Crop Insurance: Additional Actions Could Further Improve Program's
Financial Soundness (Statement/Record, 03/17/99, GAO/T-RCED-99-123).

Pursuant to a congressional request, GAO discussed the Department of
Agriculture's (USDA) crop insurance program, focusing on whether USDA:
(1) has set adequate insurance rates to achieve the legislative
requirement of actuarial soundness; (2) appropriately reimburses
participating crop insurance companies for their administrative costs;
and (3) has established methodologies in the revenue insurance plans
that set sound premium rates.

GAO noted that: (1) several aspects of the program are of concern and
need attention; (2) in 1995, GAO reported that premiums charged to
farmers for crop insurance were not adequate to achieve the actuarial
soundness as mandated by Congress; (3) GAO's review showed that the
basic premium rates for the six crops reviewed--barley, corn, cotton,
grain sorghum, soybeans, and wheat--were approaching actuarial soundness
in 1995, but USDA's rates for some crops and locations and for some
coverage and production levels were well below the legislative
requirement; (4) in 1997, GAO reported that the government's
administrative expense reimbursement to insurance companies--31 percent
of premiums--was greater than the companies' reported expenses to sell
and service federal crop insurance; (5) furthermore, GAO stated that
some of these reported expenses did not appear to be reasonably
associated with the sale and service of federal crop insurance; (6) the
Agricultural Research, Extension, and Education Reform Act of 1998
subsequently revised reimbursement rates downward to 24.5 percent of
premiums for most crop insurance; (7) however, continued oversight of
the reasonableness of the program's administrative reimbursement rate is
necessary; (8) increased program participation and sales volume that
could result from crop insurance reform may lead to lower delivery
costs, warranting a downward adjustment in the rate; (9) in 1998, GAO
reported its doubts about whether new USDA-supported revenue insurance
plans were actuarially sound over the long term and appropriate to the
risk each farmer presents to the program; (10) specifically, with
respect to the most popular plan, Crop Revenue Coverage, GAO recommended
that USDA's Risk Management Agency require the plan's developer to base
premium rates on a revenue distribution or other appropriate statistical
technique that recognizes the interrelationship between farm-level
yields and expected crop prices; (11) USDA, to date, has not fully acted
on the recommendations; (12) this year Congress is once again
considering reforms to the federal crop insurance program; and (13)
continued oversight of the federal crop insurance program is needed to
help ensure, among other things, the adequacy of premium rates, the
reasonableness of administrative expense reimbursements to companies,
and the soundness of revenue insurance plans.

--------------------------- Indexing Terms -----------------------------

 REPORTNUM:  T-RCED-99-123
     TITLE:  Crop Insurance: Additional Actions Could Further Improve 
             Program's Financial Soundness
      DATE:  03/17/99
   SUBJECT:  Insurance premiums
             Insurance cost control
             Financial management
             Grain and grain products
             Agricultural production
             Insurance companies
             Farm income stabilization programs
             Administrative costs
IDENTIFIER:  Federal Crop Insurance Program
             USDA Crop Revenue Coverage Plan
             
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Cover
================================================================ COVER


Before the Committee on Agriculture, Nutrition, and Forestry, U.S. 
Senate

To Be Released
on Delivery
at 8:00 a.m.  EST
Wednesday
March 17, 1999

CROP INSURANCE - ADDITIONAL
ACTIONS COULD FURTHER IMPROVE
PROGRAM'S FINANCIAL SOUNDNESS

Statement for the Record by
Lawrence J.  Dyckman, Director,
Food and Agriculture Issues,
Resources, Community, and Economic
Development Division

GAO/T-RCED-99-123

GAO/RCED-99-123T


(150133)


Abbreviations
=============================================================== ABBREV

  USDA -

============================================================ Chapter 0

Mr.  Chairman and Members of the Committee: 

This statement for the record summarizes our completed work on the
federal crop insurance program since 1995.  Our statement today is
based on our reports issued in 1995, 1997, and 1998.\1

Let me place our work in the context of concerns about this issue. 
As you know, farming is an inherently risky enterprise.  Federal crop
insurance is one of the primary mechanisms used by participating
farmers to protect against the risk of losses caused by events such
as droughts, floods, hurricanes, and other natural disasters.  As the
U.S.  Department of Agriculture (USDA) has rapidly expanded the
availability of crop insurance, from 59 crops insured in 1994 to 75
in 1999, and introduced new insurance products to protect farmers'
revenue, so too have the federal government's costs for crop
insurance increased.  Since 1995, the federal government has expended
an average of about $1.4 billion each year for the crop insurance
program--including premium subsidies, insurance company
reimbursements, and underwriting losses.  The program will cost an
estimated $1.6 billion in 1999. 

