NSAC's Blog

CBO Report Provides Roadmap to Crop Insurance Modernization

January 11, 2018

The Congressional Budget Office seal in Washington, D.C. Photo credit: Chip Somodevilla/Getty Images

In December, right before Christmas, the Congressional Budget Office (CBO) quietly released a bombshell report revealing what many agriculture policy analysts have long known – that modernizing the federal crop insurance program wouldn’t spell disaster, but rather savings and improvements. For example, the report found that by introducing a $50,000 cap on crop insurance premium subsidies, Congress could save taxpayers $3.4 billion over 10 years. Despite the significant savings, such a change would result in only a .0016 percent reduction in covered acres according to CBO. This finding, along with many others in the report, directly contradicts status quo defenders of the federal crop insurance program, who have repeatedly claimed that any significant attempts at modernizing crop insurance would result in a mass exodus and collapse of the program.

The National Sustainable Agriculture Coalition (NSAC) supports modernizing the federal crop insurance program to make it: more accessible to a wider array of farmers and farm types; more transparent and accountable to both farmers and taxpayers; more supportive of conserving and enhancing the natural resource base on which agriculture depends,; and more efficient and targeted in its use of subsidy support. As currently structured, the federal crop insurance program’s subsidy system is a barrier to natural resource conservation and contributes to the consolidation of farms, inflated land prices, and reduced opportunities for young, beginning, and socially disadvantaged farmers.

The Need for Crop Insurance Modernization

The CBO report shows that Congress can make needed changes to the crop insurance program without compromising the program’s integrity or harming family farmers. Capping premium subsidies at $50,000 would eliminate the incentive for the largest landowners to leverage risk reduction and revenue from crop insurance subsidies to expand and drive up the cost of land. This simple step would significantly increase opportunities for beginning and young farmers, who are the most disadvantaged by the current system’s affect on land prices.

The savings from the premium subsidy cap would also have another major benefit – freeing up funding that could be used to expand access to crop insurance for farmers under served by the program, including beginning farmers, fruit and vegetable growers, and organic producers. Savings could also be used to provide incentives for conservation practices that improve soil health and reduce yield variability risk, thereby saving the taxpayers more money in the long run.

The importance of risk management support for American farmers is undeniable. For the last five years, however, the federal crop insurance program has come in at an average taxpayer cost of about $9 billion a year, with no sign on the horizon for significant cost reduction under current policy. Given the significant price tag of the federal crop insurance program, it is  imperative that Congress ensure that it operate as efficiently and effectively as possible. Bringing the program into the modern era by placing an annual per farm cap on subsidies, as has been the case for commodity programs for decades and decades, is an important first step. Additional opportunities for crop insurance modernization highlighted by the report CBO are also explored below.

Capping Premium Subsidies

CBO concluded that an annual subsidy cap of $50,000 would save taxpayers $3.4 billion over 10 years, while resulting in an extremely modest 500,000 acre reduction in covered acreage out of about 300 million total acres covered – or ~.0016 percent of total covered acres. If USDA’s Risk Management Agency (RMA) were to use just a portion of this savings to expand the data collection and outreach needed to develop more policies for currently underserved constituencies, this small loss in acreage would almost certainly be made up for, while making the whole program more effective and less distorting.

The report also debunks the argument that premium subsidy caps would push the least risky farmers out of the program, concluding that there are “no empirical measures” to that support the claim. CBO’s conclusion is supported by most studies on the subject that have found only a weak link between demand for crop insurance and cost of policies.

NSAC strongly endorses the implementation of a $50,000 premium subsidy cap, with a higher allowance for specialty crop policies, and the addition of strong rules to ensure the benefits flow to farmers who are actively engaged in the labor and management of the farm. These changes are needed to limit the use of subsidies to accelerate farm consolidation, increase opportunities for young and beginning farmers, and cap taxpayer exposure.

Retaining the Harvest Price Option Without Extra Subsidy

If a farmer contracts to sell some of their crop in the spring, but then the price goes up, they are still required to provide the crop at the contracted price. In this same scenario, if the farmer somehow lost their crop, they would have buy replacement crops at the higher price to fulfill the contract. The crop insurance program’s Harvest Price Option (HPO) removes that risk by allowing the farmer’s indemnity for the loss to be paid at the higher price end of season price. This, therefore, gives the farmer more cash to pay for the more expensive replacement costs. While farmers do pay a portion of the subsidized premium on HPO, in addition to their portion of the premium on the underlying policy, the vast majority of crop insurance revenue policies have HPO attached.

