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.

Agricultural Outlook Forum 2003 Presented:                                           Thursday, February 20, 2003

SHOULD ANY AD HOC DISASTER AID BE TARGETED TO THE “HOLE” IN THE FARM SAFETY NET?

G.A. (Art) Barnaby, Jr.

Professor

Kansas State University

Summary.  The worst outcome for insured growers is to suffer a 35% to 40% yield loss and higher prices.  Growers 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 $59 per acre below their expected revenue when the crop was planted and they still must cover most of the harvest expenses.  TDA 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.  Many analysts are expecting disaster aid will be provided again on insurable crops under any new disaster aid legislation.  Should that disaster aid be targeted to uninsurable yield losses or to insurable yield losses?

Is Disaster Aid “Necessary”?  USDA Economists have 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.   

The “Hole” in the “Safety Net”.  An example farm was created in table 1 to address this question.  The example grower has an historical average yield of 133.3 bushels but produced only 86.6 bushels.  This would represent a 35% yield loss, which is a significant yield loss but the grower receives no traditional disaster aid.  The net insurance payment for most growers will be relatively small as is the case on line 29, table 1.  The example grower receives no Counter Cyclical (CC) payment, no Loan Deficiency Payment (LDP) because of higher prices, reduced cash sales because of reduced yields, and a “small” crop insurance payment because of the deductible.  This example insured grower’s revenue ranges from $83.91 to $59.73 below the expected revenue and he\she must cover most of the harvest expenses (table 1, line 32).  This is the “hole” in the farm “safety net” that is not covered by crop insurance or TDA programs.

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 $3.32 less the maximum of the 12 month national average price or loan rate.  The 12 month national average price is currently being calculated by National Agricultural Statistics Service (NASS).  However, under today’s market, prices are above $2.32 and the expected counter cyclical payment on line 12 is zero.  If the 12 month national average price were $1.98, then the counter cyclical payment on line 12 is 133.3 bushels times the maximum payment of 34 cents times 85% for a total of $38.52 per acre.

The direct payment on line 14 is not subject to either yield or price risk and for this grower would be 28 cents times 120 direct payment bushels times 85% for a total of $28.56 and reported on line 14 of table 1.  Total government payments on line 17 include the direct payment, loan deficiency 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 86.6 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 $33.65 indemnity payment less $9.47 farmer paid premium[1] for a net indemnity payment of $24.18.  The expected revenue was $317.82 based on an average yield of 133.3 bushels times $2.17 new crop futures prices in February 2002 less 15 cent basis, plus 85% of the 28 cent direct payment times 120 direct payment bushels.  The combined government payments, net indemnity payment and crop sales equals $258.09 for the CRC/RA-HPO insured grower on line 29, table 1.  The grower has a $59.73 loss to $83.91 below his/her expected revenue depending on the level of crop insurance purchased (table 1, line 19).  An insured grower with a total loss would generate a smaller cash loss of $46.73 and he/she saves the harvest expenses (table 2, line 32)! 

The worst outcome for insured growers is a significant 35% yield loss.  This is a “large” loss but insured growers receive no TDA payment, they lose the counter cyclical payment and LDP payments because of higher prices, 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 reduced because the price increase caused a reduction in the indemnity payment (table 1, line 27).  In addition, the crop is large enough that growers will incur most of the harvest costs.

The public policy alternatives to address the hole in the safety net include:

1.  Status quo with no additional ad hoc disaster aid payments.

2.  A disaster program that would increase the direct payments to growers regardless of yield losses in disaster eligible counties has been passed in the Senate.  Growers in non-eligible disaster counties would receive the additional payment only if they can demonstrate a 35% yield loss.

3.  The House has introduced traditional disaster aid payments that would only pay individual growers who can demonstrate at least a 35% yield loss.

4.  A disaster aid payment based on an indemnity bonus payment would target payments to individuals with yield loss and who purchase crop insurance. 

5.  An increased crop insurance coverage level that would fund the marginal increased crop insurance as an ad hoc disaster program. 

6.  The companion disaster aid program that was introduced by Congressman Graves (R-MO) would target payments towards the deductible in the insurance contract.

7.  A technical correction on the farm bill that would place a second trigger on the counter cyclical payment so that growers could collect the counter cyclical payment due to either low yields or low prices.

8.  A “free” market policy.

9.  Other alternatives.

This paper will look at an example case problem to demonstrate how each of these policies might work at the farm level.  The analysis will demonstrate under what conditions farmers would collect these various forms of ad hoc disaster aid.  In addition, some of these policies have been introduced into legislation while others have not been considered by Congress.  Alternatives that have not been introduced as legislation would need Office of Management and Budget (OMB) budget scoring.

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 TDA program payments were targeted to the low yields.  A bill has been introduced into the House that is modeled after the 1998 TDA program.  Congress will have to pass a disaster aid law and the President will need to sign it before farmers will be paid disaster payments.  Growers under a TDA program were paid 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% TDA program any yield below 86.7 bushels would trigger TDA payments.

