
switching. In terms of statutory requirements, RMA is obligated by law to
offer farmers "prevented planting" coverage--coverage that allows for
insurance claims if an insured crop is prevented from being planted
because of weather conditions, but it is often difficult to determine
whether farmers had the opportunity to plant a crop. In our 2006
testimony, we stated that Congress may wish to consider allowing RMA to
reduce premium subsidies--and hence raise the insurance premiums--for
farmers who consistently have claims, such as prevented planting claims,
that are irregular in comparison with other farmers growing the same crop
in the same location. To date, Congress has not granted RMA the authority
to make such reductions.

Finally, USDA paid the insurance companies underwriting gains of $2.8
billion, in total, from 2002 through 2006. The underwriting gains
represent an average annual rate of return of 17.8 percent over this
5-year period.^7 This rate of return is considerably higher than the
insurance industry average. According to insurance industry statistics,
the benchmark rate of return for U.S. insurance companies selling private
property and casualty insurance was 6.4 percent during this period. RMA
officials told us that this benchmark rate can be considered a starting
point for measuring the appropriateness of the underwriting gains in the
crop insurance program. As previously noted, USDA renegotiated the
financial terms of its SRA with the companies beginning with the 2005
planting season. Nonetheless, in 2005, USDA still paid insurance companies
underwriting gains of $916 million--a rate of return of 30.1 percent. In
2006, USDA paid underwriting gains of $886 million--a rate of return of
24.3 percent. The companies received these underwriting gains despite
drought conditions in parts of the country in 2005 and 2006 that would
normally suggest they would earn lower profits. In addition to
underwriting gains, USDA paid the insurance companies $4 billion in cost
allowances to cover administrative and operating expenses incurred for
program delivery from 2002 through 2006. USDA expects the cost allowance
paid per policy to increase by about 25 percent by 2008 because of higher
crop prices, particularly for corn and soybeans. These higher crop prices
increase the value of the policy. However, the companies and their
affiliated sales agents will receive this substantially higher cost
allowance without any corresponding increase in expenses for selling and
servicing the policies. Congress has an opportunity in its reauthorization
of the Farm Bill to provide USDA with the authority to periodically
renegotiate the financial terms of the standard reinsurance agreement with
the insurance companies so that the companies' rate of return is more in
line with private insurance markets. USDA has requested the authority to
renegotiate the SRA in its proposals for the Farm Bill.

^7In this testimony, we define rate of return as underwriting gains
calculated as a percentage of premiums on the policies in which companies
retain risk of loss.

Background

FCIC was established in 1938 to temper the economic impact of the Great
Depression, and was significantly expanded in 1980 to protect farmers from
the financial losses brought about by drought, flood, or other natural
disasters. RMA administers the program in partnership with private
insurance companies, which share a percentage of the risk of loss and the
opportunity for gain associated with each insurance policy written. RMA
acts as a reinsurer--reinsurance is sometimes referred to as insurance for
the insurance companies--for a portion of all policies the federal crop
insurance program covers. In addition, RMA pays companies a percentage of
the premium on policies sold to cover the administrative costs of selling
and servicing these policies. In turn, insurance companies use this money
to pay commissions to their agents, who sell the policies, and fees to
adjusters when claims are filed.

FCIC insures agricultural commodities on a crop-by-crop and
county-by-county basis, considering farmer demand and the level of risk
associated with the crop in a given region. Major crops, such as grains,
are covered in almost every county where they are grown, while specialty
crops such as fruit are covered in only some areas. Participating farmers
can purchase different types of crop insurance and at different levels.

RMA establishes the terms and conditions that the private insurance
companies selling and servicing crop insurance policies are to use through
the SRA. The SRA provides for the cost allowance intended to cover
administrative and operating expenses the companies incur for the policies
they write, among other things. The SRA also establishes the minimum
training, quality control review procedures, and performance standards
required of all insurance providers in delivering any policy insured or
reinsured under the Federal Crop Insurance Act, as amended.

Under the crop insurance program, participating farmers are assigned (1) a
"normal" crop yield based on their actual production history and (2) a
price for their commodity based on estimated market conditions. Farmers
can then select a percentage of their normal yield to be insured and a
percentage of the price they wish to receive if crop losses exceed the
selected loss threshold. In addition, under the crop insurance program's
"prevented planting" provision, insurance companies pay farmers who were
unable to plant the insured crop because of an insured cause of loss that
was general to their surrounding area, such as weather conditions causing
wet fields, and that had prevented other farmers in that area from
planting fields with similar characteristics. These farmers are entitled
to claims payments that generally range from 50 to 70 percent, and can
reach as high as 85 percent, of the coverage they purchased, depending on
the crop.

