Disclaimer: This web page is designed to aid farmers with their marketing and risk management decisions. The risk of loss in trading futures, options, forward contracts, and hedge-to-arrive can be substantial and no warranty is given or implied by the author or any other party. Each farmer must consider whether such marketing strategies are appropriate for his or her situation. This web page does not represent the views of Kansas State University. 
Disclosure:  Dr. Barnaby’s research was the basis for the privately developed Crop Revenue Coverage.

If Crop Insurance is Working Why Do Farmers Need Disaster Assistance?[1]

Updated 9/23/02

Summary.  The worst outcome for insured growers is to suffer a 35% to 40% yield loss and higher prices.  They will lose their counter cyclical payment because of higher prices, they have fewer bushels (production) to sell at the higher prices, even with this significant yield loss they will receive no payments under ad hoc traditional disaster aid (TDA), and their net insurance payments will be small or none.  However, these corn growers can expect to lose more than $50 per acre below their expected revenue when the crop was planted and they still must cover most of the harvest expenses.  Traditional disaster aid has targeted payments to zero yields that could have been insured while providing nothing for insured growers with significant yield losses.  Some growers are suggesting any disaster aid should be targeted to the “hole in the safety net” and not to the risk that is covered under crop insurance.

Introduction.  There are some crops that do not have crop insurance contracts and there are only a few pilot insurance products available for livestock and grazing.  However, past TDA was provided on crops that were insurable with subsidized crop insurance contracts and the TDA was targeted to the risk that could have been covered under those crop insurance contracts.  It is expected disaster aid will be provided again on insurable crops under any new disaster aid legislation.

Because of the current crop losses the Senate passed a disaster aid program on September 10, 2002 .  A bill has been introduced into the House.  Congress will have to pass a disaster aid law and the President will need to sign it before farmers will be paid disaster payments.  The Senate’s disaster bill follows a similar design as the previous TDA programs that were provided to growers.  Growers were paid disaster payments if their yield fell below 65% of their historical average yield.  For example, if a grower had 133.3 bushel historical yield with a 65% disaster aid program any yield below 86.7 bushels would trigger ad hoc disaster payments.

Past disaster programs targeted payments to growers with large yield losses but growers can still lose 35% of their expected crop and sustain substantial financial losses.  Growers, who lose 35% of their crop, have a significant crop loss but will still incur most of the harvesting expenses that would not occur with a total disaster.  However, under a TDA program and probably their insurance contract there would be none or only “small” payments.

Is Disaster Aid “Necessary”?  Keith Collins, Chief Economist at USDA, has stated the subsidized crop insurance program is “working”.  If the subsidized crop insurance program is “working” then why do farmers “need” disaster aid?  In order to answer that question one must consider the entire farm “safety net” that includes crop insurance and commodity programs.  An example farm was created in table 1 to address this question.  The example insured grower would be paid a TDA payment equal to 65% of the MPCI price election ($1.33 on line 13 of table 1) times the number of bushels lost below 65% of their historical yield of 133.3 bushels or 86.7 bushels, line 9, table 1.  The uninsured grower would be paid $1.23 for those lost bushels that represents 60% of the MPCI price election on line 13 of table 1.

The “Hole” in the “Safety Net”.  Assuming the example grower produced 86.7 bushels this would represent a 35% yield loss, which is a significant loss but receive no disaster aid on line 14, table 1.  The net insurance payment for most growers will be relatively small as is the case on line 30, table 1.  This is the “hole” in the farm “safety net” that is not covered by crop insurance or disaster aid.

The “Safety Net” Includes Direct Payments, Counter Cyclical Payments, and Crop Insurance.  Under the new Farm Service Agency (FSA) farm program growers would also receive the counter cyclical payment based on the historical yield times 85% times the maximum of $0.00, or $2.32 less the 12 month national average price, or $1.98 and reported on line 15, table 1.  However, under today’s market, prices are above $2.32 and the expected counter cyclical payment on line 15 is zero.  If the 12 month national average price were $1.98, then the counter cyclical payment on line 15 is 133.3 bushels times the maximum payment of 34 cents times 85% for a total of $38.53 per acre.

