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.

Illinois and Iowa Farmers have Paid more in Premiums than They have Collected in Indemnity Payments, but the Reverse is True for Kansas Farmers?[1]

Introduction.  Growers and others who have studied the Risk Management Agency’s (RMA) web page have questioned if their premium dollars are being shifted to other states.  As a result, many insured farmers have asked; “are my crop insurance premium dollars being sent to high risk states to cover underwriting losses?”. 

Data.  The data in table 1 is based on all of the crop insurance contracts sold during the period 1989-2003.  The data for the period 1989-2003 was collected from the RMA web page located at http://www.usda.rma.gov.  The objective of this analysis was to answer the question are farmer paid premiums being shifted to other states.  All “buy-up” and CAT contracts were included in the data and would include all of the reinsured products, i.e. Crop Revenue Coverage (CRC), Revenue Assurance (RA), Income Protection (IP), Group Revenue Insurance Plan (GRIP), Multi-Peril Crop Insurance Actual Production History (MPCI-APH), and all other subsidized crop insurance coverage’s purchased by farmers.

In the following analysis, aggregate loss ratios were defined as the summation of total indemnity payments divided by summation of total premiums over the 15-year period.  The Simple Average loss ratio reported in the tables is an average of annual loss ratios.  The net gain in dollars to farmers was defined as the difference between the sum of farmer paid premiums and the sum of the indemnity payments collected over this 15-year period.

The loss ratio gives one the performance of the individual state and to be considered actuarially sound the loss ratio should be 1.00, i.e. for every dollar paid in premiums (includes government paid and farmer paid premiums) over the “long run” farmers should receive one dollar in indemnity payments.  The aggregate loss ratio was 1.0 over this 15 year period when the CAT contracts were included.  Farmers paid about 49% of the premiums collected over this 15 year period.  However, farmer’s share of the premiums paid has declined in recent years with the balance paid by USDA. 

The net gain and the dollars of coverage demonstrate how important the crop insurance program is in some states versus others.  Coverage measures the total amount of protection provided by the insurance program where Iowa ranks first while the net gain measures the total indemnity dollars exceeding farmer paid premiums and Texas ranks first under this criteria.

A 15-year period may not be sufficient time to make any judgments about actuarial soundness especially in low risk states where the frequency of claim is very low.  This aggregate loss ratio approach gives the recent crop history greater weight because in most states participation has

increased since 1989.  The simple average annual loss ratio is also reported and does not weight the loss ratio by sales volume.[2]

Top 10 States with Highest Aggregate Loss Ratio.  The states are ranked by loss ratio and the 10 states with the highest aggregate loss ratio versus number 16 Kansas loss ratio is presented in figure 1 and also presented in table 1.  The 10 states with the highest loss ratio include Oregon, Utah, Connecticut, Massachusetts, Alabama, South Carolina, North Carolina, Alaska, Texas, and Oklahoma (figure 1).

Oregon had the highest loss ratio of $1.81.  However, total indemnity payments amounted to less than $195 million dollars for the state of Oregon.  Texas ranked 9th and North Dakota ranked 18th, which are 2 states that are typically identified as states with “high” loss ratios (table 1).  Texas, over this 15-year period, had a loss ratio of $1.46 while North Dakota had a loss ratio of $1.25.  These loss ratios are much lower than Oregon’s loss ratio but both Texas and North Dakota have large amounts of participation.  Therefore, these loss ratios have a greater impact on the Risk Management Agency/insurance companies.

Ranked by aggregate loss ratios, Kansas came in number 21 out of the 50 states with a loss ratio of $1.18.  This would represent a 18-cent “underwriting loss” for the state of Kansas.  There were 24 states that had an aggregate loss ratio under $1.00, which is normally considered to be the actuarially sound rate (the expense load to cover agent commissions, insurance company expenses, funding of the RMA are funded under separate budget items).  

Top 10 States with Aggregate Lowest Loss Ratio.  The 10 states with the lowest aggregate loss ratio is presented in figure 2 and table 1.  The 10 states with the lowest loss ratio include California, Minnesota, Wisconsin, Indiana, Missouri, Washington, Rhode Island, Iowa, Illinois, and Hawaii (figure 2).

California ranked 41^st and Minnesota ranked 42^nd with a loss ratio of 71 cents.  A large part of the California crop insurance market is CAT coverage.  California’s loss ratio is much higher if the CAT coverage were not included.  California ranked 9th in net dollars gained from crop insurance, because the entire premium for CAT is paid by USDA, therefore any indemnity payments are a net gain to growers.  Wisconsin ranked 43^rd, Indiana ranked 44^th, and Missouri ranked 45^th with a loss ratio of 70 cents.  Iowa ranked 48^th with a loss ratio of 56 cents followed by Illinois with a loss ratio of 49 cents.  The state with the lowest loss ratio was Hawaii but there is very little participation in that state (table 1, figure 2). 

