[Federal Register Volume 59, Number 66 (Wednesday, April 6, 1994)]
[Unknown Section]
[Page 0]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 94-8244]
[[Page Unknown]]
[Federal Register: April 6, 1994]
VOL. 59, NO. 66
Wednesday, April 6, 1994
DEPARTMENT OF AGRICULTURE
Federal Crop Insurance Corporation
Program Changes Improving the Actuarial USDA. Soundness of the
Federal Crop Insurance Program
AGENCY: Federal Crop Insurance Corporation.
ACTION: Notice.
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SUMMARY: The Omnibus Budget Reconciliation Act of 1993 (OBRA) directed
the Federal Crop Insurance Corporation (FCIC) to make program changes
as necessary to improve actuarial soundness of the Federal crop
insurance program and to achieve, by the fiscal year beginning October
1, 1995, a projected overall loss ratio not to exceed 1.10 (110
percent) (section 1501(a)). Section 1501(c)(2) further directed the
Department to issue for public comment a comprehensive plan or
``blueprint'' that identifies, among other things:
Steps FCIC intends to take to achieve a projected overall
loss ratio of no greater than 1.10 on and after October 1, 1995.
Additional steps if further action is required, based upon
actual program experience or unforeseen external circumstances.
Modifications to be considered if initial actions to
improve actuarial soundness work better than anticipated.
Projections, assumptions, and analyses which underlie the
FCIC conclusions that the above actions will achieve the required loss
ratio within the stated deadline while maintaining fairness and
effective coverage to agricultural producers, and which thereby
demonstrate FCIC's compliance with the performance standard identified
in section 1501(a).
The following notice outlines such a plan. Readers are requested to
identify additional issues other than those outlined herein that they
believe are relevant and important in assisting FCIC in its actions to
manage the program to achieve the target loss ratio. This notice
encourages comment and participation from the affected public. Comments
and inquiries should be sent to the address listed below.
FOR FURTHER INFORMATION CONTACT:
Mari Dunleavy, Regulatory and Procedural Development Staff, Federal
Crop Insurance Corporation, Washington, DC 20250, telephone (202) 254-
8314.
NOTICE: The Federal Crop Insurance Corporation's ``Blueprint for
Financial Soundness'' reads as follows:
Blueprint for Financial Soundness
Scope and Purpose
Actions identified herein result from internal analysis by FCIC and
information previously provided to FCIC by numerous interested parties.
These include the Commission for the Improvement of Crop Insurance (a
Congressionally established work group in 1989 and 1990), various crop
insurance industry organizations, members of Congress, agricultural
producers, crop insurance agents and insurance companies, the General
Accounting Office, and others. Information was not solicited
specifically for this draft but was compiled from previous
recommendations. Not all of the specific recommendations made by any or
all of these groups are included herein. This document establishes
initiatives to achieve the above actions.
Estimates of the financial impact of an action, based on available
data and professional judgment, are provided whenever possible. Readers
should recognize that these estimates are fluid due to the nature of
the data and the ever-changing program. In particular, since FCIC does
not have a single aggregate mathematical or statistical model that
describes its programs, estimates of financial impact are based on
partial analysis which considers the effect of one particular action in
the absence of any other action or initiative. Also, the exact steps to
be taken under this Blueprint depend in part upon the public comment
and recommendations received before investing resources in detailed
studies of potential impacts. Readers are encouraged to provide
information, rationale, and where possible, estimates of costs or
potential savings.
In some cases the financial impact of an action may not be
quantified. This does not mean the action is not important or that it
cannot contribute to achievement of the goal. For example, enhanced
management reporting systems do not produce a measurable financial
impact. However, such systems can enhance FCIC's ability to estimate
the potential impacts of program changes and assure that ongoing
management decisions recognize the impact of the decision on future
actions.
This document is divided into four main sections, which describe:
(1) Crop insurance program to provide context and background;
(2) Actions FCIC proposes as part of this plan to achieve the
target loss ratio;
(3) Additional actions that FCIC may take if those described in
section II are not effective or that cannot be implemented due to
unforeseen circumstances; and
(4) Changes FCIC will consider once the projected loss ratio
achieves the targeted level of 1.10.
I. Background of the Crop Insurance Program
A. Overview of Program Operations
Crop insurance is delivered primarily by commercial insurance
companies that have entered into a cooperative financial arrangement
[the Standard Reinsurance Agreement (SRA)] with FCIC. Under this
arrangement, the company agrees to deliver an FCIC designed and priced
product to eligible buyers. The company is responsible for all aspects
of customer service, and guarantees payment of the insured person's
share of the premium to FCIC. In return, FCIC reimburses the company
for administrative expenses and requires the company (on a state basis)
to share in insurance experience whether favorable or unfavorable. FCIC
also provides stop loss reinsurance that limits the maximum loss the
company can sustain.
A small and decreasing portion of the total sales is managed
directly by FCIC through sales and service contractors. These
contractors agree to sell an FCIC designed and priced product and to
perform certain servicing functions related to the sale (such as
determining the average yields). FCIC reimburses the contractor for
administrative expenses associated with selling and servicing the
product; however, FCIC is directly responsible for premium collection,
loss adjustment, and payment of losses. These latter functions are the
responsibility of the reinsured company under that delivery system.
FCIC intends to eliminate direct sales after the 1994 crop year because
this system now delivers less than 10 percent of the total business,
and maintaining a nationwide capability for delivery at an acceptable
cost is difficult.