RMA is responsible for protecting against fraud, waste, and abuse in the
federal crop insurance program. In this regard, RMA uses a broad range of
tools, including RMA's compliance reviews of companies' procedures,
companies' quality assurance reviews of claims, data mining, and FSA's
inspections of farmers' fields. For example, insurance companies must
conduct quality assurance reviews of claims that RMA has identified as
anomalous or of those claims that are $100,000 or more to determine
whether the claims the companies paid comply with policy provisions.

Congress enacted ARPA, amending the Federal Crop Insurance Act, in part,
to improve compliance with, and the integrity of, the crop insurance
program. Among other things, ARPA provided RMA authority to impose
sanctions against producers, agents, loss adjusters, and insurance
companies that willfully and intentionally provide false or inaccurate
information to FCIC or to an insurance company--previously, RMA had
authority to impose sanctions only on individuals who willfully and
intentionally provided false information. It also provided RMA with
authority to impose sanctions against producers, agents, loss adjusters,
and insurance companies for willfully and intentionally failing to comply
with any other FCIC requirement. In addition, it increased the percentage
share of the premium the government pays for most coverage levels of crop
insurance, beginning with the 2001 crop year. The percentage of the
premium the government pays declines as farmers select higher levels of
coverage. However, ARPA raised the percentage of federal subsidy for all
levels of coverage, particularly for the highest levels of coverage. For
example, the government now pays more than one-half of the premium for
farmers who choose to insure their crop at 75-percent coverage.

RMA Has Strengthened Procedures for Preventing Questionable Claims, but the
Program Remains Vulnerable to Potential Abuse

RMA has taken a number of steps to improve its procedures to prevent and
detect fraud, waste, and abuse, such as data mining, expanded field
inspections and quality assurance reviews. In particular, RMA now develops
a list of farmers each year whose operations warrant an on-site inspection
during the growing season because data mining uncovered patterns in their
past claims that are consistent with the potential for fraud and abuse.
The list includes, for example:

           o farmers, agents, and adjusters linked in irregular behavior that
           suggests collusion;
           o farmers who for several consecutive years received most of their
           crop insurance payments from prevented planting indemnity
           payments;
           o farmers who appear to have claimed the production amounts for
           multiple fields as only one field's yield, thereby creating an
           artificial loss on their other field(s); and
           o farmers who, in comparison with their peers, file unusually high
           claims for lost crops over many years.

           Since RMA began performing this data mining in 2001, it has
           identified about 3,000 farmers annually who warrant an on-site
           inspection because of anomalous claims patterns. In addition, RMA
           annually performs about 100 special analyses to identify areas of
           potential vulnerability and trends in the program.

           RMA also provides the names of farmers from its list of suspect
           claims for inspection to the appropriate FSA state office for
           distribution to FSA county offices, as well as to the insurance
           companies selling the policies to farmers. As a result of these
           inspections and other information, RMA reported total cost savings
           of $312 million from 2001 to 2004, primarily in the form of
           estimated payments avoided. For example, according to RMA, claims
           payments to farmers identified for an inspection decreased
           nationwide from $234 million in 2001 to $122 million in 2002.
           According to RMA, some of the farmers on the list for filing
           suspect claims bought less insurance and a few dropped crop
           insurance entirely, but most simply changed their behavior
           regarding loss claims.

           However, as we testified in 2006, RMA was not effectively using
           all of the tools it had available and that some farmers and others
           continued to abuse the program, as the following discussion
           indicates.

           Inspections during the growing season were not being used to
           maximum effect. FSA was not providing RMA with inspection
           assistance in accordance with USDA guidance. For example, between
           2001 and 2004, farmers filed claims on about 380,000 policies
           annually, and RMA's data mining identified about 1 percent of
           these claims as questionable and needing FSA's inspection. Under
           USDA guidance, FSA should have conducted all of the 11,966
           requested inspections, but instead conducted only 64 percent of
           them; FSA inspectors said that they did not conduct all requested
           inspections primarily because they did not have sufficient
           resources. Moreover, between 2001 and 2004, FSA offices in nine
           states did not conduct any of the field inspections RMA had
           requested in one or more of the years. Until we brought this
           matter to their attention in September 2004, FSA headquarters
           officials were unaware that the requested inspections in these
           nine states had not been conducted. Furthermore, FSA might not
           have been as effective as possible in conducting field inspections
           because RMA did not provide it with information on the nature of
           the suspected abusive behavior or the results of follow-up
           investigations. Finally, these inspections did not always occur in
           a timely fashion during the growing season. Because of these
           problems, the insurance companies and RMA could not always
           determine the validity of a claim.