The direct payment on line 17 is not subject to either yield or price risk and for this grower would be 28 cents times 110 direct payment bushels times 85% for a total of $26.18 and reported on line 17 of table 1.  Total government payments on line 18 include the direct payment, disaster payment, if any and the counter cyclical payment, if any.

Insured growers would also receive crop insurance indemnity payments if their yield is low enough to trigger those payments.  The amount of the loss required to trigger crop insurance indemnity payments depends on the level of coverage purchased by growers.  In table 1, it was assumed the grower purchased 75% crop insurance coverage and produced a below average yield of 86.7 bushels therefore, the example grower would receive a “small” indemnity payment.

The insured grower with 75% Crop Revenue Coverage or Revenue Assurance – Harvest Price Option (CRC or RA-HPO) would receive a $34.67 indemnity payment less $9.49 farmer paid premium[2] for a net indemnity payment of $25.18.  The expected revenue was $335.51 based on an average yield of 133.3 bushels times $2.32 new crop futures prices in March, plus 85% of the 28 cent direct payment times 110 direct payment bushels.  The combined government payments, net indemnity payment and crop sales equals $276.69 for the CRC/RA-HPO insured grower on line 31, table 1.  The grower has a $58.82 loss below his/her expected revenue reported on line 33, table 1.  Most growers will still generate revenue below expected revenue for combined TDA and net crop insurance payments for yield losses below 50% or less.  This may, or may not be a profitable revenue for the grower, it will depend on individual farm costs.

The worst outcome for insured growers is a significant 35% yield loss.  This is a “large” loss but insured growers receive no disaster aid, they lose the counter cyclical payment because of the higher price, they only have 65% of a normal crop to sell at the higher price, and the insurance payment is relatively “small”.  Those growers who bought lesser coverage, such as RA without the harvest price option or no insurance would sustain substantially larger losses below the expected revenue with no appreciable reduction in expenses.  The net RA payment was even negative because the price increase reduces the indemnity payment and the premium exceeded the indemnity payment (table 1, line 30).  In addition, the crop is large enough that growers will incur most of the harvest costs.

The best outcome for an insured grower with ad hoc disaster aid is no yield.  A zero yield would generate a maximum TDA payment for the insured grower of $115.48 (table 2, line 14).  This equals the maximum TDA payment limit of $115.48 on line 8, tables 1, 2 and 3.  The example grower with a zero yield would receive total government payments of $141.66 and net CRC/RA-HPO indemnity payment of $250.51 for combined revenue of $392.17 (table 2, line 31).  The grower exceeded the expected revenue by $56.66 (table 2, line 33).  The revenue would actually exceed the revenue from a normal crop and forego the harvest expenses (table 3, line 33).  The uninsured grower would suffer the largest loss with a zero yield because of no insurance payment (table 2, line 33).

There are many different yield possibilities.  Figure 1 shows yield losses of 8% to 65%.  The 75% CRC/RA-HPO insured grower suffers losses in expected revenues approaching a negative $60 per acre with a 30% yield loss.  Once yield losses exceed 35%, insured growers with 75% CRC/RA-HPO financial position will start to improve.  This result is caused by crop insurance payments that start to exceed the premium and collecting traditional ad hoc disaster payments.

Figure 2 shows the uninsured growers have smaller losses than CRC insured growers until losses exceed about 28%.  The curve is then flat at about a $60 loss below expected revenue until disaster aid starts to pay.  Growers that suffer a 50% yield loss or less will have large financial losses and the current FSA program, traditional ad hoc disaster aid and crop insurance will not cover these losses. 

Issue.  Because the largest losses for insured growers occur with 35% yield loss, should disaster aid be targeted to the “hole in the safety net” or should the payments be targeted to the low yield that could have been covered with crop insurance?  Past ad hoc disaster program payments were targeted to the low yields.  Is it time for a new public policy that will target disaster aid payments to the deductible in the federally reinsured crop insurance contract that is not insurable for non-hail risks?