The crop insurance plan for most crops indemnifies insured persons
for losses in yield exceeding a predetermined threshold amount. To
establish this threshold an average yield is determined based on the
individual's production history. The first portion of the loss
(deductible of the insurance), equal to 25, 35, 50, or 65 percent of
the average yield, must be sustained by the insured person. These are
the choices of deductibles now offered by FCIC, and typically are
described by the maximum loss in yield covered by the insurance; e.g.,
75 percent coverage, 65 percent, etc. The 50 and 75 percent coverage
levels are required by the Act to be available to all persons. The
level of coverage is chosen by the insured individual.
The insured person also must choose a price at which the yield is
valued for the purposes of computing the amount of premium and any
applicable amount of loss; this variable is called the price election.
FCIC must offer a price election that is not less than the anticipated
market price at time of harvest. This determination is made well before
the possibility of loss is known during the crop year. Otherwise,
insured persons would choose low price elections if no loss is
sustained (minimizes premium payments) the highest possible price
election if a loss occurs (maximizes indemnities).
FCIC establishes premium rates for the various coverage levels,
yields, crop types and farming practices (e.g., irrigated) for each
county. All planted acres of the crop are covered by the insurance
policy unless for some reason the acreage is uninsurable. The premium
owed by the insured person is determined by multiplying the average
yield per acre by the coverage level, multiplied by the number of acres
planted, the price election, and the premium rate. For example, if the
average yield is 100 bushels per acre, the coverage level is 65
percent, planted acres are 50, the price election is $2.25, and the
premium rate is 5.2 percent, the premium is equal to 100 x 0.65 x
50 x $2.25 x 0.052, or $380.25. The potential indemnity in the
event of a total loss is $7,312.50 (determined by multiplying the
average yield, coverage level, planted acres, and price election).
A portion of the total premium is subsidized to encourage
participation in the program. The subsidy is 30 percent of the total
premium for coverage levels up to and including the 65 percent level.
The subsidy for 75 percent level of coverage is equal to the dollar
amount that would be paid at the 65 percent level of coverage. The
premium subsidy for the above example would be $114.08; thus, the
insured person would pay $266.17. The same $114.08 subsidy would be
paid if the insured person chose the 75 percent coverage level.
In the event of a loss, the amount of production that was
harvested, or that was determined should have been harvested, is
measured by the insurer. An indemnity payment is made if the determined
production is less than the total guarantee for the acreage (yield
multiplied by coverage level and acres planted). For example, if the
insured person harvests 1,000 bushels from 25 acres and does not
harvest a potential yield of 10 bushels per acre from the remaining 25
acres, the total of the production to count is 1,250 bushels (1,000
bushels harvested plus 25 acres multiplied by 10 bushels). This is
subtracted from the total bushel guarantee for the acreage (100 x
0.65 x 50, or 3,250 bushels), resulting in a loss of 2,000 bushels.
The indemnity is equal to the number of lost bushels multiplied by the
price election. For this example, the indemnity would be 2,000 bushels
x $2.25, or $4,500.
Crop insurance does not guarantee revenue. As the above example
illustrates, it provides an insurance indemnity only if production is
less than the established guarantee. No protection is provided if the
market price is less than the price election.
B. Legislative Background and Issues
Federal crop insurance was established as a pilot program in the
1930's. Prior to 1980, crop insurance was available only on major crops
in major producing areas. The coverage level often was limited to 60
percent or less of a long-term average yield for an area. Congress
amended the Act in 1980 to expand the scope and coverage of the program
with the intent that it be the sole means of providing public disaster
assistance to U.S. farmers. Participation in the program increased
after the 1980 amendments, but remains below levels deemed necessary to
be regarded as the principal vehicle for disaster assistance. Insured
acreage peaked at about 40-45 percent of the total acreage planted to
insurable crops in 1988-89, but more commonly has been in the 30-35
percent range. Losses also increased with the expansion of the program.
The loss ratio has exceeded the break-even amount of 1.00 in every year
since 1980. Cumulative losses for the years 1980-1992 were
approximately $2.9 billion, with a cumulative loss ratio of about 1.45
for the 13 years.
Program participation is an issue influencing the Federal crop
insurance program. Full participation (i.e., 100 percent of eligible
acres insured) is the measure of program success that is accepted (at
least implicitly) by some persons. This measure may not be the most
appropriate. A rational decision to buy insurance of any kind must be
based on the magnitude of the financial difficulties that accompany a
loss. For example, buying collision coverage on a 15-year old
automobile makes little financial sense. Similarly, buying insurance on
a crop that contributes only a small portion of the expected income of
the insured person may not make financial sense. Full participation in
the crop insurance program may not represent an efficient use of the
taxpayer's resources. However, participation must be high enough to
minimize or eliminate perceived needs to legislate disaster assistance
funded under dire emergency provisions of the Budget Enforcement Act.
The level of participation in the crop insurance program that maximizes
returns to the public is not known, and is an area needing further
definition.
Many losses paid in the 1980's and early 1990's were due to
widespread disasters, the adverse financial effects of which Congress
intended to mitigate under the Act. However, continuing loss ratios
exceeding 100 percent, enactment of disaster assistance in nearly every
year since 1988, and lower than desirable participation indicate that
the public policy goals of the program have not been fully realized.
The Secretary of Agriculture has proposed a reform of the crop
insurance program to:
Achieve actuarial soundness.
Increase participation to levels that render ad hoc
disaster legislation.
Eliminate incentives to enact ad hoc disaster assistance
legislation.
The proposals contained in this Blueprint focus on these three
areas that directly relate to the goal of achieving the targeted loss
ratio. They are:
(1) Actuarial matters such as premium rates and yield guarantees,
(2) Underwriting matters such as terms and conditions of insurance
policies, and
(3) Management issues such as compliance and risk-sharing
arrangements with commercial insurers.