           USDA has implemented some of our recommendations to improve
           inspection practices. For example, we recommended that RMA more
           consistently inform FSA of the suspect claim patterns that it
           should investigate. RMA amended its crop insurance policy manual
           to provide information more frequently to FSA on suspect claims,
           as we recommended, so that FSA can conduct timelier field
           inspections to detect potential abuse. Specifically, RMA now
           provides a list twice a year--in the fall for crops such as wheat,
           and in the spring for crops such as corn and soybeans. However,
           FSA disagreed with our recommendation that it conduct all
           inspections called for under agency guidance, citing insufficient
           resources as the reason. Nevertheless, we believe that conducting
           these inspections would achieve potentially substantial savings
           for the crop insurance program by identifying cases of fraudulent
           claims.

           RMA's data analysis of the largest farming operations was
           incomplete. RMA's data mining analysis excluded comparisons of the
           largest farming operations--including those organized as
           partnerships and joint ventures. These entities may include
           individuals who are also members of one or more other entities.
           Because it did not know the ownership interests in the largest
           farming operations, RMA could not readily identify potential
           fraud. For example, farmers who are members of more than one
           farming operation could move production from one operation to
           another to file unwarranted claims, without RMA's knowledge that
           these farmers participate in more than one farming operation. RMA
           could not make these comparisons because it had not been given
           access to similar data that FSA maintains. However, ARPA required
           the Secretary of Agriculture to develop and implement a
           coordinated plan for RMA and FSA to reconcile all relevant
           information received by either agency from a farmer who obtains
           crop insurance coverage.

           Using FSA data, we examined the extent to which (1) farming
           operations report all members who have a substantial beneficial
           interest in the operation, (2) these farming operations file
           questionable crop insurance claims, and (3) agents or claims
           adjusters had financial interests in the claim.^8 By comparing
           RMA's and FSA's databases, we found that 21,310 farming entities,
           or about 31 percent of all farming entities, did not report one or
           more members who held a beneficial interest of 10 percent or more
           in the farming operation holding the policy. RMA should be able to
           recover a portion of these payments because, according to RMA
           regulations, if the policyholder fails to disclose an ownership
           interest in the farming operation, the policyholder must repay the
           amount of the claims payment that is proportionate to the interest
           of the person who was not disclosed.^9 According to our analysis,
           RMA should be able to recover up to $74 million in claims payments
           for 2003. USDA has since implemented our recommendation that FSA
           and RMA share information on policyholders to better identify
           fraud, waste, and abuse. In addition, of the 21,310 entities
           failing to disclose ownership interest in 2003, we found 210
           entities with suspicious insurance claims totaling $11.1 million.
           Finally, we identified 24 crop insurance agents who sold policies
           to farming entities in which the agents held a substantial
           beneficial interest but failed to report their ownership interest
           to RMA as required. USDA has since implemented our recommendation
           that FSA and RMA share information on policyholders to better
           identify fraud, waste, and abuse. RMA, however, has not
           implemented our recommendation to recover claims payments to
           ineligible farmers or to entities that failed to fully disclose
           ownership interest.
		   
^8The Center for Agribusiness Excellence conducted this analysis at our
request. The Center, located at Tarleton State University in Stephenville,
Texas, provides research, training, and resources for data warehousing and
data mining of agribusiness and agriculture data. The Center provides data
mining of crop insurance data for RMA.

^97 C.F.R. S 457.8.		   

           RMA was not effectively overseeing insurance companies' quality
           assurance programs. RMA guidance requires insurance companies to
           provide oversight to properly underwrite the federal crop
           insurance program, including implementing a quality control
           program, conducting quality control reviews, and submitting an
           annual report to FCIC. However, RMA was not effectively overseeing
           insurance companies' quality assurance programs, and for the
           claims we reviewed, it did not appear that most companies were
           rigorously carrying out their quality assurance functions. For
           example, 80 of the 120 insurance files we reviewed claimed more
           than $100,000 in crop losses or met some other significant
           criteria; RMA's guidance states that the insurance provider must
           conduct a quality assurance review for such claims. However, the
           insurance companies conducted reviews on only 59 of these claims,
           and the reviews were largely paper exercises, such as
           computational verifications, rather than comprehensive analysis of
           the claim. RMA did not ensure that companies conducted all reviews
           called for under its guidance and did not examine the quality of
           the companies' reviews. RMA agreed with our recommendation to
           improve oversight of companies' quality assurance programs, but we
           have not yet followed up with the agency to examine its
           implementation.