Because of the program's rapid expansion and its significant
financial costs to the government, we have been asked to examine
various aspects of the crop insurance program.  Our statement today
focuses on our work examining whether USDA (1) has set adequate
insurance rates to achieve the legislative requirement of actuarial
soundness,\2 (2) appropriately reimburses participating crop
insurance companies for their administrative costs, and (3) has
established methodologies in the revenue insurance plans that set
sound premium rates. 

In summary, we reported that several aspects of the program are of
concern and need attention.  First, in 1995, we reported that
premiums charged farmers for crop insurance were not adequate to
achieve the actuarial soundness as mandated by the Congress.  Our
review showed that the basic premium rates for the six crops
reviewed--barley, corn, cotton, grain sorghum, soybeans, and
wheat--were approaching actuarial soundness in 1995, but USDA's rates
for some crops and locations and for some coverage and production
levels were well below the legislative requirement.  For example,
about 24 percent of the crop insurance premiums for the six crops we
reviewed in 1994 had basic rates that were less than 80 percent
adequate for actuarial soundness.  USDA subsequently took actions to
improve the program's actuarial soundness, but some rates remain too
low. 

Second, in 1997, we reported that the government's administrative
expense reimbursement (commissions) to insurance companies--31
percent of premiums--were greater than the companies' reported
expenses to sell and service federal crop insurance.  Furthermore, we
stated that some of these reported expenses did not appear to be
reasonably associated with the sale and service of federal crop
insurance.  The Agricultural Research, Extension, and Education
Reform Act of 1998 subsequently revised reimbursement rates downward
to 24.5 percent of premiums for most crop insurance.  However,
continued oversight of the reasonableness of the program's
administrative reimbursement rate is necessary.  Increased program
participation and sales volume that could result from crop insurance
reform may lead to lower delivery costs, warranting a downward
adjustment in the rate. 

Finally, in 1998, we reported our doubts about whether new
USDA-supported revenue insurance plans were actuarially sound over
the long term and appropriate to the risk each farmer presents to the
program.  Specifically, with respect to the most popular plan, Crop
Revenue Coverage, we recommended that USDA's Risk Management Agency
require the plan's developer to base premium rates on a revenue
distribution or other appropriate statistical technique that
recognizes the interrelationship between farm-level yields and
expected crop prices.  USDA, to date, has not fully acted on our
recommendations. 

This year the Congress is once again considering reforms to the
federal crop insurance program.  As you explore the various proposals
to expand or restructure the program, changes should be considered in
the context of the above concerns.  Continued oversight of the
federal crop insurance program is needed to help ensure, among other
things, the adequacy of premium rates, the reasonableness of
administrative expense reimbursements to companies, and the soundness
of revenue insurance plans. 


--------------------
\1 Crop Insurance:  Additional Actions Could Further Improve
Program's Financial Condition (GAO/RCED-95-269, Sept.  28, 1995);
Crop Insurance:  Opportunities Exist to Reduce Government Costs for
Private-Sector Delivery (GAO/RCED-97-70, Apr.  17, 1997); and Crop
Revenue Insurance:  Problems With New Plans Need to be Addressed
(GAO/RCED-98-111, Apr.  29, 1998). 

\2 At the time of our report, the Federal Crop Insurance Reform and
Department of Agriculture Reorganization Act of 1994 (P.L.  103-354,
Oct.  13, 1994) required that USDA achieve a target loss ratio no
greater than 1.10.  Stated differently, insurance rates were to be
set to generate revenue from premiums to cover at least 91 percent of
the anticipated claims paymentsï¿½termed 91 percent adequate.  The
Reform Act currently requires that USDA achieve a target loss ratio
no greater than 1.075, or 93 percent adequate. 


   BACKGROUND
---------------------------------------------------------- Chapter 0:1

Farming has always been an inherently risky enterprise because
farmers operate at the mercy of nature and frequently are subjected
to weather-related perils such as droughts, floods, hurricanes, and
other natural disasters.  Since the 1930s, many farmers have been
able to transfer part of the risk of loss in production to the
federal government through subsidized crop insurance. 