The CBO report explored what would happen if Congress ended government support for this additional risk reduction tool, and found that this change would reduce the cost of the crop insurance program by 25 percent over 10 years ($19.2 billion). Eliminating HPO would also have a limited effect on acres covered – according to CBO, this option would only reduce the number of acres covered by 2.5 million, less than one percent of currently covered acres.

NSAC opposes the elimination of HPO, given the important roll it plays in forward contracting. Instead of eliminating HPO, we recommend that USDA instead simply eliminate the premium subsidy for HPO. We support continued subsidization of the delivery of the product and of the underlying revenue policy. While this proposal would result in smaller savings relative to the complete elimination proposal CBO analyzed, it would also retain an important risk management tool for farmers, and result in an even smaller impact on insured acreage.

Eliminating Yield Exclusions

The 2014 Farm Bill included a provision that allows farmers to exclude as many as 10 years of yield history wherein they experienced a 50 percent or more loss. This unique form of accounting has dramatic effects on the cost of the crop insurance program, because yield history directly determines the value of insurance coverage. For instance, the higher the historic average yields, the higher the value of the coverage if there is a loss.

Eliminating years of yields artificially inflates the historic average, allowing the farmer to purchase more coverage than they would be able to under normal circumstances. This, in turn, negatively impacts the actuarial soundness of the federal crop program. The practice of yield elimination, unfortunately, is not a rare occurrence. In fact, CBO indicates that some farmers were able to eliminate the full 10 years allowed by the program in 2015. While CBO does not cite a specific number, it does conclude that there has been “greater federal spending on premium subsidies” because of yield exclusion.

Among options the CBO report explored were: limiting the number of years that can be excluded to 3, requiring a 50 percent of county average yield when a farmer is prevented from planting a crop, and eliminating the yield trend adjustment factor. The yield trend adjustment factor increases a farmer’s average yield each year automatically to account for advancements in farming techniques. If these changes were mandated by the 2018 Farm Bill, they could result in roughly $2 billion in savings to American taxpayers over the next decade.

Yield exclusion is a new provision introduced by the 2014 Farm Bill. NSAC supports its elimination. The yield exclusion provision creates a disincentive for farmers to engage in farming practices that increase resilience by artificially shielding them from the impacts of climate change and extreme weather. The federal crop insurance program should reward farmers for lowering their risk by engaging in conservation and sustainable agriculture practices, and not continue practices that undermine the integrity of a federal program.

Bringing Rates of Return More In-Line with the Rest of Industry

According to CBO’s findings, there is strong evidence suggesting that crop insurance companies earn greater profits on average than other insurance companies operating in the private market without subsidies. This conclusion is supported by a previous report published in July 2017 by the Government Accountability Office (GAO), and an internal report prepared for USDA by an outside consultant. CBO acknowledges, as other have, that the data needed to make this determination is limited by its proprietary business nature.

Private property and casualty insurers earn a rate of return of around 8 percent. According to the findings of these reports, the current target rate of return for federally subsidized crop insurance companies is nearly twice as much, around 14.5 percent.

The actual rate of return has fluctuated widely, however, from well over 20 percent to less than zero during the 2012 drought year. GAO has suggested that the target rate of return be set at 9.6 percent, considering that between 1996-2015 the average rate of return exceeded the target rate.

NSAC has sought a more modest reduction of the target rate of return. We recommend that a rate of 12 percent would be ideal to capture some of the efficiencies created in the system over the years, while also acknowledging the inherent uncertainty about how much it actually costs to deliver crop insurance policies to farmers. Adjusting the rate of return has no direct impact on farmers, but it could provide significant cost savings that could be used to improve access to crop insurance.

What’s Next?

CBO’s landmark analysis provides critical information for Congress to consider as it begins debate on the next farm bill. Given that CBO is Congress’s own policy and spending analysis entity, we hope that congressional leadership will take the findings of this report seriously and move to take meaningful and swift action toward crop insurance modernization. NSAC’s recommendations for crop insurance modernization, which can be found in our 2018 Farm Bill Platform, tracks several of the policy options presented by CBO’s groundbreaking report.

Stay tuned for a follow-up post on the findings of the CBO report, during which we’ll take a deeper dive at the analysis and potential next steps for Congress.

Categories: Commodity, Crop Insurance & Credit Programs, Farm Bill

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