Top 10 States with Highest Simple Average Annual Loss Ratio.  The simple average loss ratio is the average of the annual loss ratios.  This will give equal weight to each year, while the aggregate loss ratio gives the greatest weight to years with the largest amount of sales.  The states are ranked by the highest simple average annual loss ratio versus number 23 Kansas.  The 10 states with the highest simple average loss ratio include Nevada, Alabama, Utah, Pennsylvania, Texas, Oklahoma, Georgia, Connecticut, Massachusetts, and West Virginia (figure 3).

Nevada had the highest simple average loss ratio of $2.56.  Texas ranked 5^th and North Dakota ranked 21^st, which are 2 states that are typically identified as states with “high” loss ratios (table 1).  Texas, over this 15-year period, had a loss ratio of $1.60 while North Dakota had a loss ratio of $1.25.  These loss ratios are much lower than Nevada’s loss ratio but both Texas and North Dakota have large amounts of participation.  Therefore, these loss ratios have a greater impact on the Risk Management Agency/insurance companies.  For example the indemnity payments to Texas were over $4.5 billion versus less than $6 million paid to farmers in Nevada.

Top 10 States with Simple Average Annual  Lowest Loss Ratio.  The 10 states with the lowest aggregate loss ratio are presented in figure 4 and table 1.  The 10 states with the lowest loss ratio include Kentucky, Indiana, California, Missouri, Washington, Iowa, Vermont, Illinois, Rhode Island, and Hawaii (figure 4).

Kentucky ranked 41^st, with a simple average loss ratio of 83 cents.  California ranked 43^rd but a large part of the California crop insurance market is CAT coverage.  California’s loss ratio is much higher if the CAT coverage were not included.  Iowa ranked 46^th and Illinois ranked 48^th and had very large participation.  The state with the lowest simple average loss ratio was Hawaii but there is very little participation in that state (table 1, figure 4). 

Top 10 States with Highest Net Dollar Gain by Farmers by State.  The states are ranked by the amount of total dollars gained by farmers over the 15 year period (table 1, figure 5).  The gain is defined as the difference between total indemnity payments collected and the total of farmer paid premiums.  This measurement identifies the greatest benefit to the individual states and identifies where crop insurance has been more heavily accepted.  The 10 states with the highest farmer net dollar gain include Texas, North Dakota, Kansas, South Dakota, Georgia, North Carolina, Montana, Nebraska, California, and Oklahoma (figure 5).

Texas ranks first with a net dollar gain by farmers of $3.1 billion dollars followed by North Dakota with $1.5 billion dollars (table 1, figure 5).  Kansas ranks 3^rd with a net gain of $927 million dollars.  South Dakota was the only Corn Belt state to break the top 10, ranking number four with a net gain of $801 million dollars.  California was a “surprise” number 9 with a net gain of $439 million dollars.  California growers only paid 38% of the total premium.  By contrast, Kansas farmers paid 50% and Nebraska farmers paid 54% of the total premium.  Because a large part of the California crop insurance sales were generated from CAT, and claims are all net to the grower, the result was a large net gain to farmers and a smaller percentage of premium paid by farmers.     

Top 10 States with Lowest Net Dollar Gain by Farmers by State.  The 10 States with the lowest net dollar gain is presented in figure 6.  The 10 states with the lowest farmer net dollar gain include West Virginia, Delaware, Nevada, Vermont, New Hampshire, Alaska, Rhode Island, Hawaii, Iowa, and Illinois (figure 6).

Illinois ranked 50^th with a $90 million dollar loss, i.e. farmers paid $90 million dollars more in premiums then were collected in indemnity payments by farmers in the state of Illinois.  Farmers in Iowa also paid more in premiums than indemnity payments collected.

Top 10 States with the Highest Dollars of Coverage by State.  Another measurement of insurance is the risk protection provided.  The states are ranked by the total dollars of coverage provided to farmers over the 15-year period (table 1, figure 7).  The total dollars of coverage is the sum of the coverages provided by all reinsured contracts including CAT sold in the state.  The total dollars of coverage is the maximum indemnity payment that could be paid under the crop insurance contract.  While individual farmers can and do collect the full coverage because of a zero yield, there is no chance that the dollars of coverage would equal indemnity payments at the state level because that would require a zero state yield.  The 10 states with the highest dollar amount of protection include Iowa, Minnesota, Illinois, California, Nebraska, Texas, North Dakota, Kansas, Florida, and Indiana (figure 7).