           RMA has infrequently used its new sanction authority to address
           program abuses. RMA had only used its expanded sanction authority
           granted under ARPA on a limited basis. It had identified about
           3,000 farmers with suspicious claims payments--notable policy
           irregularities compared with other farmers growing the same crop
           in the same county--each year since the enactment of ARPA. While
           not all of these policies with suspicious claims were necessarily
           sanctionable, RMA imposed only 114 sanctions from 2001 through
           2004. According to RMA officials, RMA requested and imposed few
           sanctions because it had not issued regulations to implement its
           expanded authority under ARPA. Without regulations, RMA had not
           established what constitutes an "FCIC requirement" and not
           explained how it would determine that a violation had occurred or
           what procedural process it would follow before imposing sanctions.
           RMA agreed with our recommendation that it promulgate regulations
           to implement its expanded authority, and has developed draft
           regulations. Once final, these regulations will allow the agency
           to fully use this authority to sanction program violators.
		   
		   RMA's Regulations and Some Statutory Requirements Hinder Efforts
		   to Reduce Abusein the Crop Insurance Program

           While RMA can improve its day-to-day oversight of the federal crop
           insurance program in a number of ways, the program's design, as
           laid out in RMA's regulations or as required by statute, hinders
           the agency's efforts to administer certain program provisions in
           order to prevent fraud, waste, and abuse, as the following
           discussion indicates.

           RMA's regulations allow farmers the option of insuring their
           fields individually rather than combined as one unit. Farmers can
           insure production of a crop on an individual field (optional
           units) or all their fields as one unit. Farmers may want to insure
           fields separately out of concern that they could experience losses
           in a certain field because of local weather conditions, such as
           hail or flooding. If farmers instead insure their entire crop in a
           single basic insurance unit, the hail losses might not cause the
           production yield of all units combined to be below the level
           guaranteed by the insurance and, therefore, would not warrant an
           indemnity payment. Although insurance on individual fields
           provides farmers added protection against loss, this optional unit
           coverage increases the potential for fraud and abuse in the crop
           insurance program.

           Insuring fields separately enables farmers to "switch" production
           among fields--reporting production of a crop from one field that
           is actually produced on another field--either to make false
           insurance claims based on low production or to build up a higher
           yield history on a particular field in order to increase that
           field's eligibility for higher future insurance guarantees. We
           reported that of the 2,371 farmers identified as having irregular
           claims in 2003, 12 percent were suspected of switching production
           among their fields.

           According to a 2002 RMA study, losses per unit (e.g., a field)
           increase as the number of separately insured optional units
           increases.^10 However, according to an RMA official, gathering the
           evidence to support a yield-switching fraud case requires
           considerable resources, especially for large farming operations.
           RMA disagreed with our recommendation to reduce the insurance
           guarantee or eliminate optional unit coverage for farmers who
           consistently have claims that are irregular in comparison with
           other farmers growing the same crop in the same location. It
           stated that our recommendation represents a disproportionate
           response, considering the small number of producers who engage in
           yield switching each year, and that the adoption of our
           recommendation would not be cost effective. Nevertheless, we
           continue to believe that RMA could tailor an underwriting rule so
           that it would target only a few producers each year and would
           entail few resources. Such a tool would provide RMA another means
           to discourage producers from abusing the program.

^10Final Research Report For Multiple Year Coverage, Task Order #
RMA-RED-01-06, Watts and Associates, Inc., June 27, 2002.

           Minimal risk sharing on some policies, as set by statute, may not
           provide insurance companies with a strong incentive to carry out
           their responsibilities under the program. In some cases, insurance
           companies have little incentive to rigorously challenge
           questionable claims. Insurance companies participating in the crop
           insurance program share a percentage of the risk of loss or
           opportunity for gain on each insurance policy they write, but the
           federal government ultimately bears a high share of the risk.
           Under the SRA, insurance companies are allowed to assign policies
           to one of three risk funds--assigned risk, developmental, or
           commercial. The SRA provides criteria for assigning policies to
           these funds. For the assigned risk fund, the companies cede up to
           85 percent of the premium and associated liability for claims
           payments to the government and share a limited portion of the
           gains or losses on the policies they retain. For the developmental
           and commercial funds, the companies cede a smaller percent of the
           premium and associated liability for claims payments to the
           government.