Major legislation enacted in 1980 and 1994 restructured the crop
insurance program.  The 1980 legislation enlisted, for the first
time, private insurance companies to sell, service, and share the
risk of federal insurance policies.  Subsequently, in 1994, the
Federal Crop Insurance Reform and Department of Agriculture
Reorganization Act revised the program to offer farmers two primary
levels of insurance coverage, catastrophic and buyup.  Catastrophic
insurance is designed to provide farmers with protection against
extreme crop losses for a small processing fee.  Buyup insurance
provides protection against more typical and smaller crop losses in
exchange for a producer-paid premium.  The government subsidizes the
total premium for catastrophic insurance and a portion of the premium
for buyup insurance. 

Farmers who purchase buyup crop insurance must choose both the
coverage level (the proportion of the crop to be insured) and the
unit price (such as, per bushel) at which any loss is calculated. 
With respect to the level of production, farmers can choose to insure
as much as 75 percent of normal production or as little as 50 percent
of normal production at different price levels.  With respect to the
unit price, farmers choose whether to value their insured production
at USDA's full estimated market price or at a percentage of the full
price. 

In recent years, USDA has introduced a new risk management tool
called revenue insurance.  Unlike traditional crop insurance, which
insures against losses in the level of crop production, revenue
insurance plans insure against losses in revenue.  The plans protect
the farmer from the effects of declines in crop prices or declines in
crop yields, or both.  Like traditional buyup insurance, the
government subsidizes a portion of the premiums.  One of the plans,
called Crop Revenue Coverage, is available in many states for major
crops.  Two other plans, called Income Protection and Revenue
Assurance, are available to farmers in only limited areas. 

USDA reimburses the insurance companies for the administrative
expenses associated with selling and servicing crop insurance
policies, including the expenses associated with adjusting claims. 
Between 1995 and 1998, USDA paid participating insurance companies
about $1.7 billion in administrative expense reimbursements. 

In addition to receiving an administrative expense reimbursement, the
insurance companies share underwriting risk with USDA and can earn or
lose money according to the claims they must pay farmers for crop
losses.  Companies earn underwriting profits when the premiums exceed
the crop loss claims paid for those policies on which the companies
retain risk.  They incur underwriting losses when the claims paid for
crop losses exceed the premiums paid for the policies that the
companies retained.  Between 1995 and 1998, USDA paid participating
insurance companies about $1.1 billion in underwriting profits. 

Critical to the success of achieving an actuarially sound crop
insurance program is aligning premium rates with the risk each farmer
represents.  The riskiness of growing a particular crop varies from
location to location, from farm to farm, and from farmer to farmer. 
If the rates are too high for the risk represented, farmers are less
likely to purchase insurance, lowering the revenue from premiums and
the usefulness of the program to farmers.  Conversely, if the rates
are too low, farmers are more likely to purchase crop insurance, but
because the rates are too low, the revenue from premiums will be
insufficient to cover the claims.  Therefore, USDA sets different
premium rates for the various coverage and production levels, which
vary by crop, location, farm, and farmer.  Consequently, hundreds of
thousands of premium rates are in effect.  To set premium rates, USDA
calculates a basic rate for each crop in each county for the farmers
who buy insurance at the 65-percent coverage level and whose normal
production level is about equal to the average production in the
county.  From this basic rate, USDA makes adjustments to establish
rates for other coverage levels and for those farmers whose
production levels are higher or lower than the county's average. 


   CHANGES IN PREMIUM RATES FOR
   TRADITIONAL CROP INSURANCE HAVE
   IMPROVED THE PROGRAM'S
   ACTUARIAL CONDITION, BUT SOME
   RATES REMAIN TOO LOW
---------------------------------------------------------- Chapter 0:2

In 1995, we reported that for the six crops we reviewedï¿½barley, corn,
cotton, grain sorghum, soybeans, and wheatï¿½basic premium rates
overall were 89 percent adequate, on average, to meet the Congress's
legislative requirement of actuarial soundness.  However, we found
that while overall premiums were approaching actuarial soundness,
USDA's rates for some crops and locations and for some coverage and
production levels were too low. 

For the 183 state crop programs\3 we examined, 54 had basic premium
rates that were adequate to achieve actuarial soundness.  These 54
programs were generally those that had the greatest volume of
insurance.  For the remaining 129 programs, 40 had premium rates that
were near the target level.  However, the other 89 programs,
representing about 24 percent of the crop insurance premiums for the
six crops in 1994, had basic rates that were less than 80 percent
adequate for actuarial soundness. 

We reported that premium rates that were too low generally occurred
when the historical databases used for establishing rates added or
deleted years of severe losses, thus affecting USDA's estimate of
expected crop losses.  USDA did not increase the rates where
necessary.  For example, for one of the crops we reviewed, USDA did
not increase the rates as much as it could have when (1) severe
losses from 1993 were added to the database for establishing the 1995
rates and (2) a year from the 1970s when losses were lower was
deleted from the database.  According to USDA, it had not
sufficiently raised rates out of concern that higher rates would
discourage farmers from buying crop insurance. 

