Proposed means testing for eligibility to purchase crop insurance[1]

Introduction. There are at least two amendments being offered in the Senate that will create a means test for eligibility to purchase crop insurance. One proposal is a maximum limit of $750,000 Adjusted Gross Income (AGI) to be eligible for crop insurance purchase. While this AGI limit would affect �few� farmers, it is unlikely to stop at $750,000. In the 2008 Farm Bill debate there was a House amendment to limit AGI to $250,000 for crop insurance eligibility. Therefore, even farmers under the $750,000 limit should be concerned because the AGI limit will likely be lowered in the future, if an AGI limit were established. If the AGI limit becomes law, it would be the first government backed insurance program with a means test.

A $250,000 AGI limit will eliminate eligibility for crop insurance purchase on about the same number of farmers as the previously proposed $40,000 premium subsidy limit. A $250,000 AGI limit has greater impact on corn while the previously proposed $40,000 premium subsidy limit would have a greater impact on wheat. The crop insurance program only became actuarially sound after 1995 when participation started to increase, especially with the introduction of Crop Revenue Coverage in 1996 (renamed Revenue Protection). Because these are the larger farms, the insurance premium pool will shrink by more than the reduction in the number of farmers insured. This could once again cause chronic underwriting losses that were referred to as �unintended subsidies�.

Crop insurance is not a traditional entitlement program. Farmers in some cases have paid in premiums for years, but have collect no indemnity payments. Their only benefit is they paid lower premium costs, but it is a negative cash flow for that farmer. By contrast farmers pay nothing for the Farm Service Agency (FSA) commodity programs and receive payments directly, i.e. a positive cash flow.

How would an AGI Limit Work? The analysis assumes the FSA commodity program AGI limit of $750,000 would be administered the same for crop insurance purchase eligibility. However, one could justify a higher AGI limit for crop insurance because on average farmers pay 40% of the cost for crop insurance and nothing for FSA commodity program benefits.

FSA applies the AGI limit to the individual tax return and also to corporations and other entities. The corporation or partnership must be under the $750,000 limit and so must the individual stock holders. If any stock holder is over the $750,000 AGI limit, then the FSA prorates payments to the corporation. If it were to apply to crop insurance one would assume the agent and insurance company would need to prorate the premium and any indemnity payments.

Under current FSA rules (it could be different for crop insurance), a husband and wife filling a joint return could each have a $750,000 limit for a total of $1.5 million for the family, if a CPA will file the paper work stating that both the husband and wife would be under the $750,000 limit had they filed separate returns. This is necessary otherwise two unrelated people farming and living together would each qualify for a $750,000 limit or $1.5 million for the two people. Otherwise it would pay to get a divorce and live together so that each person has a $750,000 limit.

Farmers would shift sales and expenses to keep the AGI under any limit. Most farmers already do these things to avoid taxes at a higher marginal rate. One possible way for larger farmers to avoid an AGI limit is to use a C corporation and the farmer becomes a crop share landlord to the C corporation. The C corporation receives farm payments (and one would assume crop insurance purchase eligibility) as long as the AGI is below $750,000 in the C corporation. The CPA accountant can keep that AGI low by paying out rents and other items to the farmer from the C corporation. A very successful western Kansas CPA with many farm clients suggested many of his current S corporations would change to C corporations, if the AGI limit were applied to crop insurance. Apparently there are ways to avoid the double taxing from the C corporation, but a complicating factor is Kansas eliminated state income tax for small business, but this may not apply to a C corporation. Another way to avoid the AGI limit is to increase the number of �farms� by adding partners (son or daughter) but this is complicated and famers should spend the money for the legal and accounting expertise to make this work.

Required Acres to Hit the AGI Limit. The estimated acres to hit a $750,000 AGI limit for Michigan, Kansas, Oklahoma, Nebraska, Minnesota, and Iowa are presented in tables 1, 2, 3, 4, and 5. These results are based on the following assumptions:

1. The APH is the long run average yield.

2. The crop insurance price is equal to the selling price; with a negative basis this overstates the estimated gross revenue.

3. The coverage level does not impact the expected gross revenue, as it does the crop insurance subsidy, therefore based on the APH the average number of acres to hit the AGI limit is likely the best estimate.

4. Assumes expenses equal the long run average expense ratio equal to 80% of the gross revenue.

5. Assumes the farmers did not use strategies to limit income below $750,000, as discussed above. Clearly farmers will work to avoid the limit and is the reason any budget savings will likely be less than the forecast.

Effectively the estimated acres are the maximum before the farmer needs to create strategies to avoid the AGI limit. Michigan corn farmers would need about 4,564 acres or 6,968 acres of soybeans to hit the $750,000 AGI limit. These are the maximum acres for single crop farmer. Most farmers plant more than one crop. For example, if this Michigan farmer planted both soybeans and corn, then it would reduce the maximum number of acres for each crop planted because they are combined in the AGI calculation.