II. Management Actions To Achieve a Loss Ratio of 1.10
A. Develop More Accurate Insurance Yields
The insurance yield may be the single most important factor in
determining the success or failure of the crop insurance program. A
yield that is too high compared to the productive potential of the
person or land will increase the number of years that a loss is paid.
An excessively high yield also increases the amount paid when a loss
occurs. A yield that is too low will not effectively protect farmers
from loss and, because it is regarded as insufficient, will not induce
desired levels of participation.
From the 1985 through 1993 crop years, insured yields were based on
a program called the Actual Production History (APH) Plan. The goal of
this program was to obtain 10 previous yields to establish the insured
yield for the next crop year. Proxy yields largely based on ASCS farm
program payment yields or county averages were allowed whenever farmers
would not or could not provide 10 years of history. Analysis by FCIC
and others determined the proxy yields were benefiting farmers whose
yields tended to be lower than average and discouraging farmers whose
yields tended to be above average. Consequently, a modified-APH program
that reduced the influence of the proxy yields was introduced beginning
with the 1994 crop year; thus, a ``ladder'' was introduced into the
proxy yields. Only 65 percent credit is given to the proxy yield if no
actual yields are reported, 80 percent credit is given if one actual
yield is reported, 90 percent if two actual yields are reported, and
100 percent if three actual yields are reported. The proxy yields are
not used after four actual yields are available. The insured yield is a
simple average of the 4 years of actual and modified proxy yields for
the first 4 years, and then (after 4 years) is the simple average of
the actual yields reported. Acquiring 10 years of production history
remains the goal of the program. These revised procedures are the core
of the initiatives to comply with the mandate of OBRA 93 to institute
rules to demonstrate actual production histories.
The revised rules are expected to substantially reduce losses of
the Federal crop insurance program. Analysis performed by FCIC
indicates the new rules would reduce losses by 15 percent for corn, 22
percent for soybeans, and 18 percent for wheat. These analyses were
based on simulations of loss histories using the rules for the two
computational methods--the previous APH and the proposed modified-APH
plans. The analyses encompassed nine states each for corn and soybeans
and three states for wheat. These states and crops represented nearly
60 percent of the total premiums earned in 1990. The results indicated
that the modified-APH rules would reduce losses by a weighted average
of 19 percent and are believed to be representative for most crops.
The actual loss ratio for the 1990 crop year was 1.23. If the
modified-APH rules did reduce losses by an average of 19 percent, the
loss ratio would have been 0.996. This would achieve significant
compliance with the loss ratio target of 1.10.
Based on these results, FCIC implemented modified-APH for the 1994
crop year by:
Promulgating regulations for the program during calendar
year 1994.
Measuring the impact of the modifications upon net program
losses by calculating insured yields, premiums, and indemnities of
policyholders under 1993 and 1994 rules.
Where possible, determining whether the modified-APH rules
had the intended effect of providing a more accurate offer for farmers
who previously elected not to purchase crop insurance.
Determining whether the average number of yields reported
for prior years has changed under the modified-APH rules compared with
APH rules for 1990 through 1993.
Implementing a tracking system to assure that insurance
experience remains associated with a person in future years (see item D
below).
Developing reporting processes to assure that the accuracy
of yield determinations is continuously monitored and improved.
Actions requiring analysis of the effects of the modified-
APH rules upon the accuracy of insured yields cannot be completed until
losses from the 1994 crop year are processed. For wheat and other fall
planted crops, such availability will occur by about the fourth
calendar quarter of 1994. For spring planted crops, this does not occur
until about the middle of the first calendar quarter of 1995.
FCIC believes that these actions to implement modified-APH will
reduce the average loss ratio over time by 10-15 percentage points
(e.g., from an average of 1.40 for several years to 1.25 to 1.30). This
estimate is based on a conservative expectation of the actual results
of the simulations described above.
B. Catastrophic Yield Adjustment
FCIC recognizes that the average of a series of observations as
short as 4 years is subject to significant variations due to abnormally
large or small yields during that time. For example, if a major
disaster year such as 1993 is included in the 4 years, the procedure
implicitly states that a similar year will occur once every 4 years.
This is not likely. Thus, FCIC will examine certain adjustments to the
modified-APH rules with a goal to assign more appropriate probabilities
to the individual observations. These adjustments commonly are called
catastrophic yield adjustments. However, just as the yields for 1 year
may be abnormally low, they also may be abnormally high. Capping the
abnormally high years may also be appropriate so that average yields
are not excessively high due solely to a few observations.
FCIC will evaluate alternative methods to recognize catastrophic
and unusually good crop years, and consider implementing appropriate
adjustments to the modified-APH plan effective for the 1995 crop year.
C. Implement Group Risk Plan
FCIC is implementing a program of insurance that is based on the
average yield of an area, not upon individual yield coverage as is
offered under the traditional APH program. The area coverage is called
the Group Risk Plan (GRP) by FCIC. GRP was introduced as a pilot
program for the 1993 crop year for soybeans in 96 counties. It was
expanded for the 1994 crop year to include seven additional crops
encompassing, 1,872 county crop programs (one crop in one county) in 27
states. Crops now included under GRP are barley (three states), corn
(17 states), cotton (seven states), forage (two states), grain sorghum
(four states), peanuts (four states), soybeans (24 states), and wheat
(eight states).
The GRP is intended to protect the insured person against the
financial consequences of a disaster that strikes all or nearly all
farmers in an area. It sets an expected county yield for each year
based on historical yields, adjusted for any trends. Whenever the
actual county average yield for the year is less than the expected
county yield by a predetermined amount, an indemnity is paid. The
principal differences of the GRP compared to traditional individual
coverage area:
Coverage is based on a trend projected yield, which
probably will exceed the average yield of all farmers insured under
individual yield coverage is there is a positive trend in yields for
the area.