           Economic incentives to control program costs associated with
           fraud, waste, and abuse are commensurate with financial exposure.
           Therefore, for policies placed in the assigned risk fund,
           companies have far less financial incentive to investigate suspect
           claims. For example, in one claim file we reviewed, an insurance
           company official characterized the farmer as filing frequent,
           questionable claims; however, the company paid a claim of over
           $500,000. The official indicated that if the company had
           vigorously challenged the claim, the farmer would have defended
           his claim just as vigorously, and the company would have
           potentially incurred significant litigation expenses, which RMA
           does not specifically reimburse. With this cost and reimbursement
           structure, in the company's opinion, it was less costly to pay the
           claim.

           RMA and insurance companies have difficulty determining potential
           abuse associated with statutory coverage for prevented planting.
           Under the Federal Crop Insurance Act, as amended, RMA must offer
           prevented planting coverage. RMA allows claims for prevented
           planting if farmers cannot plant owing to an insured cause of loss
           that is general in the surrounding area and that prevents other
           farmers from planting acreage with similar characteristics. Claims
           for prevented planting are paid at a reduced level, recognizing
           that farmers do not incur all production costs associated with
           planting and harvesting a crop. However, determining whether
           farmers can plant their crop may be difficult. Annually, RMA pays
           about $300 million in claims for prevented planting.

           Statutorily high premium subsidies may inhibit RMA's ability to
           control program abuse. ARPA increased premium subsidies--the share
           of the premium paid by the government--but this increase may
           hamper RMA's ability to control program fraud, waste, and abuse.
           Premium subsidies are calculated as a percentage of the total
           premium, and farmers pay only between 33 to 62 percent of the
           policy premium, depending on coverage level. High premium
           subsidies shield farmers from the full effect of paying higher
           premiums. Because premium rates are higher in riskier areas and
           for riskier crops, the subsidy structure transfers more federal
           dollars to those who farm in riskier areas or produce riskier
           crops.

           In addition, by regulation, premium rates are higher for farmers
           who choose to insure their fields separately under optional units,
           rather than all fields combined, because the frequency of claims
           payments is higher on the separately insured units. Again,
           however, because of high premium subsidies, farmers pay only a
           fraction of the higher premium. Thus, the subsidy structure
           creates a disincentive for farmers to insure all fields combined.
           Over one-half (56 percent) of the crop insurance agents responding
           to the survey conducted for our 2005 report believed that charging
           higher premiums for farmers with a pattern of high or frequent
           claims would discourage fraud, waste, and abuse in the crop
           insurance program. In our 2006 testimony, we stated that Congress
           may wish to consider allowing RMA to reduce premium subsidies--and
           hence raise the insurance premiums--for farmers who consistently
           have claims that are irregular in comparison with other farmers
           growing the same crop in the same location. To date, no action has
           been taken.
		   
		   Compensation to Insurance Companies Has Been Excessive

           From 1997 through 2006, USDA paid over $10.9 billion to companies
           that participate in the federal crop insurance program in cost
           allowances and underwriting gains, as table 1 shows. The $10.9
           billion in total payments to the companies represents 42 percent
           of the government's cost of the crop insurance program--about $26
           billion--over this period. That is, more than 40 cents of every
           dollar the government spent on the federal crop insurance program
           went to the companies that deliver the program, while less than 60
           cents went to farmers. While we provide 10 years of data to offer
           a broad perspective and to even out annual losses and gains, the
           most recent 5 years of data--2002 to 2006--show similar results.

Table 1: Cost Allowances and Underwriting Gains Paid to Insurance
Companies, and Government Costs, 1997 through 2006

Dollars in                                                                 
millions                                                                   
                      Payments to insurance companies                         
                                                   Total                      
                                     Company payments to  Government cost for 
                   Company cost underwriting   insurance   the crop insurance 
Year               allowance  gain (loss)   companies            program^a 
1997                  $437.8       $352.1      $789.9             $1,095.9 
1998                   443.3        279.2       722.5              1,373.8 
1999                   500.7        271.8       772.5              1,782.7 
2000                   552.1        267.8       819.9              2,175.1 
2001                   642.0        345.9       987.9              3,162.6 
2002                   625.9       (47.5)       578.4              3,465.6 
2003                   733.9        377.9     1,111.8              3,588.7 
2004                   890.0        691.9     1,581.9              3,125.7 
2005                   829.6        916.2     1,745.8              2,698.5 
2006                   949.8        885.9     1,835.7              3,462.0 
Total--1997 to      $6,605.1     $4,341.2   $10,946.3            $25,930.6 
2006                                                                       
Total--2002 to      $4,029.2     $2,824.4    $6,853.6            $16,340.5 
2006                                                                       

Source: GAO's analysis of RMA's data.