It would require about 13,437 acres of Kansas wheat and 16,499 acres of Oklahoma wheat to hit the $750,000 AGI limit. Nebraska corn, 3,994 acres; soybeans 5,683 acres; wheat 12,742 acres: Minnesota corn, 4,129 acres; soybeans 7,324 acres; wheat 7,928 acres: Iowa corn, 3,708 acres; soybeans 5,684 acres: would be required to hit a $750,000 AGI limit. The crop insurance data is not separated for irrigation, so the combined Nebraska corn values overstate the number of irrigated corn acres needed to hit the $750,000 AGI limit.

Because there is also an amendment to limit the AGI to $250,000, the estimated acres needed to hit a $250,000 AGI was also completed and reported in tables 6, 7, 8, 9, and 10. Michigan corn 1,521 acres, soybeans 2,323 acres: Kansas wheat 4,479 acres: Oklahoma wheat 5,500 acres: Nebraska corn, 1,331 (combined irrigated and non-irrigated) acres; soybeans 1,894 acres; wheat 4,247 acres: Minnesota corn, 1,331 acres; soybeans 1,894 acres; wheat 4,247 acres: Iowa corn, 1,236 acres; soybeans 1,895 acres: would be required to hit a $250,000 AGI limit.

Note the range of acres needed to hit a $40,000 premium subsidy limit depends on the coverage level. For example, Iowa corn requires acres between 5,794 and 1,076 to hit the $40,000 premium subsidy limit vs. 1,236 acres to hit the $250,000 AGI limit (table 10). For Iowa corn a $250,000 AGI limit is more restrictive in most cases than the previously proposed $40,000 premium subsidy limit. The reverse was true for wheat. It would have taken more than double the acres to hit the $250K AGI limit vs. the $40,000 premium subsidy limit. For example, Kansas wheat requires acres between 2,853 and 1,408 to hit the $40,000 premium subsidy limit vs. 4,479 acres to hit the $250,000 AGI limit (table 7).

Consequences of an AGI limit for crop insurance purchase eligibility:

1. Crop insurance is not an entitlement that makes payments to individuals, in this case farmers. Farmers can pay premium for years, but collect nothing from crop insurance, i.e. a negative cash flow. This is a current complaint from corn farmers who think their premium rates are too high.

2. Once a means test is in place there is no reason to believe the limit will increase, but lots of reasons to believe a future Congress will reduce the limit. There was a 2008 House amendment offered that would have put a $250,000 limit on the AGI for crop insurance purchase eligibility.

3. Crop insurance would be the only current government backed insurance program that has a means test. Currently there is no means test for home owners flood insurance or Medicare.

4. Large fruit, vegetable and non-program crop producers would need to manage their AGI to keep it under the limit for the first time. Many of these farmers have no experience working with FSA program limits, but they have purchased crop insurance.

5. Because crop insurance is a major risk tool for lenders, a market down turn or a major crop failure could have a major impact on Farm Credit and Ag lenders making these large ag loans without crop insurance. Would Congress stand by or would they provide ad hoc disaster aid and even aid to the ag lenders? In the 1980�s Congress did provide help to Farm Credit and provided FmHA loan guarantees on farm loans so Ag lenders could survive.

6. If the AGI limit were to eliminate large farmers from the insurance pool, that would also reduce the premium paid in to the pool and may impact the actuarial soundless of crop insurance. Crop insurance only achieved actuarial soundness after large participation was achieved. If the pool shrinks one could end up with an unsound program. Prior to 1995 it was common with a small insurance pool for the indemnity payments to exceed the premiums, and was referred to as the �unintended subsidy�. This issue would become very large if the AGI limit were further reduced to $250,000 that was offered as a House amendment in the 2008 Farm Bill debate.

7. Changing from an S corporation to a C corporation would allow farmers to limit the impact of an AGI limit on eligibility for crop insurance purchase, but require additional administrative and accounting costs.

8. A spouse could file a separate tax return and double the limit to $1.5 million or a joint filer can achieve the same ends by having their CPA certify that both parties would have AGIs below $750,000.

9. Shifting sales and expenses between years can help to avoid any AGI limit.

10. Keeping AGI below $750,000 limits Federal income taxes paid and in some cases state income taxes paid.

11. The current FSA limit also includes a second non-farm $500,000 AGI limit that adds to the complexity. If these are landlords over the $500,000 AGI non-farm limit, they will simply change to cash rent. This would shift more risk to farmers and that increases the need for crop insurance to cover the additional risk.

12. If any stock holder in a C corporation has an adjusted AGI over $750,000 (or non-farm AGI over $500,000) then FSA prorates the payments. One would assume premium and indemnity payments would also need to be prorated.

13. Adds administrative cost for farmers, crop insurance agents and insurance companies to tract entities and collecting full premium when a famer is over the AGI limit.