Higher coverage levels (deductibles are as low as 10
percent) at affordable premium rates can be sold.
Thus, in the proper circumstances, GRP will offer risk protection
that may be better than the individual coverage, and may do so at a
lower cost.
GRP has characteristics that make it unsuitable for managing the
adverse financial consequences of crop loss in certain circumstances. A
farmer's yield each year must change in the same direction and by about
the same amount as the county yield if it is to be fully effective
coverage for the individual. For example, if the county's yield
decreases by 25 percent from the expected yield for that year, the
farmer's yield also should decline by about 25 percent from the yield
he or she would have expected. In financial market terms, the ``beta''
or the farmer's yields and the county yields should be near 1.00.
Adequate data are a limitation to further significant expansion of
GRP. The concept as presently developed uses many years (30 or more) of
county yields. These data are routinely available only for counties in
which the crop has been grown in commercially significant quantities.
Weather data and crop growth models may permit expansion into counties
in which the historical yield data are not available, but research is
needed to develop and test these approaches. Further, acceptance of GRP
by bankers as collateral for loans is yet to be determined.
Significant expansion of GRP is not anticipated until its
contributions to agricultural risk management can be measured. No
estimates of savings can be attributed to GRP because customer
acceptance is not known. Customer acceptance of the soybean GRP for the
1993 crop year was limited. Fewer than 500 policies (of nearly 700,000
total for the crop insurance program) were sold. Even if the plan
improves the actuarial soundness of crop insurance, the present volume
of business is not sufficient to make any noticeable difference in
program results.
D. Implement Data Base of Taxpayer Identification Numbers
Amendments to the Federal Crop Insurance Act enacted in 1990
authorize FCIC to collect and use social security numbers and employer
identification numbers to administer its programs. These regulations
were appropriately approved and were published in the Federal Register
in late 1992. OBRA 93 further directed FCIC to implement a database of
these numbers for certain uses not later than the 1995 crop year.
FCIC implemented the database described above in January 1994,
effective for the 1994 crop year. This database is used to locate
production history that is not reported by a person to assure that
classifications assigned under the nonstandard classification system
(NCS--see paragraph E below) are used for both the individual who
accumulated the adverse history and any person having a significant
beneficial interest in a crop produced by that person, and for other
related purposes. In particular, further efforts will be made to
accumulate information about persons involved in sales and servicing of
crop insurance--agents, loss adjusters, and other insurance providers--
so that their contributions to achieving the target loss ratio can be
measured.
Implementing this database will make both modified-APH and the NCS
more effective by permitting FCIC and reinsured companies to assure
that all appropriate experience and premium rating factors are used.
Incremental improvement in the loss ratio due to modified-APH and NCS
is difficult to quantify. The database will enhance those programs as
well as permit FCIC to systematically measure the performance of
insurance providers for the first time.
FCIC will also use the social security numbers and employer
identification numbers for the implementation of an Ineligible File
Tracking System. This system will be used to restrict (through an
automated environment) producers who have been declared ineligible to
obtain benefits provided by the Federal crop insurance program. The
FCIC expects to implement the Ineligible File Tracking System beginning
with the 1995 fiscal year.
E. Expand the Nonstandard Classification System (NCS)
FCIC instituted the NCS for the 1990 crop year because evidence
indicated that a small percentage of insured persons had losses in
nearly every year. The losses paid to these persons far exceeded paid
premiums. For various reasons, the insured yields for these individuals
exceeded their apparent capabilities, and the premium rates were not
representative of the risks posed by these persons. NCS was intended to
reduce the insurance guarantee and increase the premium rate for such
individuals. Modified-APH eliminates the need to reduce insured yields
because the insured yield will be based solely on actual yields when a
person is selected for NCS. However, NCS will continue to increase the
premium rates as appropriate for those individuals who persistently
have losses.
The Agriculture, Rural Development, Food and Drug, and Related
Agencies Appropriation Act for the 1994 fiscal year prohibited FCIC
from using any funds appropriated to insure crops in certain counties
unless an NCS program had been implemented in those counties. Counties
were affected if the loss ratio, after applying the 1993 premium rates,
was greater than 1.10 more than 70 percent of the years that the crop
had been insured in that county. Approximately 2,100 county crop
programs were affected by this provision.
For the 1994 crop year, NCS has been extended to 11 crops
encompassing over 90 percent of the total value of insurance in force.
Additionally, all of the county crop programs affected by the
Appropriations language have been included under the NCS. Over 25,000
individuals (about 3.6 percent of all active policies for the 1993 crop
year) were included under this program. Not all of these persons had
been insured during the base period. NCS also extends to persons who
participated in growing the crop in some way but who may not have been
insured. These persons also are classified under NCS so that the
acreage cannot simply be insured under a different name to avoid the
NCS classification.
In 1993, FCIC commissioned a study of the NCS to determine its
effectiveness. A draft report of that study indicates that the NCS
reduced the loss ratio by 5 to 10 points. This report is undergoing
final preparation as this Blueprint for Financial Soundness is
finalized.
FCIC will expand the NCS program for the 1995 crop year. All
eligible crops will be included, although greater flexibility in
selections may be authorized whenever program factors that led to poor
experience have been identified. NCS is not suited to certain insured
crops (e.g., Texas citrus trees) that are subject to infrequent losses
of great severity. The additional savings from NCS are likely to be
small in terms of the total business because the crops that constitute
the majority of premiums and losses already are included.
