Federally subsidized crop insurance, which includes a variety of crop yield and revenue insurance options, protects participating producers against risks over the growing season. Crop yield insurance protects against yield shortfalls; crop revenue insurance protects against revenue (yield multiplied by price) shortfalls. Both yield and revenue insurance adjust from year to year, depending on crop market price expectations. Since potential insurance payouts, as well as premium costs, increase with rising commodity prices, these insurance plans have assumed greater significance in the current price environment.
For example, assume that a corn producer’s expected yield, based on recent history, is 150 bushels per acre. If, prior to planting, the expected price of corn is $4 per bushel and the producer chooses the 75-percent coverage level, then the amount insured would be $450 per acre. If the expected price of corn rises 50 percent to $6 per bushel, and expected yield does not change, the producer’s insurance coverage would increase by the same percentage to $675 per acre. This increased revenue guarantee may be used to offset risks from higher input prices.
The most widely used insurance plans—which covered more than half of U.S. corn, soybean, wheat, and cotton acres in 2008—are revenue insurance plans that also provide increased amounts of insurance, within limits, if crop prices rise over the growing season. One example is Revenue Assurance with the Harvest Price Option, offered in the major corn and soybean States. Under this plan, the projected harvest price used in the revenue guarantee for corn is the average of the daily settlement prices during February of the December Chicago Board of Trade corn futures contract (the price of a contract purchased in February for delivery in December). The actual harvest price is determined from the November average of that contract. The revenue guarantee for the crop uses the higher of these two prices, although regulations stipulate that the harvest price that is used cannot be greater than 200 percent of the projected price.
Crop yield insurance policies, the second most widely used type of insurance, also use expected market prices to establish the insured values of crops. These expected prices, however, are determined differently than those used with revenue insurance, and they do not change over the growing season. Each year, prior to the crop insurance enrollment period, USDA’s Risk Management Agency (RMA) uses forecast season-average crop prices to set the prices at which yield losses would be paid. These prices, called “price elections,” together with expected yields and coverage levels, determine the insured value of the crops covered by yield insurance.
Increases in insurance amounts, the insured value of crops, lead, of course, to higher premium costs. This means that for the same coverage level, expressed as a share of the expected yield or revenue, expenditures for insurance go up. For example, at the 75-percent coverage level, if the premium rate is 5 percent and the amount of the insurance guarantee is $450 when the price of corn is $4 per bushel, then the premium cost is $22.50 per acre. The premium rises to $33.75 if the price of corn is $6 per bushel and the amount of the guarantee is $675 per bushel. The $225 increase in the amount of insurance costs an additional $11.25 in premium, if premium rates do not change. But, premium rates for revenue insurance can increase when crop prices go up because price risk or volatility, which is part of revenue risk, usually increases when price levels increase. The amount of the premium increase depends on the size of the increase in price volatility and the size of the price risk relative to the yield risk.
Both producers and the government pay more when crop insurance costs increase. Premiums on crop insurance policies are subsidized by the Federal Government. The subsidy rate depends on the coverage level and insurance plan selected by the producer. For the most popular insurance plans and coverage level—individual farm revenue at 75-percent coverage—the premium subsidy is 55 percent, meaning that producers pay 45 percent of the premium cost. For the entire crop insurance program, the government pays about 60 percent of total premiums. Thus, rising crop prices mean higher insurance program costs for the government. Premium subsidies increased from $2.3 billion in 2005 to $3.8 billion in 2007 and are expected be even higher in 2008, due largely to crop price increases.
Higher premiums also lead to increases in costs of other crop insurance program subsidies. For instance, administrative and operating subsidies, which are paid by the government to insurance companies for selling and servicing crop insurance policies, are determined from premium values. When premium amounts go up, so do administrative and operating subsidies. In order to trim insurance program costs, the 2008 Farm Act made small reductions in premium subsidy rates for area yield and revenue plans and in administrative and operating subsidy rates.
Source: Amber Waves