The best outcome for an insured grower with a TDA program is no yield.  The example grower with a zero yield would receive government payments of $141.20 and net CRC/RA-HPO indemnity payment of $242.53 for combined revenue of $383.73 (table 3, line 30).  The grower exceeded the expected revenue by $65.91 (table 3, line 32).  The revenue would actually exceed the revenue from a normal crop and forego the harvest expenses.  The uninsured grower would suffer the largest loss with a zero yield because of no insurance payment (table 3, line 32). 

Senate bill provides payments to growers with a 35% yield loss.  Because of the current crop losses the Senate passed a disaster aid program as a part of an appropriation bill.  The Senate Bill would pay 42% of the direct payment.  The example grower would receive an additional government direct payment of $12.28 (table 4, line 16).  The additional direct payment, other government payments, crop sales and net CRC/RA-HPO indemnity payment of $24.18 generates combined revenue of $270.37 with a 35% percent yield loss (table 4, line 30).  The CRC/RA-HPO insured grower has a $47.45 loss below expected revenue (table 4, line 32).

The Senate plan would provide payments to growers with a 35% yield loss while TDA would make no payments.  However, this approach has been criticized because it would also make payments to growers that had no crop losses if they are located in a disaster approved county.  Growers located in a non-disaster approved county would need to demonstrate a 35% yield loss.

An indemnity payment bonus.  It has been suggested that a bonus indemnity payment be paid to the growers suffering natural disasters, in lieu of traditional disaster aid payments.  Under this approach growers would be paid a percentage of their indemnity payment as an ad hoc disaster aid payment.  In the analysis a bonus payment of 20% was assumed but clearly this number is an arbitrary number and would be subject to political and budget considerations.

Under this approach, uninsured growers would receive no disaster aid payments.  CAT contracts or insurance contracts with insurance deductibles larger than 35% would receive no disaster aid payments assuming a 35% yield loss as presented in table 5.  Growers, in the example farm, with a 35% yield loss a 20% indemnity bonus payment would generate a $6.73 bonus indemnity payment for CRC/RA-HPO (table 5, line 16). 

This approach would target payments to those that suffered crop losses and who purchase crop insurance.  However, it provides little protection for yield losses that occur in the first 35% of loss for most growers simply because coverage levels purchased have been primarily at 70 and 75 percent. 

An increased crop insurance coverage level.  Another proposal has been to increase all insured’s current crop insurance coverage by simply increasing the coverage level.  For example, one could add 10 points of coverage to the crop insurance coverage purchased by growers.  This would effectively increase a CRC contract from 75% coverage, in the example, on table 6, to 85% coverage.  However, because the payment is an ad hoc disaster aid payment the grower will pay no premium for the increased coverage from 75 to 85 percent.

In the example, with a 35% yield loss, this policy would provide ad hoc disaster aid to the growers who purchased crop insurance coverage and would target the payment towards the deductible part of the insurance contract purchased.  In the case example, in table 6, line 16, this policy would pay an ad hoc disaster payment based on a 10% increase in crop insurance coverage from zero with CAT to a high of $11.49 with CRC/RA-HPO coverage.  The uninsured grower would receive no payments under this program.  In addition, there maybe insured growers that would still not trigger indemnity payments even with the higher 10% coverage level. 

Companion Disaster Assistance Program (CDAP).  An alternative is to follow the design of a private companion hail policy that targets payments to cover the deductible in the federally reinsured crop insurance contract that is not insurable for non-hail risk.  A CDAP policy was introduced by Graves (R-MO) would target aid to the first 53% of yield loss and not to the total loss that could have been insured.

This alternative disaster policy would trigger payments once yield losses exceed 20%.[2]  

The grower would suffer a larger loss before CDAP would start to pay if the deductible were increased from 20%.  With larger yield losses the higher deductible CDAP would pay the same as the 20% deductible because of the level 3 payment factor.  The grower is trading a smaller CDAP payment for a larger TDA payment to collect payments on smaller yield losses, i.e. a lower deductible; 20% versus 35%.  CDAP targets the payments to the insurance deductible that is less insurable.

Growers with a 133.3 bushels historical yield would trigger payments once yields fall below 106.6 bushels under a 20% CDAP program (table 7, line 6).  For example, on line 8 of table 7, the grower has lost 35% of the crop and would trigger a payment.

The CDAP maximum payment was set at 40% ($45.06, table 7, line 7,) of the TDA maximum payment ($112.64, table 3, line 7,).  The CDAP program with a 100% yield loss will pay 60% less than the TDA but will pay higher payments for smaller losses than TDA.