F. Institute Premium Rate Adjustments
Premium rates are essential to the success of the crop insurance
program. Rates that are too low will not produce adequate income and
will lead to persistent losses. High rates will, paradoxically, likely
lead to the same outcome. Excessive premium rates discourage
participation by a broadly based cross-section of the farming
community. Instead, persons who are most likely to collect indemnities
will buy, and it is not likely that rates can be increased as rapidly
as the relative risk of the pool of insured persons increases.
FCIC has increased premium rates for all crops in a systematic
fashion beginning with the 1991 crop year. Rates have increased as much
as 70 percent for some crops in some counties from the 1991 to the 1994
crop years. Decreases of up to 20 percent have been made for some crops
in counties with histories of low losses. By an amendment to the Act in
1990, Congress limited general premium rate increases to 20 percent
annually.
The above statistics indicate the amounts that FCIC has increased
the base premium rates. The average premium rate actually earned
(actual premium paid divided by actual liability) may not have
increased by the same magnitude for various reasons. Most importantly,
insured persons may choose a lower coverage level when the rate
increases. By doing so, they accept a lesser degree of protection but
also pay a lower premium rate.
FCIC proposes to continue premium rate increases as needed to help
achieve the required loss ratio. The rate increases made during 1991-
1994 have done much to enhance the actuarial soundness of the program.
However, the premium rates for some crops and areas of the country
remain below the levels needed to achieve the overall 1.10 loss ratio
target.
The impact of premium rate adjustments has been evaluated by using
data for the 20 years from 1973-1992. The effectiveness of the
adjustments was measured by applying the current 1993 premium rate
levels to the historical period from 1973 and all subsequent years. The
loss ratios were recalculated by using the revised premium amounts.
This method does not include any change in sales that may occur due
to a higher or lower cost of insurance. It assumes the 20-year base
period is adequate to measure actuarial performance, an assumption that
may not be the most appropriate definition of actuarial soundness.
Events such as a 1993 Midwestern flood may or may not be appropriate to
include in the 20-year base period for a particular area of the
country.
In 1993, seven crops (barley, corn, cotton, grain sorghum, oats,
soybeans, and wheat) constituted 75 percent of total premiums. The loss
ratio for 1980-1992 for these seven crops was 1.45, identical to the
loss ratio for all insured crops for this same period. Thus, changes in
premium rates for these crops should be representative of the changes
that have been made for all crops in recent years. The premium rate
changes for the seven crops through the 1994 crop year are estimated to
have been adequate to reduce the 1980-1992 loss ratio from 1.45 to
1.08. This aggregate result meets the 1.10 standard required by OBRA
93, but only two of the seven crops individually meet this standard.
Within each of these crops, many parts of the country will meet the
standard but others will not. Hence, additional rate changes in 1995
and later years are appropriate.
FCIC recognizes that premium rate increases are an important
component of a viable crop insurance program. It is also recognized
that increasing premium rates to the levels suggested by the most
recent 20 year experience may not be good public policy. Extremely high
premium rates will preclude realization of the social benefits and
public policy goals of the program because participation will be
discouraged. If this happens, experience indicates that ad hoc disaster
assistance will be enacted. Such assistance is less likely to satisfy
social objectives with regard to maintaining rural communities and
adequate supplies of food and fiber because it is uncertain for any
particular year or region of the country. Thus, a catastrophic
adjustment process may be needed to temper the influence of a year such
as 1993. If the weather of 1993 truly is a 1 in 100 year event (or, as
some have suggested, a 1 in 500 year event), its influence should be
tempered in terms of the premium rates charged to insured persons.
In addition to changing premium rates as needed, FCIC proposes to
take a number of additional actions to enhance the accuracy and
adequacy of its actuarial activities. These include:
Develop computer software and other tools to enhance the
quality of the data used to establish premium rates and perform
actuarial analyses (``STATPLAN'' database, due for completion in
October 1994).
Plans to contract with a major actuarial consulting firm
to review all aspects of FCIC's actuarial methods.
Enhance staff skills by additional training in analytical
methods for existing personnel and more emphasis on recruitment of
actuarial trainees (ongoing) for appropriate functional units.
Continue to contract with external specialists such as the
Economic Research Service, land grant universities, the Cooperative
Extension Service, and others (ongoing).
Develop models to measure sources of change in premium
volumes and track the effects of premium rate changes as isolated from
changes induced by factors such as price elections, coverage level
choices, insured crops, and other factors that are not controllable by
the rate-making function (development to begin immediately).
G. Improve Underwriting of Crop Insurance Contracts.
Underwriting begins by establishing the basic terms and conditions
of the coverage. These include defining conditions that result in a
covered loss, measuring the amount of that loss, and defining the
responsibilities of the insured and the insurer. Underwriting continues
with proper classification of an insured risk. For example, planting
crop B the year after crop A was grown on the same acreage may be
riskier that if other crops were grown the previous year. Some land,
such as flood plains, is more prone to losses. Quality of management
also is important. A farmer who is organized, plans, performs
preventive maintenance on equipment, and performs field operations in a
timely manner may minimize losses.
A comprehensive underwriting system requires effective risk
management strategies and goals, standards, and documentation.
Initiatives to improve underwriting that began in the early 1990's will
be continued as part of the strategy detailed in this Blueprint. The
following specific actions will be pursued:
Fully automate the actuarial documents to facilitate more
comprehensive underwriting at the point of sale and to verify the
classification of risk in an automated environment (completed by the
1996 crop year).
Develop standards and classification systems to assess and
classify individual risk, including completion of research intended to
develop a ``scoring model'' for risk that is based on measurable
attributes of a person or situation similar to a credit rating model
(for implementation by crop year 1996 if this model is feasible).
Continue to rewrite crop insurance policies to better
describe the insurance coverage and limitations and to reduce
vulnerabilities to actuarial soundness that exist due to imprecise,
unclear, or omitted terms and conditions (ongoing, with major crops
scheduled for the 1995 crop year).
