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CARD: Center for Agricultural and Rural Development

Spring 2003, Vol. 9 No. 2

pdf for printing Disaster Assistance and Crop Insurance: Time for a New Approach?

Bruce A. Babcock
babcock@iastate.edu
515-294-5764

Chad E. Hart
chart@iastate.edu
515-294-9911

Congress has once again passed a disaster assistance program for farmers. This time the drought of 2001 and 2002 was the rationale for the legislation. (For a review of the build-up to the current disaster aid package, see "Disaster Assistance: How Best to Pay When Nature Has Her Way," in the Fall 2002 Iowa Ag Review, available at www.card.iastate.edu/iowa_ag_review/fall_02/article4.aspx.) In 1998, 1999, 2000, and 2001, the rationale was low market prices. The current disaster assistance program pays crop farmers if their harvested yield was less than 65 percent of the average yield. The cost of the crop assistance package is estimated at about $2.1 billion. While this might seem relatively modest, it is important to recognize that the crop insurance program will pay out more than $4 billion in 2002, and it paid out almost $3 billion in 2001.
What is it about the crop insurance program that makes it an inadequate assistance tool? After all, Congress passed the Agricultural Risk Protection Act (ARPA) in 2000 to better enable farmers to withstand financial downturns. Did ARPA have its intended effects?
Crop insurance works by making up the difference between harvested yield (for traditional Multiple Peril Crop Insurance) or harvested yield times market price (for revenue insurance) and a farmer's chosen insurance guarantee. The maximum guarantee available includes a 15 percent deductible, and no insurance payout is made until the loss covers the deductible. Advocates of ARPA felt that if farmers would reduce their deductibles, then the additional indemnities that would flow in difficult years would enable Congress to avoid passing annual disaster assistance.
The easiest way to get somebody to buy more of something is to lower its price, and that is what Congress did with crop insurance. Farmers have discovered that the amount of subsidy available to them on a per-acre basis increases under ARPA when they purchase a lower-deductible policy, so naturally, farmers moved in that direction.
The top map shows that the average coverage level�which is simply 100 percent minus the deductible�in every state before ARPA (1998) was less than 65 percent, which means that the average deductible in every state was greater than 35 percent. The bottom map shows that ARPA increased the average coverage level in every state. Across all states, the average coverage level increased from less than 59 percent to almost 67 percent. That is, ARPA had its intended effect.
Farmers have amplified their insurance coverage since 1998 by about $9 billion, through increasing both insured acreage and coverage per acre. The taxpayer cost of this increased coverage is about $1 billion per year. Is this money well spent?
On the surface, we might conclude that the billion dollars per year is wasted. After all, why spend a billion if Congress is still going to bail farmers out with a disaster program? But maybe a more telling question is, How much would Congress have given farmers if ARPA had not been in place? Perhaps the additional coverage farmers purchased under ARPA acted as a restraint on Congress's propensity to give farmers assistance. Conceivably crop farmers would have received $5 billion rather than $2.1 billion. If so, then taxpayers came out ahead by $1.9 billion because of ARPA!
Regardless of what kind of "spin" is used to describe the role of ARPA and disaster assistance programs, we can only conclude that ARPA has failed to wean farmers completely from federal disaster assistance. Perhaps it is time to throw in the towel and do away with federally subsidized crop insurance. Surely there must be a less bureaucratic way of providing financial assistance to farmers when regional disasters hit. After all, we have found a way to pay farmers when national prices fall. Why not find a way to pay farmers when regional yields fall? As shown in the accompanying sidebar, a combination of a new federal countercyclical payment program that covers widespread yield disasters and individualized add-on coverage that is privately provided could offer a high level of risk protection without the problems of our current system?
An Alternative to the Current System
The combination of a federal disaster program and privaized crop insurance is workable. The federal disaster program would cover widescale agricultural disasters. These disasters are what prevent privatized crop insurance from working today. A single agricultural disaster would wipe out most private companies. With a federal disaster program in place, private crop insurance would provide coverage that would pay any losses that exceed the federal payment. Farmers would decide if the federal protection was adequate for their needs or whether the additional private coverage was worth the cost, which they would pay in full.
The current crop insurance program costs roughly $3 billion per year. A federal disaster program could pay farmers when county revenue falls below a certain percentage of average county revenue for a crop within a year. We estimate that the cost of this program at a 95 percent payment trigger level would average $2.65 billion per year. The federal program could be designed to cover losses at the state or crop-reporting district level, which would lower costs, or it could provide coverage for yield losses. With a stable federal program in place, private insurers could determine adequate insurance rates, and producers would have plenty of opportunities to address their risk management needs.