The companion 3 level generates a payment rate (% yield loss less 20% X companion level 3) times the maximum payment to generate a CDAP payment of $20.27 (table 7, line 11).[3]  Defining the maximum CDAP payment as a function of the TDA maximum payment will allow the CDAP program to apply to non-program crops in addition to corn and other program crops.  In addition the grower would also collect $28.56 in direct payments for a total of $48.83 in government payments. 

If the grower had CRC/RA-HPO with a 35% yield loss, the net loss in revenue is approximately $39.45 (table 7, line 32).  Most growers will still generate revenue below expected revenue for combined CDAP and net crop insurance payments.  This may, or may not be a profitable revenue for the grower, it will depend on individual farm costs.

If this same grower had bought CRC/RA-HPO combined with TDA payments the grower would have had a larger net loss of $59.73 under the expected revenue.  While the grower does not reach his/her expected revenue, his/her revenue loss is less with a CDAP payment than a TDA payment.  Because it requires a smaller yield loss to trigger payment under a CDAP program there would be more growers with claims then would be the case under a TDA program. 

The companion 3 level could also be set at companion 2.0 or 4.0 level.  The companion level must be set at level 2 or greater but less than 4.  If the companion level were set at a lower value then it would require more than a 53% yield loss to collect the full coverage (table 8, line 11).  Yield losses of 53% of historical yield or less will generate higher CDAP payments than TDA.  The net revenue was -$11.01 for the CRC/RA-HPO insured growers (table 8, line 32).

Both the insured and uninsured grower with a zero yield would clearly prefer TDA.  Yield losses would need to exceed 53% of historical yield before TDA pays more than CDAP.  The CRC/RA-HPO insured grower would exceed expected revenue with a zero yield (table 3, line 32).

Some of the past disaster programs have capped the combined crop insurance indemnity and disaster payments to the “expected value” of the crop.  If policy makers were to reduce TDA payments for insured growers that exceeded the “expected value” of the crop, the result would be fewer growers buying crop insurance in the future. 

Zero/92 program.  A Zero/92 program is similar to CDAP that is modeled after the private companion hail policy and targets disaster aid to the insurance deductible.  A Zero/92 policy would target aid to the first 41.3% of yield loss and not to the loss that could have been insured.  It is a second payment trigger on the counter cyclical payment.  Growers with yield losses that are greater than 41.3% would have collected all of the counter cyclical payment.  This alternative disaster policy would trigger payments once yield losses exceed 8%.[4]

The grower would suffer a larger loss before Zero/92 would start to pay if the deductible were increased from 8%.  The grower is trading a smaller Zero/92 payment for a larger TDA payment to collect payments on the first bushels lost, i.e. a lower deductible; 8% versus 35%.  Zero/92 targets the payments to the insurance deductible that is not insured.

Zero/92 pays when the example farm’s yields are below 92% of the 133.3 bushels or 122.6 bushels (table 9, line 6).  Yields below 122.6 would trigger a payment based on the percent crop loss.

The Zero/92 maximum payment was set equal to the maximum counter cyclical payment ($38.52, table 9, line 7).  The CDAP program with a 100% yield loss will pay 66% less than the traditional disaster aid program (TDA).  The companion 3 level generates a payment rate (% yield loss less 8% X companion level 3) times the maximum payment to generate a Zero/92 payment of $31.20 (table 9, line 11).[5]  Defining the maximum Zero/92 payment as the maximum counter cyclical payment will apply to program crops only.  However, in many years Zero/92 would require no additional budget to fund payments because all growers would have received the counter cyclical payment caused by lower prices.  Only in years with higher prices would a second Zero/92 yield trigger counter cyclical payments and increase budget costs. 

The payment 3 level could also be set at 2.0 or level 4.0.  The payment level must be set at level 2 or greater.  If the payment level were set at lower values then it would require more than a 41% yield loss to collect the full coverage. 

Conclusions.  Growers with yield losses greater than 50% will prefer traditional disaster aid.  Growers in disaster eligible counties and no yield loss will prefer an additional direct payment as proposed by the Senate.  Growers who purchased high levels of crop insurance will prefer the bonus indemnity payment and/or an increased crop insurance coverage level.  Growers with yield losses of less than 50% will prefer the CDAP or Zero/92 policy approach.

Other alternatives include the status quo where growers would receive no additional disaster aid beyond subsidized crop insurance and livestock disaster aid.

The “free market” approach is another alternative.  Economists often argue government payments (disaster aid, subsidized crop insurance, FSA commodity payments, etc.) are bid into land values and cash rents.  Without government payments rents and land values would likely be lower and growers would continue to plant crops.  This approach was an argument for the 1995 Farm Bill, but many analyst have concluded it is a politically unacceptable alternative.

There maybe other alternative disaster designs that were not included in this paper.  However, policy makers will have to decide if they should provide any disaster aid on insurable crops.  Then if disaster aid is the choice, how will those payments be targeted?  How will disaster payments affect the future of crop insurance?