ARPA Subsidies, Unit Choice, and Reform of the U.S. Crop Insurance Program

Bruce A. Babcock, Chad E. Hart
February 2005  [05-BP 45]

The Agricultural Risk Protection Act (ARPA) has largely met its objectives of inducing farmers to increase their use of the crop insurance program. Both insured acreage and coverage levels have increased dramatically in response to ARPA's large increase in premium subsidies. An unintended consequence of the larger subsidies is a dramatic increase in the incentive for farmers to insure their crops under optional units, that is, insurance at the field level rather than at the farm or crop level. The expected rate of return to farmers who choose to invest additional premium dollars to move to optional unit coverage ranges from a low of 61 percent at the 85 percent coverage level to 144 percent at the 65 percent coverage level. This explains why the majority of farmers choose optional unit coverage even though the alternative unit structures provide identical insurance guarantees at a substantially lower cost. We consider two policy options to eliminate the unintended consequences of ARPA subsidies. The first would simply eliminate the ability of farmers to insure their crops under optional units. This change would save taxpayers more than $300 million (if 90 percent of current acreage is insured under optional units) and would not decrease the insurance guarantee of any farmer. However, transfers to farmers, crop insurance companies, and crop insurance agents would all fall under this policy option, decreasing its political attractiveness. The second alternative would decouple per-acre premium subsidies from a farmer's choice of unit coverage. Farmers would benefit from the ability to capture all the premium savings that would occur as they move to other unit structures. It is likely that there is a level of decoupled subsidy that would make both farm groups and taxpayers better off. Splitting farm groups off the blocking coalition increases the likelihood of acceptance of this proposal. Program integrity would be increased by dramatically increasing the incremental cost of farmers insuring their crops under optional units.

Keywords: Agricultural Risk Protection Act (ARPA), crop insurance, optional units.

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