Encourage development of supplemental or alternative
insurance coverages authorized by section 508(b) of the Act so that
coverage may be improved with most of the risk remaining in the
commercial sector.
Improved underwriting will improve program performance. However,
meaningful measures to quantify possible benefits are not readily
available. For this reason, FCIC cannot attribute a specific dollar
amount to the benefits of improved actuarial systems and crop insurance
policies.
H. Emphasize Program Compliance
The FCIC Compliance function is designed to confirm that the
Federal crop insurance program is operated and delivered as intended.
Through internal reviews based on generally accepted auditing
principles, it assures that program controls are in place against
excess losses due to waste, fraud and abuse. Compliance emphasis will
focus on:
1. Program Delivery
Beginning in 1987, the Compliance staff conducted reviews of
program delivery to assess compliance with regulations, policy, and
procedure. That year, according to GAO and OIG audits, errors in claims
payment represented an estimated 15 percent of all losses paid equaling
$55 million of taxpayer dollars. Since that time, Compliance efforts
have reduced these errors to approximately 5 percent of indemnities but
still need continued improvement. Losses due to claim payment errors
are not included in underwriting calculations of risk, so this
reduction in excess losses has a direct and immediate impact of
lowering the program loss ratio without increasing program cost or
premium rates.
To further reduce claims overpayment the Compliance Staff will
review the entire operations of each delivery company in coordinated
nationwide reviews. The review methodology was recently revised to
reflect generally accepted auditing principles and statistically
projectable sampling techniques.
Beginning with the 1995 crop year, Compliance requirements will be
expanded to define specific quality control and performance measurement
processes for each delivery company. Policy service error rates will be
monitored. The performance of each company will then be compared to an
established national standard.
2. Program Performance
Compliance reviews for several years have shown that a proportion
of the excess losses are attributable to features in program
construction that produce unintended results. The Compliance Staff will
conduct program performance reviews that assess regulations, policies
and procedures designed to prevent waste, fraud, and abuse and that the
program, policies, and procedures perform as intended.
As an example, in 1989 GAO claims that construction of policy
language in the California Safflower program alone resulted in
approximately $20 million in excess losses. It is not possible to
determine how much of FCIC losses may be attributable to unintended
features of program construction. However, recent program performance
pilot reviews of the peanut program and regional irrigated practices
resulted in an estimated 4 to 10 percent reduction in losses for those
areas that may otherwise have gone undetected.
For the past several years Compliance has conducted ad hoc program
reviews on topical issues. These reviews will be expanded to identify
and target reviews for crop insurance programs with the greatest
potential vulnerability.
3. Fraud Prevention
The risk of fraud is particularly acute in the insurance industry.
Estimates for property-casualty insurance indicate insurance fraud may
represent as much as 15 percent of all losses paid. Recent efforts at
crop insurance fraud detection and subsequent prosecution have been
increasingly successful. However, after-the-fact controls on program
abuse are not fully effective. Compliance will work with the delivery
companies to focus on practical, cost efficient fraud prevention.
Compliance operations, program performance, and complaint reviews will
emphasize identifying systemic vulnerabilities and assessing program
safeguards. Discrepancies noted in review findings will be evaluated to
determine the underlying causes.
Emphasis also will be placed on measures to control program abuse
that include strict contract enforcement and pro-active policy analyses
that identifies potential abuse and targets additional claims review.
These measures will be coupled with the aggressive implementation of
civil sanctions, agent/loss adjuster debarment, and designating
producer ineligibility in finding related to program abuse.
I. Assure that Adequate Risk is Borne by the Commercial Insurance
Industry
Amendments to the Act in 1990 directed FCIC to assure that adequate
risk is borne by the commercial insurance companies reinsured by FCIC,
consistent with their ability to bear risk and the availability of
commercial reinsurance. For the 1992 reinsurance year (a 12 month
period that began on July 1, 1991 and ended on June 30, 1992), FCIC
substantially modified its Standard Reinsurance Agreement (SRA) with
the commercial insurers which participate in the program. Both the
amount and the probability of losses on the part of the commercial
insurers were increased in this agreement. Additional incremental
changes in the amount of potential gains and losses were made for both
the 1993 and 1994 SRA's.
The GAO suggests in a report entitled Crop Insurance Program Has
Not Fostered Significant Risk Sharing by Insurance Companies (GAO/RCED
92-25, January 13, 1992) that the changes in the 1992 SRA are not
significant enough in the area of risk bearing by the commercial
insurance companies. Still, the 1992 SRA fundamentally changed the
manner in which gains and losses are calculated, a subtle but effective
measure to increase risk. The amount of potential loss increased, but
the change in the formula increased the chances that the company would
lose in years of poor experience. As a comparison, the commercial
industry lost approximately $8 million in 1988 when the crop insurance
program sustained a loss ratio of 2.45 primarily due to drought in the
Midwest. If that experience is restated to the larger 1993 premium
amounts, the loss still would have amounted to only about $10-$15
million. Results from the 1993 crop year are not yet complete, but
current estimates indicate that commercial insurers will sustain losses
of $80-$85 million although the loss ratio will be less than in 1988.
The difference is caused by the SRA changes.
Some will argue that industry-wide losses of $80-$85 million are
not significant compared to overall program losses that may be near
$900 million in 1993. Two factors bear on this issue:
(1) The ability of the insurance companies to earn reserves under
the SRA, and
(2) The effect of losses upon an insurance company's operations in
future years.