Furthermore, when we examined the rates at various levels of coverage
and production, we found that the rates were (1) too high for
coverage at the 75-percent level and (2) too low for farmers with
above-average crop yields.  As a result, the rates for both coverage
and production levels were not always aligned with risk.  This
occurred because USDA did not periodically review and update the
calculations it used to adjust rates above and below the basic rate. 

To set premium rates for the 75-percent coverage level, USDA applies
pre-established mathematical factors to the basic rate.  However,
these factors have not resulted in rates that are aligned with risk. 
For crops insured at the 75-percent coverage level, USDA set premium
rates ranging from 19 to 27 percent more than required.  As a result,
the 1994 income from premiums was about $30 million more than
required for this coverage.  Although grain sorghum had the greatest
percentage of rates in excess of those required, corn had the
greatest amount of additional premium income because its program is
much larger. 

USDA also adjusts the basic rates for a farmer's individual crop
yields.  USDA's basic rate applies to the farmer whose average yield
is about equal to the average for all producers in the county. 
However, many farmers' average yield is above or below the county's
average, and USDA's research shows that the higher a farmer's yield,
the lower the chance of a loss.  Therefore, USDA establishes rates
for different yield levels using a mathematical model.  The rates per
$100 of insurance coverage decrease as a farmer's average yield
increases; however, the mathematical model overstated the rate
decrease.  According to our analysis, the rates at higher average
crop yields were too low for the six crops reviewed.  We reported
that for these above-average yields, USDA's rates in 1995 should have
been from 13 to 33 percent higher than they were. 

Subsequent to our 1995 report, USDA took action to increase premium
rates an average of 6 percent and developed a plan to periodically
evaluate the mathematical factors used to set rates.  These actions
have contributed to the federal crop insurance program's achieving a
loss ratio well below the target in recent years, thereby improving
the program's financial soundness.  However, although overall premium
rates appear adequate, rates for crops in some states remain too low. 
For example, since 1996, the loss ratio has averaged 1.36 for cotton
in Texas and 1.45 for peanuts in Alabama, well exceeding the target
loss ratio.  Thus, premium rates for these farmers may be too low. 
Consequently, USDA needs to continue to monitor and adjust premium
rates to ensure they are appropriately aligned with risk. 


--------------------
\3 Each crop insured in a state is counted as a state crop program. 
An example of a state crop program is corn in Iowa.  In 1994, for the
six crops reviewed, USDA offered insurance for a combination of 183
states and crops. 


   OPPORTUNITIES TO REDUCE
   GOVERNMENT COSTS FOR PRIVATE
   SECTOR DELIVERY
---------------------------------------------------------- Chapter 0:3

In 1997, we reported that USDA's administrative expense
reimbursements to participating insurance companies selling
traditional buyup insurance--31 percent of premiums--were much higher
than the expenses that can be reasonably associated with the sale and
service of federal crop insurance.  For the 2-year period we
reviewed, 1994 and 1995, the companies reported $542.3 million in
expenses, compared with a reimbursement of $580.2 million--a
difference of about $38 million.  Additionally, about $43 million of
the companies' reported expenses could not be reasonably associated
with the sale and service of federal crop insurance to farmers. 
Therefore, we reported that these expenses should not be considered
in determining an appropriate future reimbursement rate for
administrative expenses. 

The expenses that could not be reasonably associated with the sale
and service of federal crop insurance included the following: 

  -- payments of $12 million to compensate executives of an acquired
     company to refrain from joining or starting competing companies,

  -- fees of about $11 million paid to other insurance companies to
     protect against underwriting losses,

  -- bonuses of about $11 million tied to company profitability,

  -- management fees of about $1 million assessed by parent companies
     with no identifiable benefit to subsidiary crop insurance
     companies, and

  -- lobbying expenditures of about $400,000. 

In addition, we found a number of expenses reported by the companies
that, while in categories associated with the sale and service of
crop insurance, seemed to be excessive under a taxpayer-supported
program.  These expenses included agents' commissions of about $6
million, paid by one company, that exceeded the industry standard. 

Thus, we reported that opportunities existed for the government to
reduce its reimbursement rate for administrative expenses while still
adequately reimbursing companies for the reasonable expenses of
selling and servicing crop insurance policies.  Subsequent to our
report, the Agricultural Research, Extension, and Education Reform
Act of 1998 revised reimbursement rates downward to 24.5 percent of
premiums for traditional buyup insurance.  However, as changes are
made to the crop insurance program that increase participation and
sales volume, downward adjustments to the reimbursement rate may be
warranted. 