Iowa ranked first with a total coverage of $43 billion dollars over this 15-year period (table 1, figure 7).  Minnesota ranks second with $30 billion dollars of coverage followed by Illinois at $29 billion dollars.  Surprisingly, Illinois farmers have purchased a considerable amount of coverage while at the same time collecting lower than expected indemnity payments.  Kansas ranked eight with a total of $16 billion dollars of aggregate coverage purchased over this 15-year period. 

Top 10 States with the Lowest Dollars of Coverage by State.  The 10 states with the lowest aggregate dollars of coverage is presented in figure 8.  The 10 states with the lowest dollar amount of protection include Massachusetts, New Jersey, Delaware, West Virginia, Utah, Vermont, Nevada, New Hampshire, Rhode Island, and Alaska. (figure 8).

Massachusetts ranked 41^st in aggregate dollars of coverage but 4^th in loss ratio at $1.60.  While Illinois ranked 3^rd in aggregate dollars of coverage but was 49^th in loss ratio of $0.49.  This would suggest that underrated crop insurance contracts do not necessarily increase participation.   

Are Farmer Paid Premiums Sent to Other States to Cover Underwriting Losses?  When farmers ask the question “are my premium dollars being sent to other states to pay losses?” the answer clearly is no for most states.  However, those 19 states with loss ratios under $1.00 have shifted tax revenues to the higher risk states.  Illinois and Iowa farmers would have the best argument that their premium dollars have been used to pay losses in higher risk states.  However, one must remember 15 years is still a very short time horizon to be measuring loss ratios.  This is especially true in a state where one expects a low frequency of claim, like Illinois.  A single loss year in a state with a low frequency of claims will take several years to recover the underwriting loss.

RMA would also argue that rates and underwriting rules have been changed to address states with high loss ratios.  RMA has also allocated a large about of resources to prevent and prosecute fraud.  Over the long run these changes will affect the loss ratio.

Change Rates?  This would suggest rates should be increased in Texas and North Dakota, while reducing rates in Iowa and Illinois.  The data also suggests the rates in Kansas may need adjustment.  However, even within states there may be differences between irrigated versus dryland, or wheat versus corn.  Therefore, one would not want to do an “across the board” rate change. 

The 15 year USA loss ratio was $1.00 and would be considered actuarially sound for the entire book, but that loss ratio historically has not been evenly distributed by state.  Iowa, and Illinois would have the strongest argument they are  “sending” premiums to high risk states to cover losses.  These states have very little irrigation and are mostly corn and soybeans, so there is little chance the crop mix is a factor.

The one problem when considering rates is that low risk states have “low” rates combined with a low frequency of claim.  A single loss year like 1988 or 1993 requires many years with underwriting gains to recover the loss.  However, if rate reductions were provided, most actuaries would likely apply those reductions to Iowa, and Illinois.

Most private actuaries would also do a rate evaluation of states with higher loss ratios.  In most cases they would either suggest rate increases or underwriting changes or both.  Many of the states with high loss ratios also have multiple crops (beyond corn and soybeans) that may grow during different time periods and under irrigation.  Those factors would be a part of any actuarial study and it is unlikely that private actuaries would recommend “across the board” rate increases, even in states with high loss ratios.

Summary.  This analysis gives no credit for the risk reduction.  People buy property-casualty insurance where the expected indemnity payout is less than the paid premiums.  The difference between premiums and the indemnity payment is used to pay agent commissions, insurance company expenses, and profits for stockholders.  The government pays all of the expenses plus a premium subsidy that averages about 50% of premiums.

The current rates in Iowa and Illinois would be very close to a private property-casualty rate.  So why does the private sector not offer a private product?  A private product would be very unlikely without government reinsurance to cover the catastrophic risk that would bankrupt most insurance companies, i.e. the one in 500 year drought.  Farmers also receive Farm Service Agency payments that reduce risk and the demand for insurance.  Also, any unsubsidized product would have to overcome the USDA expense and premium subsidies, a very unlikely result.

Both of these states have a large amount of participation.  Suggesting these farmers are buying risk protection and don’t expect payments that will provide subsidies.

Kansas loss ratio is above target and likely the result of poor recent crops.  Kansas farmers have had the advantage of risk reduction and they have captured the crop insurance subsidies.

Texas and North Dakota farmers continue to capture all of the subsidies and the underwriting loss where indemnities exceed premiums (includes farmer and USDA premiums paid).  These farmers have received an “unintended subsidy” that is covered by taxpayers.

Individual Farmer.  This data is all state aggregated data.  While a whole state may have received more dollars then were paid by farmers, this data will include farmers who have bought crop insurance in those states but received no indemnity payments.

Table 1.  1989-2003 Crop Insurance History for USA Crop Insurance, All Crops, All Insurance Plans¹