The commercial industry can bear a greater share of the losses only
if there is corresponding opportunity to achieve comparable earnings in
favorable years. Over the long term, the industry must achieve a
satisfactory rate of return on invested capital, or it would make
economic sense for participants to invest in other endeavors. The SRA
must allow adequate opportunity to earn this satisfactory rate of
return. It also must permit accumulation of reserves to pay losses in
years that disasters strike. Under the present SRA and the conditions
of actuarial soundness of the program, there is no opportunity to
accumulate the reserves needed to bear a large portion of a $900
million loss.
Losses directly impact the capital structure of the companies. An
insurance company leverages its capital (the term ``surplus'' is used
by the industry) to support the volume of business that it writes. As a
general rule, an insurance company is permitted by regulators to bear
the risk associated with $2 to $3 of premium per $1 of surplus. The
ratio of premiums to surplus may be lower for risky lines of insurance
such as multiple peril crop insurance. Thus, whenever an insurance
company loses a portion of its capital, its ability to accept premiums
in future years is reduced by a greater amount, which in turn reduces
its ability to earn profits and reserves. These factors must be
considered when the ability of the industry to bear risk is evaluated,
as is mandated by the Act.
As appropriate, given the factors discussed above, FCIC will
evaluate (1) the need to increase risk sharing with the commercial
insurance industry as the program achieves greater actuarial soundness,
(2) reducing cessions to the assigned risk fund by requiring the
industry to share in losses for loss ratios that exceed 5.00, (3)
changing the stop loss provisions of the SRA, and (4) recruiting
additional commercial insurers to participate in the crop insurance
business. These changes will be made incrementally beginning with the
1995 SRA that takes effect on July 1, 1994.
J. Improve Loss Adjustment
Any actuarial and underwriting system can be affected by errors in
adjustment of losses. These errors include both overpayment and
underpayment of claims. Underpayment would not seem to be a factor
influencing actuarial soundness, but failure to pay a loss when due
will cause insured persons to question the value of the insurance and
potentially reduce participation. The insurance experience also will
not accurately depict the nature of the risk insured, leading to
inaccuracies in future premium rates.
Some problems in loss adjustment are directly related to
deficiencies in underwriting. For example, if the crop insurance policy
is not clear on a particular point, the loss adjuster may find it
necessary to make a determination in favor of the insured person.
FCIC will undertake the following initiatives to assure high
quality of loss adjustment determinations so that results are fair to
insured persons and taxpayers:
Develop uniform loss adjustment standards that clearly
specify the requirements for accurate determinations.
Continue research to improve loss adjustment methods, such
as yield appraisal methods and techniques for unharvested crops, and
measurement techniques for stored production.
Strengthen the quality adjustment provisions of crop
insurance contracts and develop standards to prevent abuse of
production determinations when quality losses are claimed.
The contributions of these factors to achieve the 1.10 target loss
ratio will be measured by a reduction in improper amounts paid on
claims and a reduced error rate. The potential impact of these actions
is difficult to quantify since the initiatives to improve underwriting
also affect this area. These actions are ongoing. Loss adjustment
standards for major crops and changes to the quality adjustment
provisions are targeted for the 1995 crop year.
K. Marketing Crop Insurance
FCIC marketing efforts for 1994 will be directed by a strategic
marketing plan based on information and data received from market
research compiled across the country. The plan's main objectives will
be to inform members of the farming community about changes in the
program and to educate farmers about risk management, emphasizing the
value of crop insurance to farming operations.
FCIC will conduct a year-long media campaign targeted at
publications and broadcast markets with an agricultural audience.
Also, emphasis on outreach to minority farmers, traditionally
under-represented in the program, will be coordinated through a
Minority Outreach Marketing Plan that specifically identifies minority
farmers in each of the 10 FCIC Regional Service Offices.
L. Expand Participation by Introducing New Products
Numerous ideas for products that will enhance the quality and
acceptance of the crop insurance program have been suggested. These
include cost of production coverage (several different concepts),
dollar denominated coverage, revenue insurance, replacement cost
insurance, and others. FCIC currently has contracts with the Economic
Research Service to evaluate several alternatives in the context of
public policy contributions, availability of data to support the
concepts, assessments of producer acceptance, and other factors. FCIC
proposes to continue such research and seeks comments about additional
concepts that may be appropriate. Implementation of a pilot test of the
best alternatives will be pursued.
M. Improve Accuracy of Other Program Variables
This section includes items that impact the program but are not
easily categorized under a previous heading. These are:
Unit division. A unit is a tract of land used to establish
the amount of insurance and any indemnity. For example, the crop
insurance policy defines a unit as all land in a county that is owned
by the farmer or rented for cash and planted to the insured crop. This
unit may be subdivided under certain conditions, including payment of
additional premium. Generally, insured persons favor a program that
gives them great flexibility and freedom for establishing a unit. Some
research indicates that size of a unit may affect losses, i.e., a unit
consisting of 10 acres may have a great loss (in relative terms) than a
unit consisting of 100 acres. This research, if verified, suggests that
a surcharge may be needed for small acreage units regardless of how
these are formed (by dividing larger units or because this is all the
land planted to the crop). FCIC will examine the research and determine
if this surcharge is appropriate, both actuarially and as a public
policy initiative. FCIC also will explore the potential to provide
greater flexibility of unit determinations as a tool to enhance program
acceptance by customers. The pricing needed to support greater
flexibility must be determined before it can be implemented.
Implementation of changes will be targeted for the 1996 crop year.