Notes: (1) Cost data are reported on a fiscal year basis. (2) Payments to
companies are reported on a crop year basis. (3) Totals may not add due to
rounding.

aGovernment costs also include total indemnities and other administrative
and operating expenses, including certain costs for research, development,
and other activities. This total is reduced by the premiums and
administration fees that farmers pay.

As discussed earlier, USDA pays both underwriting gains and cost
allowances, as negotiated in the SRA. Since the crop insurance program was
revised under ARPA--that is, from 2002 through 2006--USDA has paid the
insurance companies a total of $2.8 billion in underwriting gains. In
terms of profitability, these underwriting gains represent an average
annual rate of return of 17.8 percent over this 5-year period.^11
According to industry statistics, the benchmark rate of return for U.S.
insurance companies selling private property and casualty insurance was
6.4 percent during this period.^12 RMA officials told us that this
benchmark rate can be considered a starting point for measuring the
appropriateness of the underwriting gains in the crop insurance program.
However, they stated that this program should have a somewhat higher rate
of return because of the (1) high volatility of underwriting gains for
this program compared with the relatively steady gains associated with the
property and casualty insurance industry, and (2) lack of investment
opportunities when participating in the program because premiums are paid
to the companies at harvest, not when farmers purchase a policy. But these
officials also said that current rates of return are excessive. USDA
renegotiated the financial terms of its SRA with the companies beginning
with the 2005 planting season. In 2005, USDA paid the insurance companies
underwriting gains of $916 million--a rate of return of 30.1 percent. In
2006, USDA paid them underwriting gains of $886 million--a rate of return
of 24.3 percent. The companies received these underwriting gains despite
drought conditions in parts of the country in 2005 and 2006. Adverse
weather conditions, such as drought, normally suggest that insurance
companies would earn lower profits because of greater producer losses.

In addition to underwriting gains, RMA pays companies a cost allowance to
cover program delivery expenses. The allowance is calculated as a
percentage of total premiums on the insurance policies that they sell.
Because the cost allowance is not tied to specific expenses, the companies
can use the payments in any way they choose. From 2002 through 2006, USDA
paid the insurance companies over $4 billion in cost allowances. Because
the cost allowance is a percentage of the premiums, it also increases when
the value of policies companies sell increases, as it does when crop
prices rise. For example, USDA expects the value of policies, and thereby
the cost allowances paid to companies, to increase by about 25 percent
from 2006 through 2008. USDA expects these higher policy values, and
ultimately higher cost allowances, because of external factors, including
higher crop prices, particularly for corn and soybeans. Consequently, the
companies and their affiliated sales agents will receive substantially
higher cost allowances without any corresponding increase in expenses for
selling and servicing the policies. Substantially higher cost allowances
provide these companies and their agents with a kind of windfall. Greater
insurance coverage results in higher premiums and ultimately higher cost
allowances; yet, the purpose of this allowance is to reimburse program
delivery expenses.

^11Similarly, over the 10-year period, from 1997 through 2006, USDA paid
companies participating in the crop insurance program underwriting gains
of $4.3 billion, which represents an average annual rate of return of 17.8
percent.

^12Best's Aggregates and Averages: Property/Casualty, United States and
Canada. (Oldwick, New Jersey: 2006). According to this publication, the
benchmark rate of return for property and casualty insurance for the
10-year period ending in 2005 (the most recent year data were available)
was 6.9 percent. For calculating the rate of return, we used Best's ratio
of pre-tax operating income to net premium earned.

In this context, USDA has requested the authority to renegotiate the SRA
in its proposals for the Farm Bill. Specifically, USDA recommends
renegotiating the SRA financial terms and conditions once every 3 years.
According to USDA, the crop insurance program's participation has grown
significantly since the implementation of ARPA. Because higher
participation rates have resulted in more stable program performance, the
reinsured companies have enjoyed historically large underwriting gains in
the last 2 years of the program. Granting USDA authority to renegotiate
periodically would also permit USDA to renegotiate the SRA if the
reinsured companies experience an unexpected adverse impact.

Conclusion

In conclusion, Mr. Chairman, federal crop insurance plays an invaluable
role in protecting farmers from losses due to natural disasters, and the
private insurance companies that participate in the program are integral
to the program's success. Nonetheless, as we mentioned before, we
identified crop insurance as an area for oversight to ensure that program
funds are spent as economically, efficiently, and effectively as possible.
Furthermore, a key reason that we identified crop insurance, as well as
other farm programs, for oversight is that we cannot afford to continue
business as usual, given the nation's current deficit and growing
long-term fiscal challenges.

