Crop Insurance: Further Actions Could Strengthen Program's Financial
Soundness (Testimony, 04/21/99, GAO/T-RCED-99-161).

Pursuant to a congressional request, GAO discussed the Department of
Agriculture's (USDA) federal 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;
(3) can deliver catastrophic crop insurance at less cost to the
government than private insurance companies; and (4) has established
methodologies in the revenue insurance plans that set sound premium
rates.

GAO noted that: (1) GAO has reported that several aspects of USDA's crop
insurance program are of concern and need attention; (2) in 1995, GAO
reported that premiums charged farmers for crop insurance were not
adequate to achieve the actuarial soundness mandated by Congress; (3)
GAO's review showed that the basic premium rates for the six crops
reviewed 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) about 24 percent of the
crop insurance premiums for the six crops GAO reviewed had basic rates
that were less than 80-percent adequate for actuarial soundness; (5)
USDA subsequently took actions to improve the program's actuarial
soundness, but some rates remain too low; (6) the government's
administrative expense reimbursement to insurance companies--31 percent
of premiums--were greater than the companies' reported expenses to sell
and service federal crop insurance; (7) GAO stated that some of these
reported expenses did not appear to be reasonably associated with the
sale and service of federal crop insurance; (8) 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; (9) 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; (10) GAO
reported that the government's costs to deliver catastrophic insurance
in 1995 were higher through private companies than through USDA; (11)
although the basic costs associated with selling and servicing
catastrophic crop insurance through USDA and private companies were
comparable, delivery through USDA avoids paying an underwriting gain to
companies in years when there is a low incidence of catastrophic loss
claims; (12) GAO reported its doubts about whether new USDA-supported
revenue insurance plans will be actuarially sound over the long term and
appropriate to the risk each farmer presents to the program; and (13)
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.

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

 REPORTNUM:  T-RCED-99-161
     TITLE:  Crop Insurance: Further Actions Could Strengthen Program's
	     Financial Soundness
      DATE:  04/21/99
   SUBJECT:  Grain and grain products
	     Insurance premiums
	     Administrative costs
	     Farm income stabilization programs
	     Insurance cost control
	     Insurance losses
	     Disaster relief aid
	     Agricultural production
	     Farm subsidies
IDENTIFIER:  Federal Crop Insurance Program
	     USDA Revenue Assurance Plan
	     USDA Crop Revenue Coverage Plan
	     USDA Income Protection Plan

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CROP INSURANCE: Further Actions Could Strengthen Program's
Financial Soundness GAO/T-RCED-99-161 United States General
Accounting Office

GAO Testimony Before the Committee on Agriculture, Nutrition, and

Forestry, U. S. Senate For Release on Delivery Expected at 8: 30
a. m. EDT Wednesday April 21, 1999

CROP INSURANCE Further Actions Could Strengthen Program's
Financial Soundness

Statement of Lawrence J. Dyckman, Director, Food and Agriculture
Issues, Resources, Community, and Economic Development Division

GAO/T-RCED-99-161

  GAO/T-RCED-99-161

Mr. Chairman and Members of the Committee: We are pleased to have
this opportunity to discuss our work on the federal crop insurance
program. Our testimony today is based on our reports issued in
1995, 1997, and 1998. 1

Let me place our work in context. 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 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 testimony 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, (3) can
deliver catastrophic crop insurance at less cost to the government
than private insurance companies, and (4) has established
methodologies in the revenue insurance plans that set sound
premium rates.

In summary, we have 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 mandated by the Congress. Our
review showed that

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 payments termed 91 percent
adequate. The Reform Act currently requires that USDA achieve a
target loss ratio no greater than 1.075, or 93 percent adequate.

GAO/T-RCED-99-161 Page 1

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 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.

Also in 1997, we reported that the government's costs to deliver
catastrophic insurance in 1995 were higher through private
companies than through USDA. Although the basic costs associated
with selling and servicing catastrophic crop insurance through
USDA and private companies were comparable, delivery through USDA
avoids paying an underwriting gain to companies in years when
there is a low incidence of catastrophic loss claims.

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.

GAO/T-RCED-99-161 Page 2

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.

Background 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

GAO/T-RCED-99-161 Page 3

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.

GAO/T-RCED-99-161 Page 4

Changes in Premium Rates for Traditional Crop Insurance Have
Improved the Program's Actuarial Condition, but Some Rates Remain
Too Low

In 1995, we reported that for the six crops we reviewed barley,
corn, cotton, grain sorghum, soybeans, and wheat basic 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

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.

GAO/T-RCED-99-161 Page 5

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.

Opportunities to Reduce Government Costs for Private Sector
Delivery

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.

GAO/T-RCED-99-161 Page 6

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, further downward adjustments to
the reimbursement rate may be warranted.

We also reported that although the current arrangement for
reimbursing companies for their administrative expenses has
certain advantages, including ease of administration, expense
reimbursements based on a percentage of premiums do not
necessarily reflect the amount of work involved to sell and
service crop insurance policies and may create incentives to focus
sales to larger farmers. Alternative reimbursement arrangements,
such as (1) capping the reimbursement per policy and (2) paying a
flat dollar amount per policy plus a reduced fixed percentage of
premiums, offer the potential to have reimbursements more
reasonably reflect expenses and encourage more service to smaller
farmers than does

GAO/T-RCED-99-161 Page 7

the current arrangement. While these alternative reimbursement
methods may result in lower cost reimbursements to insurance
companies, they may increase USDA's own administrative expenses
for reporting and compliance. In 1995, we found that companies
generally preferred USDA's current reimbursement method because of
its administrative simplicity.

Government's 1995 Cost to Deliver Catastrophic Insurance Through
USDA Was Less Than Through Private Companies

In 1997, we also reported that the government's costs to deliver
catastrophic insurance policies in 1995 were higher through
private companies than through the local offices of USDA's Farm
Service Agency. The basic cost to the government for selling and
servicing catastrophic crop insurance was comparable for both
delivery systems. However, when private companies delivered the
insurance, they received an estimated $45 million underwriting
gain, which did not apply to USDA's delivery. Underwriting gains
are not guaranteed and vary annually, depending on crop losses.
Our report did not conclude or recommend the insurance industry
should have its role in catastrophic insurance delivery reduced.
However, we recommended that USDA needs to more closely monitor
the level of underwriting gain paid to the participating insurance
companies. For 1996, 1997, and 1998, underwriting gains for
catastrophic coverage totaled $58 million, $87 million, and $105
million, respectively. Beginning with crops harvested in 1997, the
Federal Agriculture Improvement and Reform Act of 1996 required
that USDA phase out its delivery of catastrophic crop insurance in
areas that have sufficient private company providers. In May 1997,
the Secretary of Agriculture authorized the movement of all
catastrophic insurance policies away from USDA to commercial
delivery.

Problems With USDA- SUPPORTED Revenue Insurance Plans Need to Be
Addressed

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 presents. We

GAO/T-RCED-99-161 Page 8

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

GAO/T-RCED-99-161 Page 9

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.

As the Congress considers proposals to reform the federal crop
insurance program and improve the safety net for farmers, the
issues and some of the recommendations 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. In addition, USDA
needs to closely monitor the catastrophic insurance program to
ensure that over time the underwriting gain earned by insurance
companies is not excessive. 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.

(150136) GAO/T-RCED-99-161 Page 10

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