Program dates. Program dates include sales closing,
acreage reporting, cancellation, and others. Several of these dates may
directly affect the actuarial soundness of the program. For example,
neither the farmer nor the insurer should be able to predict the
potential for loss on the sales closing date. However, a study by one
university indicates that farmers may achieve better than a 50-50
probability of predicting a loss with the current sales closing date of
April 15 in the Midwest. Arguments in favor of having a sales closing
date as late as possible generally focus on the need to maximize sales
opportunities; i.e., that interest in purchasing crop insurance is
greatest as planting time approaches. In a draft report, the GAO has
encouraged FCIC to close sales earlier. FCIC proposes to close sales
for the 1995 crop year by 15-30 days earlier than the present dates.
FCIC requests comments regarding other actions with regard to program
dates that will facilitate achievement of the targeted 1.10 loss ratio.
Staged guarantees. Staged guarantees reduce the amount of
insurance when a crop is lost before harvest. For example, a farmer who
abandons a crop within 30 days of planting might be paid only 40
percent of the amount of insurance. The concept underlying staged
guarantees is investment costs; the farmer's investment is less than
the total needed to produce and harvest the crop. Some believe this
approach will reduce outlays for indemnities and help achieve actuarial
soundness. However, in the long run its efforts could be to reduce
premium rates from levels otherwise needed. The impact of staged
guarantees upon customer acceptance of crop insurance may be the valid
measure of this concept. FCIC specifically requests comments on this
feature and assessments of its potential contribution to achieving the
targeted 1.10 loss ratio.
De minimis yields. This term denotes a yield below which
any production is disregarded for the purpose of determining the amount
of indemnity. The concept is advanced by interested parties as an
equity issue--that it costs the farmer more to harvest the crop than it
is worth in the market. If allowed by the program, indemnities will
increase compared to the present provisions of the crop policies,
which, in turn, requires higher premium rates to achieve the goal.
Readers are encouraged to comment on the desirability of increasing
premium rates by an amount needed to permit this feature to be included
in crop insurance policies.
Suspension and debarment. Inappropriate determinations and
poor administration of the crop insurance program is alleged about
agents, loss adjusters, and others who are involved with delivery of
crop insurance. The SSN/EIN database is intended to help FCIC monitor
the conduct of these persons. However, monitoring in and of itself is
insufficient if there are no penalties for violations of program rules.
FCIC proposes to develop clear and concise suspension and debarment
procedures for agents, loss adjusters, reinsured companies and others
who fail to observe the highest standards of performance in program
delivery and administration.
Price Elections. The GAO recommended in a 1991 report that
for the major crops, FCIC set its price elections equal to the
forecasts issued by the World Agricultural Outlook Board in its semi-
annual estimates. These estimates correspond to the cycle used to
prepare the annual budget of the United States Government. These
estimates are available only twice each year. Based on a sampling of a
few years, GAO stated that overall losses would be reduced if this
recommendation were adopted. FCIC is committed to offering a price
election that complies fully with the requirements of the law. In
addition, the offer must be meaningful to farmers. FCIC requests
comments regarding this recommendation and assessments by readers of
its likelihood of contributing to reduced loss ratios and improved
participation.
Readers are requested to identify additional issues that they
believe are relevant and important to assist FCIC in its actions to
manage the program to achieve the target loss ratio while maintaining
or increasing participation levels.
III. Management Actions If Section II Are Not Successful
The actions identified in Section II of this document represent a
continuation of current management initiatives that have been and
continue to be important for the effective administration of a public
program. FCIC believes that successful completion of these actions will
meet the objective of achieving actuarial soundness as required by OBRA
93. Several years must elapse before it will be possible to observe
FCIC's achievement of the objective. In the interim, attainment must be
measured by realistic models of risk that adequately represent the crop
insurance program. Flexibility in managing the program to attain the
objective while simultaneously achieving other important policy
objectives must be stressed.
Few options that do not adversely affect participation in a
material manner are available in the event the actions described in
this blueprint are determined to be inadequate. One option is to focus
better on defining the risk that is included in the premium rates
charged to current insureds. Extreme crop disasters (such as the 1993
flooding and cold, wet growing season) tend to be widespread and occur
infrequently. Crop insurance is not actuarially sound in a commercial
sense because the private sector cannot manage the magnitude of these
risks or arrange the financing over the long periods of time needed to
accumulate reserves for a major disaster. This characteristic of crop
disasters argues that actuarial soundness perhaps should be measured on
a basis that separates normally expected conditions from the extreme
disasters. This would serve to more precisely define the risk included
in the premium rates for current insureds, and the risk that should be
amortized over longer time periods.
If the above is not acceptable, another action would be to limit
the liability of crop insurance to specific areas and crops. This
limitation could take the form of complete withdrawal of insurance in
some cases, or limitations on the volume of business that would be
accepted in a year for a crop or area. Commercial insurers use this
process to manage their exposure to avoid concentrations geographically
or by product line. Crop insurance may need the same management of its
exposures rather than accepting any and all risk whenever farmers
decide to enter and exit the program. This extreme action would
indicate that the program was unable to completely fulfill its social
and public policy responsibilities, and must be regarded as an
initiative of last resort.
IV. Management Actions If Actions in Section II Are More Successful
Than Needed
The greatest impediment to increased program participation will be
high premium rates that might result from the actions defined in this
plan. Moderation of premium rate increases will be a priority if more
stringent program administration reduces the loss ratio below the
target. If this occurs, experience should be examined to identify
losses paid that no longer should be expected. Once the impact of those
losses is eliminated from the experience, some improvement in premium
rates would be anticipated. FCIC believes that the remaining management
actions that have improved administration of the program or that have
better defined the coverage provided to U.S. agriculture should not be
relaxed because these generally represent good administration of public
policy.
Done in Washington, DC on April 1, 1994.
Kenneth D. Ackerman,
Manager, Federal Crop Insurance Corporation.
[FR Doc. 94-8244 Filed 4-5-94; 8:45 am]
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