RMA has made progress in addressing fraud, waste, and abuse, but the
weaknesses we identified in program management and design continue to
leave the crop insurance program vulnerable to potential abuse.
Furthermore, as our work on underwriting gains and losses has shown, RMA's
effort to limit cost allowances and underwriting gains by renegotiating
the SRA has had minimal effect. In fact, it offers insurance companies and
their agents a windfall. We believe that the crop insurance program should
be delivered to farmers at a reasonable cost that does not over-compensate
insurance companies participating in the program. A reduced cost allowance
for administrative and operating expenses and a decreased opportunity for
underwriting gains would potentially save hundreds of millions of dollars
annually, yet still provide sufficient funds for the companies to continue
delivering high-quality service while receiving a rate of return that is
closer to the industry benchmark.

Congress has an opportunity in its reauthorization of the Farm Bill to
provide USDA with the authority to periodically renegotiate the financial
terms of the SRA with the insurance companies so that the companies' rate
of return is more in line with private insurance markets. Such a step can
help position the nation to meet its fiscal responsibilities.

Mr. Chairman, this concludes my prepared statement. I would be happy to
respond to any questions that you or other Members of the Committee may
have.

Contact and Staff Acknowledgments

Contact points for our Offices of Congressional Relations and Public
Affairs may be found on the last page of this testimony. For further
information about this testimony, please contact Lisa Shames, Acting
Director, Natural Resources and Environment, (202) 512-3841 or
[email protected] . Key contributors to this testimony were James R.
Jones, Jr., Assistant Director; Thomas M. Cook; and Carol Herrnstadt
Shulman.

Related GAO Products

Climate Change: Financial Risks to Federal and Private Insurers in Coming
Decades Are Potentially Significant. [17]GAO-07-760T . Washington, D.C.:
April 19, 2007.

Climate Change: Financial Risks to Federal and Private Insurers in Coming
Decades Are Potentially Significant. [18]GAO-07-285 . Washington, D.C.:
March 16, 2007.

Suggested Areas for Oversight for the 110th Congress. [19]GAO-07-235R .
Washington, D.C.: November 17, 2006.

Crop Insurance: More Needs to Be Done to Reduce Program's Vulnerability to
Fraud, Waste, and Abuse. [20]GAO-06-878T . Washington, D.C.: June 15,
2006.

Crop Insurance: Actions Needed to Reduce Program's Vulnerability to Fraud,
Waste, and Abuse. [21]GAO-05-528 . Washington, D.C.: September 30, 2005.

Crop Insurance: USDA Needs to Improve Oversight of Insurance Companies and
Develop a Policy to Address Any Future Insolvencies. [22]GAO-04-517 .
Washington, D.C.: June 1, 2004.

Crop Insurance: USDA Needs a Better Estimate of Improper Payments to
Strengthen Controls Over Claims. [23]GAO/RCED-99-266 . Washington, D.C.:
September 22, 1999.

Crop Insurance: USDA's Progress in Expanding Insurance for Specialty
Crops. [24]GAO/RCED-99-67 . Washington, D.C.: April 16, 1999.

Crop Insurance: Opportunities Exist to Reduce Government Costs for
Private-Sector Delivery. [25]GAO/RCED-97-70 . Washington, D.C.: April 17,
1997.

Crop Insurance: Federal Program Faces Insurability and Design Programs.
[26]GAO/RCED-93-98 . Washington, D.C.: May 24, 1993.

Crop Insurance: Program Has Not Fostered Significant Risk Sharing by
Insurance Companies. [27]GAO/RCED-92-25 . Washington, D.C.: January 13,
1992.

(360841)

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www.gao.gov/cgi-bin/getrpt?GAO-07-819T .

To view the full product, including the scope
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Highlights of [35]GAO-07-819T , a testimony before the Committee on
Oversight and Government Reform, House of Representatives

May 3, 2007

CROP INSURANCE

Continuing Efforts Are Needed to Improve Program Integrity and Ensure
Program Costs Are Reasonable

The U.S. Dept. of Agriculture's (USDA) Risk Management Agency (RMA)
administers the federal crop insurance program in partnership with private
insurers. In 2006, the program cost $3.5 billion, including millions in
losses from fraud, waste, and abuse, according to USDA. The Agricultural
Risk Protection Act of 2000 granted RMA authority to renegotiate the terms
of RMA's standard reinsurance agreement with companies once over 5 years.