   PROBLEMS WITH USDA-SUPPORTED
   REVENUE INSURANCE PLANS NEED TO
   BE ADDRESSED
---------------------------------------------------------- Chapter 0:4

In 1998, we reported shortcomings in the way premium rates are
established for each of the three revenue insurance plans we
reviewed.  Appropriate methods for setting rates for these plans are
critical to ensuring the financial soundness of the crop insurance
program over time.  We reported that the Crop Revenue Coverage plan
did not base its rate structure on the interrelationship between crop
prices and farm-level yields--an essential component of actuarially
sound rate setting.  For example, a decline in yields is often
accompanied by an increase in prices, which mitigates the impact of
the decline in yields on a farmer's revenue.  Because this plan did
not recognize this interrelationship, the premium adjustments may not
be sufficient over the long term to cover claims payments and may not
be appropriate to the risk each farmer brings to the program.  We
were not able to determine whether premium rates for this plan were
too high or too low. 

In contrast, the rate-setting approaches for the Revenue Assurance
and Income Protection plans were based on a likely statistical
distribution of revenues that reflects the interrelationship between
crop prices and yields.  However, the two plans had several
shortcomings that were not as serious as the problem we identified
for Crop Revenue Coverage.  For example, in constructing its revenue
distribution, we found that the Revenue Assurance plan used only 10
years of yield data (1985-94), which was not a sufficient historical
record to capture the fluctuations in yield over time.  Furthermore,
3 of these 10 years had abnormal yields:  1988 and 1993 had
abnormally low yields, and 1994 had abnormally high yields. 
Additionally, Income Protection based its estimate of future price
increases or decreases on the way that prices moved in the past. 
This approach could be a problem because price movements in the past
occurred in the context of past government programs, such as
commodity income-support payments, which were eliminated by the 1996
farm bill.  In the absence of the above government programs, the
price movements may have been considerably more pronounced.  While
favorable weather and stable crop prices generated very favorable
claims experience over the first 2 years that the plans were
available to farmers, these shortcomings raise questions about
whether the rates established for each plan will be actuarially sound
and fair--that is, appropriate to the risk each farmer presents over
the long term. 

Furthermore, while the plans were initially approved only on a
limited basis, USDA authorized the substantial expansion of Crop
Revenue Coverage before the initial results of claims experience were
available.  In doing so, USDA was acting within its authority to
approve privately developed crop insurance plans in response to
strong demand from farmers.  USDA's Office of General Counsel advised
against the expansion, noting that an expansion without any data to
determine whether the plans or rates are sound might expose the
government to excessive risk.  While Crop Revenue Coverage was
expanded rapidly, Revenue Assurance and Income Protection essentially
remain pilot plans with no nationwide availability. 

As a result of the shortcomings with the revenue insurance plans'
rating methods and to ensure premiums were appropriate to the risk
each farmer presents, we recommended that the Secretary of
Agriculture direct the Administrator of the Risk Management Agency to
address the shortcomings in the methods used to set premiums. 
Specifically, with respect to all three plans, we recommended that
the Secretary direct the Risk Management Agency to reevaluate the
methods and data used to set premium rates to ensure that each plan
is based on the most actuarially sound foundation.  With respect to
Crop Revenue Coverage, which does not incorporate the
interrelationship between crop prices and farm-level yields, we
recommended that the Risk Management Agency direct the plan's
developer to base premium rates on a revenue distribution or another
appropriate statistical technique that recognizes this
interrelationship.  While USDA subsequently took action to improve
the actuarial soundness of the Revenue Assurance plan, it has not, to
date, acted on our recommendations regarding the other two plans. 


-------------------------------------------------------- Chapter 0:4.1

As the Congress considers proposals to reform the federal crop
insurance program and improve the safety net for farmers, the issues
in our reports remain important to the success of the program. 
Specifically, premiums in all areas of the country should be set at
levels that are actuarially sound and represent the risk each farmer
brings to the program.  Furthermore, continued oversight of the
reasonableness of the program's administrative reimbursement rate is
necessary.  Increased program participation and sales volume that
could result from crop insurance reform may lead to lower delivery
costs, warranting a downward adjustment in the rate.  Finally, before
revenue insurance plans are expanded to cover new crops, USDA needs
to ensure that the plans are based on an actuarially sound
foundation. 


*** End of document. ***