14. Adds FSA administrative costs assuming they determine eligibility for farmers under the limit because they will now have to certify the non-program crop producers.

Administration�s Plan. During a telephone radio interview, I was asked about the administration�s proposal to limit subsidy to 50% of the premium, but no other limits (this was news to me, may be the reader has more information). If this debate were about budget savings, then Congress would accept the Administration plan to cap the percent subsidy at 50%, but no means testing or other limits. Because farmers currently pay about 40% of the premium, this on average would increase farmer paid premiums because they would now pay at least 50% of the premium cost. CAT �buyers� would have to pay 50% of their premium, 85% insured farmers would see no change in farmer paid premiums, and the amount of farmer paid premium increases would vary by coverage level. Those free CAT contracts in Florida and California can provide over a million dollars of coverage as was recently documented on AgManger.info. The farmer paid share of the premium would increase by 5-10% for most farmers at the buyup coverage levels currently being purchased. This policy issue is clearly about more than saving money or even farmers.

A 50% premium subsidy cap would save real money because it is an across the board cut in subsidy that cannot be avoided. Assuming farmers did not reduce coverage as a result of higher farmer paid premiums, the savings would be over $1.3 billion annually or more because some farmers would reduce their coverage. Many of the CAT buyers who receive �free� coverage would be the most likely to drop their coverage. By contrast, the AGI limit would save very little budget because farmers would work to avoid the limit, therefore even very �large� farmers may still be able to buy crop insurance.

This 50% cap on percent subsidy is more economically efficient than a means test because this policy creates no new incentive to change type of entity, change leases, shifting income, no added administrative cost, etc. Farmers will not like paying a higher share of their premiums, but if this were the choice vs. means testing then many farmers would prefer the cap on the maximum subsidy rate, even if the current means test does not affect them. Many farmers would assume once a means test is policy it is more likely that the limit will be reduced in the future and they too will be eliminated from the crop insurance program.

Summary. The AGI creates �large� public and private administrative costs to avoid an AGI limit. It is a dead weight loss on the agricultural industry because there would be no incentives to alter an organization or change management without this policy change. If farmers are eliminated from the program, then likely ad hoc disaster aid will once again be proposed and perhaps help for ag lenders. The reduction of farms in the pool may also affect actuarial results. Crop insurance would become the first government backed insurance program with a means test.

Table 1. Michigan Corn and Soybean acres needed to reach $750,000 AGI vs. acres to reach a $40,000 Revenue Protection (RP) crop insurance subsidy limit, assuming state average coverage, average rates by coverage level*

Table 2. Kansas and Oklahoma Wheat acres needed to reach $750,000 AGI vs. acres to reach a $40,000 Revenue Protection (RP) crop insurance subsidy limit, assuming state average coverage, average rates by coverage level*

Table 3. Nebraska Corn, Soybean and Wheat acres needed to reach $750,000 AGI vs. acres to reach a $40,000 Revenue Protection (RP) crop insurance subsidy limit, assuming state average coverage, average rates by coverage level*

Table 4. Minnesota Corn, Soybean and Wheat acres needed to reach $750,000 AGI vs. acres to reach a $40,000 Revenue Protection (RP) crop insurance subsidy limit, assuming state average coverage, average rates by coverage level*

Table 5. Iowa Corn and Soybean acres needed to reach $750,000 AGI vs. acres to reach a $40,000 Revenue Protection (RP) crop insurance subsidy limit, assuming state average coverage, average rates by coverage level*

Table 6. Michigan Corn and Soybean acres needed to reach $250,000 AGI vs. acres to reach a $40,000 Revenue Protection (RP) crop insurance subsidy limit, assuming state average coverage, average rates by coverage level*

Table 7. Kansas and Oklahoma Wheat acres needed to reach $250,000 AGI vs. acres to reach a $40,000 Revenue Protection (RP) crop insurance subsidy limit, assuming state average coverage, average rates by coverage level*

Table 8. Nebraska Corn, Soybean and Wheat acres needed to reach $250,000 AGI vs. acres to reach a $40,000 Revenue Protection (RP) crop insurance subsidy limit, assuming state average coverage, average rates by coverage level*

Table 9. Minnesota Corn, Soybean and Wheat acres needed to reach $250,000 AGI vs. acres to reach a $40,000 Revenue Protection (RP) crop insurance subsidy limit, assuming state average coverage, average rates by coverage level*

Table 10. Iowa Corn and Soybean acres needed to reach $250,000 AGI vs. acres to reach a $40,000 Revenue Protection (RP) crop insurance subsidy limit, assuming state average coverage, average rates by coverage level*

[1]Prepared by G. A. (Art) Barnaby, Jr., Professor, Department of Agricultural Economics, K-State Research and Extension, Kansas State University, Manhattan, KS 66506, June 8, 2012, Phone 785-532-1515, e-mail � barnaby@ksu.edu.