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Safety Net “Hole” Caused by Multiple Year and “Shallow” Crop Losses[1]

Introduction

In his remarks on May 7, 2004 to the RMA pre-proposal conference on “Alternative Methods for Mitigating Declines in Approved Yields after Successive Years of Low Yields,” U.S. Rep. Jerry Moran (R-KS) stated that his goal was not to expose shortfalls in the crop insurance program, but rather to encourage the development of another tool that could be added to the already-effective risk management safety net for America’s farmers.[2]  Congressman Moran further indicated that his top agricultural priority is a tool that addresses the impact of multi-year crop yield declines on crop insurance guarantees (the declining APH problem).  Development of a risk management tool or crop insurance product that addresses multi-year crop yield declines is a potential long-term solution to this problem. 

Multiple years of crop failures undermine the very stability of American agriculture and the economic assumptions on which farmers base their decisions.  APH-based crop insurance works extremely well for a total loss or a normal crop, but it provides less protection for multiple year crop losses or consecutive years of “shallow” losses.[3]  Multiple years of crop failures result in a declining actual production history (APH) that reduces future guarantees and increases premium rates.  Multiple years of shallow crop losses also cause large financial losses because of “large” deductibles in APH products.

For several years, Kansas and Great Plains farmers have suffered from a prolonged shortage of rainfall.  This drought has led to a corresponding decline in APHs, which affects crop insurance coverage levels.  Figure 1 shows the 10-year moving average corn yield for four geographical regions in Kansas (northwest (NW), west central (WC), south central (SC), and northeast (NE)).  The 10-year averages in the western regions, where drought conditions have persisted, have been steadily declining since 1999.  On the other hand, the 10-year averages in the central and eastern Kansas regions have been steady or increasing throughout this time period, as would be expected with technological advancement.  While the data shown in Figure 1 are aggregate data as opposed to farm-level data, it clearly indicates the impact multiple years of losses can have on future crop insurance coverage and hence the ability to manage risk.  Thus, this multiple year loss concern is not a trivial issue — it has serious implications for producers’ ability to manage future risk.  Subcommittee hearings across the country confirmed the most common theme:  a call to fix the problems associated with multiple years of crop losses.  Thus, the issue of multiple year losses is a high priority in many states besides Kansas.

Figure 1.  Ten-Year Average Corn Yields in Kansas

Effects of Catastrophic and Shallow Yield Losses on Revenue and APH

An example corn farm is depicted in Table 1 to illustrate the effects of catastrophic yield losses on the APH and the returns from crop insurance and crop sales with three different insurance policies.  It is assumed the long run expected average yield is 133.3 bushels per acre, the farmer suffered a total crop loss in year 1, and normal yields occurred in years 2 and 3.  The APH does decline in this scenario, but the decline is limited under current underwriting rules. 

While there was a loss in year 1, the net return for the 3-year period was positive.  The variable harvest expenses were zero because yield was zero causing the net return in year 1 to be nearly positive.  Given that the APH is based on a very short data set (10 years or less), a few poor crops will generate an APH that is not representative of the long run expected average yield.  While the APH declined in this example farm, under current underwriting rules the reduction in the APH is limited because the zero yield can be replaced with 60% of the “T” yield.  Under this scenario, the APH declined from 133.3 to 128.3 bushels starting in the fourth year. 

Growers with a total loss are better off financially if the market price also declines.  For example, Table 2 shows similar information as was shown in Table 1 only it was assumed the market price declined from $2.50 to $1.95.  In year 1 there is no production to sell at the lower price but the low price causes the maximum counter cyclical payment that is tied to the FSA “historical” program yield and not to current production.  As a result, the lower price will increase the FSA payment and generate a positive return with no yield.

In recent years USDA has provided additional financial assistance to farmers through disaster aid, but for only one out of two years.  In this example that would provide adequate coverage because the grower would have received the maximum disaster payment for the one crop failure followed by two normal crops.  This is the type of loss the current crop insurance program and disaster aid cover quite well.  However, if this same farmer suffered 3 years of shallow losses, 75% coverage level crop insurance would make only small net indemnity payments and ad hoc disaster assistance would provide no help because of the 35% yield deductible built into disaster assistance programs.

Table 3 illustrates the effects of shallow yield losses on the APH and the returns from crop insurance and crop sales for the same insurance policies examined in Table 1.  If this farm suffers a 31.2 percent yield loss in all three years, the net returns on line 25 are all negative.  The total yield for the 3 years is 266.6 bushels under both scenarios (Tables 1 and 3, line 27).  However, the 3-year total net income declines from a positive return of $41.93 to $39.18 per acre to negative returns ranging from $147.78 to $150.56 per acre (Tables 1 and 3, line 26).  The negative impact on the APH is also greater when consecutive shallow losses occur.  The example shallow loss scenario results in the per acre APH declining from 133.3 bushels to 121.2 bushels in the fourth year versus 128.3 bushels for single total crop failure (Tables 1 and 3, line 28). 

Farmers suffering crop losses have the option of applying the plug rule, which replaces a poor yield with 60% of the county transitional yield (T yield).  The example farm assumes a county T yield of 120 bushels per acre.  Replacing the total crop loss scenario in Table 1 with the yield plug limits the reduction in the APH, while the T yield plug has no effect on APH in the multiple year shallow loss scenario presented in Table 3.

Financially, corn growers with three years of shallow losses are worse off than growers with one total crop failure because they must cover harvest expenses in all three years, net crop insurance payments are “small,” and ad hoc disaster assistance provides no help under this yield scenario.  The total bushels of production generated under all three scenarios was 266.6 bushels.  While the total production was the same, clearly how those yields were distributed over the three years has a major impact on financial results.   Note that in this analysis crop price did not change from planting to harvest (Tables 1 and 3).  The worst outcome for the shallow loss scenario occurs when crop price increases because that eliminates the FSA counter-cyclical payment.  The losses are even greater if the farmer purchases APH crop insurance or revenue insurance without the harvest price option.

Table 1.  An example corn farm with a crop failure in year 1 followed by two years of normal crop yields.

Table 2.  An example corn farm with a crop failure in year 1 followed by two years of normal crop yields and market price declines to the loan.

Table 3.  An example corn farm with 3 years of “shallow” crop losses and no price change.