This testimony is based on GAO's 2005 report, Crop Insurance: Actions
Needed to Reduce Program's Vulnerability to Fraud, Waste, and Abuse, as
well as new analyses this Committee requested on underwriting gains and
administrative and operating expenses USDA paid companies. GAO discusses
(1) USDA's processes to address fraud, waste, and abuse; (2) extent the
program's design makes it vulnerable to abuse; and (3) reasonableness of
underwriting gains and other expenses. USDA agreed with most of GAO's 2005
recommendations to improve program integrity. RMA agreed that GAO's new
analyses were technically accurate.

[36]What GAO Recommends

Congress has an opportunity in the Farm Bill reauthorization to grant RMA
authority to periodically renegotiate the financial terms of its agreement
with companies to provide reasonable cost allowances and underwriting
gains.

GAO reported that RMA did not use all available tools to reduce the crop
insurance program's vulnerability to fraud, waste, and abuse. RMA has
since taken some steps to improve its procedures. In particular:

           o USDA's Farm Service Agency (FSA) inspections during the growing
           season were not being used to maximum effect. Between 2001 and
           2004, FSA conducted only 64 percent of the inspections RMA
           requested. Without inspections, farmers may falsely claim crop
           losses. However, FSA said it could not conduct all requested
           inspections, as GAO recommended, because of insufficient
           resources. RMA now provides information more frequently so FSA can
           conduct timelier inspections.
           o RMA's data analysis of the largest farming operations was
           incomplete. In 2003, about 21,000 of the largest farming
           operations did not report all of the individuals or entities with
           an ownership interest in these operations, as required. Therefore,
           RMA was unaware of ownership interests that could help it prevent
           potential program abuse. FSA and RMA now share information to
           identify such individuals or entities. USDA should be able to
           recover up to $74 million in improper payments made during 2003.
           o RMA was not effectively overseeing insurance companies' efforts
           to control program abuse. According to GAO's review of 120 cases,
           companies did not complete all the required quality assurance
           reviews of claims, and those that were conducted were largely
           paper exercises. RMA agreed to improve oversight of their reviews,
           but GAO has not followed up to examine its implementation.

RMA's regulations to implement the crop insurance program, as well as some
statutory requirements, create design problems that hinder its efforts to
reduce abuse. For example, the regulations allow farmers to insure fields
individually rather than together. As such, farmers can "switch" reporting
of yield among fields to make false claims or build up a higher yield
history on a field to increase its eligibility for higher insurance
guarantees. RMA did not agree with GAO's recommendation to address the
problems associated with insuring individual fields. Statutorily high
premium subsidies may also limit RMA's ability to control program abuse:
the subsidies shield farmers from the full effect of paying higher
premiums associated with frequent claims.

From 2002 through 2006, USDA paid the insurance companies underwriting
gains of $2.8 billion, which represents an average annual rate of return
of 17.8 percent. In contrast, according to insurance industry statistics,
the benchmark rate of return for companies selling property and casualty
insurance was 6.4 percent. USDA renegotiated the financial terms of its
standard reinsurance agreement with the companies in 2005, but their rate
of return was 30.1 percent in 2005, and 24.3 percent in 2006. It also paid
the companies a cost allowance of $4 billion to cover administrative and
operating costs for 2002 through 2006. USDA recommended that Congress
provide RMA with authority to renegotiate the financial terms and
conditions of its standard reinsurance agreement once every 3 years.

References

Visible links
  13. http://www.gao.gov/cgi-bin/getrpt?GAO-07-235R
  14. http://www.gao.gov/cgi-bin/getrpt?GAO-06-878T
  15. http://www.gao.gov/cgi-bin/getrpt?GAO-07-285
  17. http://www.gao.gov/cgi-bin/getrpt?GAO-07-760T
  18. http://www.gao.gov/cgi-bin/getrpt?GAO-07-285
  19. http://www.gao.gov/cgi-bin/getrpt?GAO-07-235R
  20. http://www.gao.gov/cgi-bin/getrpt?GAO-06-878T
  21. http://www.gao.gov/cgi-bin/getrpt?GAO-05-528
  22. http://www.gao.gov/cgi-bin/getrpt?GAO-04-517
  23. http://www.gao.gov/cgi-bin/getrpt?GAO/RCED-99-266
  24. http://www.gao.gov/cgi-bin/getrpt?GAO/RCED-99-67
  25. http://www.gao.gov/cgi-bin/getrpt?GAO/RCED-97-70
  26. http://www.gao.gov/cgi-bin/getrpt?GAO/RCED-93-98
  27. http://www.gao.gov/cgi-bin/getrpt?GAO/RCED-92-25
  35. http://www.gao.gov/cgi-bin/getrpt?GAO-07-819T
*** End of document. ***